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HORTON D R INC 10-K 2006 Documents found in this filing:
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Commission file number 1-14122
(817) 390-8200
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the
Act:
Securities registered pursuant to Section 12(g) of the
Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes þ No
o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of “accelerated filer and large
accelerated filer” in
Rule 12b-2
of the Exchange Act.
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of March 31, 2006, the aggregate market value of the
outstanding shares held by non-affiliates of the registrant was
approximately $9,464,684,000. Solely for purposes of this
calculation, all directors and executive officers were excluded
as affiliates of the registrant.
As of December 4, 2006, there were 317,209,740 shares
of Common Stock, par value $.01 per share, issued and
313,556,940 shares outstanding.
Portions of the registrant’s definitive Proxy Statement for
the 2007 Annual Meeting of Stockholders are incorporated herein
by reference in Part III.
D.R. Horton, Inc. is the largest homebuilding company in the
United States, based on our domestic homes closed during the
twelve months ended September 30, 2006. We construct and
sell high quality homes through our operating divisions in
27 states and 84 metropolitan markets of the United States,
primarily under the name of D.R. Horton, America’s
Builder. D.R. Horton, Inc. is a Fortune 500 company,
and our common stock is included in the S&P 500 Index and
listed on the New York Stock Exchange under the ticker symbol
“DHI.” Unless the context otherwise requires, the
terms “D.R. Horton,” the “Company,”
“we” and “our” used herein refer to D.R.
Horton, Inc., a Delaware corporation, and its predecessors and
subsidiaries.
Donald R. Horton began our homebuilding business in 1978. In
1991, we were incorporated in Delaware to acquire the assets and
businesses of our predecessor companies, which were residential
home construction and development companies owned or controlled
by Mr. Horton. In 1992, we completed our initial public
offering of our common stock. From inception, we have
consistently grown the size of our company by investing our
available capital into our existing homebuilding markets and
into
start-up
operations in new markets. Additionally, we have acquired
numerous other homebuilding companies, which have strengthened
our market position in existing markets and expanded our
geographic presence and product offerings in other markets. The
effectiveness of our organic growth and acquisition strategies
enabled us to become the largest homebuilding company in the
United States, a distinction we have maintained for our
last five fiscal years. Our homes generally range in size from
1,000 to 5,000 square feet and in price from $90,000 to
$900,000. For the year ended September 30, 2006, we closed
53,099 homes with an average closing sales price of
approximately $273,900.
Through our financial services operations, we provide mortgage
banking and title agency services to homebuyers in many of our
homebuilding markets. DHI Mortgage, our wholly-owned subsidiary,
provides mortgage financing services, principally to purchasers
of homes we build and sell. We originate mortgage loans, then
package and sell them and their servicing rights to third-party
investors shortly after origination on a non-recourse or limited
recourse basis. Our subsidiary title companies serve as title
insurance agents by providing title insurance policies,
examination and closing services, primarily to purchasers of
homes we build and sell.
Our financial reporting segments consist of six homebuilding
segments and a financial services segment. Our homebuilding
operations are by far the most substantial part of our business,
comprising approximately 98% of consolidated revenues and
approximately 95% of consolidated income before income taxes in
fiscal 2006. During fiscal 2006, our total consolidated revenues
were $15.1 billion, and our total consolidated income
before income taxes was $2.0 billion. Our homebuilding
reporting segments generate most of their revenues from the sale
of completed homes, with a lesser amount from the sale of land
and lots. In addition to building traditional single-family
detached homes, the homebuilding segments also build attached
homes, such as town homes, duplexes, triplexes and condominiums
(including some mid-rise buildings), which share common walls
and roofs. The sale of detached homes generated approximately
80%, 83%, and 84% of home sales revenues in fiscal 2006, 2005
and 2004, respectively. Our financial services segment generates
its revenues from originating and selling mortgages and
collecting fees for title insurance agency and closing services.
We make available, as soon as reasonably practicable, on our
Internet website all of our reports required to be filed with
the Securities and Exchange Commission. These reports include
our annual report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
changes in beneficial ownership reports on Forms 3, 4,
and 5, proxy statements and amendments to such reports.
These reports may be accessed by going to our Internet website
and clicking on the “Investor Relations” link. We will
also provide these reports in electronic or paper format to our
stockholders free of charge upon request made to our Investor
Relations department. Information on our Internet website is not
part of this annual report on
Form 10-K.
Our principal executive offices are located at 301 Commerce
Street, Suite 500, Fort Worth, Texas 76102. Our
telephone number is
(817) 390-8200,
and our Internet website address is www.drhorton.com.
Operating
Strategy
Our overall operating strategy has long been to take advantage
of opportunities to grow our homebuilding business profitably
through capturing greater market share, while continuing to
maintain a strong balance sheet. To execute our strategy we have
invested our available capital in our existing homebuilding
markets through our capital allocation process and entered
satellite markets as opportunities were available. We have also
evaluated homebuilding acquisition opportunities as they arose.
The market conditions in our homebuilding markets have softened
considerably during the fiscal year ended September 30,
2006. Although we believe the long-term fundamentals which
support home sales demand remain solid and the current negative
conditions in many of our markets will moderate over time, we
cannot predict the duration and severity of the current market
conditions. Consequently, while our long-term strategy remains
to continue to profitably grow our homebuilding business, our
focus while the market conditions are weaker will primarily be
upon continued strengthening of the financial condition of the
Company by reducing inventories of homes and land, thereby
increasing liquidity.
From 1978 to late 1987, our homebuilding activities were
conducted in the Dallas/Fort Worth area. We then began
diversifying geographically by entering additional markets, both
through
start-up
operations and acquisitions. We now operate in 27 states
and 84 markets. This provides us with geographic diversification
in our homebuilding inventory investments and our sources of
revenues and earnings.
We believe our diversification strategy mitigates the effects of
local and regional economic cycles and enhances our growth
potential. Typically, we do not invest material amounts of
capital in real estate, including raw land, developed lots,
models and speculative homes or overhead in
start-up
operations in new markets, until such markets demonstrate growth
potential and acceptance of our products. While we believe there
are long-term growth opportunities in our existing markets, we
also intend to continue our diversification strategy by seeking
to selectively enter new markets, primarily through the opening
of satellite operations in smaller markets near our existing
operating divisions. We also continue to evaluate opportunities
to enter new markets or strengthen our presence in our existing
markets through acquisitions of other homebuilding companies.
We are the largest homebuilding company in the United States in
terms of number of homes closed in fiscal 2006. By the same
measure, we are also either the largest or one of the five
largest builders in many of our markets in fiscal 2006. We
believe that our national, regional and local scale of
operations has provided us with benefits that may not be
available in the same degree to some other smaller homebuilders,
such as:
Our economies of scale have contributed to our strong
homebuilding operating margins over the years. Our operating
margins have provided us with operational flexibility to compete
for additional market share in each of our markets and in new
satellite markets versus our competitors with lower operating
margins.
We decentralize our homebuilding activities to give more
operating flexibility to our local division presidents. At
September 30, 2006, we had 41 separate homebuilding
operating divisions, some of which are in the same market area
and some of which operate in more than one market area.
Generally, each operating division consists of a division
president; land entitlement, acquisition and development
personnel; a sales manager and sales personnel; a construction
manager and construction superintendents; customer service
personnel; a controller; a purchasing manager and office staff.
We believe that division presidents and their management teams,
who are familiar with local conditions, have better information
on which to base decisions regarding local operations. Our
division presidents receive performance bonuses based upon
achieving targeted financial and operational measures in their
operating divisions.
Each operating division is responsible for:
— A feasibility study;
— Soil and environmental reviews;
— Review of existing zoning and other
governmental requirements; and
— Review of the need for and extent of offsite
work required to meet local building codes;
We centralize the key risk elements of our homebuilding business
through our regional and corporate offices. We have seven
separate homebuilding regional offices. Generally, each regional
office consists of a region president, legal counsel, a chief
financial officer, a purchasing manager and limited office
support staff. Each of our region presidents and their
management teams are responsible for oversight of the operations
of up to eight homebuilding operating divisions, including:
Our corporate executives and corporate office departments are
responsible for establishing our operational policies and
internal control standards and for monitoring compliance with
established policies and controls throughout our operations. The
corporate office also has primary responsibility for direct
management of certain key risk elements and initiatives through
the following centralized functions:
We control our overhead costs by centralizing certain
administrative and accounting functions and by closely
monitoring the number of administrative personnel and management
positions in our operating divisions, as well as in our regional
and corporate offices. We also minimize advertising costs by
participating in promotional activities sponsored by local real
estate brokers.
We control construction costs by striving to design our homes
efficiently and by obtaining competitive bids for construction
materials and labor. We also negotiate favorable pricing from
our primary subcontractors and suppliers based on the volume of
services and products we purchase from them on a local, regional
and national basis. We monitor our construction costs on each
house through our purchasing and construction budgeting systems,
and we monitor our inventory levels, margins, returns and
expenses through our management information systems.
We have recently focused on internal growth, strengthening our
balance sheet and increasing our liquidity. However, as an
integral component of our operational strategy, we continue to
evaluate opportunities for strategic acquisitions. We believe
that, in some instances, expanding our operations through the
acquisition of existing homebuilding companies can provide us
benefits not found in
start-up
operations, such as:
In evaluating potential acquisition candidates, we seek
homebuilding companies that have excellent reputations, track
records of profitability and strong management teams. We seek to
limit the risks associated with acquiring such companies by
conducting extensive operational, financial and legal due
diligence on each
acquisition and by only acquiring homebuilding companies that we
believe will have a positive impact on our earnings within an
acceptable period of time. We believe that our acquisition
evaluation and due diligence processes combined with our
decentralized operating approach with centralized controls have
contributed to the successful integration of our prior
acquisitions.
We conduct our homebuilding operations in all of the geographic
regions, states and markets listed below, and we conduct our
mortgage and title operations in many of these markets. The
names of the regions and the markets comprising each region
reflect the aggregation of our homebuilding operating segments
into six separate reportable regions.
When evaluating new or existing homebuilding markets, we
consider the following local, market-specific factors, among
others:
Typically, we acquire land after we have completed appropriate
due diligence and generally after we have obtained the rights
(“entitlements”) to begin development or construction
work resulting in an acceptable number of residential lots.
Before we acquire lots or tracts of land, we will, among other
things, complete a feasibility study, which includes soil tests,
independent environmental studies and other engineering work,
and evaluate the status of necessary zoning and other
governmental entitlements required to develop and use the
property for home construction. Although we purchase and develop
land primarily to support our homebuilding activities, we also
sell lots and land to other developers and homebuilders.
We also enter into land/lot option contracts, in which we obtain
the right, but generally not the obligation, to buy land or lots
at predetermined prices on a defined schedule commensurate with
anticipated home closings or planned land development. Our
option contracts generally are non-recourse, which limits our
financial exposure to our earnest money deposited with land and
lot sellers. This enables us to control significant land and lot
positions with minimal capital investment, which substantially
reduces the risks associated with land ownership and development.
Almost all of our land positions are acquired directly by us. We
avoid entering into joint venture arrangements due to their
increased costs and complexity, as well as the loss of
operational control inherent in such arrangements. We are a
party to a very small number of joint ventures that were
acquired through acquisitions of other homebuilders. All of
these joint ventures are consolidated in our financial
statements.
We attempt to mitigate our exposure to real estate inventory
risks by:
Our home designs are selected or prepared in each of our markets
to appeal to local tastes and preferences of homebuyers in each
community. We also offer optional interior and exterior features
to allow homebuyers to enhance the basic home design and to
allow us to generate additional revenues from each home sold.
Substantially all of our construction work is performed by
subcontractors. Subcontractors typically are retained for a
specific subdivision pursuant to a contract that obligates the
subcontractor to complete construction at an agreed-upon price.
Agreements with the subcontractors and suppliers we use
generally are negotiated for each subdivision. We compete with
other homebuilders for qualified subcontractors, raw materials
and lots in the markets where we operate. We employ construction
superintendents to monitor homes under construction, participate
in major design and building decisions, coordinate the
activities of subcontractors and suppliers, review the work of
subcontractors for quality and cost controls and monitor
compliance with zoning and building codes. In addition, our
construction superintendents play a significant role in working
with our homebuyers by assisting with option selection and home
modification decisions, educating buyers on the construction
process and instructing buyers on post-closing home maintenance.
Construction time for our homes depends on the weather,
availability of labor, materials and supplies, size of the home,
and other factors. We typically complete the construction of a
home within four to six months.
We typically do not maintain significant inventories of
construction materials, except for work in progress materials
for homes under construction. Typically, the construction
materials used in our operations are readily available from
numerous sources. We have contracts exceeding one year with
certain suppliers of our building materials that are cancelable
at our option with a 30 day notice. In recent years, we
have not experienced delays in construction due to shortages of
materials or labor that have materially affected our
consolidated operating results.
We market and sell our homes through commissioned employees and
independent real estate brokers. We typically conduct home sales
from sales offices located in furnished model homes in each
subdivision, and we typically do not offer our model homes for
sale until the completion of a subdivision. Our sales personnel
assist prospective homebuyers by providing them with floor
plans, price information, tours of model homes and assisting
them with the selection of options and other custom features. We
train and inform our sales personnel as to the availability of
financing, construction schedules, and marketing and advertising
plans. As market conditions warrant, we may provide potential
homebuyers with one or more of a variety of incentives,
including discounts and free upgrades, to be competitive in a
particular market. In the current weak market conditions, we
have significantly increased the level of incentives we are
offering to homebuyers in many markets.
