D. R. Horton - 10-Q quarterly report FY

 

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See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

The accompanying unaudited, consolidated financial statements include the accounts of D.R. Horton, Inc. and all of its wholly-owned, majority-owned and controlled subsidiaries (the “Company”), as well as certain variable interest entities from which we are purchasing land or lots under option purchase contracts. All significant intercompany accounts, transactions and balances have been eliminated in consolidation. The statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Regulation S-X. In the opinion of management, all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation have been included. These statements do not include all of the information and notes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2004. Certain reclassifications have been made in the prior year’s financial statements to conform to classifications used in the current year.

Historically, the homebuilding industry has experienced seasonal fluctuations; therefore, the operating results for the three-month and nine-month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2005.

Business - The Company is a national homebuilder that is engaged primarily in the construction and sale of single-family housing in 71 markets and 23 states in the United States. The Company designs, builds and sells single-family houses on lots developed by the Company and on finished lots which it purchases, ready for home construction. Periodically, the Company sells land and lots it has developed or bought. The Company also provides title agency and mortgage brokerage services to its homebuyers. The Company does not retain or service the mortgages that it originates but, rather, sells the mortgages and related servicing rights to investors.

Stock Split – In February 2005, the Company’s Board of Directors declared a four-for-three stock split (effected as a 33% stock dividend), paid on March 16, 2005 to common stockholders of record on March 1, 2005. The earnings per share and cash dividends declared per share for the three and nine months ended June 30, 2005 and 2004 reflect the effects of the stock split.

The Company’s reportable business segments consist of homebuilding and financial services. Homebuilding is the Company’s core business, generating 98% of consolidated revenues during the nine months ended June 30, 2005 and 2004, and 96% and 94% of consolidated income before income taxes during the nine months ended June 30, 2005 and 2004, respectively. The homebuilding reporting segment is comprised of the aggregate of the Company’s regional homebuilding operations and generates most of its revenues from the sale of completed homes, with a lesser amount from the sale of land and lots. Approximately 85% and 84% of home sales revenues were generated from the sale of single-family detached homes for the nine months ended June 30, 2005 and 2004, respectively, and the remainder of home sales revenues were generated from the sale of attached homes, such as town homes, duplexes, triplexes and condominiums (including some mid-rise buildings), which share common walls and roofs. The financial services segment generates its revenues from originating and selling mortgages and collecting fees for title insurance agency and closing services.

Basic earnings per share for the three months and nine months ended June 30, 2005 and 2004 is based on the weighted average number of shares of common stock outstanding. Diluted earnings per share is based on the weighted average number of shares of common stock and dilutive securities outstanding.

The following table sets forth the denominators used in the computation of basic and diluted earnings per share:

In February 2005, the Company’s Board of Directors declared a four-for-three stock split (effected as a 33% stock dividend), paid on March 16, 2005 to common stockholders of record on March 1, 2005. The share amounts presented above reflect the effects of the four-for-three stock split.

All options outstanding during the three and nine months ended June 30, 2005 and 2004 were included in the computation of diluted earnings per share.

In the ordinary course of its homebuilding business, the Company enters into land and lot option purchase contracts in order to procure land or lots for the construction of homes. Under such option purchase contracts, the Company 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 the Company’s option deposits are non-refundable. Under the requirements of Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), certain of the Company’s option purchase contracts result in the acquisition of a variable interest in the entity holding the land parcel under option.

In applying the provisions of FIN 46, the Company evaluates those land and lot option purchase contracts with variable interest entities to determine whether the Company is the primary beneficiary based upon analysis of the variability of the expected gains and losses of the entity. Based on this evaluation, if the Company is the primary beneficiary of an entity with which the Company has entered into a land or lot option purchase contract, the variable interest entity is consolidated.

The consolidation of these variable interest entities and other inventory obligations added $185.2 million in land inventory not owned and minority interests related to entities not owned to the Company’s balance sheet at June 30, 2005. The Company’s obligations related to these land or lot option contracts are guaranteed by cash deposits totaling $18.8 million and performance letters of credit, promissory notes and surety bonds totaling $3.3 million. Creditors of these variable interest entities have no recourse against the Company.

At June 30, 2005, including the deposits with the variable interest entities above, the Company had deposits amounting to $284.0 million to purchase land and lots with a total remaining purchase price of $5.7 billion. For the variable interest entities which are unconsolidated because the Company is not subject to a majority of the risk of loss or entitled to receive a majority of the entities’ residual returns, the maximum exposure to loss is generally limited to the amounts of the Company’s option deposits, which totaled $218.4 million at June 30, 2005.

