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HORTON D R INC /DE/ – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Results of Operations - Fiscal Year 2012 Overview
In fiscal 2012, demand for new homes improved in most of our operating markets, as evidenced by the number and value of our net sales orders increasing 21% and 29% compared to the prior year. Revenues from home sales increased 19% to$4.2 billion in fiscal 2012 compared to$3.5 billion in fiscal 2011. The average selling prices of our homes closed increased 5% and our gross margins on homes closed increased by 160 basis points in fiscal 2012 as compared to fiscal 2011. Pre-tax income was$242.9 million in the current year compared to$12.1 million in the prior year. Our sales order backlog of$1.7 billion atSeptember 30, 2012 is up 61% from a year ago, which positions us for a strong start in fiscal 2013. These results reflect our ability to operate profitably and grow in the current environment through our strategy of investing capital to expand and improve the profitability of our operations, managing inventory levels efficiently and controlling SG&A and interest costs. Our recent results and other national data indicate that the overall demand for new homes has improved from the prior year. However, both national new home sales and our company's home sales remain below historical levels due to the current weak U.S. economic conditions, the restrictive mortgage lending environment and variations in local housing market conditions. Until there is a more robust U.S. economic recovery, we expect national demand for new homes to remain at historically low levels, with uneven improvement across our operating markets. We believe our business is well-positioned to benefit from a housing recovery due to our strong balance sheet and liquidity, our finished lot position, our inventory of available homes and our broad geographic operating base, which have allowed us to profitably grow our business in the current market conditions. We have begun increasing our investments in land, lot and home inventories in response to increased demand for our homes and we will continue to adjust our business strategies based on housing demand in each of our markets. Nevertheless, our future results could be negatively impacted by weakening economic conditions, decreases in the level of employment, a significant increase in mortgage interest rates or further tightening of mortgage lending standards. 23
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Strategy
While we are encouraged by the recent improvement in new home demand, we are uncertain whether homebuilding industry conditions will continue to improve at the pace we experienced in fiscal 2012. We expect that further improvement in individual markets will be uneven, and will be largely dependent on local economic conditions. However, we believe our strategy through the downturn of generating significant cash flow from operations, increasing our cash balances, reducing our outstanding debt and controlling attractive land and lot positions through option contracts has positioned us to capitalize on improving demand across our markets. In response to increasing new home demand, we are using our liquidity and strong balance sheet to provide the capital and capacity to increase our investments in housing and land inventory, geographically expand our operations, opportunistically pursue business acquisitions and grow our profitability. Our operating strategy includes the following initiatives:
• Maintaining a strong cash balance and overall liquidity position.
• Managing the sales prices and level of sales incentives on our homes to
optimize the balance of sales volumes, profits, returns on inventory
investments and cash flows. • Entering into lot option contracts to purchase finished lots, where possible, which mitigates many of the risks of land ownership.
• Investing in land acquisition, land development and housing inventory
opportunities to meet housing demand and expand our operations in desirable markets. • Managing our inventory of homes under construction relative to demand in each of our markets, including starting construction on unsold homes to capture new home demand, monitoring the number and aging of unsold
homes and aggressively marketing unsold, completed homes in inventory.
• Controlling the cost of goods purchased from both vendors and subcontractors.
• Modifying product offerings and pricing to meet consumer demand in each of our markets.
• Controlling our SG&A infrastructure to match production levels.
Our operating strategy produced positive results in fiscal 2012. However, we cannot provide any assurances that the initiatives listed above will continue to be successful, and we may need to adjust components of our strategy to meet future market conditions. If market conditions do not deteriorate from current levels, we expect that our operating strategy will allow us to grow our profitability while maintaining a strong balance sheet and liquidity position in fiscal 2013. 24
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Key Results
Key financial results as of and for our fiscal year ended
Homebuilding Operations: • Homebuilding revenues increased 19% to$4.2 billion . • Homes closed increased 13% to 18,890 homes, and the average selling price of those homes increased 5% to$223,300 . • Net sales orders increased 21% to 21,048 homes, and the value of net sales orders increased 29% to$4.8 billion .
• Sales order backlog increased 61% to
• Home sales gross margins increased 160 basis points to 17.7%.
• Inventory impairments and land option cost write-offs were$6.2 million , compared to$45.4 million .
• Homebuilding SG&A expenses decreased as a percentage of homebuilding
revenues by 100 basis points to 12.5%.
• Interest expensed directly decreased 53% to
• Interest amortized to cost of sales declined to 2.7% of total home and
land/lot cost of sales, from 3.0%.
• Homebuilding pre-tax income was
loss of
• Homes in inventory totaled 13,000, compared to 10,500.
• Owned and optioned lots totaled 152,700, compared to 112,700.
• Homebuilding debt was
• Net homebuilding debt to total capital was 21.4%, up 340 basis points, and gross homebuilding debt to total capital was 39.1%, up 140 basis points. • Homebuilding cash and marketable securities totaled$1.3 billion , compared to$1.0 billion .
• Homebuilding inventory totaled
Financial Services Operations: • Total financial services revenues, net of recourse and reinsurance
expenses, increased 35% to
• Financial services pre-tax income increased 105% to
Consolidated Results: • Consolidated pre-tax income was
• Income tax benefit was
in the valuation allowance on our deferred tax asset in the third
quarter of fiscal 2012.
• Net income was
• Diluted earnings per share was
• Total equity was
• Net cash used in operations was$298.1 million , compared to$14.9 million provided by operations. 25
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Results of Operations - Homebuilding
Our operating segments are our 32 homebuilding operating divisions, which we aggregate into six reporting segments. These reporting segments, which we also refer to as reporting regions, have homebuilding operations located in the following states: East:Delaware ,Georgia (Savannah only),Maryland ,New Jersey ,North Carolina ,Pennsylvania ,South Carolina andVirginia Midwest:Colorado ,Illinois andMinnesota Southeast:Alabama ,Florida ,Georgia andMississippi South Central:Louisiana ,New Mexico (Las Cruces only),Oklahoma andTexas Southwest:Arizona andNew Mexico West:California ,Hawaii ,Idaho ,Nevada ,Oregon ,Utah andWashington
Fiscal Year Ended
The following tables and related discussion set forth key operating and financial data for our homebuilding operations by reporting segment as of and for the fiscal years ended 2012 and 2011.
Net Sales Orders (1) Fiscal Year Ended September 30, Net Homes Sold Value (In millions) Average Selling Price % % % 2012 2011 Change 2012 2011 Change 2012 2011 Change East 2,244 2,066 9 % $ 565.3 $ 482.6 17 % $ 251,900 $ 233,600 8 % Midwest 1,301 1,005 29 % 386.2 272.0 42 % 296,800 270,600 10 % Southeast 5,378 4,019 34 % 1,101.9 776.1 42 % 204,900 193,100 6 % South Central 6,822 6,169 11 % 1,282.3 1,092.2 17 % 188,000 177,000 6 % Southwest 1,715 1,284 34 % 327.7 239.6 37 % 191,100 186,600 2 % West 3,588 2,878 25 % 1,139.9 865.1 32 % 317,700 300,600 6 % 21,048 17,421 21 % $ 4,803.3 $ 3,727.6 29 % $ 228,200 $ 214,000 7 % Sales Order Cancellations Fiscal Year Ended September 30, Cancelled Sales Orders Value (In millions)
Cancellation Rate (2) 2012 2011 2012 2011 2012 2011 East 655 689 $ 147.7 $ 146.7 23 % 25 % Midwest 192 177 53.9 45.9 13 % 15 % Southeast 1,851 1,531 351.6 275.1 26 % 28 % South Central 2,426 2,763 436.4 470.3 26 % 31 % Southwest 705 639 120.0 109.9 29 % 33 % West 828 769 256.3 233.5 19 % 21 % 6,657 6,568 $ 1,365.9 $ 1,281.4 24 % 27 % ______________
(1) Net sales orders represent the number and dollar value of new sales
contracts executed with customers (gross sales orders), net of cancelled
sales orders.
(2) Cancellation rate represents the number of cancelled sales orders divided by gross sales orders. 26
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Net Sales Orders
The value of net sales orders increased 29%, to$4,803.3 million (21,048 homes) in 2012 from$3,727.6 million (17,421 homes) in 2011. The number of net sales orders increased 21% in fiscal 2012 compared to fiscal 2011, reflecting an increase in sales demand for our homes. While the improvement in our sales as compared to the prior year reflects improvement in new home demand and market conditions, overall demand for new homes remains at a historically low level. In comparing fiscal 2012 to fiscal 2011, the volume of net sales orders increased in all six of our market regions. The largest percentage increases occurred in our Southeast and Southwest regions as a result of improved market conditions in the majority of ourFlorida markets and in ourPhoenix market. Sales orders in our Southeast region were also positively impacted by our acquisition of the homebuilding operations ofBreland Homes during the fourth quarter of fiscal 2012, which added 118 homes and$24.3 million to our net sales in fiscal 2012 subsequent to the acquisition date. Changes in the value of net sales orders were generally due to the change in the number of homes sold in each respective region and, to a lesser extent, to increases in the average selling price of those homes, reflective of improving market conditions. Our future sales volumes will depend on the strength of the overall economy, employment levels and our ability to successfully implement our operating strategies in each of our markets. The average price of our net sales orders increased 7% to$228,200 in 2012, from$214,000 in 2011. The increase reflects slight increases in the average size and amenity levels of our homes sold, as well as small price increases we have been able to implement recently in some of our communities as demand for new homes has improved. Our sales order cancellation rate (cancelled sales orders divided by gross sales orders for the period) was 24% in fiscal 2012, compared to 27% in fiscal 2011. While our cancellation rates have improved, they remain slightly higher than they were prior to the recent housing downturn, and are mainly reflective of tight mortgage lending standards. Sales Order Backlog As of September 30, Homes in Backlog Value (In millions) Average Selling Price % % % 2012 2011 Change 2012 2011 Change 2012 2011 Change East 663 606 9 % $ 170.5 $ 147.6 16 % $ 257,200 $ 243,600 6 % Midwest 425 288 48 % 127.4 80.6 58 % 299,800 279,900 7 % Southeast 2,209 1,285 72 % 465.0 246.9 88 % 210,500 192,100 10 % South Central 2,232 1,710 31 % 433.5 309.5 40 % 194,200 181,000 7 % Southwest 699 426 64 % 134.9 76.6 76 % 193,000 179,800 7 % West 1,012 539 88 % 336.6 175.0 92 % 332,600 324,700 2 % 7,240 4,854 49 % $ 1,667.9 $ 1,036.2 61 % $ 230,400 $ 213,500 8 % Sales Order Backlog Sales order backlog represents homes under contract but not yet closed at the end of the period. Many of the contracts in our sales order backlog are subject to contingencies, including mortgage loan approval and buyers selling their existing homes, which can result in cancellations. A portion of the contracts in backlog will not result in closings due to cancellations. Our homes in backlog atSeptember 30, 2012 increased 49% from the prior year, with significant increases in most regions due to increases in net sales orders as compared with the prior year. The sales order backlog in the Southeast region atSeptember 30, 2012 included the impact of our acquisition of the homebuilding operations ofBreland Homes during the fourth quarter of fiscal 2012. 27
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Table of Contents Homes Closed and Home Sales Revenue Fiscal Year Ended September 30, Homes Closed Value (In millions) Average Selling Price % % % 2012 2011 Change 2012 2011 Change 2012 2011 Change East 2,187 1,932 13 % $ 542.4 $ 438.4 24 % $ 248,000 $ 226,900 9 % Midwest 1,164 964 21 % 339.3 261.5 30 % 291,500 271,300 7 % Southeast 4,682 3,546 32 % 930.7 691.8 35 % 198,800 195,100 2 % South Central 6,300 6,150 2 % 1,158.4 1,080.0 7 % 183,900 175,600 5 % Southwest 1,442 1,263 14 % 269.4 234.8 15 % 186,800 185,900 - % West 3,115 2,840 10 % 978.2 835.8 17 % 314,000 294,300 7 % 18,890 16,695 13 % $ 4,218.4 $ 3,542.3 19 % $ 223,300 $ 212,200 5 % Home Sales Revenue Revenues from home sales increased 19%, to$4,218.4 million (18,890 homes closed) in 2012 from$3,542.3 million (16,695 homes closed) in 2011. The average selling price of homes closed during 2012 was$223,300 , up 5% from the$212,200 average in 2011, reflecting slight increases in the average size and amenity levels of our homes closed, as well as small price increases we have been able to implement recently in some of our communities as demand for new homes has improved. During fiscal 2012, home sales revenues increased in all of our market regions, resulting from increases in the number of homes closed and increases in average selling prices. The number of homes closed in fiscal 2012 increased 13% from 2011 due to increases in all of our market regions. The most significant percentage increase in the current year occurred in our Southeast region, with theFlorida markets contributing the most to the increase. Home closings in the Southeast region also benefited from our acquisition of the homebuilding operations ofBreland Homes during the fourth quarter of fiscal 2012, which added 114 home closings and$22.4 million to our home sales revenue in fiscal 2012 subsequent to the acquisition date. Homebuilding Operating Margin Analysis Percentages of Related Revenues Fiscal Year Ended September 30, 2012 2011 Gross profit - Home sales 17.7 % 16.1 % Gross profit - Land/lot sales and other 25.3
% 5.5 % Effect of inventory impairments and land option cost write-offs on total homebuilding gross profit
(0.1 )% (1.3 )% Gross profit - Total homebuilding 17.6 % 14.8 % Selling, general and administrative expense 12.5 % 13.5 % Interest expense 0.6 % 1.4 % Loss on early retirement of debt, net - % 0.3 % Other (income) (0.3 )% (0.2 )% Income (loss) before income taxes 4.8 % (0.2 )% 28
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Home Sales Gross Profit
Gross profit from home sales increased by 30%, to$745.5 million in 2012, from$571.3 million in 2011, and, as a percentage of home sales revenues, increased 160 basis points, to 17.7%. Approximately 130 basis points of the increase in the home sales gross profit percentage was a result of the average selling price of our homes increasing by more than the average cost, reflecting improved market conditions from the prior year. Approximately 40 basis points of the increase was due to a decrease in the amortization of capitalized interest and property taxes as a percentage of homes sales revenues, resulting from reductions in our interest and property taxes incurred and capitalized and more closings occurring on recently acquired finished lots. These increases were partially offset by a 10 basis point decrease due to a$5.3 million out-of-period adjustment in the prior year period related to an error in recording the loss reserves of our 100% owned captive insurance subsidiary that increased gross profit in 2011.