We advertise in our local markets as necessary. We advertise in
newspapers, marketing brochures and newsletters. We also use
billboards, radio and television advertising and our Internet
website to market the location, price range and availability of
our homes. To minimize advertising costs, we attempt to operate
in subdivisions in conspicuous locations that permit us to take
advantage of local traffic patterns. We also believe that model
homes play a substantial role in our marketing efforts, so we
expend significant effort to create an attractive atmosphere in
our model homes.
In addition to using model homes, in certain markets we build a
limited number of speculative homes in each subdivision. These
homes enhance our marketing and sales efforts to prospective
homebuyers who are relocating to these markets, as well as to
independent brokers, who often represent homebuyers requiring a
completed home within 60 days. We determine our speculative
homes strategy in each market based on local market factors,
such as new job growth, the number of job relocations, housing
demand, seasonality, current sales contract cancellation trends
and our past experience in the market. We determine the number
of speculative homes to build in each subdivision based on our
current and planned sales pace, and we monitor
and adjust speculative homes inventory on an ongoing basis as
conditions warrant. We typically sell a substantial majority of
our speculative homes while they are under construction or
immediately following completion; however, the softness in the
current market conditions and related high cancellation rates
have increased our speculative homes inventory to approximately
50% of our total homes in inventory as of September 30,
2006, up from 41% as of September 30, 2005.
Our sales contracts require an earnest money deposit of at least
$500. The amount of earnest money required varies between
markets and subdivisions, and may significantly exceed $500.
Additionally, customers are generally required to pay additional
deposits when they select options or upgrade features for their
homes. Most of our sales contracts stipulate that when customers
cancel their contracts with us, we have the right to retain
their earnest money and option deposits; however, our operating
divisions occasionally choose to refund such deposits. Our sales
contracts also include a financing contingency which permits
customers to cancel and receive a refund of their deposits if
they cannot obtain mortgage financing at prevailing or specified
interest rates within a specified period. Our contracts may
include other contingencies, such as the sale of an existing
home. Depending upon market conditions, the sales contracts used
in certain subdivisions may also contain restrictions aimed at
limiting purchases of our homes by speculative investors who
plan to purchase our homes and then quickly place the homes up
for resale. As a percentage of gross sales orders, cancellations
of sales contracts in fiscal 2006 were 28%, and our quarterly
cancellation rates increased throughout fiscal 2006 to 40% in
the fourth quarter, significantly higher than our typical
historical range of 16% to 20%. The length of time between the
signing of a sales contract for a home and delivery of the home
to the buyer (closing) averages between three and six months.
Our operating divisions are responsible for pre-closing quality
control inspections and responding to customers’
post-closing needs. We believe that prompt and courteous
response to homebuyers’ needs during and after construction
reduces post-closing repair costs, enhances our reputation for
quality and service, and ultimately leads to significant repeat
and referral business from the real estate community and
homebuyers. We provide our homebuyers with a limited one-year
warranty on workmanship and building materials. The
subcontractors who perform the actual construction also provide
us with warranties on workmanship and are generally prepared to
respond to us and the homeowner promptly upon request. In
addition, we typically provide a supplemental ten-year limited
warranty that covers major construction defects, and some of our
suppliers provide manufacturer’s warranties on specified
products installed in the home.
We provide mortgage financing services principally to purchasers
of our homes in the majority of our homebuilding markets through
our wholly-owned subsidiary, DHI Mortgage. DHI Mortgage
coordinates and expedites the entire sales transaction by
ensuring that mortgage commitments are received and that
closings take place in a timely and efficient manner. DHI
Mortgage originates mortgage loans for a substantial portion of
our homebuyers and, when necessary to fulfill the needs of some
homebuyers, also brokers loans to third-party lenders who
directly originate the mortgage loans. During the year ended
September 30, 2006, approximately 94% of DHI
Mortgage’s loan volume related to homes closed by our
homebuilding operations, and DHI Mortgage provided mortgage
financing services for approximately 68% of our total homes
closed.
For loans that it originates, DHI Mortgage packages and sells
the loans and their servicing rights to third-party investors
shortly after origination on a non-recourse or limited recourse
basis. In markets where we currently do not provide mortgage
financing, we work with a variety of mortgage lenders that make
available to homebuyers a range of mortgage financing programs.
We serve as a title insurance agent in selected markets by
providing title insurance policies, examination and closing
services to purchasers of homes we build and sell, through our
subsidiary title companies. We currently assume little or no
underwriting risk associated with these title policies.
At September 30, 2006, we employed 8,772 persons, of whom
1,432 were sales and marketing personnel, 2,764 were executive,
administrative and clerical personnel, 2,846 were involved in
construction and 1,730 worked in mortgage and title operations.
We had fewer than 20 employees covered by collective bargaining
agreements. Employees of some of the subcontractors which we use
are represented by labor unions or are subject to collective
bargaining agreements. We believe that our relations with our
employees and subcontractors are good.
The homebuilding industry is highly competitive. We compete in
each of our markets with numerous other national, regional and
local homebuilders for homebuyers, desirable properties, raw
materials, skilled labor and financing. We also compete with
resales of existing homes and with the rental housing market.
Our homes compete on the basis of quality, price, design,
mortgage financing terms and location. Our financial services
business competes with other mortgage lenders, including
national, regional and local mortgage bankers and other
financial institutions, some of which have greater access to
capital markets, different lending criteria and potentially
broader product offerings.
The homebuilding industry is subject to extensive and complex
regulations. We and the subcontractors we use must comply with
various federal, state and local laws and regulations, including
zoning, density and development requirements, building,
environmental, advertising and real estate sales rules and
regulations. These requirements affect the development process,
as well as building materials to be used, building designs and
minimum elevation of properties. Our homes are inspected by
local authorities where required, and homes eligible for
insurance or guarantees provided by the FHA and VA are subject
to inspection by them. These regulations often provide broad
discretion to the administering governmental authorities. In
addition, our new housing developments may be subject to various
assessments for schools, parks, streets and other public
improvements.
Our homebuilding operations are also subject to a variety of
local, state and federal statutes, ordinances, rules and
regulations concerning protection of health, safety and the
environment. The particular environmental laws for each site
vary greatly according to location, environmental condition and
the present and former uses of the site and adjoining properties.
Our mortgage company and title insurance agencies must also
comply with various federal and state laws and regulations.
These include eligibility and other requirements for
participation in the programs offered by the FHA, VA, GNMA,
Fannie Mae and Freddie Mac. These also include required
compliance with consumer lending and other laws and regulations
such as disclosure requirements, prohibitions against
discrimination and real estate settlement procedures. All of
these laws and regulations may subject our operations to
examination by the applicable agencies.
We have typically experienced seasonal variations in our
quarterly operating results and capital requirements. In prior
years, we generally had more homes under construction, closed
more homes and had greater revenues and operating income in the
third and fourth quarters of our fiscal year. This 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, our results of operations
and financial position at the end of the third and fourth fiscal
quarters are not necessarily representative of the balance of
our fiscal year.
In fiscal 2006, 57% of our consolidated revenues was
attributable to operations in the third and fourth fiscal
quarters. In contrast to our typical seasonal results, due to
softening homebuilding market conditions during fiscal 2006,
only 46% of our consolidated operating income was attributable
to operations in the third
and fourth fiscal quarters. This decrease was primarily due to
the increased use of incentives to sell homes and inventory
impairment charges and land option cost write-offs recorded
during the third and fourth quarters of fiscal 2006. We expect
that we will experience our historical seasonal patterns of
revenues and operating income in future fiscal years.
Discussion of our business and operations included in this
annual report on
Form 10-K
should be read together with the risk factors set forth below.
They describe various risks and uncertainties to which we are or
may become subject. These risks and uncertainties, together with
other factors described elsewhere in this report, have the
potential to affect our business, financial condition, results
of operations, cash flows, strategies or prospects in a material
and adverse manner.
Cyclical Industry. The homebuilding industry
is cyclical and is significantly affected by changes in general
and local economic conditions, such as:
These may occur on a national scale or may affect some of the
regions or markets in which we operate more than others. If
adverse conditions affect any of our larger markets, they could
have a proportionately greater impact on us than on some other
homebuilding companies.
An oversupply of alternatives to new homes, such as rental
properties and used or foreclosed homes, including homes held
for sale by investors and speculators, can also depress new home
prices and reduce our margins on the sales of new homes.
During fiscal 2006, the homebuilding industry experienced an
industry-wide softening of demand for new homes. In many
markets, home price appreciation over the past several years had
attracted real estate investors and speculators. As price
appreciation slowed in fiscal 2006, the demand from investors
and speculators for new homes also slowed, resulting in an
increase in new homes available for sale. At the same time,
existing homes offered for sale by investors and speculators
increased. In response to higher inventories of both new and
existing homes, homebuilders increased the use of sales
incentives to continue to sell new homes. In the third and
fourth quarters of fiscal 2006, we experienced a decrease in our
net sales orders due to a decrease in homebuyer consumer
confidence and a related increase in sales contract
cancellations, both of which we believe were caused by the
continued increase in the level of sales incentives offered by
both builders of new homes and sellers of existing homes. Our
use of incentives also contributed to significantly lower gross
margins on the homes we closed during those quarters. We cannot
predict the duration or severity of the current market
conditions, nor provide any assurances that the adjustments we
have made in our operating strategy to address these conditions
will be successful.
Risks Related to National Security. Continued
military deployments in the Middle East and other overseas
regions, terrorist attacks, other acts of violence or threats to
national security, and any corresponding response by the United
States or others, or related domestic or international
instability, may adversely affect general economic conditions or
cause a slowdown of the national economy.
Inventory Risks. Inventory risks are
substantial for our homebuilding business. Our long-term ability
to build homes depends upon our acquiring land suitable for
residential building at affordable prices in locations where our
potential customers want to live. We must anticipate demand for
new homes and continuously seek and make acquisitions of land
for replacement and expansion of land inventory within our
current markets and for new markets. In some markets, this has
become more difficult and costly.
The risks inherent in controlling or purchasing and developing
land increase as consumer demand for housing decreases. Thus, we
may have acquired options on or bought and developed land at a
cost we will not be able to recover fully or on which we cannot
build and sell homes profitably. Our deposits for building lots
controlled under option or similar contracts may be put at risk.
The value of undeveloped land, building lots and housing
inventories can also fluctuate significantly as a result of
changing market conditions. In addition, inventory carrying
costs can be significant and can result in reduced margins or
losses in a poorly performing project or market. In weak
economic or market conditions, we may have to sell homes or land
for a lower profit margin or at a loss, and we may have to
record inventory impairment charges. We cannot make any
assurances that the measures we employ to manage inventory risks
and costs will be successful.
During fiscal 2005 and the first part of fiscal 2006, our goals
for years of supply for ownership and control of land and
building lots were based on management’s expectations for
future volume growth. In light of the much weaker market
conditions recently encountered, our expectations have changed
and we have significantly slowed our purchases of land and lots
to reduce our inventory to better match our new reduced rate of
production. We have recently terminated numerous land option
contracts and have written off earnest money deposits and
pre-acquisition costs related to these option contracts. We have
also recorded inventory impairment charges related to some of
our under-performing projects.
Supply Risks. The homebuilding industry has
from time to time experienced significant difficulties that can
affect the cost or timing of construction, including:
Risks from Nature. Weather conditions and
natural disasters, such as hurricanes, tornadoes, earthquakes,
volcanic activity, droughts, floods and wildfires, can harm our
homebuilding business. These can delay home closings, adversely
affect the cost or availability of materials or labor, or damage
homes under construction. The climates and geology of many of
the states in which we operate, including California, Florida
and Texas, where we have some of our larger operations, present
increased risks of adverse weather or natural disaster.
Consequences. As a result of the foregoing
matters, potential customers may be less willing or able to buy
our homes, or we may take longer or incur more costs to build
them. We may not be able to recapture increased costs by raising
prices in many cases because of market conditions or because we
fix our prices in advance of delivery by signing home sales
contracts. We may be unable to change the mix of our home
offerings or the affordability of our homes to maintain our
margins or satisfactorily address changing market conditions in
other ways. In addition, cancellations of home sales contracts
in backlog may increase as homebuyers cancel or do not honor
their contracts. In the third and fourth quarters of fiscal
2006, we experienced an increase in sales contract cancellations
due to a decrease in homebuyer consumer confidence, which we
believe was caused by the continued increase in the level of
sales incentives offered by both builders of new homes and
sellers of existing homes. We are not certain how long the
increased level of cancellations will continue.
Our financial services business is closely related to our
homebuilding business, as it originates mortgage loans
principally to purchasers of the homes we build. A decrease in
the demand for our homes because of the foregoing matters may
also adversely affect the financial results of this segment of
our business. Consumer preferences for adjustable rate and other
low-margin loans may also adversely affect our financial
services
results. An increase in the default rate on the mortgages we
originate may adversely affect the pricing we receive upon the
sale of mortgages that we originate and our profitability on
such loan sales.
Most of our customers finance their home purchases through
lenders providing mortgage financing. In recent years, interest
rates have been at historical lows. Many homebuyers have also
chosen adjustable rate, interest only or other mortgages that
involve initial lower monthly payments. As a result, new homes
have been more affordable. Increases in interest rates or
decreases in the availability of mortgage financing products,
however, may adversely affect the market for new homes.
