Business Context and Reporting Period
Company: D.R. Horton, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2006
Business Overview: D.R. Horton is the largest homebuilder in the United States by homes closed, operating in 85 markets across 27 states. The company constructs and sells single-family and attached homes and provides mortgage banking and title agency services through its financial services segment.
Key Financial Metrics
| Metric (in millions) | Q1 2007 (Ended Dec 31, 2006) | Q1 2006 (Ended Dec 31, 2005) |
|---|---|---|
| Total Revenues | $2,868.0 | $2,903.1 |
| Net Income | $109.7 | $310.1 |
| Diluted EPS | $0.35 | $0.98 |
| Operating Cash Flow | $295.5 | ($1,012.6) |
| Homebuilding Gross Margin | 15.8% | 28.3% |
| Home Sales Gross Margin | 18.6% | 27.8% |
| Total Assets | $13,668.7 | $14,820.7 |
| Notes Payable (Total) | $5,148.9 | $6,078.6 |
| Cash and Cash Equivalents | $139.8 | $225.2 |
Material Changes vs. Prior Period
- Profitability Decline: Net income decreased 65% to $109.7 million, and diluted earnings per share fell 64% to $0.35. This was driven by a 45% drop in total homebuilding gross profit.
- Revenue Stability: Total homebuilding revenues remained relatively flat at $2.8 billion, despite a 23% decrease in net sales orders. Homes closed increased 3% to 10,202, but the average selling price decreased 4% to $270,600.
- Margin Compression: Home sales gross margins declined 920 basis points to 18.6% due to increased sales incentives and price concessions in a softening market.
- Impairment Charges: The company recorded $77.7 million in inventory impairments and land option cost write-offs, compared to only $3.7 million in the prior year. This included a $40.9 million impairment charge primarily in California and Colorado.
- Cash Flow Improvement: Operating cash flow turned positive at $295.5 million, a significant improvement from the $1.0 billion cash outflow in the prior year, largely due to reduced inventory investment.
- Backlog Reduction: Sales order backlog decreased 24% to $4.7 billion (16,694 homes) due to higher cancellation rates (33%) and lower sales volume.
Outlook, Risks, and Management Commentary
- Market Conditions: Management cites an industry-wide softening of demand, reduced consumer confidence, and increased competition from existing home inventory. The company expects these conditions to moderate over time but cannot predict the duration or severity.
- Strategic Response: The company is executing a strategy to decrease SG&A infrastructure, reduce land and lot inventory purchases, limit construction of unsold homes, and offer incentives to maximize cash flow.
- Liquidity and Debt: The company maintains a strong balance sheet with a net homebuilding debt to total capital ratio of 41.2%, within its target range of below 45%. It has $1.8 billion of borrowing capacity remaining on its $2.5 billion revolving credit facility.
- Dividends: The Board declared a quarterly cash dividend of $0.15 per share, an increase from $0.09 in the prior year period.
- Risks: Key risks include further market deterioration leading to additional inventory impairments, the ability to refinance debt, and the impact of interest rate fluctuations on mortgage financing availability.
Investor Verification Checklist
- Inventory Impairments: Verify the extent of potential future write-downs, as $653.3 million of projects with impairment indicators remain unevaluated for fair value adjustments.
- Cancellation Rates: Monitor the 33% cancellation rate, which is significantly above the historical 16-20% range, and its impact on future backlog conversion.
- Land Option Contracts: Review the $3.2 billion remaining purchase price on land options, noting that $38.8 million in deposits related to contracts the company does not expect to exercise have been written off.
- Debt Covenants: Confirm continued compliance with debt covenants, particularly the leverage and interest coverage ratios, given the decline in earnings.
- Regional Performance: Assess the divergence in regional performance, with the South Central region showing revenue growth while the Southwest and California regions faced significant margin compression and impairments.