Land sales and other revenues increased to$17.8 million in 2012, from$7.3 million in 2011. Fluctuations in revenues from land sales are a function of how we manage our inventory levels in various markets. We generally purchase land and lots with the intent to build and sell homes on them; however, we occasionally purchase land that includes commercially zoned parcels which we typically sell to commercial developers, and we also sell residential lots or land parcels to manage our land and lot supply. Land and lot sales occur at unpredictable intervals and varying degrees of profitability. Therefore, the revenues and gross profit from land sales fluctuate from period to period. As ofSeptember 30, 2012 , we had$32.6 million of land held for sale that we expect to sell in the next twelve months. Included in land sales and other revenues, is revenue from a single long-term construction project in which we serve as the general contractor. Revenue is recognized on a percentage-of-completion basis as the construction is completed. In fiscal 2012, the revenue and gross profit related to this project was$6.5 million and$1.2 million , respectively.
Inventory Impairments and Land Option Cost Write-offs
During fiscal 2012, we performed our quarterly inventory impairment analyses by reviewing the performance and outlook for all of our land inventories and communities under development for indicators of potential impairment. Based on this review as ofSeptember 30, 2012 , we then performed impairment evaluations of communities with a combined carrying value of$216.9 million . Through these evaluations, we determined that communities with a carrying value of$1.8 million as ofSeptember 30, 2012 , were impaired. As a result, during the three months endedSeptember 30, 2012 , we recorded impairment charges of$0.6 million to reduce the carrying value of the impaired communities to their estimated fair value, as compared to$10.2 million of impairment charges in the same period of 2011. During fiscal 2012 and 2011, impairment charges totaled$3.2 million and$37.3 million , respectively. The decrease in the amount of impairment charges in fiscal 2012 reflects the overall improvement of housing industry conditions and our increased profitability compared to the prior year, which has significantly reduced the number of our communities and carrying value of inventories that have indicators of potential impairment. It is possible that our estimate of undiscounted cash flows from these communities may change and could result in a future need to record impairment charges to adjust the carrying value of these assets to their estimated fair value. If conditions in the broader economy, homebuilding industry or specific markets in which we operate worsen, and as we re-evaluate specific community pricing and incentives, construction and development plans, and our overall land sale strategies, we may be required to evaluate additional communities or re-evaluate previously impaired communities for potential impairment. These evaluations may result in additional impairment charges. During fiscal 2012 and 2011, we wrote off$3.0 million and$8.1 million , respectively, of earnest money deposits and land option costs related to land option contracts which are not expected to be acquired. AtSeptember 30, 2012 , outstanding earnest money deposits associated with our portfolio of land and lot option purchase contracts totaled$35.0 million . The inventory impairment charges and write-offs of earnest money deposits and land option costs reduced total homebuilding gross profit as a percentage of homebuilding revenues by approximately 10 basis points in fiscal 2012, compared to 130 basis points in fiscal 2011. 29
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Selling, General and Administrative (SG&A) Expense
SG&A expense from homebuilding activities increased 10% to$528.7 million in 2012 from$480.0 million in 2011. As a percentage of homebuilding revenues, SG&A expense decreased 100 basis points, to 12.5% in 2012 from 13.5% in 2011. The largest component of our homebuilding SG&A expense is employee compensation and related costs, which represented 63% and 60% of SG&A costs in 2012 and 2011, respectively. These costs increased by 17%, to$335.6 million in 2012 from$286.5 million in 2011, primarily due to an increase in the level of incentive compensation related to the significant increases in revenues, profitability and the price of our common stock in the current year as compared to the prior year. Our homebuilding operations employed approximately 2,740 and 2,380 employees atSeptember 30, 2012 and 2011, respectively.
Interest Incurred
Homebuilding interest costs are incurred on our homebuilding debt outstanding during the period. Comparing fiscal 2012 with fiscal 2011, interest incurred related to homebuilding debt decreased 7% to$120.8 million , corresponding to a 7% decrease in our average homebuilding debt. We capitalize homebuilding interest to inventory during active development and construction. Our inventory under active development and construction is currently lower than our debt level; therefore, a portion of our interest incurred is expensed. We expensed$23.6 million of homebuilding interest during fiscal 2012, compared to$50.5 million of interest during 2011. The reduction in interest expensed during the current year is a result of an increase in our inventory under active development and construction as well as the decline in interest incurred. Interest amortized to cost of sales, excluding interest written off with inventory impairment charges, declined to 2.7% of total home and land/lot cost of sales in fiscal 2012 from 3.0% in fiscal 2011 as a result of more home closings on recently acquired finished lots and decreases in construction times over the past year.
Gain/Loss on Early Retirement of Debt
During fiscal 2012, we retired$10.8 million principal amount of our senior notes prior to their maturity. During fiscal 2011, in addition to repaying$176.2 million principal amount of maturing senior notes, we retired$319.2 million principal amount of our senior notes prior to their maturity. As a result of the early retirement of these notes, we recognized a net gain of$0.1 million and a net loss of$10.8 million in fiscal 2012 and 2011, respectively. These amounts represent the difference between the principal amount of the notes and the aggregate purchase price, after the write-off of any unamortized discounts and fees.
Other Income
Other income, net of other expenses, included in our homebuilding operations was$12.1 million in 2012, compared to$8.0 million in 2011. Other income consists of interest income, rental income and various other types of income not directly associated with our core homebuilding activities. The largest component of other income in both years was interest income.
Acquisitions
InAugust 2012 , we acquired the homebuilding operations ofBreland Homes for$105.9 million in cash, of which$9.4 million was paid subsequent toSeptember 30, 2012 .Breland Homes operates inHuntsville andMobile inAlabama and along the gulf coast ofMississippi . The assets acquired primarily included approximately 300 homes in inventory, 1,000 finished lots and control of approximately 3,700 additional lots through option contracts. We also acquired a sales order backlog of 228 homes valued at$46.9 million . The acquisition of the homebuilding operations ofBreland Homes was not material to our results of operations or financial condition. 30
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Homebuilding Results by
Fiscal Year Ended September 30, 2012 2011 Homebuilding Homebuilding % of Income (Loss) % of Homebuilding Income Before Region Homebuilding Before Region Revenues Income Taxes (1) Revenues Revenues Income Taxes (1) Revenues (In millions) East $ 542.4 $ 16.0 2.9 % $ 438.5 $ (13.5 ) (3.1 )% Midwest 339.3 1.1 0.3 % 261.5 (13.7 ) (5.2 )% Southeast 934.6 38.0 4.1 % 696.8 (19.9 ) (2.9 )% South Central 1,158.4 80.6 7.0 % 1,081.0 52.4 4.8 % Southwest 270.7 16.8 6.2 % 234.8 (3.8 ) (1.6 )% West 990.8 51.2 5.2 % 837.0 (8.5 ) (1.0 )% $ 4,236.2 $ 203.7 4.8 % $ 3,549.6 $ (7.0 ) (0.2 )%
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(1) Expenses maintained at the corporate level consist primarily of interest and
property taxes, which are capitalized and amortized to cost of sales or
expensed directly, and the expenses related to operating our corporate
office. The amortization of capitalized interest and property taxes is
allocated to each segment based on the segment's revenue, while interest
expense and those expenses associated with the corporate office are allocated
to each segment based on the segment's inventory balances.East Region - Homebuilding revenues increased 24% in 2012 compared to 2011, due to an increase in the number of homes closed as well as an increase in the average selling price in the majority of the region's markets. The largest increases in closings volume occurred in ourGreenville ,Charlotte andRaleigh/Durham markets. The region reported pre-tax income of$16.0 million in 2012, compared to a pre-tax loss of$13.5 million in 2011, primarily as a result of increases in revenues and gross profit. Gross profit from home sales as a percentage of home sales revenue (home sales gross profit percentage) increased 240 basis points in fiscal 2012, compared to fiscal 2011. As a percentage of homebuilding revenues, SG&A expenses decreased by 160 basis points in 2012 due to the increase in revenues.Midwest Region - Homebuilding revenues increased 30% in 2012 compared to 2011, due to an increase in the number of homes closed as well as an increase in the average selling price in the majority of the region's markets. The largest increases in closings volume occurred in ourDenver andChicago markets. The region reported pre-tax income of$1.1 million in 2012, compared to a pre-tax loss of$13.7 million in 2011, primarily as a result of increases in revenues and gross profit. Home sales gross profit percentage increased 150 basis points in fiscal 2012, compared to fiscal 2011. As a percentage of homebuilding revenues, SG&A expenses decreased by 240 basis points in fiscal 2012 due to the increase in revenues.Southeast Region - Homebuilding revenues increased 34% in 2012 compared to 2011, primarily due to an increase in the number of homes closed in the majority of the region's markets. The largest increases in closings volume occurred in ourFlorida markets. The region reported pre-tax income of$38.0 million in 2012, compared to a pre-tax loss of$19.9 million in 2011, primarily as a result of increases in revenues and gross profit. Home sales gross profit percentage increased 140 basis points in fiscal 2012, compared to fiscal 2011. Total gross profit in the prior year was reduced by inventory impairment charges and earnest money and land option cost write-offs totaling$17.4 million . As a percentage of homebuilding revenues, SG&A expenses decreased by 170 basis points in fiscal 2012 due to the increase in revenues.South Central Region - Homebuilding revenues increased 7% in 2012 compared to 2011, due to an increase in the average selling price in the majority of the region's markets. The region reported pre-tax income of$80.6 million in 2012, compared to$52.4 million in 2011, primarily as a result of increases in revenues and gross profit. Home sales gross profit percentage increased 170 basis points in fiscal 2012, compared to fiscal 2011. As a percentage of homebuilding revenues, SG&A expenses increased by 50 basis points in fiscal 2012 as a result of higher employee incentive compensation costs. 31
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Southwest Region - Homebuilding revenues increased 15% in 2012 compared to 2011, primarily due to an increase in the number of homes closed in thePhoenix market. The region reported pre-tax income of$16.8 million in 2012, compared to a pre-tax loss of$3.8 million in 2011, primarily as a result of increases in revenues and gross profit. Home sales gross profit percentage increased 270 basis points in fiscal 2012, compared to fiscal 2011. As a percentage of homebuilding revenues, SG&A expenses decreased by 220 basis points in fiscal 2012 due to the increase in revenues and the reduction in total SG&A expenses.West Region - Homebuilding revenues increased 18% in 2012 compared to 2011, due to an increase in the number of homes closed as well as an increase in the average selling price in the majority of the region's markets. The largest increases in closings volume occurred in ourSeattle ,Salt Lake City andPortland markets. The region reported pre-tax income of$51.2 million in 2012, compared to a pre-tax loss of$8.5 million in 2011, primarily as a result of increases in revenues and gross profit. The improvement in gross profit was the result of fewer inventory impairment charges and earnest money and land option cost write-offs, and an increase in the home sales gross profit percentage of 120 basis points in fiscal 2012, compared to fiscal 2011. As a percentage of homebuilding revenues, SG&A expenses decreased by 140 basis points in fiscal 2012 due to the increase in revenues. 32
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Land and Lot Position and Homes in Inventory
Our inventory investment strategy includes entering into new lot option contracts to purchase finished lots in our operating markets, where possible, and we attempt to renegotiate existing lot option contracts when necessary to reduce our lot costs and better match the scheduled lot purchases with new home demand in each community. We are also increasing our investments in land acquisition, land development and housing inventory to meet housing demand and expand our operations in desirable markets. We manage our inventory of homes under construction relative to demand in each of our markets, including starting construction on unsold homes to capture new home demand, monitoring the number and aging of unsold homes and aggressively marketing our unsold, completed homes in inventory.