Potential homebuyers may be less willing or able to pay the
increased monthly costs or to obtain mortgage financing that
exposes them to interest rate changes. Lenders may increase the
qualification requirements needed for mortgages or adjust their
terms to address any increased credit risk. Even if potential
customers do not need financing, changes in interest rates and
the availability of mortgage financing products may make it
harder for them to sell their current homes to potential buyers
who need financing. These matters may adversely affect the sales
or pricing of our homes and may also reduce the volume or
margins in our financial services business. The impact on our
financial services business may be compounded to the extent we
are unable to match interest rates and amounts on loans we have
committed to originate through the various hedging strategies we
employ.
We believe that the availability of FHA and VA mortgage
financing is an important factor in marketing some of our homes.
We also believe that the liquidity provided by Fannie Mae and
Freddie Mac to the mortgage industry is important to the housing
market; however, the federal government has sought to limit the
size of the home-loan portfolios and operations of these two
government-sponsored enterprises. Any limitations or
restrictions on the availability of the financing or on the
liquidity provided by them could adversely affect interest
rates, mortgage financing and our sales of new homes and
mortgage loans.
Significant expenses of owning a home, including mortgage
interest expense and real estate taxes, generally are deductible
expenses for an individual’s federal, and in some cases
state, income taxes, subject to various limitations under
current tax law and policy. If the federal government or a state
government changes its income tax laws, as has been discussed,
to eliminate or substantially modify these income tax
deductions, the after-tax cost of owning a new home could
increase for many of our potential customers. The resulting loss
or reduction of homeowner tax deductions, if such tax law
changes were enacted without offsetting provisions, could
adversely impact demand for and sales prices of new homes.
We are subject to extensive and complex regulations that affect
land development and home construction, including zoning,
density restrictions, building design and building standards.
These regulations often provide broad discretion to the
administering governmental authorities as to the conditions we
must meet prior to being approved, if approved at all. We are
subject to determinations by these authorities as to the
adequacy of water or sewage facilities, roads or other local
services. In addition, in many markets government authorities
have implemented no growth or growth control initiatives. Any of
these can limit, delay or increase the costs of development or
homebuilding.
New housing developments may be subject to various assessments
for schools, parks, streets and other public improvements, which
could cause an increase in the effective prices for our homes.
In addition, increases in property tax rates by local
governmental authorities, as experienced in response to reduced
federal and state funding, can adversely affect the ability of
potential customers to obtain financing or their desire to
purchase new homes.
We are subject to a variety of local, state and federal laws and
regulations concerning protection of health, safety and the
environment. The impact of environmental laws varies depending
upon the prior uses of
the building site or adjoining properties and may be greater in
areas with less supply where undeveloped land or desirable
alternatives are less available. These matters may result in
delays, may cause us to incur substantial compliance,
remediation and other costs, and can prohibit or severely
restrict development and homebuilding activity in
environmentally sensitive regions or areas.
Our financial services operations are also subject to numerous
federal, state and local laws and regulations. These include
eligibility requirements for participation in federal loan
programs, compliance with consumer lending and similar
requirements such as disclosure requirements, prohibitions
against discrimination and real estate settlement procedures.
They may also subject our operations to examination by the
applicable agencies. These factors may limit our ability to
provide mortgage financing or title services to potential
purchasers of our homes.
We have a significant amount of debt. As of September 30,
2006, our consolidated debt was $6,078.6 million. In the
ordinary course of business, we may incur significant additional
debt, to the extent permitted by our revolving credit facility
and our indentures.
Possible Consequences. The amount of our debt
could have important consequences. For example, it could:
Dependence on Future Performance. Our ability
to meet our debt service and other obligations will depend upon
our future financial performance. We are engaged in businesses
that are substantially affected by changes in economic
conditions. Our revenues and earnings vary with the level of
general economic activity in the markets we serve. Our
businesses are also affected by financial, political, business
and other factors, many of which are beyond our control. The
factors that affect our ability to generate cash can also affect
our ability to raise additional funds for these purposes through
the sale of debt or equity securities, the refinancing of debt,
or the sale of assets. Changes in prevailing interest rates may
affect our ability to meet our debt service obligations, because
borrowings under our credit facilities bear interest at floating
rates and our “interest rate swap” agreements fix our
interest rate for only a portion of these borrowings.
As of September 30, 2006, the scheduled maturities of
principal on our outstanding debt for the subsequent
12 months totaled $1,217.8 million, including
$1,191.7 million in financial services debt that must be
renewed annually. Based on the current level of operations, we
believe our cash flow from operations, available cash, available
borrowings under our credit facilities and our ability to access
the capital markets and to refinance or renew our facilities in
a timely manner will be adequate to meet our future cash needs.
We cannot, however, make any assurances that in the future our
business will generate sufficient cash flow from operations or
that borrowings or access to the capital markets or refinancing
or renewal facilities will be available to us in amounts
sufficient to enable us to pay or refinance our indebtedness or
to fund other cash needs.
Indenture and Revolving Credit Facility
Restrictions. Our revolving credit facility and
the indenture governing our senior subordinated notes impose
restrictions on our operations and activities. The most
significant restrictions relate to limits on investments, cash
dividends, stock repurchases and other restricted payments,
incurrence of indebtedness, creation of liens and asset
dispositions, and require maintenance of a maximum leverage
ratio, a minimum ratio of earnings before interest, income
taxes, depreciation and
amortization to interest incurred, minimum levels of tangible
net worth and compliance with other financial covenants. In
addition, the indentures governing our senior notes impose
restrictions on the creation of liens. If we fail to comply with
any of these restrictions or covenants, the trustees, the
noteholders or the lending banks, as applicable, could cause our
debt to become due and payable prior to maturity. If we do not
maintain our current credit ratings, available credit under our
revolving credit facility is subject to limitations based on
specified percentages of unsold homes, developed lots and lots
under development included in inventory and the amount of other
senior unsecured indebtedness.
Change of Control Purchase Options. If a
change of control occurs as defined in the indentures governing
many series of our senior and senior subordinated notes,
constituting $2,150.0 million principal amount in the
aggregate as of September 30, 2006, we would be required to
offer to purchase such notes at 101% of their principal amount,
together with all accrued and unpaid interest, if any. Moreover,
a change of control may also result in the acceleration of our
revolving credit facility and our financial services credit
facilities. If purchase offers were required under the
indentures for these notes or these credit facilities were
accelerated, we can give no assurance that we would have
sufficient funds to pay the amounts that we would be required to
repurchase or repay. At September 30, 2006, we did not have
sufficient funds available to purchase all of such outstanding
debt upon a change of control.
Impact of Financial Services Debt. Our
financial services business is conducted through subsidiaries
that are not restricted by our indentures or revolving credit
facility. The ability of our financial services segment to
provide funds to our homebuilding operations, however, is
subject to restrictions in its own credit facilities. These
funds would not be available to us upon the occurrence and
during the continuance of defaults under these facilities.
Moreover, our right to receive assets from these subsidiaries
upon liquidation or recapitalization will be subject to the
prior claims of the creditors of these subsidiaries. Any claims
we may have to funds from this segment would be subordinate to
subsidiary indebtedness to the extent of any security for such
indebtedness and to any indebtedness otherwise recognized as
senior to our claims.
The homebuilding industry is highly competitive. Homebuilders
compete not only for homebuyers, but also for desirable
properties, financing, raw materials and skilled labor. We
compete with other local, regional and national homebuilders,
including those with a sales presence on the Internet, often
within larger subdivisions designed, planned and developed by
such homebuilders. We also compete with existing home sales. The
competitive conditions in the homebuilding industry can result
in:
Our financial services business competes with other mortgage
lenders, including national, regional and local mortgage banks
and other financial institutions. Mortgage lenders with greater
access to capital markets or different lending criteria may be
able to offer more attractive financing to potential customers.
When we are affected by these competitive conditions, our
business and financial results could be adversely affected.
Our operations require significant amounts of cash, and our
requirements for capital typically increase in the third and
fourth quarters of our fiscal year. We may be required to seek
additional capital, whether from sales of equity, debt issuances
or additional bank borrowings, for the development and any
future growth of
our business. We can give no assurance as to the availability of
such additional capital or, if available, whether it would be on
terms acceptable to us. Moreover, the indentures for our
outstanding public debt and the covenants of our revolving
credit facility contain provisions that may restrict the debt we
may incur in the future. If we are not successful in obtaining
sufficient capital, it could reduce our sales and may adversely
affect our financial results.
Since 1993, we have acquired many homebuilding companies.
Although we recently focused on internal growth, we may make
strategic acquisitions of homebuilding companies in the future.
Successful strategic acquisitions require the integration of
operations and management and other efforts to realize the
benefits that may be available. Although we believe that we have
been successful in doing so in the past, we can give no
assurance that we would be able to identify, acquire and
integrate successfully strategic acquisitions in the future.
Acquisitions can result in the dilution of existing stockholders
if we issue our common stock as consideration or reduce our
liquidity or increase our debt if we fund them with cash. In
addition, acquisitions can expose us to the risk of writing off
goodwill related to such acquisitions based on the subsequent
results of the operating segments to which the acquired
businesses were assigned. The risk of write-offs related to
goodwill impairment increases during a cyclical housing downturn
when profitability of our operating segments may decline.
Moreover, we may not be able to implement successfully our
operating and growth strategies within our existing markets.
As a homebuilder, we are subject to home warranty and
construction defect claims arising in the ordinary course of
business. As a consequence, we maintain product liability
insurance, obtain indemnities and certificates of insurance from
subcontractors generally covering claims related to workmanship
and materials, and create warranty and other reserves for the
homes we sell based on historical experience in our markets and
our judgment of the qualitative risks associated with the types
of homes built. Because of the uncertainties inherent to these
matters, we cannot provide assurance that our insurance
coverage, our subcontractor arrangements and our reserves will
be adequate to address all of our warranty and construction
defect claims in the future. Contractual indemnities can be
difficult to enforce, we may be responsible for applicable
self-insured retentions and some types of claims may not be
covered by insurance or may exceed applicable coverage limits.
Additionally, the coverage offered by and the availability of
product liability insurance for construction defects are
currently limited and costly. We have responded to increases in
insurance costs and coverage limitations in recent years by
increasing our self-insured retentions and claim reserves. There
can be no assurance that coverage will not be further restricted
or become more costly.
As previously disclosed in our Quarterly Report on
Form 10-Q
for the quarter ended June 30, 2006, the staff of the
Securities and Exchange Commission (SEC Staff) conducted a
review of our Annual Report on
Form 10-K
for the fiscal year ended September 30, 2005 and Quarterly
Reports on
Form 10-Q
for the respective quarters ended December 31, 2005 and
March 31, 2006 and issued a letter commenting on certain
aspects of those reports. We believe that all matters addressed
in the comment letter and our subsequent discussions with the
SEC Staff have been resolved, except with regard to the
reporting of our operating segments under
SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information.” As a result of the
discussions, we have disaggregated the disclosure regarding our
homebuilding operations from one reportable homebuilding segment
to six separate reportable homebuilding segments. The
disclosures within this Annual Report on
Form 10-K
for all periods presented reflect this revised aggregation,
which had no effect on our previously reported consolidated
financial position, results of operations or cash flows.
However, in the discussions, the SEC Staff also commented that
similar disclosures should be made in our prior Annual Report on
Form 10-K
for the fiscal year ended September 30, 2005. We have not
agreed to the SEC Staff’s comment because, among other
reasons, the information in this year’s Annual Report on
Form 10-K
includes, in addition to fiscal 2006 segment information, prior
year comparable revised segment information related to revenues,
inventory impairments and income before income taxes for both
fiscal 2005 and 2004, revised segment inventories as of
September 30, 2005, and additional presentation and
discussion of segment information in our Management Discussion
and Analysis section for fiscal years 2006, 2005 and 2004. The
prior year segment information has no effect on our previously
reported consolidated financial position, results of operations
or cash flows. Our discussions with the SEC Staff on this
remaining matter have not been concluded.
In addition to our inventories of land, lots and homes, we own
several office buildings totaling approximately
246,000 square feet and we lease approximately
1,609,000 square feet of office space under leases expiring
through January 2015, in our various operating markets to house
our homebuilding and financial services operating divisions, as
well as our regional and corporate offices.
We are involved in lawsuits and other contingencies in the
ordinary course of business. Management believes that, while the
ultimate outcome of the contingencies cannot be predicted with
certainty, the ultimate liability, if any, will not have a
material adverse effect on our financial position or operations.
None.
Our common stock is listed on the New York Stock Exchange (NYSE)
under the symbol “DHI.” The following table shows the
high and low sales prices for our common stock for the periods
indicated, as reported by the NYSE, and dividends declared per
common share. The amounts reflect the
four-for-three
stock split (effected as a
331/3%
stock dividend) of March 16, 2005.
As of December 4, 2006, the closing price of our common
stock on the NYSE was $26.29, and there were approximately
616 holders of record.
The declaration of 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 general
financial condition and general business conditions. We are
required to comply with certain covenants contained in the bank
agreements and our senior subordinated note indenture. The most
restrictive of these requirements allows us to pay cash
dividends on our common stock in an amount, on a cumulative
basis, not to exceed 50% of consolidated net income, as defined,
subject to certain other adjustments. Pursuant to the most
restrictive of these requirements, at September 30, 2006,
cash dividend payments in fiscal 2007 were limited to
$583.5 million, and approximately $3.4 billion was
available for all restricted payments in the future.
