D.R. Horton, Inc. — Form 10-Q Summary
Business context and period: National homebuilder operating in 26 states and 71 markets, with mortgage and title services. This filing covers the fiscal third quarter and nine months ended June 30, 2011; comparisons are with the corresponding 2010 periods. Unaudited interim results may be affected by seasonality.
Financial performance and position
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Consolidated revenue | $999.2 million, down 29% from $1,406.1 million | $2,538.5 million, down 26% from $3,451.7 million |
| Net income | $28.7 million, versus $50.5 million | $36.0 million, versus $253.9 million |
| Diluted EPS | $0.09, versus $0.16 | $0.11, versus $0.78 |
| Homebuilding pretax income (loss) | $22.2 million, versus $37.4 million | $(34.4) million, versus $84.6 million |
| Financial services pretax income | $6.7 million, versus $8.9 million | $12.6 million, versus $16.6 million |
- Homebuilding: Home sales revenue was $974.5 million, down 29%, in the quarter and $2,468.6 million, down 27%, year to date. Closings fell 33% to 4,555 in the quarter and 29% to 11,708 year to date; average selling prices rose 6% to $213,900 and 3% to $210,800, respectively.
- Margins: Home sales gross margin was 16.5% for the quarter (down 70 basis points) and 16.2% year to date (down 120 basis points). Total homebuilding gross margin was 15.5% and 14.8%, respectively. Homebuilding SG&A was 11.7% of revenue for the quarter and 14.4% year to date, higher by 130 and 250 basis points. Management attributed margin pressure principally to pricing incentives and discounts; lower revenue also increased SG&A as a share of sales.
- Orders and backlog: Quarterly net orders decreased 1% to 4,874 homes, while order value rose 4% to $1.067 billion. Nine-month net orders declined 14% to 13,180. June 30 backlog was 5,600 homes valued at $1.182 billion, up 26% in units and 24% in value year over year. Cancellation rates were 27% for both the quarter and nine-month period, versus 28% and 24% in 2010.
- Cash flow: Nine-month operating cash flow was negative $75.3 million, compared with positive $587.1 million in 2010. Investing used $14.5 million and financing used $378.5 million. Cash and cash equivalents declined $468.3 million from the fiscal-year opening balance to $841.0 million at June 30. Management attributed operating cash use mainly to inventory growth and noted the prior-year period benefited from tax refunds and earnings. MD&A also reports quarterly operating cash use of $54.2 million, versus $159.3 million provided a year earlier.
- Liquidity and debt: Homebuilding cash was $824.2 million and marketable securities were $297.1 million, totaling approximately $1.12 billion, versus $1.58 billion at September 30, 2010. Homebuilding notes payable were $1.764 billion, down from $2.085 billion; the financial-services mortgage repurchase obligation was $116.3 million. Net homebuilding debt to total capital was 19.9%, versus 16.1% at September 30, 2010; gross debt to total capital was 40.5%. The company reported compliance with its public debt restrictions and mortgage-facility covenants.
- Balance sheet: Total assets were $5.505 billion, down from $5.939 billion at September 30, 2010; total liabilities were $2.911 billion and total equity was $2.594 billion. Inventories were $3.501 billion. The mortgage repurchase facility had $150 million temporary capacity through October 20, 2011, then reverting to $100 million, and matures March 4, 2012.
Material changes and unusual items
- Quarterly homebuilding revenue and closings contracted sharply compared with 2010, when the federal homebuyer tax credit supported demand. Management said quarterly orders were broadly stable against both the preceding and prior-year quarters, but demand remained low.
- Year-to-date net income included a $57.8 million income tax benefit. A favorable IRS ruling on inventory-cost capitalization reduced unrecognized tax benefits and related interest by $59.2 million. By contrast, 2010 year-to-date results included a $152.7 million tax benefit, primarily from net operating loss carrybacks. Deferred tax assets of $849.0 million remained fully offset by a valuation allowance.
- Inventory impairment charges were $7.8 million in the quarter and $27.2 million year to date; land-option deposit and pre-acquisition cost write-offs were $2.1 million and $5.4 million, respectively. Combined impairment and write-off expense was $9.9 million for the quarter, versus $30.3 million in 2010. Management cautioned further charges could result if market or community-level assumptions worsen.
- The company retired $312.2 million principal amount of notes during the nine months, with a $10.7 million net early-retirement loss. It repurchased $38.6 million of its shares in the quarter. On August 1, 2011, the board authorized new repurchase programs of up to $500 million of debt and $100 million of stock, each effective through July 31, 2012.
- Construction-defect and other litigation liabilities were $523.2 million, with related insurance receivables of $214.2 million. Management said it could not reasonably estimate losses above recorded reserves and that additional charges could be significant. Chinese drywall matters included a $1.5 million remaining repair liability and several lawsuits; possible recoveries were not recorded.
Outlook, commentary and risks
Management expected fiscal 2011 home sales, closings and pretax income to be below fiscal 2010, but expected closings and pretax income in the second half of fiscal 2011 to exceed the first half. It described housing demand as weak and the timing of a sustainable recovery as uncertain, while stating that liquidity and a reduced debt burden provided flexibility. The company planned to limit undeveloped-land spending, use selected finished-lot options, manage unsold-home inventory, adjust pricing and incentives, and control costs. It expected lower operating cash generation in fiscal 2011 than in each of the prior four fiscal years.
Key risks identified include prolonged economic and housing weakness, unemployment and low consumer confidence, foreclosures and competing resale inventory, restricted mortgage availability or higher rates, commodity inflation, inventory valuation changes, land and construction costs, warranty and construction-defect claims, mortgage repurchase and reinsurance exposure, debt and refinancing needs, and uncertainty over realization of deferred tax assets. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the higher order backlog converts to closings, given 27% cancellation rates and mortgage-approval contingencies.
- Whether home sales margins, sales incentives and SG&A ratios stabilize as closings and demand remain weak.
- Cash generation, inventory growth, liquidity levels and upcoming debt and mortgage-facility capacity or maturity needs.
- Potential further inventory impairments, particularly in communities with impairment indicators and under changing pricing, absorption and cost assumptions.
- Adequacy of construction-defect, litigation, warranty, mortgage-repurchase and reinsurance reserves, including recoverability of related insurance receivables.
- Tax developments: the valuation allowance, ongoing IRS and state audits, and possible realization of deferred tax assets and tax refunds.