The following is a summary of our land and lot position and homes in inventory at
As of September 30, 2012 2011 Lots Lots Controlled Controlled Under Lot Total Under Lot Total Option and Land/Lots Homes Option and Land/Lots Homes Land/Lots Similar Owned and in
Land/Lots Similar Owned and in
Owned Contracts (1) Controlled Inventory Owned Contracts (1) Controlled Inventory East 11,600 7,100 18,700 1,500 9,900 4,700 14,600 1,300 Midwest 5,000 1,100 6,100 800 5,300 500 5,800 600 Southeast 24,900 20,500 45,400 3,400 22,500 9,200 31,700 2,600 South Central 25,700 22,300 48,000 4,200 21,700 9,700 31,400 3,500 Southwest 5,200 4,200 9,400 1,000 5,300 1,100 6,400 900 West 22,200 2,900 25,100 2,100 21,100 1,700 22,800 1,600 94,600 58,100 152,700 13,000 85,800 26,900 112,700 10,500 62 % 38 % 100 % 76 % 24 % 100 % _______________
(1) Excludes approximately 5,200 and 8,000 lots at
respectively, representing lots controlled under lot option contracts for
which we do not expect to exercise our option to purchase the land or lots,
but the underlying contracts have yet to be terminated. We have reserved the
deposits related to these contracts. AtSeptember 30, 2012 , we owned or controlled approximately 152,700 lots, compared to approximately 112,700 lots atSeptember 30, 2011 . Of the 152,700 total lots, we controlled approximately 58,100 lots (38%), with a total remaining purchase price of approximately$1.7 billion , through land and lot option purchase contracts with a total of$35.0 million in earnest money deposits. AtSeptember 30, 2012 , approximately 24,700 of our owned lots were finished. We had a total of approximately 13,000 homes in inventory, including approximately 1,100 model homes atSeptember 30, 2012 , compared to approximately 10,500 homes in inventory, including approximately 1,100 model homes atSeptember 30, 2011 . Of our total homes in inventory, approximately 6,400 and 5,600 were unsold atSeptember 30, 2012 and 2011, respectively. AtSeptember 30, 2012 , approximately 2,100 of our unsold homes were completed, of which approximately 400 homes had been completed for more than six months. AtSeptember 30, 2011 , approximately 2,800 of our unsold homes were completed, of which approximately 600 homes had been completed for more than six months. 33
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Fiscal Year Ended
The following tables and related discussion set forth key operating and financial data for our homebuilding operations by reporting segment as of and for the fiscal years ended
Net Sales Orders (1) Fiscal Year Ended September 30, Net Homes Sold Value (In millions) Average Selling Price % % % 2011 2010 Change 2011 2010 Change 2011 2010 Change East 2,066 2,027 2 % $ 482.6 $ 469.0 3 % $ 233,600 $ 231,400 1 % Midwest 1,005 1,045 (4 )% 272.0 296.0 (8 )% 270,600 283,300 (4 )% Southeast 4,019 3,892 3 % 776.1 728.7 7 % 193,100 187,200 3 % South Central 6,169 7,375 (16 )% 1,092.2 1,273.4 (14 )% 177,000 172,700 2 % Southwest 1,284 1,785 (28 )% 239.6 315.3 (24 )% 186,600 176,600 6 % West 2,878 3,251 (11 )% 865.1 928.6 (7 )% 300,600 285,600 5 % 17,421 19,375 (10 )% $ 3,727.6 $ 4,011.0 (7 )% $ 214,000 $ 207,000 3 % Sales Order Cancellations Fiscal Year Ended September 30, Cancelled Sales Orders Value (In millions) Cancellation Rate (2) 2011 2010 2011 2010 2011 2010 East 689 581 $ 146.7 $ 127.2 25 % 22 % Midwest 177 250 45.9 68.7 15 % 19 % Southeast 1,531 1,409 275.1 250.0 28 % 27 % South Central 2,763 3,076 470.3 514.1 31 % 29 % Southwest 639 677 109.9 115.1 33 % 27 % West 769 789 233.5 227.3 21 % 20 % 6,568 6,782 $ 1,281.4 $ 1,302.4 27 % 26 % ______________
(1) Net sales orders represent the number and dollar value of new sales
contracts executed with customers (gross sales orders), net of cancelled
sales orders.
(2) Cancellation rate represents the number of cancelled sales orders divided
by gross sales orders.
Net Sales Orders
The value of net sales orders decreased 7%, to$3,727.6 million (17,421 homes) in 2011 from$4,011.0 million (19,375 homes) in 2010. The number of net sales orders decreased 10% in fiscal 2011 compared to fiscal 2010. Sales order volume during the first part of fiscal 2010 benefited from the federal homebuyer tax credit. During the last half of fiscal 2011, the number and value of our net sales orders were 2% and 8% higher, respectively, than in the last half of fiscal 2010. In comparing fiscal 2011 to fiscal 2010, the value and volume of net sales orders decreased in most of our market regions, with much of the volume decrease resulting from the expiration of the federal homebuyer tax credit. The volume decline in our Southwest region also reflected weaker market conditions in all of its markets, combined with a reduction in the number of active communities during fiscal 2011. Our East and Southeast regions experienced slight increases in net sales orders as a result of operating more communities during fiscal 2011. Fluctuations in the value of net sales orders were primarily due to the change in the number of homes sold in each respective region and, to a lesser extent, to small fluctuations in the average selling price of those homes. 34
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The average price of our net sales orders in 2011 was$214,000 , an increase of 3% from the$207,000 average in 2010. The largest percentage increases were in our Southwest and West regions and were primarily due to opening new communities and adjusting our product mix, with higher priced communities representing more of our sales.
Our annual sales order cancellation rate was 27% in fiscal 2011, compared to 26% in fiscal 2010. These cancellation rates were above historical levels, reflecting the challenges in most of our homebuilding markets.
Sales Order Backlog As of September 30, Homes in Backlog Value (In millions) Average Selling Price % % % 2011 2010 Change 2011 2010 Change 2011 2010 Change East 606 472 28 % $ 147.6 $ 103.4 43 % $ 243,600 $ 219,100 11 % Midwest 288 247 17 % 80.6 70.1 15 % 279,900 283,800 (1 )% Southeast 1,285 812 58 % 246.9 162.5 52 % 192,100 200,100 (4 )% South Central 1,710 1,691 1 % 309.5 297.3 4 % 181,000 175,800 3 % Southwest 426 405 5 % 76.6 71.9 7 % 179,800 177,500 1 % West 539 501 8 % 175.0 145.6 20 % 324,700 290,600 12 % 4,854 4,128 18 % $ 1,036.2 $ 850.8 22 % $ 213,500 $ 206,100 4 %
Sales Order Backlog
Our homes in backlog atSeptember 30, 2011 increased 18% from the prior year, with significant increases in our East, Midwest and Southeast regions. The number of homes in backlog in these regions benefited from more active communities and improved third and fourth quarter sales as compared with the same periods of the prior year. Homes Closed and Home Sales Revenue Fiscal Year Ended September 30, Homes Closed Value (In millions) Average Selling Price % % % 2011 2010 Change 2011 2010 Change 2011 2010 Change East 1,932 2,114 (9 )% $ 438.4 $ 492.2 (11 )% $ 226,900 $ 232,800 (3 )% Midwest 964 1,187 (19 )% 261.5 330.9 (21 )% 271,300 278,800 (3 )% Southeast 3,546 4,049 (12 )% 691.8 745.2 (7 )% 195,100 184,000 6 % South Central 6,150 8,046 (24 )% 1,080.0 1,378.8 (22 )% 175,600 171,400 2 % Southwest 1,263 1,872 (33 )% 234.8 329.7 (29 )% 185,900 176,100 6 % West 2,840 3,607 (21 )% 835.8 1,025.5 (18 )% 294,300 284,300 4 % 16,695 20,875 (20 )% $ 3,542.3 $ 4,302.3 (18 )% $ 212,200 $ 206,100 3 % Home Sales Revenue Revenues from home sales decreased 18%, to$3,542.3 million (16,695 homes closed) in 2011 from$4,302.3 million (20,875 homes closed) in 2010. The average selling price of homes closed during 2011 was$212,200 , up 3% from the$206,100 average in 2010 which reflected a change in product mix rather than broad price appreciation. During fiscal 2011, home sales revenues decreased in all of our market regions, resulting from decreases in the number of homes closed. The number of homes closed in fiscal 2011 decreased 20% due to decreases in all of our market regions. The federal homebuyer tax credit helped stimulate demand for new homes during fiscal 2010 and following its expiration we experienced a significant decline in demand for our homes that extended into fiscal 2011. 35
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Table of Contents Homebuilding Operating Margin Analysis Percentages of Related Revenues Fiscal Year Ended September 30, 2011 2010 Gross profit - Home sales 16.1 % 17.3 % Gross profit - Land/lot sales and other 5.5
% 37.8 % Effect of inventory impairments and land option cost write-offs on total homebuilding gross profit
(1.3 )% (1.5 )% Gross profit - Total homebuilding 14.8 % 15.8 % Selling, general and administrative expense 13.5 % 12.1 % Interest expense 1.4 % 2.0 % Loss on early retirement of debt, net 0.3 % 0.1 % Other (income) (0.2 )% (0.2 )% Income (loss) before income taxes (0.2 )% 1.8 % Home Sales Gross Profit Gross profit from home sales decreased by 23%, to$571.3 million in 2011, from$744.0 million in 2010, and, as a percentage of home sales revenues, decreased 120 basis points, to 16.1%. The reduction in gross profit from home sales was primarily due to the increased levels of incentives and discounts needed to sell homes in fiscal 2011, which narrowed the range between our selling prices and costs of our homes in most of our markets. Fiscal 2010 benefited from the federal homebuyer tax credit, which created demand for our homes without the need for us to provide as many incentives and discounts
Inventory Impairments and Land Option Cost Write-offs
As ofSeptember 30, 2011 , we evaluated communities with a combined carrying value of$391.5 million for impairment. Through this evaluation process, we determined that communities with a carrying value of$37.1 million as ofSeptember 30, 2011 , were impaired. As a result, during the three months endedSeptember 30, 2011 , we recorded impairment charges of$10.2 million to reduce the carrying value of the impaired communities to their estimated fair value, as compared to$29.1 million in the same period of 2010. During fiscal 2011 and 2010, impairment charges totaled$37.3 million and$62.3 million , respectively.