The information required by this item with respect to equity
compensation plans is set forth under Item 12 of this
annual report on
Form 10-K
and is incorporated herein by reference.
During fiscal years 2006, 2005 and 2004, we did not sell any
securities that were not registered under the Securities Act of
1933, as amended.
In November 2005, our Board of Directors authorized the
repurchase of up to $500 million of our common stock,
replacing the previous common stock repurchase authorization.
During fiscal 2006, we repurchased 1,000,000 shares of our
common stock at a total cost of $36.8 million, all of which
occurred during the three months ended December 31, 2005.
As of September 30, 2006, we had $463.2 million
remaining of the Board of Directors’ authorization for
repurchases of common stock. In November 2006, our Board of
Directors extended the remaining $463.2 million common
stock repurchase authorization to November 30, 2007.
On January 26, 2006, our shareholders approved an amendment
to the Company’s charter which increased the number of
authorized shares of common stock to one billion shares.
The following selected consolidated financial data are derived
from our Consolidated Financial Statements. The data should be
read in conjunction with the Consolidated Financial Statements,
related Notes thereto and other financial data elsewhere herein.
These historical results are not necessarily indicative of the
results to be expected in the future.
During fiscal 2006, the homebuilding industry experienced an
industry-wide softening of demand for new homes. In many
markets, home price appreciation over the past several years had
attracted real estate investors and speculators. As price
appreciation slowed in fiscal 2006, the demand from investors
and speculators for new homes also slowed, resulting in an
increase in new homes available for sale. At the same time,
existing homes offered for sale by investors and speculators
increased. In response to higher inventories of both new and
existing homes, homebuilders increased the use of sales
incentives to continue to sell new homes. In the third and
fourth quarters of fiscal 2006, we experienced a decrease in our
net sales orders due to a decrease in homebuyer consumer
confidence and a related increase in sales contract
cancellations, both of which we believe were caused by the
continued increase in the level of sales incentives offered by
both builders of new homes and sellers of existing homes. Our
use of incentives also contributed to significantly lower gross
margins on the homes we closed during those quarters. Although
we believe the long-term fundamentals which support home sales
demand remain solid and the current negative conditions in many
of our markets will moderate over time, we cannot predict the
duration and severity of the current market conditions.
During fiscal 2006, we adjusted our operating strategy to meet
the new homebuilding business environment, and we expect to
continue with these initiatives through fiscal 2007. These
adjustments include:
We expect that these adjustments to our operating strategy will
generate positive cash flows in fiscal 2007 and allow us to
maintain a strong balance sheet and liquidity position,
providing us with flexibility to take advantage of opportunities
as they become available in the future. Because we cannot
predict the duration or severity of the current market
conditions, we cannot provide any assurances that the
adjustments we have made in our operating strategy to address
these conditions will be successful.
Key financial results as of and for our fiscal year ended
September 30, 2006 were as follows:
Although specific directives within our operating strategy may
have changed or may be implemented at a slower pace, our
long-term operating strategy remains much the same. We intend to
continue to take advantage of opportunities to grow our
homebuilding business profitability through capturing greater
market share, while maintaining a strong balance sheet. We plan
to continue investing our available capital in our existing
homebuilding markets through our capital allocation process and
entering satellite markets as opportunities are available. We
will also continue to evaluate homebuilding acquisition
opportunities as they arise. To the extent that additional
capital is available in excess of amounts we choose to invest in
our homebuilding operations or retain as liquidity, we will
consider directing such capital toward alternative uses,
including repayment of debt, dividend payments or stock
repurchases, as market conditions or other circumstances may
warrant, within the constraints of our balance sheet leverage
targets and the restrictions in our bank agreements and
indentures.
Results
of Operations — Homebuilding
Our seven homebuilding operating regions are our operating
segments. We present six reportable segments, as we aggregate
two of the operating regions into one reporting segment. These
reporting segments, which we also refer to as reporting regions,
have homebuilding operations located in the following states:
The following tables set forth key operating and financial data
for our homebuilding operations by reporting region as of and
for the fiscal years ended September 30, 2006 and 2005.
Based on our revised aggregation of operating segments, we have
restated fiscal 2005 amounts between regions to conform to the
fiscal 2006 presentation.
Net sales orders represent the number and dollar value of new
sales contracts executed with customers, net of sales contract
cancellations. The value of net sales orders decreased 5%, to
$13,895.2 million (51,980 homes) in 2006 from
$14,643.4 million (53,232 homes) in 2005. The number of net
sales orders decreased 2% in fiscal 2006 compared to fiscal
2005, reflecting the industry-wide softening of demand for new
homes in most homebuilding markets. We believe the most
significant factors contributing to the slowing of demand for
new homes in most of our markets include an increase in the
supply of existing homes for sale, a reduction in investor
purchases, an increase in incentives offered by homebuilders and
sellers of existing homes and an increase in sales contract
cancellation rates. Many prospective homebuyers are approaching
the purchase decision more tentatively due to the increased
uncertainty surrounding the housing market. These factors
affected our business most significantly in our fourth fiscal
quarter, when our net sales orders decreased 25% compared to the
same quarter of fiscal 2005. Subsequent to fiscal year 2006, our
net sales orders for the month ended October 31, 2006
decreased 20% compared to the month ended October 31, 2005.
Our annual cancellation rate increased to 28% in fiscal 2006,
and our cancellation rate in the fourth quarter of fiscal 2006
and the month ended October 31, 2006 increased to
approximately 40%, exceeding our typical historical range of 16%
to 20%. The higher overall cancellation rate for fiscal 2006 was
primarily attributable to cancellations in many of our Arizona,
California and Florida markets. A significant portion of the
increase in cancellations was due to our prospective homebuyers
being unable to sell their existing homes.
The largest percentage decreases in the number and value of net
sales orders in fiscal 2006 compared to fiscal 2005 occurred in
our Northeast, Southeast and California regions. The decreases
in sales in these regions are primarily attributable to the
changes in market conditions described above. Partially
offsetting the decreases in net sales orders was an 18% increase
in net sales orders in our South Central region, where many of
our markets did not experience the same slowdown in demand in
fiscal 2006.
The average price of a net sales order in fiscal 2006 was
$267,300, a decrease of 3% from the $275,100 average in fiscal
2005. During the year, slight to moderate increases and
decreases in average sales prices occurred among our regions,
resulting in our relatively flat average price compared to 2005.
In general, our ability to raise prices is dependent on the
demand for our homes; therefore, the lack of any significant
overall price appreciation during 2006 was due in large part to
the recent decrease in demand and our increased use of sales
incentives in many markets. Particularly, the home price
appreciation that occurred in many of our California, Arizona
and Florida markets during fiscal 2005 has since moderated and
in many instances has reversed. We also continually monitor and
may adjust our product and geographic mix and pricing within our
homebuilding markets in an effort to keep our core product
offerings affordable for our target customer base, typically
first-time and
move-up
homebuyers. This sometimes also contributes to a decrease in the
average price.
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, which can result in cancellations. In
the past, our backlog has been a reliable indicator of the level
of closings in our two subsequent fiscal quarters, although this
relationship may change if our cancellation rates remain above
normal levels or continue to increase. Historically, our backlog
conversion rates (closings during the quarter divided by
beginning of the quarter backlog), have generally been in the
range of 50% to 75%, with the highest quarterly conversion rate
of each fiscal year typically occurring in the fourth quarter.
At September 30, 2006, the value of our backlog of sales
orders was $5,185.1 million (18,125 homes), down 11% from
$5,835.2 million (19,244 homes) at September 30, 2005.
The average sales price of homes in backlog was $286,100 at
September 30, 2006, down 6% from the $303,200 average at
September 30, 2005. The value of our sales order backlog
decreased in four of our six market regions, led by decreases of
31%, 30% and 26% in our Northeast, Southeast and California
regions, respectively, which is reflective of the current
difficult sales environment. The average selling price of homes
in backlog at September 30, 2006 as compared to
September 30, 2005 reflect only slight to moderate
increases and decreases among our regions.
Revenues from home sales increased 9%, to $14,545.4 million
(53,099 homes closed) in 2006 from $13,376.6 million
(51,172 homes closed) in 2005. Revenues from home sales
increased in all six of our market regions, led by the Northeast
and Southeast regions, with increases of 22% and 13%,
respectively. The average selling price of homes closed during
2006 was $273,900, up 5% from $261,400 in 2005. The average
selling price of homes closed increased by slight to moderate
amounts in five of our six market regions, led by the Southwest
and Southeast regions with increases of 12% and 11%,
respectively. Many markets, especially some of the California,
Arizona and Florida markets which experienced the most price
appreciation in recent years, have experienced weakening demand
in the latter part of fiscal 2006, resulting in declines in
total and per home revenue. As reflected in our net sales order
volume, demand has slowed in a number of our markets in recent
quarters, and in general, we are offering more incentives and
price concessions to obtain home sales.
Revenues from home sales in fiscal 2006 were increased by
$1.6 million, while revenues from home sales in fiscal 2005
were reduced by $92.2 million from changes in profit
deferred pursuant to Statement of Financial Accounting Standards
(SFAS) No. 66, “Accounting for Sales of Real
Estate.” The home sales profit related to our mortgage
loans held for sale is deferred in instances where a buyer
finances a home through our wholly-owned mortgage company and
has not made an adequate initial or continuing investment as
prescribed by SFAS No. 66. As of September 30,
2006, the balance of deferred profit related to such mortgage
loans held for sale was $90.6 million.
Total homebuilding gross profit decreased by 4%, to
$3,342.2 million in 2006 from $3,488.3 million in
2005. Including sales of both homes and land/lots, total
homebuilding gross profit as a percentage of homebuilding
revenues decreased 300 basis points, to 22.6% in 2006 from
25.6% in 2005.
Gross profit from home sales as a percentage of home sales
revenues decreased 150 basis points, to 24.0% in 2006 from
25.5% in 2005. The primary factors reducing our home sales gross
profit margin were the difficult market conditions discussed
above, which narrowed the range between our selling prices and
costs of our homes in many of our markets and caused a decline
of approximately 200 basis points in home sales gross
margin. We have had to utilize additional incentives in many of
our markets due to the current challenging sales environment.
Sales incentives affect our gross profit margin by reducing the
selling price of the home, or by increasing the cost of the home
without a proportional increase in the selling price. An
additional 45 basis points of home sales gross margin decline
was a result of the decrease in the relative number of closings
in markets such as California and Nevada, which have had
significant price appreciation in the last few years and,
therefore, have had above average gross margins. These declines
were partially offset by an improvement of approximately
55 basis points related to the increase in home sales
revenues and gross profit from the recognition of profit
previously deferred in accordance with SFAS No. 66.
The remaining improvement of 40 basis points was primarily due
to a reduction in warranty and construction defect expenses as a
percentage of home sales revenues.
In accordance with SFAS No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets,” land
inventory and related communities under development are reviewed
for potential write-downs when impairment indicators are
present. SFAS No. 144 requires that in the event the
undiscounted cash flows estimated to be generated by those
assets are less than their carrying amounts, impairment charges
are required to be recorded if the fair value of such assets is
less than their carrying amounts. These estimates of cash flows
are significantly impacted by estimates of revenues, costs, and
other factors. Due to uncertainties in the estimation process,
actual results could differ from such estimates. For those
assets deemed to be impaired, the impairment to be recognized is
measured by 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. Valuation adjustments on finished homes are recorded
when events or circumstances indicate that the carrying value is
less than the fair value less costs to sell the home.
During fiscal 2006, several communities under development that
demonstrated potential impairment indicators, with a combined
carrying value of $739.5 million at September 30, 2006, were
evaluated for potential impairment. Our analyses of these
projects generally assumed flat to reduced revenues as compared
with current sales orders for the particular project or revenues
realized from comparable projects. We determined that projects
with a carrying value of $459.3 million, the majority of which
were in California, were impaired. Consequently, we recorded
impairment charges of $146.2 million to reduce the carrying
value of the impaired projects to their estimated fair value.
The remaining $280.2 million of such projects with
impairment indicators are primarily in California. It is
possible that our estimate of undiscounted cash flows from these
projects may change and could result in a future need to record
impairment charges to write these assets down to fair value.
Additionally, if conditions in the homebuilding industry worsen
in the future, we may be required to evaluate additional
projects for potential impairment which may result in additional
impairment charges and such charges could be significant.
We periodically write off earnest money deposits and
pre-acquisition costs related to land and lot option contracts
which we no longer plan to pursue. During fiscal 2006 and 2005,
we wrote off $124.7 million and $17.1 million,
respectively, of earnest money deposits and pre-acquisition
costs related to land purchase option contracts which we
determined we would not pursue. The inventory impairment charges
and write-offs of earnest money deposits and pre-acquisition
costs reduced total homebuilding gross profit as a percentage of
homebuilding revenues by approximately 180 basis points in
fiscal 2006. Should the current weak homebuilding market
conditions persist and if we are unable to successfully
renegotiate certain land purchase contracts, we may have to
write off additional earnest money deposits and pre-acquisition
costs. We currently do not expect the potential for such
write-offs in fiscal 2007 to be as significant as the fiscal
2006 write-offs.
