Business Context and Reporting Period
Company: D.R. Horton, Inc. (D.R. Horton)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and nine months ended June 30, 2008
Business Overview: D.R. Horton is the largest homebuilder in the United States by homes closed, operating in 80 markets across 27 states. The company engages in the construction and sale of single-family and attached homes, as well as land sales. It also operates a financial services segment providing mortgage financing and title agency services. The reporting period reflects a severe downturn in the homebuilding industry characterized by high inventory, elevated cancellation rates, and tightening credit markets.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2008 |
Nine Months Ended June 30, 2008 |
Three Months Ended June 30, 2007 |
Nine Months Ended June 30, 2007 |
|---|---|---|---|---|
| Homebuilding Revenues | $1,433.3 million | $4,764.9 million | $2,548.1 million | $7,965.8 million |
| Financial Services Revenues | $30.9 million | $98.8 million | $50.0 million | $158.3 million |
| Consolidated Net Loss | $(399.3) million | $(1,833.8) million | $(823.8) million | $(662.3) million |
| Net Loss Per Share (Basic/Diluted) | $(1.26) | $(5.81) | $(2.62) | $(2.11) |
| Home Sales Gross Margin | 10.1% | 11.3% | 16.7% | 17.7% |
| Inventory Impairments & Write-offs | $330.4 million | $1,410.0 million | $852.0 million | $1,010.8 million |
| Cash and Cash Equivalents | $851.2 million | (Balance Sheet) | $60.8 million | (Balance Sheet) |
| Total Debt (Notes Payable) | $3,668.1 million | (Balance Sheet) | $4,376.8 million | (Balance Sheet) |
| Net Cash Provided by Operating Activities | N/A | $1,400.4 million | N/A | $547.2 million |
Material Changes Versus Prior Period
- Revenue Decline: Homebuilding revenues decreased 44% for the quarter and 40% for the nine-month period compared to the prior year, driven by a 36% drop in homes closed and a 10% decrease in average selling prices.
- Net Loss Volatility: While the quarterly net loss improved (decreased) from $823.8 million to $399.3 million due to significantly lower impairment charges in the current quarter compared to the prior year, the nine-month net loss widened to $1.8 billion from $662.3 million. This widening was primarily due to lower gross profits and a $883.0 million deferred tax valuation allowance recorded in the current year.
- Margin Compression: Home sales gross margins declined 660 basis points for the quarter and 640 basis points for the nine-month period, pressured by price reductions, sales incentives, and increased amortization of capitalized interest.
- Inventory Reduction: The company aggressively reduced inventory, with owned lots declining by 35,000 to 134,000 and homes in inventory declining by 11,700 to 15,400.
- Liquidity Improvement: Cash and cash equivalents increased significantly to $851.2 million from $60.8 million a year ago, bolstered by strong operating cash flows of $1.4 billion for the nine-month period.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
Management maintains a cautious outlook, expecting housing market conditions to remain challenging and potentially deteriorate further in the near term. The timing of a recovery remains unclear. The company is executing a strategy to reduce land and lot inventory, restrict development spending, and offer price incentives to maximize cash flow.
Unusual Items
- Deferred Tax Valuation Allowance: The company recorded a total valuation allowance of $883.0 million on deferred tax assets during the nine months ended June 30, 2008, due to a cumulative pre-tax loss position for fiscal years 2006 through 2008.
- Inventory Impairments: Significant impairment charges were recorded ($323.2 million in the quarter; $1,383.7 million for nine months) to reduce the carrying value of impaired communities to fair value, primarily in California, West, and Midwest regions.
- Goodwill Impairment: No goodwill impairment was recorded in the current period, compared to $425.6 million in the prior year period.
Risks and Contingencies
- Debt Covenants: The company's senior debt ratings were downgraded to below investment grade (Moody's Ba2, S&P BB, Fitch BB+), triggering borrowing base limitations on its revolving credit facility. Additional borrowing capacity is limited to $880 million.
- Legislative Impact: The "American Housing Rescue and Foreclosure Prevention Act of 2008" eliminates seller-funded down payment assistance on FHA loans effective October 1, 2008, which is expected to negatively impact future sales.
- Legal Proceedings: The company is involved in putative class actions alleging violations of the Real Estate Settlement Procedures Act and antitrust laws regarding mortgage financing practices. One case was dismissed with prejudice but is under appeal; another is in early stages.
Investor Verification Checklist
- Inventory Valuation: Verify the assumptions used in the fair value calculations for the $915.3 million of impaired communities and the $1.7 billion of communities with impairment indicators but not yet impaired.
- Deferred Tax Assets: Assess the likelihood of realizing the remaining $518.7 million in deferred tax assets, particularly the $153 million dependent on property dispositions before September 30, 2008.
- Debt Covenant Compliance: Monitor compliance with the borrowing base limitation and tangible net worth covenants, especially given the below-investment-grade credit ratings.
- Down Payment Assistance: Evaluate the potential impact of the elimination of seller-funded down payment assistance on sales volume in the South Central, Southwest, and Southeast regions.
- Cancellation Rates: Review the trend in sales order cancellation rates (39% for the quarter), which impacts the reliability of the sales order backlog as a predictor of future closings.