During fiscal 2011 and 2010, we wrote off
Selling, General and Administrative (SG&A) Expense
SG&A expense from homebuilding activities decreased 8% to$480.0 million in 2011 from$523.2 million in 2010. As a percentage of homebuilding revenues, SG&A expense increased 140 basis points, to 13.5% in 2011 from 12.1% in 2010. The largest component of our homebuilding SG&A expense is employee compensation and related costs, which represented 60% and 58% of SG&A costs in 2011 and 2010, respectively. These costs decreased by 6%, to$286.5 million in 2011 from$304.0 million in 2010, primarily due to a decline in the level of incentive compensation and to a lesser extent, to a decline in the number of employees. Our homebuilding operations employed approximately 2,380 and 2,500 employees atSeptember 30, 2011 and 2010, respectively. A reduction in advertising costs also contributed to the decline in SG&A expense. 36
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Interest Incurred
Comparing fiscal 2011 with fiscal 2010, interest incurred related to homebuilding debt decreased 25% to$130.2 million , primarily due to a 26% decrease in our average homebuilding debt. We expensed$50.5 million of homebuilding interest during fiscal 2011, compared to$86.3 million of interest during fiscal 2010. The reduction in interest expensed is a result of a decline in interest incurred. Interest amortized to cost of sales, excluding interest written off with inventory impairment charges, declined to 3.0% of total home and land/lot cost of sales in fiscal 2011 from 3.4% in 2010 as a result of more home closings on acquired finished lots and decreases in construction times.
Loss on Early Retirement of Debt
During fiscal 2011, in addition to repaying maturing senior notes, we retired$319.2 million principal amount of our senior notes prior to their maturity, compared to$822.2 million in fiscal 2010. Related to the early retirement of these notes, we recognized a net loss of$10.8 million and$4.9 million in fiscal 2011 and 2010, respectively. The net loss in fiscal 2011 includes a loss of$6.3 million for the call premium and write-off of unamortized fees related to the early redemption of our 5.375% senior notes due 2012. The net loss in fiscal 2010 includes a loss of$2.0 million for the call premium and write-off of unamortized fees related to the early redemption of the 5.875% senior notes due 2013. Other Income Other income, net of other expenses, associated with homebuilding activities was$8.0 million in 2011, compared to$10.4 million in 2010. The largest component of other income in both years was interest income. 37
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Homebuilding Results by
Fiscal Year Ended September 30, 2011 2010 Homebuilding Homebuilding Income (Loss) % of Income (Loss) % of Homebuilding Before Region Homebuilding Before Region Revenues Income Taxes (1) Revenues Revenues Income Taxes (1) Revenues (In millions) East $ 438.5 $ (13.5 ) (3.1 )% $ 492.3 $ (6.3 ) (1.3 )% Midwest 261.5 (13.7 ) (5.2 )% 331.0 (31.3 ) (9.5 )% Southeast 696.8 (19.9 ) (2.9 )% 747.6 (7.5 ) (1.0 )% South Central 1,081.0 52.4 4.8 % 1,383.5 83.4 6.0 % Southwest 234.8 (3.8 ) (1.6 )% 329.7 12.0 3.6 % West 837.0 (8.5 ) (1.0 )% 1,025.6 27.8 2.7 % $ 3,549.6 $ (7.0 ) (0.2 )% $ 4,309.7 $ 78.1 1.8 % _______________
(1) Expenses maintained at the corporate level consist primarily of interest and
property taxes, which are capitalized and amortized to cost of sales or
expensed directly, and the expenses related to operating our corporate
office. The amortization of capitalized interest and property taxes is
allocated to each segment based on the segment's revenue, while interest
expense and those expenses associated with the corporate office are allocated
to each segment based on the segment's inventory balances.East Region - Homebuilding revenues decreased 11% in 2011 compared to 2010, primarily due to decreases in the number of homes closed in the majority of the region's markets. The largest decrease in closings volume occurred in ourNew Jersey andCharlotte markets. The region reported a pre-tax loss of$13.5 million in 2011, compared to a loss of$6.3 million in 2010, primarily as a result of declines in revenues and gross profit. Inventory impairment charges and earnest money and land option cost write-offs were$4.6 million and$8.6 million in fiscal 2011 and 2010, respectively. Gross profit from home sales as a percentage of home sales revenue (home sales gross profit percentage) decreased 200 basis points in fiscal 2011 compared to fiscal 2010 due to the increased use of incentives to sell homes and weakening market conditions during fiscal 2011. Although total SG&A expenses in fiscal 2011 decreased from the prior year, they increased as a percentage of homebuilding revenues by 120 basis points in 2011.Midwest Region - Homebuilding revenues decreased 21% in 2011 compared to 2010, primarily due to decreases in the number of homes closed in all of the region's markets. The region reported a pre-tax loss of$13.7 million in 2011, compared to a loss of$31.3 million in 2010. The improvement in fiscal 2011 was primarily a result of fewer inventory impairment charges and earnest money and land option cost write-offs, which were$0.9 million in fiscal 2011, compared to$22.0 million in fiscal 2010. However, weak conditions in theChicago market contributed substantially to the region's loss. Home sales gross profit percentage decreased 190 basis points in fiscal 2011 compared to fiscal 2010 due to weakening market conditions compared to the prior year. Although total SG&A expenses in fiscal 2011 decreased from the prior year, they increased as a percentage of homebuilding revenues by 110 basis points in 2011.Southeast Region - Homebuilding revenues decreased 7% in 2011 compared to 2010, due to a decrease in the number of homes closed, partially offset by an increase in the average selling price of those homes. The region reported a pre-tax loss of$19.9 million in fiscal 2011 compared to a loss of$7.5 million in fiscal 2010, primarily as a result of declines in revenue and gross profit. These results generally reflected softening across most markets from the expiration of the federal homebuyer tax credit, as well as more challenging conditions in theOrlando market. Inventory impairment charges and earnest money and land option cost write-offs were$17.4 million and$17.5 million in fiscal 2011 and 2010, respectively. Home sales gross profit percentage decreased 110 basis points in fiscal 2011 compared to fiscal 2010 due to increased warranty costs in ourOrlando andPensacola markets. As a percentage of homebuilding revenues, total SG&A expenses increased 110 basis points in fiscal 2011. 38
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South Central Region - Homebuilding revenues decreased 22% in 2011 compared to 2010, primarily due to decreases in the number of homes closed in all of the region's markets, partially offset by an increase in the average selling prices of those homes. While we continued to be profitable in all markets in the region, overall the region reported a decline in pre-tax income to$52.4 million in fiscal 2011, from$83.4 million in fiscal 2010. The reduced income was the result of closing fewer homes with the expiration of the federal homebuyer tax credit, leading to declines in revenue and gross profit. Inventory impairment charges and earnest money and land option cost write-offs were$0.7 million and$14.0 million in fiscal 2011 and 2010, respectively. Home sales gross profit percentage decreased 100 basis points in fiscal 2011 compared to fiscal 2010 due to lower margins in the majority of the region's markets, caused by an increase in construction and lot costs as a percentage of revenues. Although total SG&A expenses in fiscal 2011 decreased from the prior year, they increased as a percentage of homebuilding revenues by 150 basis points in 2011. Our centralTexas ,Dallas andHouston markets continued to be the most profitable in the region.Southwest Region - Homebuilding revenues decreased 29% in 2011 compared to 2010, due to decreases in the number of homes closed in all of the region's markets, partially offset by an increase in the average selling price of those homes. The region reported a pre-tax loss of$3.8 million fiscal 2011, compared to pre-tax income of$12.0 million in fiscal 2010, primarily as a result of declines in revenue and gross profit in all of its markets, withPhoenix experiencing the worst conditions. Home sales gross profit percentage decreased 200 basis points in fiscal 2011 compared to fiscal 2010, primarily as a result of the increased use of incentives to sell homes and weakening market conditions in all of the region's markets. Also contributing to the decrease in gross profit percentage in fiscal 2011, inventory impairment charges and earnest money and land option cost write-offs increased to$4.7 million , from$0.6 million in the prior year. Although total SG&A expenses in fiscal 2011 decreased from the prior year, they increased as a percentage of homebuilding revenues by 170 basis points in 2011.West Region - Homebuilding revenues decreased 18% in 2011 compared to 2010, due to decreases in the number of homes closed in all of the region's markets, partially offset by an increase in the average selling price of those homes. TheSeattle market continued to generate the highest profits, while the inland, centralCalifornia markets again did not achieve profitability. The region reported a pre-tax loss of$8.5 million in fiscal 2011, compared to pre-tax income of$27.8 million in fiscal 2010, primarily as a result of a decline in revenue and increased impairment charges. Inventory impairment charges and earnest money and land option cost write-offs were$17.1 million in fiscal 2011, compared to$2.0 million in fiscal 2010. Home sales gross profit percentage decreased 40 basis points in fiscal 2011 compared to fiscal 2010. Although total SG&A expenses in fiscal 2011 decreased from the prior year, they increased as a percentage of homebuilding revenues by 150 basis points in 2011. 39
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Results of Operations - Financial Services
Fiscal Year Ended
The following tables set forth key operating and financial data for our financial services operations, comprising
Fiscal Year
Ended September 30,
2012
2011 % Change Number of first-lien loans originated or brokered by
11,228 10,262 9 % Number of homes closed by D.R. Horton 18,890 16,695 13 % DHI Mortgage capture rate 59 % 61 % Number of total loans originated or brokered by DHI Mortgage for D.R. Horton homebuyers 11,283 10,343 9 %
Total number of loans originated or brokered by
13,499 12,118 11 % Captive business percentage 84 % 85 % Loans sold by DHI Mortgage to third parties 13,397 11,888 13 % Fiscal Year Ended September 30, 2012 2011 % Change (In millions) Loan origination fees $ 18.9 $ 18.3 3 % Sale of servicing rights and gains from sale of mortgages 73.9 53.2 39 % Recourse expense (4.7 ) (11.6 ) (59 )% Sale of servicing rights and gains from sale of mortgages, net 69.2 41.6 66 % Other revenues 7.5 9.2 (18 )% Reinsurance expense (1.5 ) (1.8 ) (17 )% Other revenues, net 6.0 7.4 (19 )% Total mortgage operations revenues 94.1 67.3 40 % Title policy premiums, net 23.7 19.9 19 % Total revenues 117.8 87.2 35 % General and administrative expense 85.5 76.3 12 % Interest expense 3.3 1.4 136 % Interest and other (income) (10.2 ) (9.6 ) 6 % Income before income taxes $ 39.2 $ 19.1 105 % Financial Services Operating Margin Analysis Percentages of Financial Services Revenues (1) Fiscal Year Ended September 30, 2012 2011 Recourse and reinsurance expense 5.0 % 13.3 % General and administrative expense 69.0 % 75.8 % Interest expense 2.7 % 1.4 % Interest and other (income) (8.2 )% (9.5 )% Income before income taxes 31.6 % 19.0 %
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(1) Excludes the effects of recourse and reinsurance charges on financial
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Mortgage Loan Activity
The volume of loans originated and brokered by our mortgage operations is directly related to the number of homes closed by our homebuilding operations. In fiscal 2012, total first-lien loans originated or brokered byDHI Mortgage for our homebuyers increased by 9%, reflective of the 13% increase in the number of homes closed by our homebuilding operations. The percentage increase in loans originated was lower than the percentage increase in the number of homes closed due to a slight decrease in our mortgage capture rate (the percentage of total home closings by our homebuilding operations for whichDHI Mortgage handled the homebuyers' financing) to 59% in fiscal 2012, from 61% in fiscal 2011. Home closings from our homebuilding operations constituted 84% ofDHI Mortgage loan originations in 2012, compared to 85% in 2011, reflectingDHI Mortgage's continued focus on the captive business provided by our homebuilding operations. The number of loans sold to third-party purchasers increased by 13% in 2012 compared to 2011, corresponding to the 11% increase in the number of loans originated between the years. Virtually all of the mortgage loans originated during fiscal 2012 and mortgage loans held for sale onSeptember 30, 2012 were eligible for sale to the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) orGovernment National Mortgage Association (Ginnie Mae ). Approximately 73% of the mortgage loans sold byDHI Mortgage during fiscal 2012 were sold to one major financial institution that provided better pricing and execution than other available loan purchasers. On an ongoing basis, we seek to establish additional loan purchase arrangements with multiple institutions. If we are unable to sell mortgage loans to additional purchasers on attractive terms, our ability to originate and sell mortgage loans at competitive prices could be limited, which would negatively affect profitability.