SG&A expenses from homebuilding activities increased by
$230.0 million, or 19%, to $1,456.6 million in 2006
from $1,226.6 million in 2005. As a percentage of revenues,
SG&A expenses increased 90 basis points, to 9.9% in
2006 from 9.0% in 2005. The largest component of our
homebuilding SG&A is employee compensation and related
costs, which represented 64% and 67% of SG&A costs in 2006
and 2005, respectively. Those costs increased
$115.1 million, or 14%, to $932.4 million in 2006 from
$817.3 million in 2005, largely due to the addition of
employees to support our previously planned growth. The
remaining increase in SG&A of $114.9 million was
primarily attributable to increases in advertising costs,
property taxes, rent expense and subdivision maintenance. These
increases were due to the growth in our inventory levels and the
competitive selling environment.
Throughout fiscal 2005 and through the first half of fiscal
2006, we increased the infrastructure of our homebuilding
operations to support the then planned delivery of approximately
58,000 homes in fiscal 2006 and further growth in home closings
into fiscal 2007. However, due to recent sales trends, the
increase in home closings of only 4% in fiscal 2006 compared to
17% in fiscal 2005 and an actual decline in home closings in the
fourth quarter of fiscal 2006 compared to the same period of
fiscal 2005, we no longer expect further growth in home closings
in the near term. We are adjusting our SG&A infrastructure
to support our
decreased expectations of future closing volumes; however, we
cannot provide assurance that future SG&A expense levels as
a percentage of homebuilding revenues will be as low as
historical levels.
We capitalize interest costs only to inventory under
construction or development. During both fiscal 2005 and 2006,
our inventory under construction or development exceeded our
interest-bearing debt; therefore, we capitalized virtually all
interest from homebuilding debt except for the call premium,
unamortized discount/premium and fees related to debt we paid
off prior to maturity. Interest amortized to cost of sales was
2.1% of total cost of sales in 2006, compared to 2.2% in 2005.
In fiscal 2006, in connection with the early redemption of our
9.375% senior notes due 2011 and our 10.5% senior
subordinated notes due 2011, we recorded interest expense of
approximately $13.4 million for the call premium and the
unamortized discount and issuance costs, net of any unamortized
premium related to these redeemed notes. Similarly, we recorded
interest expense of approximately $4.4 million related to
the unamortized fees associated with the redemption and
replacement of our revolving credit facility in fiscal 2006. In
fiscal 2005, in connection with the early redemption of our
9.375% senior notes due 2009, we recorded interest expense
of approximately $4.4 million for the call premium and
unamortized issuance costs, net of the unamortized premium
related to these redeemed notes.
Excluding interest charges related to early retirement of debt
and the replacement of our revolving credit facility, interest
incurred related to homebuilding debt increased by 19%, to
$325.4 million in fiscal 2006 compared to
$272.9 million in fiscal 2005. The increase resulted from
an increase in our average homebuilding debt of 34% in 2006
compared to 2005. Interest incurred increased at a slower rate
than our debt primarily because our debt has been more heavily
weighted to our revolving credit facility in 2006. The revolving
credit facility carries a lower interest rate than the weighted
average interest rate of our senior and senior subordinated
notes. Our ongoing efforts to replace our older, higher interest
rate notes with notes bearing lower interest rates also
contributed to the improvement in relative interest costs.
Other income, net of other expenses, associated with
homebuilding activities was $11.0 million in 2006, compared
to $15.7 million in 2005. The major component of other
income in both 2006 and 2005 was the increase in the fair value
of our interest rate swaps of $3.1 million and
$9.5 million, respectively. Also included in other income
in 2006 and 2005 was interest income of $6.9 million and
$3.9 million, respectively.
At September 30, 2006, we had $578.9 million in
goodwill, which we evaluate for impairment annually or when
circumstances warrant an earlier review. We have allocated our
goodwill to our reporting regions as follows, as of
September 30, 2006 and 2005: Northeast $74.4 million,
Southeast $11.5 million, South Central $15.9 million,
Southwest $102.4 million, California $300.3 million
and West $74.4 million. Although no impairment existed as
of September 30, 2006, if market conditions continue to
deteriorate in our reporting regions, our impairment review may
result in goodwill impairment charges in the future.
Northeast Region — Homebuilding revenues
increased 22% in 2006 compared to 2005, primarily due to a 16%
increase in the number of homes closed, as well as a slight
increase in the average selling price of those homes. Income
before income taxes for the region was relatively flat between
the two years; however, as a percentage of the region’s
revenues, it decreased 220 basis points to 9.0%, from 11.2%
in 2005. This decrease was due to a decrease in the
region’s core home sales gross profit percentage (home
sales gross profit percentage excluding impairments and earnest
money and pre-acquisition cost write-offs), with the gross
margin declines in our Virginia and Coastal Carolina markets
having the greatest impact on the overall decrease.
Additionally, profitability was negatively affected by the
recording of inventory impairment charges and land option cost
write-offs of $38.5 million in fiscal 2006 versus
$1.3 million in fiscal 2005.
Southeast Region — Homebuilding revenues
increased 12% in 2006 compared to 2005, primarily due to an 11%
increase in the average selling price of homes closed, as well
as a slight increase in the number of homes closed. Income
before income taxes for the region was relatively flat between
the two years; however, as a percentage of the region’s
revenues, it decreased 250 basis points to 17.0%, from 19.5% in
2005. This decrease was primarily due to a decrease in the
region’s gross profit percentage, which was negatively
affected by the recording of inventory impairment charges and
land option cost write-offs of $34.4 million in fiscal 2006
versus $3.8 million in fiscal 2005. Excluding these
charges, we experienced similar core home sales gross profit
margins in both fiscal years; however, we did experience a sharp
decline in these margins during the second half of fiscal 2006,
reflecting the softening market conditions, especially in
Florida.
South Central Region — Homebuilding revenues
increased 9% in 2006 compared to 2005, primarily due to an
increase in the number of homes closed, as well as a slight
increase in the average selling price of those homes. Income
before income taxes for the region was 26% higher in 2006
compared to 2005, and as a percentage of the region’s
revenues, increased 100 basis points to 7.4%, from 6.4% in
2005. This increase in income before income taxes was primarily
due to a decrease in the region’s selling, general and
administrative costs as a percentage of revenues, as gross
margin for the region was comparable from fiscal 2005 to fiscal
2006.
Southwest Region — Homebuilding revenues
increased 10% in 2006 compared to 2005, due to a 12% increase in
the average selling price of homes closed, while the number of
homes closed decreased 3%. Income before income taxes for the
region was 10% higher in 2006 compared to 2005, and as a
percentage of the region’s revenues was 15.2% in both
years. Inventory impairment charges and land option cost
write-offs of $25.7 million in fiscal 2006 versus
$1.3 million in fiscal 2005 contributed to an 80 basis
point decline in the region’s gross margin. This decline
was offset by a $22.8 million increase in gross margin
resulting from changes in profit deferred pursuant to
SFAS No. 66. While core homebuilding margins were
relatively flat in the Denver and Phoenix markets for the full
fiscal year 2006 as compared with fiscal year 2005, we did
experience a sharp decline in the Phoenix market home sales
gross margin in the fourth quarter of fiscal 2006 as compared
with the earlier quarters.
California Region — Homebuilding revenues
remained relatively flat, increasing only 1% in 2006 compared to
2005, reflecting a slight increase in the number of homes closed
and a slight decline in the average selling price of those
homes. Income before income taxes for the region was 54% lower
in 2006 compared to 2005 and as a percentage of the
region’s revenues, decreased 1,120 basis points to 9.5%,
from 20.7% in 2005. This decrease was due to a decrease in the
region’s gross profit percentage, which was significantly
affected by a decline of approximately 600 basis points in
the region’s core home sales gross margins with the largest
declines in the Sacramento and San Diego markets. In
addition, the recording of inventory impairment charges and
earnest money and pre-acquisition cost write-offs of
$165.8 million in fiscal 2006 versus $9.2 in fiscal 2005
had a significant negative impact on gross margins.
West Region — Homebuilding revenues remained
relatively flat, increasing only 2% in 2006 compared to 2005,
due to slight increases in both the number of homes closed and
in the average selling price of those homes. Income before
income taxes for the region was 13% lower in 2006 compared to
2005 and as a percentage of the region’s revenues,
decreased 390 basis points to 22.9%, from 26.8% in 2005.
This decrease was due to a decrease in the region’s gross
profit percentage, primarily attributable to lower gross margins
in the Las Vegas market.
Fiscal
Year Ended September 30, 2005 Compared to Fiscal Year Ended
September 30, 2004
The following tables set forth key operating and financial data
for our homebuilding operations by reporting region as of and
for the fiscal years ended September 30, 2005 and 2004.
Based on our revised aggregation of operating segments, we have
restated fiscal 2005 and 2004 amounts between regions to conform
to the fiscal 2006 presentation.
The value of net sales orders increased 28%, to
$14,643.4 million (53,232 homes) in 2005 from
$11,406.2 million (45,263 homes) in 2004. The overall
cancellation rates of the value of new sales contracts in 2005
and 2004 were 19% and 17%, respectively. The average price of a
net sales order in 2005 was $275,100, up 9% from the $252,000
average in 2004. The number and value of net sales orders
increased in all six of our market regions, reflecting the
execution of our organic growth strategies and the overall
strong demand for our homes in fiscal 2005.
All regions produced double-digit percentage increases in the
value of net sales orders during fiscal 2005, led by our
Southeast and Southwest regions, with increases of 46% and 40%,
respectively. The increase in our Southeast region resulted from
the continued expansion of our presence in our Florida markets
where housing demand was high. The increase in our Southwest
region was primarily due to increases in homes sold and average
sales price in our Arizona and New Mexico markets. The average
price of net sales orders increased at varying levels across all
of our regions, reflecting our ability to increase prices in
markets where demand for our homes was strongest. The highest
percentage increases in average sales prices occurred in our
Southwest, Southeast and California regions, while lesser
increases were experienced in our West, South Central and
Northeast regions. In the Northeast region where demand was
still strong, our efforts to offer more lower-priced products,
particularly in the Chicago market, resulted in an increase of
only 1% in the average sales price.
At September 30, 2005, the value of our backlog of sales
orders was $5,835.2 million (19,244 homes), up 28% from
$4,568.5 million (17,184 homes) at September 30, 2004.
The average sales price of homes in backlog was $303,200 at
September 30, 2005, up 14% from the $265,900 average at
September 30, 2004. The value of our sales order backlog
increased in four of our six market regions, led by increases of
50% in both our Northeast and Southwest regions. The average
selling price of homes in backlog increased in all of our market
regions, with the largest percentage increases occurring in our
Southeast and Southwest regions, where generally strong demand
for our homes allowed us to increase prices.
Revenues from home sales increased 28%, to
$13,376.6 million (51,172 homes closed) in 2005 from
$10,491.1 million (43,567 homes closed) in 2004. Revenues
from home sales increased by 20% or more in four of our six
market regions and the number of homes closed increased by more
than 10% in five of our six market regions. These results
reflect the execution of our growth strategies, continued
strength in demand for new homes and our homebuilding
divisions’ ability to efficiently deliver homes in backlog
to homebuyers. The average selling price of homes closed during
2005 was $261,400, up 9% from $240,800 in 2004. The average
selling price of homes closed increased by more than 10% in four
of our six market regions.
Revenues from home sales in fiscal 2005 were reduced by a
$92.2 million deferral of profit at September 30,
2005, pursuant to SFAS No. 66.
Total homebuilding gross profit increased by 42%, to
$3,488.3 million in 2005 from $2,460.7 million in
2004. Including sales of both homes and land/lots, total
homebuilding gross profit as a percentage of homebuilding
revenues increased 250 basis points, to 25.6% in 2005 from
23.1% in 2004. Gross profit from home sales as a percentage of
home sales revenues increased 250 basis points, to 25.5% in 2005
from 23.0% in 2004. Of the 250 basis point improvement in
home sales gross profit percentage, approximately 170 basis
points was due to market conditions that led to strong demand
for our homes. Those conditions allowed us to raise the selling
prices of our homes more rapidly than the overall increases in
the construction costs of our homes in the majority of our
markets. Our largest selling price and gross profit increases
were obtained in our Florida and Arizona markets. An additional
70 basis points of the improvement in home sales gross profit
percentage was due to a decrease in the capitalized interest
amortized to cost of sales as a percentage of home sales
revenues, which was attributable to our homebuilding leverage
ratio improvement and our debt refinancing efforts over the past
two years. The remaining home sales gross profit percentage
improvement related primarily to the relative increase in
closings in our more profitable markets due to our efforts to
re-allocate capital to these markets.
SG&A expenses from homebuilding activities increased by
$267.6 million, or 28%, to $1,226.6 million in 2005
from $959.0 million in 2004. As a percentage of revenues,
SG&A expenses were 9.0% in both years. The largest component
of our homebuilding SG&A is employee compensation and
related costs, which represented 67% and 65% of SG&A costs
in 2005 and 2004, respectively. Those costs increased
$192.4 million, or 31%, to $817.3 million in 2005 from
$624.9 million in 2004, largely due to the addition of
employees to support our growth. The remaining increase in
SG&A of $75.2 million was primarily attributable to
increases in advertising costs, rent expense, subdivision
maintenance and model home furniture depreciation.