The Company’s notes payable at their principal amounts, net of unamortized discount or premium, as applicable, consist of the following:

The Company has a $1.21 billion unsecured revolving credit facility, which includes a $350 million letter of credit sub-facility, that matures on March 25, 2008. The Company’s borrowing capacity under this facility is reduced by the amount of letters of credit outstanding. At June 30, 2005, the Company’s borrowing capacity from this facility was $1.04 billion. The facility is guaranteed by substantially all of the Company’s wholly-owned subsidiaries other than its financial services subsidiaries. Borrowings bear daily interest at rates based upon the London Interbank Offered Rate (LIBOR) plus a spread based upon the Company’s ratio of debt to tangible net worth and senior unsecured debt rating. The interest rate applicable to the revolving credit facility at June 30, 2005 was 4.6%. In addition to the stated interest rates, the revolving credit facility requires the Company to pay certain fees.

In October 2004, the Company issued $250 million principal amount of 4.875% senior notes due 2010. The notes, which are due January 15, 2010, with interest payable semi-annually, represent unsecured obligations of the Company. The Company may redeem the notes in whole at any time or in part from time to time, at a redemption price equal to the greater of 100% of their principal amount or the present value of the remaining scheduled payments on the redemption date, discounted at a rate equal to the yield to maturity of a United States Treasury security with a comparable maturity, plus 25 basis points (0.25%), plus, in each case, accrued interest. The annual effective interest rate of the notes, after giving effect to the amortization of deferred financing costs and discounts, is 5.1%.

In December 2004, the Company issued $300 million principal amount of 5.625% senior notes due 2016. The notes, which are due January 15, 2016, with interest payable semi-annually, represent unsecured obligations of the Company. The Company may redeem the notes in whole at any time or in part from time to time, at a redemption price equal to the greater of 100% of their principal amount or the present value of the remaining scheduled payments on the redemption date, discounted at a rate equal to the yield to maturity of a United States Treasury security with a comparable maturity, plus 30 basis points (0.30%), plus, in each case, accrued interest. The annual effective interest rate of the notes, after giving effect to the amortization of deferred financing costs and discounts, is 5.8%.

In February 2005, the Company issued $300 million principal amount of 5.25% senior notes due 2015. The notes, which are due February 15, 2015, with interest payable semi-annually, represent unsecured obligations of the Company. The Company may redeem the notes in whole at any time or in part from time to time, at a redemption price equal to the greater of 100% of their principal amount or the present value of the remaining scheduled payments on the redemption date, discounted at a rate equal to the yield to maturity of a United States Treasury security with a comparable maturity, plus 25 basis points (0.25%), plus, in each case, accrued interest. The annual effective interest rate of the notes, after giving effect to the amortization of deferred financing costs and discounts, is 5.4%.

On April 1, 2005, the Company repaid the $200 million principal amount of its 10.5% senior notes which were due on that date.

The bank credit facilities and the indentures for most of the senior and senior subordinated notes contain covenants which, taken together, limit investments in inventory, stock repurchases, cash dividends and other restricted payments, incurrence of indebtedness, asset dispositions and creation of liens, and require certain levels of tangible net worth. At June 30, 2005, under the most restrictive covenants, the additional debt the Company could incur would be limited to $3.1 billion, which included $1.04 billion available under the revolving credit facility. At that date, under the most restrictive covenants, $1.2 billion was available for restricted payments.

In April 2005, the Company’s mortgage subsidiary renewed its $300 million mortgage warehouse loan facility payable to financial institutions, extending the maturity date to April 7, 2006 and increasing the amount that may be borrowed under the uncommitted accordion feature to $150 million. In June 2005, through amendment to the credit agreement, the Company exercised the accordion feature and obtained commitments from its lenders that increased the total size of the facility to $450 million. The mortgage warehouse facility is secured by certain mortgage loans held for sale and is not guaranteed by D.R. Horton, Inc. or any of the guarantors of its homebuilding debt. Borrowings bear daily interest at the 30-day LIBOR rate plus a fixed premium. The interest rate of the mortgage warehouse facility at June 30, 2005 was 4.2%.

The Company’s mortgage subsidiary also has a $500 million commercial paper conduit facility (the CP conduit facility), that expires on June 29, 2006. In June 2005, through amendment to the credit agreement, the Company increased the capacity available under this facility from $300 million to $500 million. The CP conduit facility is secured by certain mortgage loans held for sale and is not guaranteed by D.R. Horton, Inc. or any of the guarantors of its homebuilding debt. The mortgage loans pledged to secure the CP conduit facility are used as collateral for asset backed commercial paper issued by multi-seller conduits in the commercial paper market. The interest rate of the CP conduit facility at June 30, 2005 was 3.9%.