Financial Services Revenues and Expenses
Revenues from the financial services segment increased 35%, to$117.8 million in fiscal 2012 from$87.2 million in fiscal 2011. The volume of loans sold increased 13% while revenues from the sale of servicing rights and gains from sale of mortgages increased 39%. Loan sale revenue increased at a higher rate than loan sale volume primarily due to improved loan sale execution in the secondary market. Loan origination fees increased 3%, compared to an 11% increase in the number of loans originated. The percentage increase in loan origination fees was lower than the percentage increase in the number of loans originated due to pricing changes in some of our markets and was generally offset by improved loan sale execution. Charges related to recourse obligations were$4.7 million in fiscal 2012, compared to$11.6 million in fiscal 2011. The calculation of our required repurchase loss reserve is based upon an analysis of repurchase requests received, our actual repurchases and losses through the disposition of such loans or requests, discussions with our mortgage purchasers and analysis of the mortgages we originated. While we believe that we have adequately reserved for losses on known and projected repurchase requests, if either actual repurchases or the losses incurred resolving those repurchases exceed our expectations, additional recourse expense may be incurred. Additionally, a subsidiary of ours reinsured a portion of the private mortgage insurance written on loans originated byDHI Mortgage in prior years. Charges to increase reserves for expected losses on the reinsured loans were$1.5 million and$1.8 million during fiscal 2012 and 2011, respectively. Financial services general and administrative (G&A) expense increased 12%, to$85.5 million in 2012 from$76.3 million in 2011. As a percentage of financial services revenues (excluding the effects of recourse and reinsurance expense), G&A expense decreased to 69.0% in 2012, from 75.8% in 2011, primarily due to the increase in loan origination volume and revenues. Fluctuations in financial services G&A expense as a percentage of revenues can be expected to occur as some expenses are not directly related to mortgage loan volume or to changes in the amount of revenue earned. 41
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Fiscal Year Ended
The following tables set forth key operating and financial data for our financial services operations, comprising
Fiscal Year
Ended September 30,
2011
2010 % Change Number of first-lien loans originated or brokered by
10,262 12,679 (19 )% Number of homes closed by D.R. Horton 16,695 20,875 (20 )% DHI Mortgage capture rate 61 % 61 % Number of total loans originated or brokered by DHI Mortgage for D.R. Horton homebuyers 10,343 12,754 (19 )%
Total number of loans originated or brokered by
12,118 14,146 (14 )% Captive business percentage 85 % 90 % Loans sold by DHI Mortgage to third parties 11,888 14,001 (15 )% Fiscal Year Ended September 30, 2011 2010 % Change (In millions) Loan origination fees $ 18.3 $ 17.7 3 % Sale of servicing rights and gains from sale of mortgages 53.2 59.6 (11 )% Recourse expense (11.6 ) (13.7 ) (15 )% Sale of servicing rights and gains from sale of mortgages, net 41.6 45.9 (9 )% Other revenues 9.2 6.8 35 % Reinsurance expense (1.8 ) (1.9 ) (5 )% Other revenues, net 7.4 4.9 51 % Total mortgage operations revenues 67.3 68.5 (2 )% Title policy premiums, net 19.9 22.0 (10 )% Total revenues 87.2 90.5 (4 )% General and administrative expense 76.3 77.2 (1 )% Interest expense 1.4 1.9 (26 )% Interest and other (income) (9.6 ) (10.0 ) (4 )% Income before income taxes $ 19.1 $ 21.4 (11 )% Financial Services Operating Margin Analysis Percentages of Financial Services Revenues (1) Fiscal Year Ended September 30, 2011 2010 Recourse and reinsurance expense 13.3 % 14.7 % General and administrative expense 75.8 % 72.8 % Interest expense 1.4 % 1.8 % Interest and other (income) (9.5 )% (9.4 )% Income before income taxes 19.0 % 20.2 %
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(1) Excludes the effects of recourse and reinsurance charges on financial
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Mortgage Loan Activity
Total first-lien loans originated or brokered byDHI Mortgage for our homebuyers decreased by 19% in fiscal 2011 compared to fiscal 2010, corresponding to the 20% decrease in the number of homes closed. Our mortgage capture rate was 61% in both years. Home closings from our homebuilding operations constituted 85% ofDHI Mortgage loan originations in 2011, compared to 90% in 2010, reflectingDHI Mortgage's continued focus on the captive business provided by our homebuilding operations. The relatively lower captive percentage in 2011 reflects a higher level of refinancing and new mortgage loan originations from non-homebuilding sources than in 2010. The number of loans sold to third-party purchasers decreased by 15% in 2011 compared to 2010, corresponding to the 14% decrease in the number of loans originated between the years. Virtually all of the mortgage loans originated during fiscal 2011 and mortgage loans held for sale onSeptember 30, 2011 were eligible for sale to Fannie Mae, Freddie Mac orGinnie Mae . Approximately 89% of the mortgage loans sold byDHI Mortgage during fiscal 2011 were sold to two major financial institutions pursuant to their loan purchase agreements.
Financial Services Revenues and Expenses
Revenues from the financial services segment decreased 4%, to$87.2 million in fiscal 2011 from$90.5 million in fiscal 2010. Revenues from the sale of servicing rights and gains from sale of mortgages decreased 11% as a result of a 15% decrease in the volume of loans sold. Loan origination fees increased 3%, despite a 14% decrease in loans originated, due to small changes in pricing structure implemented during fiscal 2011. Charges related to recourse obligations were$11.6 million in fiscal 2011, compared to$13.7 million in fiscal 2010. Charges to increase reserves for expected losses on the reinsured loans were$1.8 million and$1.9 million during fiscal 2011 and 2010, respectively.
Financial services G&A expense was
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Results of Operations - Consolidated
Fiscal Year Ended
Income before Income Taxes Income before income taxes for fiscal 2012 was$242.9 million , compared to$12.1 million for fiscal 2011. The difference in our operating results for the current year compared to a year ago is primarily due to higher revenues from increased home closings, a higher gross profit margin and lower interest expense.
Income Taxes
In fiscal 2012, our income tax benefit was$713.4 million , compared to a benefit of$59.7 million in 2011. The income tax benefit in fiscal 2012 was due primarily to a significant reduction of our deferred tax asset valuation allowance during the three months endedJune 30, 2012 . The income tax benefit in fiscal 2011 was due to us receiving a favorable result from theInternal Revenue Service (IRS) on a ruling request concerning capitalization of inventory costs. We do not have meaningful effective tax rates in these years because our net deferred tax assets were fully offset by a valuation allowance until the third quarter of fiscal 2012 when we reduced the valuation allowance on our deferred tax asset. Based on current income tax laws, we expect our effective tax rate in fiscal 2013 to be approximately 38.5%. AtSeptember 30, 2012 , we had federal net operating loss (NOL) carryforwards of$310.5 million that expire in fiscal 2030 and 2031 and tax benefits for state NOL carryforwards of$85.2 million that expire (beginning at various times depending on the tax jurisdiction) from fiscal 2013 to fiscal 2031. AtSeptember 30, 2012 , we had federal tax credit carryforwards of$4.4 million that expire in fiscal years 2029 through 2032 and a minimum tax credit carryforward of$2.6 million . AtSeptember 30, 2012 and 2011, we had deferred tax assets, net of deferred tax liabilities, of$751.4 million and$848.5 million , respectively, offset by valuation allowances of$41.9 million and$848.5 million , respectively. The realization of our deferred tax assets depends upon the existence of sufficient taxable income in future periods. We have a valuation allowance of$41.9 million atSeptember 30, 2012 because it is more likely than not that a portion of our state NOL carryforwards will not be realized due to the more limited carryforward periods that exist in certain states.
At
In our evaluation of the need for and level of a valuation allowance on our deferred tax assets atJune 30, 2012 , the most significant piece of evidence considered was the objective, direct positive evidence related to our recent financial results, including our positive and growing levels of pre-tax income and our strong growth in net sales orders and sales order backlog. These positive pre-tax income, sales and backlog levels and trends continued throughSeptember 30, 2012 . We believe we will continue to increase our pre-tax income in future years, as we are utilizing our balance sheet and liquidity position to invest in opportunities to sustain and grow our operations. If industry conditions weaken from current levels, we expect to be able to adjust our operations to maintain long-term profitability. While our expectations are that annual pre-tax income will grow from the fiscal 2012 level, if annual pre-tax income in future years remains flat with the current level, we estimate that we will realize all of our current federal net operating losses in less than five years and will be able to absorb all federal deductible temporary differences as they reverse in future years. Prior to the quarter endedJune 30, 2012 , a significant part of the negative evidence we considered was our three-year cumulative pre-tax loss position, which had become a cumulative pre-tax income position atJune 30, 2012 , and was no longer considered to be as significant. Other negative evidence we considered was our previous losses incurred during the housing market decline, the current overall weakness in the economy and the housing market, the restrictive mortgage lending environment and our gross margins, which are currently lower than historical levels before the housing downturn. Based on our evaluation of both positive and negative evidence atJune 30, 2012 , we concluded that the objective, direct positive evidence related to our operating results achieved during the recent challenging economic and housing market conditions and the sustainability of current pre-tax income levels outweighed the negative evidence and that it was more likely than not that the substantial majority of our deferred tax assets will be realized. 44
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The accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcomes of these future results could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws and tax rates also affect actual tax results and the valuation of deferred tax assets over time. Unrecognized tax benefits are the differences between tax positions taken or expected to be taken in a tax return and the benefits recognized for accounting purposes. Included in the balance of unrecognized tax benefits as ofSeptember 30, 2012 are$11.8 million of tax benefits that, if recognized, would reduce our income tax expense. Also included in the balance of unrecognized tax benefits as ofSeptember 30, 2012 are$2.3 million of tax benefits that, if recognized, would result in an adjustment to deferred income taxes. AtSeptember 30, 2011 all tax positions, if recognized, would have reduced our income tax expense because of the full valuation allowance that existed on our deferred tax assets. We classify interest expense and penalties on income taxes as income tax expense. During fiscal 2012 and 2011, we recognized interest benefits related to unrecognized tax benefits of$0.1 million and$12.7 million , respectively, in our consolidated statements of operations. At bothSeptember 30, 2012 and 2011, our total accrued interest expense relating to unrecognized tax benefits was$5.1 million and there were no accrued penalties. A reduction of$9.9 million in the amount of unrecognized tax benefits and$3.1 million of accrued interest is reasonably possible within the next 12 months, of which$11.0 million would be reflected as an income tax benefit in our consolidated statement of operations and$2.0 million would result in an adjustment to deferred income taxes. We are subject to federal income tax and to income tax in multiple states. The statute of limitations for our major tax jurisdictions remains open for examination for fiscal years 2004 to 2006 and from 2008 through 2012. We are currently being audited by various states. AtSeptember 30, 2012 and 2011, we had income taxes receivable of$14.4 million and$12.4 million , respectively, for expected federal tax refunds related to our 2006 and 2007 tax returns. During fiscal 2012, theIRS concluded its audit of our 2006 and 2007 tax returns, and theU.S. Congressional Joint Committee on Taxation concluded its review of the tax refunds requested by us. InOctober 2012 , we received the$14.4 million tax refund.