Interest incurred related to homebuilding debt increased by 17%,
to $277.3 million in 2005 from $236.7 million in 2004,
while our average daily homebuilding debt increased 26% in 2005
from 2004. The percentage increase in our average homebuilding
debt was higher than the percentage increase in our interest
incurred due to the March 2004 restructuring of our unsecured
revolving credit facility which resulted in lower borrowing
costs throughout 2005, and due to our efforts over the past two
fiscal years to replace some of our higher interest rate notes
with notes bearing lower interest rates.
We capitalize interest costs only to inventory under
construction or development. During both fiscal years, our
inventory under construction or development exceeded our
interest-bearing debt; therefore, we capitalized all interest
from homebuilding debt except for the unamortized discounts,
premiums and fees related to debt we paid off prior to maturity.
Interest amortized to cost of sales decreased by 10%, to
$225.0 million in 2005 from $249.0 million in 2004.
This reduction in interest amortized to total cost of sales is a
direct result of the reductions in our homebuilding leverage and
our debt refinancing efforts over the last two years.
Other income, net of other expenses, associated with
homebuilding activities was $15.7 million in 2005, compared
to $9.9 million in 2004. The major component of other
income in both 2005 and 2004 was the increase in the fair value
of our interest rate swaps of $9.5 million and
$8.1 million, respectively. Also included in other income
in 2005 and 2004 was interest income of $3.9 million and
$2.2 million, respectively.
Northeast Region — Homebuilding revenues
increased 19% in 2005 compared to 2004, primarily due to an
increase in the number of homes closed, as well as a slight
increase in the average selling price of those homes. Income
before income taxes for the region was 29% higher in 2005
compared to 2004, and as a percentage of the region’s
revenues, increased 90 basis points to 11.2%, from 10.3% in
2004. This increase was due to an increase in the region’s
home sales gross profit percentage, with the gross margin
improvements in our Virginia and Coastal Carolina markets having
the greatest impact on the overall increase.
Southeast Region — Homebuilding revenues
increased 71% in 2005 compared to 2004, primarily due to a 54%
increase in the number of homes closed, as well as a 12%
increase in the average selling price of those homes, reflecting
an increase in housing demand and our increased investments in
the region, particularly in Florida. Income before income taxes
for the region was 135% higher in 2005 compared to 2004, and as
a percentage of the region’s revenues, increased
530 basis points to 19.5%, from 14.2% in 2004. This
increase was primarily due to an increase in the region’s
home sales gross profit percentage, particularly in our Florida
markets, where the high demand for homes enabled us to both
aggressively increase prices and close more homes.
South Central Region — Homebuilding revenues
increased 16% in 2005 compared to 2004, primarily due to a 14%
increase in the number of homes closed, as well as a slight
increase in the average selling price of those homes. Income
before income taxes for the region was 16% higher in 2005
compared to 2004; however, as a percentage of the region’s
revenues, it decreased 10 basis points to 6.4%, from 6.5%
in 2004. The increase in income before income taxes was
primarily due to the increase in the number of homes closed,
while the slight decrease in income before taxes as a percentage
of the region’s revenues was the result of home sales gross
profit percentages decreasing slightly in 2005 compared to 2004.
Southwest Region — Homebuilding revenues
increased 25% in 2005 compared to 2004, due to an 11% increase
in the number of homes closed and a 13% increase in the average
selling price of those homes, reflecting an increase in housing
demand, particularly in Arizona. Income before income taxes for
the region was 98% higher in 2005 compared to 2004, and as a
percentage of the region’s revenues, increased
560 basis points to 15.2%, from 9.6% in 2004. This increase
was primarily due to an increase in the region’s home sales
gross profit percentage, particularly in our Arizona and New
Mexico markets, where the high demand for homes enabled us to
more aggressively increase prices.
California Region — Homebuilding revenues
increased 19% in 2005 compared to 2004, due to a 9% increase in
the number of homes closed and an 11% increase in the average
selling price of those homes, reflecting continued strong
housing demand in California in 2005. Income before income taxes
for the region was 17% higher in 2005 compared to 2004; however,
as a percentage of the region’s revenues, it decreased
30 basis points to 20.7%, from 21.0% in 2004 largely due to
an increase in SG&A as a percentage of the region’s
revenues.
West Region — Homebuilding revenues increased
49% in 2005 compared to 2004, primarily due to a 25% increase in
the number of homes closed, as well as a 13% increase in the
average selling price of those homes, reflecting the strong
housing demand throughout the region in 2005 and our increased
investments in the region, particularly in Nevada. Income before
income taxes for the region was 77% higher in 2005 compared to
2004 and as a percentage of the region’s revenues,
increased 430 basis points to 26.8%, from 22.5% in 2004.
This increase was primarily due to an increase in the
region’s home sales gross profit percentage, particularly
in our Hawaii and Oregon markets, where we experienced
significant price appreciation during fiscal 2005.
Results
of Operations — Financial Services
The following tables set forth key operating and financial data
for our financial services operations, comprising DHI Mortgage
and our subsidiary title companies, for the fiscal years ended
September 30, 2006 and 2005:
The volume of loans originated and brokered by our mortgage
operations is directly related to the number and value of homes
closed by our homebuilding operations. Total first-lien loans
originated or brokered by DHI Mortgage for our homebuyers
increased 11% in fiscal 2006 compared to fiscal 2005. The
increase in loans originated or brokered was greater than our 4%
increase in the number of homes closed because our mortgage
capture rate (the percentage of total home closings by our
homebuilding operations for which DHI Mortgage handled the
homebuyers’ financing) increased to 68% in 2006 from 63% in
2005. Home closings from our homebuilding operations constituted
94% of DHI Mortgage loan originations in 2006, compared to
93% in 2005, reflecting DHI Mortgage’s continued focus on
supporting the captive business provided by our homebuilding
operations.
The number of loans sold to third-party investors increased 41%
in 2006 as compared to 2005. The increase was primarily due to
the increase in the number of mortgage loans originated, as well
as the implementation of more efficient loan sale processes
during fiscal 2006. Additionally, the increase in fiscal 2006
includes the effect of the sales of an unusually high volume of
mortgage loans held at September 30, 2005.
Revenues from the financial services segment increased 24%, to
$290.8 million in 2006 from $235.1 million in 2005.
The increase in financial services revenues was primarily due to
the increase in the number of mortgage loans originated and
sold, partially offset by a slight decrease in the average
mortgage revenues earned per loan sold. The decline in revenue
per loan was largely due to less favorable selling conditions
for mortgage originations and the interest rate environment in
fiscal 2006 compared to 2005. The majority of the revenues
associated with our mortgage operations are recognized when the
mortgage loans and related servicing rights are sold to
third-party investors.
General and administrative (G&A) expenses associated with
financial services increased 37%, to $202.2 million in 2006
from $147.6 million in 2005. As a percentage of financial
services revenues, G&A expenses increased by 670 basis
points, to 69.5% in 2006 from 62.8% in 2005. The largest
component of our financial services G&A expense is employee
compensation and related costs, which represented 77% and 76% of
G&A costs in 2006 and 2005, respectively. Those costs
increased 39%, to $155.4 million in 2006 from
$111.6 million in 2005, largely due to the addition of
employees to support our previously planned growth. The increase
in general and administrative expenses as a percentage of
financial services revenues reflects the growth of our financial
services infrastructure at a faster rate than the growth in
revenues. Because we now do not expect our year over year growth
in home closings and the related mortgage loan originations to
continue, we have adjusted, and will continue to adjust, our
financial services G&A infrastructure to support our
expected closings volume. Significant fluctuations in financial
services general and administrative expense as a percentage of
revenues can be expected to occur due to changes in the amount
of revenue earned. In addition, our financial services
operations are generally staffed at levels sufficient to support
our anticipated seasonal higher mortgage loan volume periods,
which may vary significantly between periods.
Fiscal
Year Ended September 30, 2005 Compared to Fiscal Year Ended
September 30, 2004
The following tables set forth key operating and financial data
for our financial services operations for the fiscal years ended
September 30, 2005 and 2004:
Total first-lien loans originated or brokered by DHI Mortgage
for our homebuyers increased 23% in fiscal 2005 compared to
fiscal 2004, which was greater than our 17% increase in the
number of homes closed because our mortgage capture rate (the
percentage of total home closings from our homebuilding
operations for which DHI Mortgage handled the homebuyers’
financing) increased to 63% in 2005 from 61% in 2004. Home
closings from our homebuilding operations constituted 93% of DHI
Mortgage loan originations in 2005, compared to 92% in 2004,
reflecting DHI Mortgage’s continued focus on supporting the
captive business provided by our homebuilding operations. Sales
of loans to third-party investors increased 28% in 2005 as
compared to 2004.
Revenues from the financial services segment increased 29%, to
$235.1 million in 2005 from $182.8 million in 2004.
The increase in financial services revenues was primarily due to
the increase in the number of mortgage loans originated and
sold, while the average mortgage revenues earned per loan sold
remained relatively constant. The majority of the revenues
associated with our mortgage operations are recognized when the
mortgage loans and related servicing rights are sold to
third-party investors.
G&A expenses associated with financial services increased
22%, to $147.6 million in 2005 from $121.0 million in
2004. As a percentage of financial services revenues, G&A
expenses decreased by 340 basis points, to 62.8% in 2005
from 66.2% in 2004. The largest component of our financial
services G&A expense is employee compensation and related
costs, which represented 76% and 73% of G&A costs in 2005
and 2004, respectively. Those costs increased 26%, to
$111.6 million in 2005 from $88.8 million in 2004,
largely due to the addition of employees to support our growth.
The improvement in general and administrative expenses as a
percentage of financial services revenues was due primarily to
the more efficient use of our personnel to support the increase
in mortgage loan volume. Significant fluctuations in financial
services general and administrative expense as a percentage of
revenues can be expected to occur due to changes in the amount
of revenue earned.
35
Overview
of Current Capital Resources and Liquidity
We fund our homebuilding and financial services operations with
cash flows from operating activities, borrowings under our bank
credit facilities and the issuance of new debt securities. As we
utilize our capital resources and liquidity to fund our
operations, we have focused on maintaining a strong balance
sheet.
At September 30, 2006, our ratio of net homebuilding debt
to total capital was 40.7%, an increase of 850 basis points
from 32.2% at September 30, 2005. Net homebuilding debt to
total capital consists of homebuilding notes payable net of cash
divided by total capital net of cash (homebuilding notes payable
net of cash plus stockholders’ equity). Homebuilding notes
payable does not include the balance of liabilities, if any,
associated with consolidated land inventory not owned. The
increase in our ratio of net homebuilding debt to total capital
at September 30, 2006 as compared with the ratio a year
earlier was due to the decrease in cash and the increase in
borrowings associated with funding our increase in inventory,
partially offset by the increase in retained earnings. Our
target operating range for net homebuilding debt to total
capital is below 45%, so the 40.7% ratio at September 30,
2006 is in line with our operating target. We remain focused on
maintaining our liquidity and strengthening our balance sheet so
we can be flexible in reacting to market conditions; however,
future fiscal year-end net homebuilding debt to total capital
ratios may be higher than the fiscal 2006 year-end ratio.
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 us with other
homebuilders. We exclude the debt of our financial services
business because the business is separately capitalized and its
debt is substantially collateralized by specified mortgage loans
held for sale, and its debt is not guaranteed by our parent
company or any of our homebuilding entities. Because of its
capital function, we include homebuilding cash as a reduction of
our homebuilding debt and total capital. For comparison, at
September 30, 2006 and 2005, our ratios of homebuilding
debt to total capital, without netting cash balances, were 43.1%
and 40.6%, respectively.
We believe that we will be able to continue to fund our
homebuilding and financial services operations and our future
cash needs (including debt maturities) through a combination of
our existing cash resources, cash flows from operations, our
existing or renewed credit facilities and the issuance of new
debt securities through the public capital markets.
Cash and Cash Equivalents — At
September 30, 2006, our available homebuilding cash and
cash equivalents amounted to $457.8 million.
Bank Credit Facility — During November 2006, we
increased the size of our $2.15 billion unsecured revolving
credit facility, which includes a $1.0 billion letter of
credit
sub-facility,
to $2.5 billion and extended its maturity by one year to
December 16, 2011. The revolving credit facility has an
uncommitted $400 million accordion provision which could be
used to increase the facility to $2.9 billion. The facility
is guaranteed by substantially all of our wholly-owned
subsidiaries other than our financial services subsidiaries. We
borrow funds through the revolving credit facility throughout
the year to fund working capital requirements, and we repay such
borrowings with cash generated from our operations and from the
issuance of public debt securities.
We had $800.0 million in cash borrowings outstanding on our
homebuilding revolving credit facility at September 30,
2006 and no outstanding borrowings on the facility at
September 30, 2005. Under the debt covenants associated
with our revolving credit facility, when we have fewer than two
investment grade senior unsecured debt ratings from Moody’s
Investors Service, Fitch Ratings and Standard and Poor’s
Corporation, our additional homebuilding borrowing capacity
under the facility is limited to the lesser of the unused
portion of the facility, $1.23 billion at
September 30, 2006, or an amount determined under a
borrowing base arrangement. Under the borrowing base limitation,
the sum of our senior debt and the amount drawn on our revolving
credit facility may not exceed certain percentages of the
various categories of our unencumbered inventory. Beginning
November 7, 2005, we had the two required investment grade
debt ratings, so the
borrowing base limitation is not currently in effect. On
April 5, 2006, we received the investment grade rating from
the third rating agency.