The Company capitalizes homebuilding interest costs to inventory during development and construction. Capitalized interest is charged to cost of sales as the related inventory is delivered to the buyer. The following table summarizes the Company’s homebuilding interest costs incurred, charged to cost of sales, and expensed directly during the three-month and nine-month periods ended June 30, 2005 and 2004:

The Company provides its homebuyers a one-year comprehensive limited warranty for all parts and labor and a ten-year limited warranty for major construction defects. The Company’s warranty reserve is based upon historical warranty cost experience in each market in which it operates and is adjusted as appropriate to reflect qualitative risks associated with the types of homes built and the geographic areas in which they are built.

     Changes in the Company’s warranty reserve are as follows:

The Company may, with the approval of the Compensation Committee of its Board of Directors, grant to its employees options to purchase a fixed number of shares of its common stock. The Company accounts for stock option grants in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” The exercise price of the Company’s employee stock options generally equals the market price of the underlying stock on the date of grant; therefore, no compensation expense is recognized for the initial grant. The Company adopted the disclosure provisions specified by Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” SFAS No. 123 and SFAS No. 148 require disclosure of pro forma net income and pro forma net income per share as if the fair value based method had been applied in measuring compensation expense.

The following table sets forth the effect on net income and earnings per share (split-adjusted) for the three months and nine months ended June 30, 2005 and 2004 as if the fair value based method had been applied:

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” This statement, which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements,” changes the requirements for the accounting for and reporting of a change in accounting principle. The statement requires retrospective application of changes in accounting principle to prior periods’ financial statements unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” This statement, which replaces SFAS No. 123 and supersedes APB Opinion No. 25, requires that companies measure and recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements. The statement will be effective beginning in the Company’s first quarter of fiscal year 2006. The Company is currently evaluating the impact of the adoption of SFAS No. 123(R); however, it is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued Staff Position 109-1, “Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1). The American Jobs Creation Act, which was signed into law in October 2004, provides a tax deduction on qualified domestic production activities. When fully phased-in, the deduction will be up to 9% of the lesser of “qualified production activities income” or taxable income. Based on the guidance provided by FSP 109-1, this deduction should be accounted for as a special deduction under SFAS No. 109 and will reduce tax expense in the period or periods that the amounts are deductible on the tax return. The tax benefits, if any, resulting from the new deduction will be effective beginning in the Company’s first quarter of fiscal year 2006. The Company is currently evaluating the impact of this law on its future financial statements.

In October 2004, the FASB ratified Emerging Issues Task Force Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” (EITF 04-8). EITF 04-8 requires that shares underlying contingently convertible debt be included in diluted earnings per share computations using the if-converted method regardless of whether the market price trigger, or other contingent features, has been met. The effective date for EITF 04-8 is for reporting periods ending after December 15, 2004. EITF 04-8 also requires restatement of earnings per share amounts for prior periods presented during which the instrument was outstanding. In May 2001, the Company issued 381,113 zero coupon convertible senior notes, which were converted into shares of its common stock in June 2003. During certain quarters of the years ended September 30, 2003, 2002 and 2001, the market price trigger was not met and the convertible shares were not included in the computation of diluted earnings per share.

The following table sets forth the effect of the adoption of EITF 04-8 on diluted income before cumulative effect of change in accounting principle per share and net income per share for the periods affected. Per share amounts have been adjusted to reflect the effects of all stock splits paid subsequent to the date these per share amounts were originally reported.

The Company has been named as defendant in various claims, complaints and other legal actions arising in the ordinary course of business, including warranty and construction defect claims on closed homes. The Company has established reserves for such contingencies, based on the expected costs of the self-insured portion of such claims. The Company’s estimates of such reserves are based on the facts and circumstances of individual pending claims and historical data and trends, including estimates of the costs of unreported claims related to past operations. These reserve 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.

Management believes that, while the outcome of such contingencies cannot be predicted with certainty, the liabilities arising from these matters will not have a material adverse effect on the Company’s financial position. However, to the extent the liability arising from the ultimate resolution of any matter exceeds management’s estimates reflected in the reserves relating to such matter, the Company could incur additional charges that could be significant.

All of the Company’s senior and senior subordinated notes and borrowings under the homebuilding revolving credit facility are fully and unconditionally guaranteed, on a joint and several basis, by all of the Company’s direct and indirect subsidiaries (Guarantor Subsidiaries), other than financial services subsidiaries and certain other inconsequential subsidiaries (collectively, Non-Guarantor Subsidiaries). Each of the Guarantor Subsidiaries is wholly-owned. In lieu of providing separate financial statements for the Guarantor Subsidiaries, consolidated condensed financial statements are presented below. Separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented because management has determined that they are not material to investors.