Fiscal Year Ended
Income before Income Taxes
Income before income taxes for fiscal 2011 was
Income Taxes
In fiscal 2011, our income tax benefit was$59.7 million , compared to a benefit of$145.6 million in 2010. The income tax benefit in fiscal 2011 was due to the reduction of our accrual for unrecognized tax benefits and corresponding interest by$61.4 million , partially offset by an accrual for state income taxes of$1.7 million . In fiscal 2010, a tax law change regarding net operating loss (NOL) carrybacks resulted in an income tax benefit of$208.3 million , which was partially offset by an increase in unrecognized tax benefits and state income tax expense. We did not have meaningful effective tax rates in these years because our net deferred tax assets were fully offset by a valuation allowance. AtSeptember 30, 2011 and 2010, we had income taxes receivable of$12.4 million and$16.0 million , respectively. We had deferred tax assets, net of deferred tax liabilities, of$848.5 million and$902.6 million , respectively, offset by valuation allowances of$848.5 million and$902.6 million , respectively. In determining the continued need for a valuation allowance with respect to our deferred tax assets, a significant part of the negative evidence we considered came from our three-year cumulative pre-tax loss position, which was$445 million at the end of fiscal 2011. AtSeptember 30, 2011 and 2010, the total amount of our unrecognized tax benefits was$16.3 million and$65.0 million , respectively. The decrease in unrecognized tax benefits resulted from us receiving a favorable result from theIRS on a ruling request concerning the capitalization of inventory costs and a reduction in our accrual for state income tax issues. Related to unrecognized tax benefits, we recognized an interest benefit of$12.7 million and interest expense of$11.6 million during fiscal 45
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2011 and 2010, respectively. At
Overview of Capital Resources and Liquidity
We have historically funded our homebuilding and financial services operations with cash flows from operating activities, borrowings under bank credit facilities and the issuance of new debt securities. During the industry downturn from 2007 to 2011, we generated substantial cash flows primarily through reductions in assets and income tax refunds, which allowed us to increase our liquidity and reduce our debt. This has provided us with the operational flexibility to adjust to changing homebuilding market conditions. In response to increased demand for our homes, we have recently increased our investments in housing and land inventory opportunities to expand our operations and grow our profitability. We intend to maintain adequate liquidity and balance sheet strength, and we regularly evaluate opportunities to access the capital markets as they become available. AtSeptember 30, 2012 , our ratio of net homebuilding debt to total capital was 21.4%, an increase of 340 basis points from 18.0% atSeptember 30, 2011 . Net homebuilding debt to total capital consists of homebuilding notes payable net of cash and marketable securities divided by total capital net of cash and marketable securities (homebuilding notes payable net of cash and marketable securities plus total equity). In the near term, we intend to maintain a ratio of net homebuilding debt to total capital below our historic target operating range of 40% to 45%. However, future net homebuilding debt to total capital ratios may be higher than current levels. We believe that the ratio of net homebuilding debt to total capital is useful in understanding the leverage employed in our homebuilding operations and comparing our capital structure with other homebuilders. We exclude the debt of our financial services business because it is separately capitalized and its obligation under its repurchase agreement is substantially collateralized and not guaranteed by our parent company or any of our homebuilding entities. Because of their capital function, we include our homebuilding cash and marketable securities as a reduction of our homebuilding debt and total capital. For comparison to our ratios of net homebuilding debt to capital above, atSeptember 30, 2012 and 2011, our ratios of homebuilding debt to total capital, without netting cash and marketable securities balances, were 39.1% and 37.7%, respectively. We believe that our existing cash resources, our revolving credit facility and our mortgage repurchase facility provide sufficient liquidity to fund our near-term working capital needs and debt obligations. We regularly assess our projected capital requirements to fund future growth in our business, repay our longer-term debt obligations, and support our other general corporate and operational needs, and we regularly evaluate our opportunities to raise additional capital. We have an automatically effective universal shelf registration statement filed with theSEC inSeptember 2012 , registering debt and equity securities which we may issue from time to time in amounts to be determined. As market conditions permit, we may issue new debt or equity securities through the public capital markets or obtain additional bank financing to fund our projected capital requirements or provide additional liquidity.
Homebuilding Capital Resources
Cash and Cash Equivalents - At
Marketable Securities - AtSeptember 30, 2012 , we had marketable securities of$298.0 million . Our marketable securities consist of U.S. Treasury securities, government agency securities, corporate debt securities and certificates of deposit. Recently Issued Public Unsecured Debt - InMay 2012 , we issued$350 million principal amount of 4.75% senior notes dueMay 15, 2017 , with interest payable semi-annually. The annual effective interest rate of the notes, after giving effect to the amortization of deferred financing costs is 5.0%. InSeptember 2012 , we issued$350 million principal amount of 4.375% senior notes dueSeptember 15, 2022 , with interest payable semi-annually. The annual effective interest rate of the notes, after giving effect to the amortization of deferred financing costs is 4.5%. 46
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Bank Credit Facility - InSeptember 2012 , we entered into a five-year,$125 million senior unsecured revolving credit facility with a major bank. As ofSeptember 30, 2012 , the facility had an uncommitted$375 million accordion feature which could increase the size of the facility, subject to certain conditions and availability of additional bank commitments. Borrowings bear interest at rates based upon the London Interbank Offered Rate (LIBOR) plus an applicable margin as determined by our leverage ratio as defined in the credit agreement governing the facility. The facility also provided for the issuance of letters of credit equal to 50% of the revolving credit commitment through a letter of credit sublimit. AtSeptember 30, 2012 , we had no borrowings outstanding and$0.4 million in letters of credit outstanding under the revolving credit facility. OnNovember 1, 2012 , we increased the capacity of the credit facility to$600 million by obtaining additional lending commitments from banks, and increased the accordion feature available under the facility to allow us to increase the size of the facility to$1.0 billion , subject to certain conditions and availability of additional bank commitments. The amended sublimit for the issuance of letters of credit is now$300 million . Our revolving credit facility imposes restrictions on our operations and activities, including requiring the maintenance of a minimum level of tangible net worth, a maximum allowable leverage ratio and a borrowing base restriction if our leverage ratio exceeds a certain level. These covenants are measured as defined in the credit facility and are reported to our lenders quarterly. In addition, our credit facility and the indentures governing the senior notes impose restrictions on the creation of secured debt and liens. AtSeptember 30, 2012 , we were in compliance with all of the covenants, limitations and restrictions of our revolving credit facility and public debt obligations. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facility or cause any outstanding borrowings to become due and payable prior to maturity. Secured Letter of Credit Agreements - We have secured letter of credit agreements which require us to deposit cash, in an amount approximating the balance of letters of credit outstanding, as collateral with the issuing banks. AtSeptember 30, 2012 and 2011, the amount of cash restricted for this purpose totaled$47.2 million and$47.5 million , respectively, and is included in homebuilding restricted cash on our consolidated balance sheets. The amount of cash restricted atSeptember 30, 2012 includes cash collateral related to the letters of credit outstanding under the revolving credit facility.
Financial Services Capital Resources
Cash and Cash Equivalents - At
Mortgage Repurchase Facility - Our mortgage subsidiary,DHI Mortgage , has a mortgage repurchase facility that is accounted for as a secured financing. The mortgage repurchase facility provides financing and liquidity toDHI Mortgage by facilitating purchase transactions in whichDHI Mortgage transfers eligible loans to the counterparties against the transfer of funds by the counterparties, thereby becoming purchased loans.DHI Mortgage then has the right and obligation to repurchase the purchased loans upon their sale to third-party purchasers in the secondary market or within specified time frames from 45 to 120 days in accordance with the terms of the mortgage repurchase facility. InMarch 2012 , the mortgage repurchase facility was amended and renewed throughMarch 3, 2013 . The committed capacity of the facility remains at$180 million ; however, the capacity can be increased up to$225 million as needed. Increases in borrowing capacity in excess of$180 million are provided on an uncommitted basis and at a higher borrowing cost than committed borrowings. As ofSeptember 30, 2012 ,$278.6 million of mortgage loans held for sale with a collateral value of$263.9 million were pledged under the mortgage repurchase facility. As a result of advance paydowns totaling$76.1 million ,DHI Mortgage had an obligation of$187.8 million outstanding under the mortgage repurchase facility atSeptember 30, 2012 at a 2.8% annual interest rate. The mortgage repurchase facility is not guaranteed by eitherD.R. Horton, Inc. or any of the subsidiaries that guarantee our homebuilding debt. The facility contains financial covenants as to the mortgage subsidiary's minimum required tangible net worth, its maximum allowable ratio of debt to tangible net worth and its minimum required liquidity. These covenants are measured and reported monthly. AtSeptember 30, 2012 ,DHI Mortgage was in compliance with all of the conditions and covenants of the mortgage repurchase facility. In the past, our mortgage subsidiary has been able to renew or extend its mortgage credit facility on satisfactory terms prior to its maturity, and obtain temporary additional commitments through amendments to the credit agreement during periods of higher than normal volumes of mortgages held for sale. The liquidity of our financial services business depends upon its 47
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continued ability to renew and extend the mortgage repurchase facility or to obtain other additional financing in sufficient capacities.
Operating Cash Flow Activities
In fiscal 2012, we used$298.1 million of cash in our operating activities, compared to$14.9 million provided by our operating activities in fiscal 2011, which reflects cash used to invest in additional land and lot inventory and homes under construction as market conditions improved during 2012, offset by cash provided by net income and increases in payables and other liabilities. We have a substantial amount of liquidity which has given us the flexibility to invest capital to grow our operations. As our sales demand and profitability has improved, we have used cash from operating activities to increase our homes in inventory and invest in land acquisition, land development and housing inventory opportunities to meet housing demand and expand our operations in desirable markets. Over the past several years, our land investments had been primarily purchases of finished lots in most of our markets. In fiscal 2012, we began increasing our investments in undeveloped land and land development spending as the supply of finished lots declined in many of our markets. We expect a larger portion of our investments will shift from finished lot purchases to land acquisition and development, which will result in increased inventory levels.
Investing Cash Flow Activities
In fiscal 2012, net cash used in our investing activities was$138.3 million , compared to$19.3 million in fiscal 2011. The most significant investing use of cash in fiscal 2012 relative to fiscal 2011 was the purchase of the homebuilding operations ofBreland Homes , whereby$96.5 million of the purchase price was paid during the year. Also, purchases of property and equipment to support our operations, including model home furniture, office and technology equipment and office buildings, were$33.6 million in fiscal 2012 as compared to$16.3 million in fiscal 2011.
Financing Cash Flow Activities
During the past few years, most of our short-term financing needs have been funded with cash generated from operations and borrowings available under our financial services credit facility. Long-term financing needs of our homebuilding operations have historically been funded with the issuance of senior unsecured debt securities through the public capital markets. Going forward, the short-term financing needs of our homebuilding operations will be funded with existing cash, cash generated from profits and borrowings available under our new revolving credit facility.
During fiscal 2012, financing activities provided
Consistent with dividends paid in fiscal 2010 and 2011, our Board of Directors approved four quarterly cash dividends of$0.0375 per common share during fiscal 2012. The last of these was paid onAugust 24, 2012 to stockholders of record onAugust 13, 2012 . OnNovember 8, 2012 , our Board of Directors approved a cash dividend of$0.0375 per common share, payable onDecember 17, 2012 , to stockholders of record onDecember 3, 2012 . The declaration of future cash dividends is at the discretion of our Board of Directors and will depend upon, among other things, future earnings, cash flows, capital requirements, our financial condition and general business conditions. 48
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Changes in Capital Structure
EffectiveAugust 1, 2012 , our Board of Directors authorized the repurchase of up to$500 million of debt securities and$100 million of our common stock effective throughJuly 31, 2013 . The full amount of each of these authorizations was remaining atSeptember 30, 2012 . InMay 2012 , we issued$350 million principal amount of 4.75% senior notes dueMay 15, 2017 , and inSeptember 2012 , we issued$350 million principal amount of 4.375% senior notes dueSeptember 15, 2022 . In recent years, our primary non-operating use of available capital has been to repay debt, and in fiscal 2011 we also made limited stock repurchases. As our sales demand and profitability improved in fiscal 2012, our operating and investing uses of capital increased and our debt repayments decreased as compared to the past several years. We regularly assess our projected capital requirements to fund future growth in our business, repay our longer-term debt obligations, and support our other general corporate and operational needs, and we regularly evaluate our opportunities to raise additional capital. As market conditions permit, we may issue new debt or equity securities through the public capital markets or obtain additional bank financing to fund our projected capital requirements or provide additional liquidity.