Our revolving credit facility also imposes restrictions on our
operations and activities, including limits on investments, cash
dividends, stock repurchases and incurrence of indebtedness, and
required maintenance of a maximum leverage ratio, a minimum
ratio of earnings before interest, income taxes, depreciation,
amortization and extraordinary gains and losses to interest
incurred and minimum levels of tangible net worth. At
September 30, 2006, we were in compliance with all of the
covenants, limitations and restrictions that form a part of our
bank revolving credit facility and our public debt obligations.
Repayments of Public Unsecured Debt — On
March 15, 2006, we redeemed our 9.375% senior notes
due 2011 at an aggregate redemption price of approximately
$209.4 million, plus accrued interest. Concurrent with the
redemption, we recorded interest expense of approximately
$10.6 million, representing the call premium and the
unamortized discount and fees related to the redeemed notes.
On July 15, 2006, we redeemed our 10.5% senior
subordinated notes due 2011. The notes, which were originally
issued by Schuler Homes, Inc. and were assumed in the merger in
February 2002, were redeemed at an aggregate price of
approximately $152.4 million, plus accrued interest.
Concurrent with the redemption, we recorded interest expense of
approximately $2.8 million, representing the call premium,
net of the unamortized premium related to the redeemed notes.
Recently Issued Public Unsecured Debt — In
April 2006, we issued $500 million of 6.5% senior
notes due 2016 and $250 million of 6.0% senior notes
due 2011. We used the proceeds from these offerings for the
repayment of borrowings under our revolving credit facility.
Shelf Registration Statements — On
June 13, 2006, we filed with the Securities and Exchange
Commission an automatically effective universal shelf
registration statement registering debt and equity securities
which we may issue from time to time in amounts to be
determined. Also, at September 30, 2006, we had the
capacity to issue approximately 22.5 million shares of
common stock under our acquisition shelf registration statement,
to effect, in whole or in part, possible future business
acquisitions.
Cash and Cash Equivalents — At
September 30, 2006, we had available financial services
cash and cash equivalents of $129.8 million.
Mortgage Warehouse Loan Facility — Our
wholly-owned mortgage company has a mortgage warehouse loan
facility. Upon its maturity in April 2006, the loan agreement
was amended and restated to extend its maturity date to
April 6, 2007. This amendment also changed the total
capacity of the mortgage warehouse loan facility from
$600 million to $670 million until May 1, 2006
and then to $540 million thereafter, subject to increases
upon consent of the lenders to $750 million under the
accordion provision of the credit agreement. Through exercise of
the accordion provision in September 2006, the total capacity of
the mortgage warehouse loan facility was increased to
$750 million from September 22, 2006 to
November 6, 2006 and then to $540 million thereafter.
At September 30, 2006, we had borrowings of
$371.7 million outstanding under the mortgage warehouse
facility.
Our borrowing capacity under this facility is limited to the
lesser of the unused portion of the facility or an amount
determined under a borrowing base arrangement. Under the
borrowing base limitation, the amount drawn on our mortgage
warehouse facility may not exceed 98% of all eligible mortgage
loans held for sale and made available to the lenders to secure
any borrowings under the facility.
Commercial Paper Conduit Facility — Our
wholly-owned mortgage company also has a commercial paper
conduit facility (the “CP conduit facility”). Upon its
maturity in June 2006, the loan agreement was amended and
restated, increasing the total capacity of the CP conduit
facility from $650 million to $1.2 billion. The new
agreement expires June 27, 2009, subject to the annual
renewal of the
364-day
backup liquidity feature. At September 30, 2006, we had
borrowings of $820.0 million outstanding under the CP
conduit facility.
In the past, we have been able to renew or extend the mortgage
warehouse loan facility and the CP conduit facility on
satisfactory terms prior to their maturities and obtain
temporary additional commitments through amendments of the
respective credit agreements during periods of higher than
normal volumes of mortgages held for sale. Although we do not
anticipate any problems in renewing or extending these
facilities or obtaining temporary additional commitments in the
future, the liquidity of our financial services business depends
upon our continued ability to do so.
The mortgage warehouse loan facility and the CP conduit facility
are not guaranteed by either D.R. Horton, Inc. or any of the
subsidiaries that guarantee our homebuilding debt. Borrowings
under both facilities are secured by certain mortgage loans held
for sale. Additionally, at September 30, 2006, borrowings
under the CP conduit facility were secured by restricted cash
arising from borrowings under the facility prior to the
assignment of mortgage loans held for sale as collateral. The
mortgage loans assigned 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. At
September 30, 2006, our total mortgage loans held for sale
were $1,022.9 million. All mortgage company activities are
financed with the mortgage warehouse facility, the CP conduit
facility or internally generated funds. Both of our financial
services credit facilities contain financial covenants as to our
mortgage subsidiary’s minimum required tangible net worth,
its maximum allowable ratio of debt to tangible net worth and
its minimum required net income. At September 30, 2006, our
mortgage subsidiary was in compliance with all of these
covenants.
During the year ended September 30, 2006, we used
$1.2 billion of cash in our operating activities, as
compared to $620.7 million of cash used in such activities
during the prior year. The net cash used in operations during
fiscal 2006 was primarily the result of cash provided from net
income and a decrease in mortgage loans held for sale, offset by
cash used to increase residential land and lot and home
inventories. The net cash used in operations during fiscal 2005
was the result of cash provided from net income and an increase
in accounts payable and other liabilities, offset by cash used
to increase residential land, lot and home inventories, mortgage
loans held for sale and other assets.
The principal reason for the decrease in operating cash flows in
fiscal 2006 was our decision to invest $3.1 billion of cash
to fund inventory growth in the period as compared to a
$1.9 billion cash investment for inventory growth in fiscal
2005. The decision to fund additional inventory growth was based
on management’s expectations for future returns from the
incremental inventory investments. In light of the more
challenging market conditions encountered in the last six months
of fiscal 2006, our expectations have changed, so we have
substantially slowed our planned purchases of land and lots to
reduce our inventory to better match our new reduced rate of
production. Our ability to reduce our inventory levels in the
near term is, however, partially dependent upon our ability to
close a sufficient number of homes in the next few quarters. To
the extent our inventory levels decrease during fiscal 2007, we
expect net positive cash flows from operating activities in
fiscal 2007, assuming all other factors remain constant.
A large portion of our cash invested in inventories represents
purchases of land and lots that will be used to generate
revenues and cash flows in future years. Since we control the
amounts and timing of our investments in land and lots based on
our inventory growth goals and our market opportunities, we
believe that cash flows from operating activities before
increases in residential land and lot inventories is currently a
better indicator of our cash flows from operations.
Another significant factor affecting our operating cash flows in
fiscal 2006 was the decrease in mortgage loans held for sale of
$335.8 million during fiscal 2006. The decrease in mortgage
loans held for sale was due to an increase in the volume of
loans sold in the fourth quarter of fiscal 2006, compared to the
fourth quarter of fiscal 2005, as a result of more efficient
loan sale processes put in place during fiscal 2006. We expect
to continue to use cash to fund an increase in mortgage loans
held for sale in quarters when our homebuilding closings grow.
However, in periods when home closings are flat or decline as
compared to prior periods or if our mortgage capture rate
declines, the amount of net cash used may be reduced or we may
generate positive cash flows from the reduction in the balance
of mortgage loans held for sale.
In fiscal 2006 and 2005, cash used in investing activities
represented net purchases of property and equipment, primarily
model home furniture and office equipment. Such purchases are
not significant relative to our total assets or cash flows, and
they typically do not vary significantly from year to year.
The majority of our short-term financing needs are funded with
cash generated from operations and borrowings available under
our homebuilding and financial services credit facilities.
Long-term financing needs are generally funded with the issuance
of new senior unsecured debt securities through the public
capital markets. Our homebuilding senior and senior subordinated
notes are guaranteed by substantially all of our wholly-owned
subsidiaries other than our financial services subsidiaries.
In March 2006, we redeemed our 9.375% senior subordinated
notes due 2011 at an aggregate redemption price of approximately
$209.4 million, plus accrued interest. Concurrent with the
redemption, we recorded interest expense of approximately
$10.6 million, representing the call premium and the
unamortized discount and fees related to the redeemed notes.
In April 2006, we issued $500 million principal amount of
6.5% senior notes due 2016 and $250 million principal
amount of 6.0% senior notes due 2011. We used the proceeds
from these offerings for the repayment of borrowings under the
revolving credit facility.
In July 2006, we redeemed our 10.5% senior subordinated
notes due 2011. The notes, which were originally issued by
Schuler Homes, Inc. and were assumed in the merger in February
2002, were redeemed at an aggregate price of approximately
$152.4 million, plus accrued interest. Concurrent with the
redemption, we recorded interest expense of approximately
$2.8 million, representing the call premium, net of the
unamortized premium related to the redeemed notes.
Borrowings by our mortgage subsidiary under the CP conduit
facility are secured by the assignment of mortgage loans held
for sale and restricted cash arising from borrowings under the
facility prior to the assignment of the mortgage loans as
collateral. At September 30, 2006 and 2005, the balances of
cash restricted for this purpose were $248.3 million and
$0, respectively.
During fiscal 2006, our Board of Directors declared one
quarterly cash dividend of $0.09 per common share, two
quarterly cash dividends of $0.10 per common share, and one
quarterly cash dividend of $0.15 per common share, the last
of which was paid on September 1, 2006 to stockholders of
record on August 21, 2006. On October 12, 2006, our
Board of Directors declared a cash dividend of $0.15 per
common share, which was paid on November 1, 2006, to
stockholders of record on October 23, 2006.
In December 2003, our Board of Directors declared a
three-for-two
stock split (effected as a 50% stock dividend), paid on
January 12, 2004 to holders of record of our common stock
as of December 22, 2003. In February 2005, our Board of
Directors declared a
four-for-three
stock split (effected as a
331/3%
stock dividend), paid on March 16, 2005 to holders of
record of our common stock as of March 1, 2005.
In November 2005, our Board of Directors authorized the
repurchase of up to $500 million of our common stock and up
to $200 million of outstanding debt securities, replacing
the previous common stock and debt securities repurchase
authorizations. During fiscal 2006, we repurchased one million
shares of our common stock at a total cost of
$36.8 million, all of which occurred during the three
months ended December 31, 2005. As of September 30,
2006, we had $463.2 million remaining of the Board of
Directors’ authorization for repurchases of common stock
and $200 million remaining of the authorization for
repurchases of debt securities. In November 2006, our Board of
Directors renewed the remaining $463.2 million common stock
repurchase authorization and increased the debt repurchase
authorization to $500 million. Additionally, both
authorizations were extended to November 30, 2007.
On January 26, 2006, our shareholders approved an amendment
to the D.R. Horton, Inc. charter which increased the number of
authorized shares of common stock to one billion shares.
We continue to evaluate our alternatives for future
non-operating
uses of our available capital, including repayment of debt,
dividend payments and common stock repurchases, based on market
conditions and other circumstances, and within the constraints
of our balance sheet leverage targets and the restrictions gin
our bank agreements and indentures.
Contractual
Cash Obligations and Commercial Commitments
Our primary contractual cash obligations for our homebuilding
and financial services segments are payments under short-term
and long-term debt agreements and lease payments under operating
leases. Purchase obligations of our homebuilding segment
represent specific performance requirements under lot option
purchase agreements that may require us to purchase land
contingent upon the land seller meeting certain obligations. We
expect to fund our contractual obligations in the ordinary
course of business through our operating cash flows, our
homebuilding and financial services credit facilities and by
accessing the debt capital markets.
Our future cash requirements for contractual obligations as of
September 30, 2006 are presented below:
At September 30, 2006, our homebuilding operations had
outstanding letters of credit of $128.2 million and surety
bonds of $2.3 billion, 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.
To meet the financing needs of our customers, our mortgage
operations extend interest rate lock commitments (IRLCs) to
borrowers who have applied for loan funding and meet defined
credit and underwriting criteria. Typically, the IRLCs have a
duration of less than six months. Some IRLCs are committed
immediately to a specific investor through the use of
best-efforts whole loan delivery commitments, while other IRLCs
are funded prior to being committed to third-party investors.
We manage interest rate risk related to our uncommitted IRLCs
through the use of forward sales of mortgage-backed securities
(FMBS) and the purchase of Eurodollar Futures Contracts (EDFC)
on certain loan types. As of September 30, 2006, our IRLCs
totaled $647.7 million, and we had approximately
$391.6 million of best-efforts whole loan delivery
commitments and $429.5 million outstanding of FMBS and EDFC
related to our uncommitted IRLCs.
In an effort to stimulate home sales by potentially offering
homebuyers a below market interest rate on their home financing,
we began a program during fiscal 2006 which protects us from
future increases in interest rates related to potential mortgage
originations of approximately $599 million. To accomplish
this, we purchase forward rate agreements (FRAs) and economic
interest rate hedges in the form of FMBS and put options on both
EDFC and mortgage-backed securities (MBS). At September 30,
2006, the notional amount of the FRAs was $354 million,
while economic interest rate hedges totaled $2.4 billion in
EDFC put options and $104 million in MBS put options,
hedging a notional principal of $245.0 million in mortgage
loan commitments. Both the FRAs and economic interest rate
hedges have various maturities not exceeding twelve months.