Contractual Cash Obligations, Commercial Commitments and Off-Balance Sheet Arrangements
Our primary contractual cash obligations for our homebuilding and financial services segments are payments under our debt agreements and lease payments under operating leases. We expect to fund our contractual obligations in the ordinary course of business through a combination of our existing cash resources; cash flows generated from profits; renewed, amended or new revolving credit facilities, mortgage repurchase facilities or other bank financing; and the issuance of new debt or equity securities through the public capital markets as market conditions may permit. Our future cash requirements for contractual obligations as ofSeptember 30, 2012 are presented below: Payments Due by Period Less Than More Than Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years (In millions) Homebuilding:
Notes Payable - Principal (1)
107.9 159.2 73.6 75.9 Operating Leases 22.6 10.5 11.5 0.6 - Purchase Obligations 24.1 17.1 5.1 1.8 0.1 Totals $ 2,823.6 $ 311.4 $ 1,117.3 $ 968.9 $ 426.0 Financial Services: Notes Payable - Principal (2) $ 187.8 $ 187.8 $ - $ - $ - Notes Payable - Interest (2) 5.2 5.2 - - - Operating Leases 0.7 0.5 0.2 - - Totals $ 193.7 $ 193.5 $ 0.2 $ - $ -
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(1) Homebuilding notes payable represent principal and interest payments due on
our senior, convertible senior and secured notes.
(2) Financial services notes payable represent principal and interest payments
due on our mortgage subsidiary's repurchase facility. The interest obligation
associated with this variable rate facility is based on its annual effective
rate of 2.8% and principal balance outstanding atSeptember 30, 2012 . 49
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AtSeptember 30, 2012 , our homebuilding operations had outstanding letters of credit of$46.6 million , all of which were cash collateralized, and surety bonds of$698.4 million , issued by third parties, to secure performance under various contracts. We expect that our performance obligations secured by these letters of credit and bonds will generally be completed in the ordinary course of business and in accordance with the applicable contractual terms. When we complete our performance obligations, the related letters of credit and bonds are generally released shortly thereafter, leaving us with no continuing obligations. We have no material third-party guarantees. Our mortgage subsidiary enters into various commitments related to the lending activities of our mortgage operations. Further discussion of these commitments is provided in Item 7A "Quantitative and Qualitative Disclosures About Market Risk" under Part II of this annual report on Form 10-K. We enter into land and lot option purchase contracts to acquire land or lots for the construction of homes. Lot option contracts enable us to control significant lot positions with limited capital investment and substantially reduce the risks associated with land ownership and development. Within the land and lot option purchase contracts atSeptember 30, 2012 , there were a limited number of contracts, representing$24.1 million of remaining purchase price, subject to specific performance clauses which may require us to purchase the land or lots upon the land sellers meeting their obligations. Further discussion of our land option contracts is provided in the "Land and Lot Position and Homes in Inventory" section included herein.
Seasonality
Prior to the recent downturn in the homebuilding industry which began to affect our seasonal patterns in fiscal 2007, we experienced relatively predictable seasonal variations in our quarterly operating results and capital requirements. We began to experience our normal seasonal pattern again in both fiscal 2011 and 2012. We generally have more homes under construction, close more homes and have greater revenues and operating income in the third and fourth quarters of our fiscal year. The seasonal activity increases our working capital requirements for our homebuilding operations during the third and fourth fiscal quarters and increases our funding requirements for the mortgages we originate in our financial services segment at the end of these quarters. As a result of seasonal activity, our quarterly results of operations and financial position at the end of a particular fiscal quarter are not necessarily representative of the balance of our fiscal year. Inflation We may be adversely affected during periods of high inflation, primarily because of higher land, financing, labor and material construction costs. In addition, higher mortgage interest rates significantly affect the affordability of mortgage financing to prospective homebuyers. We attempt to pass through to our customers any increases in our costs through increased sales prices. However, during periods when housing market conditions are challenging, we may not be able to offset our cost increases with higher selling prices. 50
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Forward-Looking Statements
Some of the statements contained in this report, as well as in other materials we have filed or will file with theSecurities and Exchange Commission , statements made by us in periodic press releases and oral statements we make to analysts, stockholders and the press in the course of presentations about us, may be construed as "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on management's beliefs as well as assumptions made by, and information currently available to, management. These forward-looking statements typically include the words "anticipate," "believe," "consider," "estimate," "expect," "forecast," "goal," "intend," "objective," "plan," "predict," "projection," "seek," "strategy," "target," "will" or other words of similar meaning. Any or all of the forward-looking statements included in this report and in any other of our reports or public statements may not approximate actual experience, and the expectations derived from them may not be realized, due to risks, uncertainties and other factors. As a result, actual results may differ materially from the expectations or results we discuss in the forward-looking statements. These risks, uncertainties and other factors include, but are not limited to: • potential deterioration in homebuilding industry conditions and the current weak U.S. economy;
• the cyclical nature of the homebuilding industry and changes in general
economic, real estate and other conditions;
• constriction of the credit markets, which could limit our ability to
access capital and increase our costs of capital;
• reductions in the availability of mortgage financing and the liquidity
provided by government-sponsored enterprises, the effects of government
programs, a decrease in our ability to sell mortgage loans on
attractive terms or an increase in mortgage interest rates;
• the risks associated with our land and lot inventory;
• home warranty and construction defect claims;
• supply shortages and other risks for acquiring land, building materials
and skilled labor;
• reductions in the availability of performance bonds;
• increases in the costs of owning a home;
• the effects of governmental regulations and environmental matters on
our homebuilding operations;
• the effects of governmental regulation on our financial services operations;
• our debt obligations and our ability to comply with related debt covenants, restrictions and limitations;
• competitive conditions within our industry;
• our ability to effect any future growth strategies successfully;
• the impact of an inflationary or deflationary environment;
• our ability to realize the full amount of our deferred income tax asset; and
• information technology failures and data security breaches.
We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. Additional information about issues that could lead to material changes in performance and risk factors that have the potential to affect us is contained in Item 1A, "Risk Factors" under Part I of this annual report on Form 10-K. 51
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Critical Accounting Policies
General - A comprehensive enumeration of the significant accounting policies ofD.R. Horton, Inc. and subsidiaries is presented in Note A to the accompanying financial statements as ofSeptember 30, 2012 and 2011, and for the years endedSeptember 30, 2012 , 2011 and 2010. Each of our accounting policies has been chosen based upon current authoritative literature that collectively comprises U.S. Generally Accepted Accounting Principles (GAAP). In instances where alternative methods of accounting are permissible under GAAP, we have chosen the method that most appropriately reflects the nature of our business, the results of our operations and our financial condition, and have consistently applied those methods over each of the periods presented in the financial statements. The Audit Committee of our Board of Directors has reviewed and approved the accounting policies selected. Revenue Recognition - We generally recognize homebuilding revenue and related profit at the time of the closing of a sale, when title to and possession of the property are transferred to the buyer. In situations where the buyer's financing is originated byDHI Mortgage , our 100% owned mortgage subsidiary, and the buyer has not made an adequate initial or continuing investment, the profit is deferred until the sale of the related mortgage loan to a third-party purchaser has been completed. Any profit on land sales is deferred until the full accrual method criteria are met. When appropriate, revenue and profit on long-term construction projects are recognized under the percentage-of-completion method. We include proceeds from home closings held for our benefit at title companies in homebuilding cash. When we execute sales contracts with our homebuyers, or when we require advance payment from homebuyers for custom changes, upgrades or options related to their homes, we record the cash deposits received as liabilities until the homes are closed or the contracts are canceled. We either retain or refund to the homebuyer deposits on canceled sales contracts, depending upon the applicable provisions of the contract or other circumstances. We recognize financial services revenues associated with our title operations as closing services are rendered and title insurance policies are issued, both of which generally occur simultaneously as each home is closed. We transfer substantially all underwriting risk associated with title insurance policies to third-party insurers. We typically elect the fair value option for our mortgage loan originations. Mortgage loans held for sale are initially recorded at fair value based on either sale commitments or current market quotes and are adjusted for subsequent changes in fair value until the loan is sold. Net origination costs and fees associated with mortgage loans are recognized at the time of origination. The expected net future cash flows related to the associated servicing of a loan are included in the measurement of all written loan commitments that are accounted for at fair value through earnings at the time of commitment. We generally sell the mortgages we originate and the related servicing rights to third-party purchasers. Interest income is earned from the date a mortgage loan is originated until the loan is sold. Some mortgage loans are sold with limited recourse provisions. Based on historical experience, discussions with our mortgage purchasers, analysis of the mortgages we originated and current housing and credit market conditions, we estimate and record a loss reserve for mortgage loans held in portfolio and mortgage loans held for sale, as well as known and projected mortgage loan repurchase requests. A 20% or 40% increase in the amount of expected mortgage loan repurchases and expected losses on mortgage loan repurchases would result in an increase of approximately$0.8 million or$2.6 million , respectively, in our reserve for expected mortgage loan repurchases.Marketable Securities - We invest a portion of our cash on hand by purchasing marketable securities with maturities in excess of three months. These securities are held in the custody of a single financial institution. We consider our investment portfolio to be available-for-sale. Accordingly, these investments are recorded at fair value. At the end of a reporting period, unrealized gains and losses on these investments, net of tax, are recorded in accumulated other comprehensive income (loss) on the consolidated balance sheet. Gains and losses realized upon the sale of marketable securities are determined by specific identification and are included in homebuilding other income. Inventories and Cost of Sales - Inventory includes the costs of direct land acquisition, land development and home construction, capitalized interest, real estate taxes and direct overhead costs incurred during development and home construction. Costs that we incur after development projects or homes are substantially complete, such as utilities, maintenance, and cleaning, are charged to SG&A expense as incurred. All indirect overhead costs, such as compensation of sales personnel, division and region management, and the costs of advertising and builder's risk insurance are charged to SG&A expense as incurred. 52
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Land and development costs are typically allocated to individual residential lots on a pro-rata basis, and the costs of residential lots are transferred to construction in progress when home construction begins. We use the specific identification method for the purpose of accumulating home construction costs. Cost of sales for homes closed includes the specific construction costs of each home and all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) allocated to each residential lot based upon the total number of homes expected to be closed in each community. Any changes to the estimated total development costs subsequent to the initial home closings in a community are allocated on a pro-rata basis to the homes in the community benefiting from the relevant development activity, which generally relates to the remaining homes in the community. When a home is closed, we generally have not paid all incurred costs necessary to complete the home. We record as a liability and as a charge to cost of sales the amount we determine will ultimately be paid related to completed homes that have been closed. We compare our home construction budgets to actual recorded costs to determine the additional costs remaining to be paid on each closed home. We monitor the accrual by comparing actual costs incurred on closed homes in subsequent months to the amount previously accrued. Although actual costs to be paid in the future on previously closed homes could differ from our current accruals, differences in amounts historically have not been significant. Each quarter, the performance and outlook of land inventory and communities under development are reviewed for indicators of potential impairment. If indicators of impairment are present for a community, we perform an impairment evaluation of the community, which generally includes an analysis to determine if the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts, and if so, impairment charges are recorded to cost of sales if the fair value of such assets is less than their carrying amounts. We generally review our inventory for impairment indicators at the community level and the inventory within each community is categorized as land held for development, residential land and lots developed and under development, and/or construction in progress and finished homes, based on the stage of production or plans for future development. A particular community often includes inventory in more than one category. In certain situations, inventory may be analyzed separately for impairment purposes based on its product type (e.g. single family homes evaluated separately from condominium parcels). In reviewing each of our communities, we determine if impairment indicators exist on inventory held and used by analyzing a variety of factors including, but not limited to, the following: • gross margins on homes closed in recent months;
• projected gross margins on homes sold but not closed;
• projected gross margins based on community budgets;
• trends in gross margins, average selling prices or cost of sales;
• sales absorption rates; and
• performance of other communities in nearby locations.
If indicators of impairment are present for a community, we perform an impairment evaluation of the community, which generally includes an analysis to determine if the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts, and if so, impairment charges are recorded to cost of sales if the fair value of such assets is less than their carrying amounts. These estimates of cash flows are significantly impacted by community specific factors including estimates of the amounts and timing of future revenues and estimates of the amount of land development, materials and labor costs which, in turn, may be impacted by the following local market conditions:
• supply and availability of new and existing homes;
• location and desirability of our communities;
• variety of product types offered in the area;
• pricing and use of incentives by us and our competitors;
• alternative uses for our land or communities such as the sale of land, finished lots or home sites to third parties; • amount of land and lots we own or control in a particular market or sub-market; and
• local economic and demographic trends.
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For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Our determination of fair value is primarily based on discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams. When an impairment charge for a community is determined, the charge is then allocated to each lot in the community in the same manner as land and development costs are allocated to each lot. The inventory within each community is categorized as construction in progress and finished homes, residential land and lots developed and under development, and land held for development, based on the stage of production or plans for future development. Impairment charges are also recorded on finished homes in substantially completed communities when events or circumstances indicate that the carrying values are greater than the fair values less estimated costs to sell these homes. For the inventory impairment analyses we performed during fiscal 2012, we assumed that for the majority of communities, sales prices in future periods will be equal to or lower than current sales order prices in each community, or in comparable communities, in order to generate an acceptable absorption rate. For a minority of communities that we do not intend to develop or operate in current market conditions, some increases over current sales prices were assumed. The remaining lives of the communities evaluated were estimated to be in a range from six months to in excess of ten years, and we utilized a range of discount rates for communities from 12% to 16%. We typically do not purchase land for resale. However, when we own land or communities under development that do not fit into our development and construction plans and we determine to sell the asset, the project is accounted for as land held for sale. We record land held for sale at the lesser of its carrying value or fair value less estimated costs to sell. In performing the impairment evaluation for land held for sale, we consider several factors including, but not limited to, prices for land in recent comparable sales transactions, market analysis studies, which include the estimated price a willing buyer would pay for the land and recent legitimate offers received. If the estimated fair value less costs to sell an asset is less than the current carrying value, the asset is written down to its estimated fair value less costs to sell. The key assumptions relating to inventory valuations are impacted by local market economic conditions and the actions of competitors, and are inherently uncertain. Due to uncertainties in the estimation process, actual results could differ from such estimates. Our quarterly assessments reflect management's estimates and we continue to monitor the fair value of held-for-sale assets through the disposition date. Land and Lot Option Purchase Contracts - We enter into land and lot option purchase contracts to acquire land or lots for the construction of homes. Under these contracts, we will fund a stated deposit in consideration for the right, but not the obligation, to purchase land or lots at a future point in time with predetermined terms. Under the terms of the option purchase contracts, many of our option deposits are not refundable at our discretion. Option deposits and pre-acquisition costs we incur related to land and lot option purchase contracts are capitalized if all of the following conditions have been met: (1) the costs are directly identifiable with the specific property; (2) the costs would be capitalized if the property were already acquired; and (3) acquisition of the property is probable, meaning we are actively seeking and have the ability to acquire the property, and there is no indication that the property is not available for sale. We consider the following when determining if the acquisition of the property is probable: (1) changes in market conditions subsequent to contracting for the purchase of the land; (2) current contract terms, including per lot price and required purchase dates; and (3) our current land position in the given market or sub-market. Option deposits and capitalized pre-acquisition costs are expensed to cost of sales when we believe it is probable that we will no longer acquire the property under option and will not be able to recover these costs through other means. Occasionally, an option purchase contract can result in the creation of a variable interest in the entity holding the land parcel under option. We determine if we are the primary beneficiary of the variable interest entity based on our ability to control both (1) the activities of a variable interest entity that most significantly impact the entity's economic performance and (2) the obligation to absorb losses of the entity or the right to receive benefits from the entity. Based on this evaluation, if we are the primary beneficiary of an entity with which we have entered into a land or lot option purchase contract, the variable interest entity is consolidated. Creditors, if any, of these variable interest entities have no recourse against us. 54
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Fair Value Measurements - The FASB's authoritative guidance for fair value measurements establishes a three-level hierarchy based upon the inputs to the valuation model of an asset or liability. The fair value hierarchy and its application to our assets and liabilities, is as follows: • Level 1 - Valuation is based on quoted prices in active markets for
identical assets and liabilities.
• Level 2 - Valuation is determined from quoted prices for similar assets or
liabilities in active markets, quoted prices for identical or similar
instruments in markets that are not active, or by model-based techniques
in which all significant inputs are observable in the market.
• Level 3 - Valuation is derived from model-based techniques in which at
least one significant input is unobservable and based on our own estimates
about the assumptions that market participants would use to value the asset or liability. When available, we use quoted market prices in active markets to determine fair value. We consider the principal market and nonperformance risk associated with our counterparties when determining the fair value measurements, if applicable. Fair value measurements are used for our marketable securities, mortgage loans held for sale, interest rate lock commitments (IRLCs) and other derivative instruments on a recurring basis, and are used for inventories, other mortgage loans and real estate owned on a nonrecurring basis, when events and circumstances indicate that the carrying value may not be recoverable. Goodwill - We record goodwill associated with our acquisitions of businesses when the consideration paid exceeds the fair value of the net tangible and identifiable intangible assets acquired. We evaluate our goodwill balances for potential impairment on an annual basis. The current guidance allows an entity to assess qualitatively whether it is necessary to perform step one of a prescribed two-step annual goodwill impairment test. If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, the two-step goodwill impairment test is not required. We performed a qualitative assessment of our goodwill balances of$38.9 million and$15.9 million atSeptember 30, 2012 and 2011, respectively, and determined that the two-step process was not necessary. Warranty Claims - We typically provide our homebuyers with a ten-year limited warranty for major defects in structural elements such as framing components and foundation systems, a two-year limited warranty on major mechanical systems, and a one-year limited warranty on other construction components. Since we subcontract our construction work to subcontractors who typically provide an indemnity and a certificate of insurance prior to receiving payments for their work, claims relating to workmanship and materials are generally the primary responsibility of the subcontractors. Warranty liabilities are established by charging cost of sales for each home delivered. The amounts charged are based on management's estimate of expected warranty-related costs under all unexpired warranty obligation periods. Our warranty liability is based upon historical warranty cost experience in each market in which we operate, and is adjusted as appropriate to reflect qualitative risks associated with the types of homes we build and the geographic areas in which we build them. Actual future warranty costs could differ from our currently estimated amounts. A 10% change in the historical warranty rates used to estimate our warranty accrual would not result in a material change in our accrual. Legal Claims and Insurance - We are named as a defendant in various claims, complaints and other legal actions in the ordinary course of business. At any point in time, we are managing several hundred individual claims related to construction defect matters, personal injury claims, employment matters, land development issues and contract disputes. We have established reserves for these contingencies based on the estimated costs of pending claims and the estimated costs of anticipated future claims related to previously closed homes. At bothSeptember 30, 2012 and 2011, 99% of these reserves related to construction defect matters. Our reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. As ofSeptember 30, 2012 , we have reserves for approximately 170 pending construction defect claims, and no individual existing claim was material to our financial statements. The majority of our total construction defect reserves consists of the estimated exposure to future claims on previously closed homes. We have closed a significant number of homes during recent years, and as a result we may be subject to future construction defect claims on these homes. Although regulations vary from state to state, construction defect issues can generally be reported for up to ten years after the home has closed in many states in which we operate. Historical data and trends regarding the frequency of claims incurred and the costs to resolve claims relative to the types of products and markets where we operate are used to estimate the construction defect liabilities for both existing and anticipated future claims. These estimates are subject to ongoing revision as the circumstances of individual pending claims and historical data and trends change. Adjustments to estimated reserves are recorded in the accounting period in which the change in estimate occurs. 55
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Historical trends in construction defect claims have been inconsistent, and we believe they may continue to fluctuate over the next several years. Housing market conditions have been volatile across most of our markets over the past ten years, and we believe such conditions can affect the frequency and cost of construction defect claims. We closed a significant number of homes during our peak operating years from 2003 to 2007. If the ultimate resolution of construction defect claims resulting from closings in our peak operating years varies from current expectations, it could significantly change our estimates regarding the frequency and timing of claims incurred and the costs to resolve existing and anticipated future claims, which would impact the construction defect reserves in the future. If the frequency of claims incurred or costs of existing and future legal claims significantly exceed our current estimates, they will have a significant negative impact on our future earnings and liquidity. We estimate and record receivables under applicable insurance policies related to our estimated contingencies for known claims and anticipated future construction defect claims on previously closed homes and other legal claims and lawsuits incurred in the ordinary course of business when recovery is probable. Additionally, we may have the ability to recover a portion of our losses from our subcontractors and their insurance carriers when we have been named as an additional insured on their insurance policies. The estimation of losses related to these reserves and the related estimates of receivables from insurance policies are subject to a high degree of variability due to uncertainties such as trends in construction defect claims relative to our markets and the types of products built, claim frequency, claim settlement costs and patterns, insurance industry practices and legal interpretations, among others. Due to the high degree of judgment required in establishing reserves for these contingencies, actual future costs and recoveries from insurance could differ significantly from current estimated amounts. A 10% increase in the claim frequency and the average cost per claim used to estimate the reserves would result in an increase of approximately$137.7 million in our reserves and a$73.3 million increase in our receivable, resulting in additional expense of$64.4 million . A 10% decrease in the claim frequency and the average cost per claim would result in a decrease of approximately$96.0 million in our reserves and a$58.1 million decrease in our receivable, resulting in a reduction in expense of$37.9 million . Income Taxes - We calculate our income tax expense (benefit) using the asset and liability method, under which deferred tax assets and liabilities are recorded based on the tax consequences of temporary differences between the financial statement amounts of assets and liabilities and their tax bases, and of tax loss and credit carryforwards. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is primarily dependent upon the generation of sufficient taxable income in future periods and in the jurisdictions in which those temporary differences become deductible. We record a valuation allowance when we determine it is more likely than not that a portion of our deferred tax assets will not be realized. In determining the future tax consequences of events that have been recognized in our financial statements or tax returns, judgment is required. The accounting for deferred taxes is based upon an estimate of future results. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws and tax rates also affect actual tax results and the valuation of deferred tax assets over time. Interest and penalties related to unrecognized tax benefits are recognized in the financial statements as a component of income tax expense. Significant judgment is required to evaluate uncertain tax positions. We evaluate our uncertain tax positions on a quarterly basis. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change. 56
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Stock-based Compensation - From time to time, the compensation committee of our board of directors authorizes the issuance of stock-based compensation to our employees and directors. The committee approves grants out of amounts remaining available for grant from amounts formally authorized by the common stockholders. Options are granted at exercise prices which equal the market value of our common stock at the date of the grant. The options vest over periods of 2 to 9.75 years and expire 10 years after the dates on which they were granted. We measure and recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements for all awards granted or modified afterOctober 1, 2005 , using the modified prospective method. Compensation expense for any unvested stock option awards outstanding as ofOctober 1, 2005 is recognized on a straight-line basis over the remaining vesting period. We calculate the fair values of stock options using the Black-Scholes option pricing model. Determining the fair value of share-based awards at the grant date requires judgment in developing assumptions, which involve a number of variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, the expected dividend yield and expected stock option exercise behavior. In addition, we also use judgment in estimating the number of share-based awards that are expected to be forfeited.
Recent Accounting Pronouncements
InDecember 2011 , the FASB issued ASU 2011-11, "Disclosures about Offsetting Assets and Liabilities," which requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. The guidance is effective for us beginningOctober 1, 2013 and is to be applied retrospectively. The adoption of this guidance, which is related to disclosure only, is not expected to have a material impact on our consolidated financial position, results of operations or cash flows. InJuly 2012 , the FASB issued ASU 2012-02, "Intangibles - Goodwill and Other," which provides the option to perform a qualitative, rather than quantitative, assessment to determine whether it is more likely than not an indefinite-lived intangible asset is impaired. If the asset is considered impaired, an entity is required to perform the quantitative assessment under the existing guidance. The guidance is effective for our interim and annual impairment tests beginning in fiscal 2013. The adoption of this guidance, which is intended to simplify the impairment testing, is not expected to impact our consolidated financial position, results of operations or cash flows. 57
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