These instruments are considered non-designated derivatives and
are accounted for at fair value with gains and losses recognized
in current earnings. The gains and losses for the year ended
September 30, 2006 were not significant.
Land and
Lot Position and Homes in Inventory
The following is a summary of our land and lot position and
homes in inventory at September 30, 2006 and 2005:
In the ordinary course of business, we enter into land and lot
option purchase contracts to procure land or lots for the
construction of homes. Lot option contracts enable us to control
significant lot positions with a minimal capital investment and
substantially reduce the risks associated with land ownership
and development. At September 30, 2006, we owned or
controlled approximately 323,000 lots, 41% of which were lots
under option or similar contracts, compared with approximately
346,000 lots at September 30, 2005.
At September 30, 2006, we controlled approximately 133,000
lots with a total remaining purchase price of approximately
$4.0 billion under land and lot option purchase contracts,
with a total of $211.3 million in deposits. Our lots
controlled include approximately 23,500 optioned lots with a
remaining purchase price of approximately $875 million for
which we do not expect to exercise our option to purchase the
land or lots, but the contract has not yet been terminated. We
have written off $30.5 million of deposits and
$10.3 million of pre-acquisition costs relating to these
23,500 lots under contract, resulting in a net deposit balance
of $180.8 million at September 30, 2006. During fiscal
2006, including the write-offs described above, we wrote off a
total of $124.7 million of earnest money deposits and
pre-acquisition costs related to land and lot
purchase option contracts for which we do not intend to exercise
our option to purchase the land or lots. Write-offs of earnest
money deposits and pre-acquisition costs in fiscal 2005 and
fiscal 2004 were $17.1 million and $20.1 million,
respectively.
Within the land and lot option purchase contracts in force at
September 30, 2006, there were a limited number of
contracts, representing only $54.8 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. Pursuant to the provisions of
Interpretation No. 46, “Consolidation of Variable
Interest Entities — an interpretation of ARB
No. 51” as amended (FIN 46), issued by the
Financial Accounting Standards Board (FASB), we consolidated
certain variable interest entities with assets of
$100.4 million related to some of our outstanding land and
lot option purchase contracts.
At September 30, 2006, we had a total of approximately
28,500 homes in inventory, including approximately 1,900 model
homes and approximately 440 unsold homes that had been completed
for more than six months. At September 30, 2005, we had a
total of approximately 23,200 homes in inventory, including
approximately 1,600 model homes and approximately 200 unsold
homes that had been completed for more than six months. Of our
total homes in inventory, 50% and 41% were unsold at
September 30, 2006 and 2005, respectively.
We have typically experienced seasonal variations in our
quarterly operating results and capital requirements. In prior
years, we generally had more homes under construction, closed
more homes and had greater revenues and operating income in the
third and fourth quarters of our fiscal year. This 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, our results of operations
and financial position at the end of the third and fourth fiscal
quarters are not necessarily representative of the balance of
our fiscal year.
In fiscal 2006, 57% of our consolidated revenues was
attributable to operations in the third and fourth fiscal
quarters. In contrast to our typical seasonal results, due to
softening homebuilding market conditions during fiscal 2006,
only 46% of our consolidated operating income was attributable
to operations in the third and fourth fiscal quarters. This
decrease was primarily due to the increased use of incentives to
sell homes and inventory impairment charges and land option cost
write-offs recorded during the third and fourth quarters of
fiscal 2006. We expect that we will experience our historical
seasonal patterns of revenues and operating income in future
fiscal years.
We and the homebuilding industry in general 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 can significantly
affect the affordability of permanent mortgage financing to
prospective homebuyers. We attempt to pass through to our
customers any increases in our costs through increased sales
prices and, to date, inflation has not had a material adverse
effect on our results of operations. However, during periods of
softer homebuilding market conditions, we may not be able to
offset the increases in our costs with higher selling prices.
Certain statements contained in this report, as well as in other
materials we have filed or will file with the Securities 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” 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
unknown 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:
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.
Further discussion of these and other risk considerations is
provided in Item 1A “Risk Factors” under
Part I of this annual report on
Form 10-K.
Critical
Accounting Policies
General — A comprehensive enumeration of the
significant accounting policies of D.R. Horton, Inc. and
subsidiaries is presented in Note A to the accompanying
financial statements as of September 30, 2006 and 2005, and
for the years ended September 30, 2006, 2005 and 2004. 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.
Basis of Presentation — Our financial
statements include the accounts of D.R. Horton, Inc. and all of
its wholly-owned, majority-owned and controlled subsidiaries. We
have also consolidated certain variable interest entities from
which we are purchasing lots under option purchase contracts,
under the requirements of FIN 46. All significant
intercompany accounts, transactions and balances have been
eliminated in consolidation.
Use of Estimates — The preparation of financial
statements in conformity with GAAP requires us to make estimates
and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results
could differ materially from those estimates.
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 by DHI Mortgage, our
wholly-owned mortgage subsidiary, and the buyer has not made an
adequate initial or continuing investment as prescribed by
SFAS No. 66, the profit on such sales is deferred
until the sale of the related mortgage loan to a third-party
investor has been completed. We include amounts in transit from
title companies at the end of each reporting period 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 recognize the majority of the
revenues associated with our mortgage operations when the
mortgage loans and related servicing rights are sold to
third-party investors. Origination fees and direct origination
costs are deferred and recognized as revenues and expenses,
respectively, along with the associated gains and losses on the
sales of the loans and related servicing rights, when the loans
are sold. We sell all mortgage loans and related servicing
rights to third-party investors.
Some of the loans sold by DHI Mortgage are sold with limited
recourse provisions. Based on historical experience, we estimate
and record an allowance for losses related to loans sold with
recourse.
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. Applicable direct overhead 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 construction superintendents, sales personnel
and division and region management, advertising and
builder’s risk insurance are charged to SG&A expense as
incurred.
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. Home construction costs are
accumulated for each specific home.
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) based upon
the total number of homes expected to be closed in each project.
Any changes to the estimated total development costs subsequent
to the initial home closings in a project are generally
allocated on a pro-rata basis to the remaining homes in the
project.
When a home is closed, we generally have not yet paid and
recorded all incurred costs necessary to complete the home. Each
month 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 as of the end of that
month. 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 accuracy of each
month’s accrual by comparing actual costs incurred on
closed homes in subsequent months to the amount we accrued.
Although actual costs to be paid in the future on previously
closed homes could differ from our current accruals,
historically, differences in amounts have not been significant.
In accordance with SFAS No. 144, land inventory and
related communities under development are reviewed for potential
write-downs when impairment indicators are present.
SFAS No. 144 requires that in the event the
undiscounted cash flows estimated to be generated by those
assets are less than their carrying amounts, impairment charges
are required to be recorded if the fair value of such assets is
less than their carrying amounts. These estimates of cash flows
are significantly impacted by estimates of revenues, costs, and
other factors. Due to uncertainties in the estimation process,
actual results could differ from such estimates. For those
assets deemed to be impaired, the impairment to be recognized is
measured by 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.
In accordance with SFAS No. 144, valuation adjustments
are recorded on finished homes when events or circumstances
indicate that the carrying value is less than the fair value
less costs to sell the home.
Consolidated Land Inventory Not Owned — We
account for our land and lot option purchase contracts in
accordance with the provisions of FIN 46. FIN 46
provides guidance for the financial accounting and reporting of
interests in certain variable interest entities, which
FIN 46 defines as certain business entities that either
have equity investors with no voting rights or have equity
investors that do not provide sufficient financial resources for
the entities to support their activities. FIN 46 requires
consolidation of such entities by any company that is subject to
a majority of the risk of loss from the entities’
activities or is entitled to receive a majority of the
entities’ residual returns or both, defined as the primary
beneficiary of the variable interest entity.
In the ordinary course of our homebuilding business, we enter
into land and lot option purchase contracts to procure land or
lots for the construction of homes. Under such option purchase
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. Under the requirements of
FIN 46, certain of the option purchase contracts result in
the creation of a variable interest in the entity holding the
land parcel under option.
In applying the provisions of FIN 46, we evaluate those
land and lot option purchase contracts with variable interest
entities to determine whether we are the primary beneficiary
based upon analysis of the variability of the expected gains and
losses of 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.
Since we own no equity interest in any of the unaffiliated
variable interest entities that we must consolidate pursuant to
FIN 46, we generally have little or no control or influence
over the operations of these entities or their owners. When our
requests for financial information are denied by the land
sellers, certain assumptions about the assets and liabilities of
such entities are required. In most cases, the fair value of the
assets of the consolidated entities has been assumed to be the
remaining contractual purchase price of the land or lots we are
purchasing. In these cases, it is assumed that the entities have
no debt obligations and the only asset recorded is the land or
lots we have the option to buy with a related offset to minority
interest for the assumed third party investment in the variable
interest entity. Creditors, if any, of these variable interest
entities have no recourse against us.
Warranty Costs — We have established warranty
reserves by charging cost of sales and crediting a warranty
liability for each home closed. We estimate the amounts charged
to be adequate to cover expected warranty-related costs for
materials and labor required under one- and ten-year warranty
obligation periods. The one-year warranty is comprehensive for
all parts and labor; the ten-year period is for major
construction defects. Our warranty cost accruals are based upon
our historical warranty cost experience in each market in which
we operate and are adjusted as appropriate to reflect
qualitative risks associated with the type 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.
Insurance Claim Costs — We have, and require
the majority of the subcontractors we use to have, general
liability insurance (including construction defect coverage) and
workers compensation insurance. These insurance policies protect
us against a portion of our risk of loss from claims, subject to
certain self-insured retentions, deductibles and other coverage
limits. In some states where we believe it is too difficult or
expensive for the subcontractors to obtain general liability
insurance, we have waived our traditional subcontractor general
liability insurance requirements to obtain lower bids from
subcontractors. We self-insure a portion of our overall risk,
partially through the use of a captive insurance entity which
issues a general liability policy to us, naming some
subcontractors as additional insureds.
We record expenses and liabilities related to the costs to cover
our self-insured and deductible amounts under our insurance
policies and for any estimated costs of potential claims and
lawsuits (including expected legal costs) in excess of our
coverage limits or not covered by our policies, based on an
analysis of our historical claims, which includes an estimate of
construction defect claims incurred but not yet reported.
Projection of losses related to these liabilities is 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 we build, claim settlement
patterns, insurance industry practices and legal
interpretations, among others. Because of the high degree of
judgment required in determining these estimated liability
amounts, actual future costs could differ significantly from our
currently estimated amounts. A 10% change in the claim rate or
the average cost per claim used to estimate the self-insured
accruals would not result in a material change in our accrual.
Goodwill — Goodwill represents the excess of
purchase price over net assets acquired. Pursuant to the
provisions of SFAS No. 142, “Goodwill and Other
Intangible Assets,” we review goodwill for potential
impairment annually or when events and circumstances warrant an
earlier review. Impairment is determined to exist when the
estimated fair value of goodwill is less than its carrying
value. During fiscal 2006, 2005 and 2004, we measured the fair
value of our reporting units using a discounted cash flow model
and determined that the fair value of our reporting units was
greater than their book value and therefore no impairment of
goodwill existed.
We regularly evaluate whether events and circumstances have
occurred that indicate the remaining balance of goodwill may not
be recoverable. The goodwill assessment procedures required by
SFAS No. 142 require management to make comprehensive
estimates of future revenues and costs. Due to the uncertainties
associated with such estimates, actual results could differ from
such estimates. Continued softness in the homebuilding industry
may result in the determination that some of our goodwill has
become impaired, which would result in a potentially significant
charge to reflect goodwill impairment.
Income Taxes — We calculate a provision for
income taxes using the asset and liability method, under which
deferred tax assets and liabilities are recognized by
identifying the temporary differences arising from the different
treatment of items for tax and accounting purposes. In
determining the future tax consequences of events that have been
recognized in our financial statements or tax returns, judgment
is required. 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.
Stock-based Compensation — With the approval of
our compensation committee, consisting of independent members of
our Board of Directors, we from time to time issue to employees
and directors options to purchase our common stock. The
committee approves grants only out of amounts remaining
available for grant from amounts formally authorized by our
common stockholders. We typically grant approved options with
exercise prices equal to the market price of our common stock on
the date of the option grant. The majority of the options
granted vest ratably over a ten-year period.
On October 1, 2005, we adopted the provisions of
SFAS No. 123(R), “Share Based Payment,”
which requires that companies measure and recognize compensation
expense at an amount equal to the fair value of share-based
payments granted under compensation arrangements. We calculate
the fair value 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.
Prior to October 1, 2005, we accounted for stock option
grants using the intrinsic value method in accordance with the
Accounting Principles Board (APB) Opinion No. 25,
“Accounting for Stock Issued to Employees,” and
recognized no compensation expense for stock option grants since
all options granted had an exercise price equal to the market
value of the underlying common stock on the date of grant.
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements.” The statement defines fair
value, establishes a framework for measuring fair value in GAAP,
and expands disclosures about fair value measurements.
SFAS No. 157 is effective as of the beginning of an
entity’s fiscal year that begins after November 15,
2007. We are currently evaluating the impact of the adoption of
SFAS No. 157; however, it is
not expected to have a material impact on our consolidated
financial position, results of operations or cash flows.
In September 2006, the Securities and Exchange Commission (SEC)
Staff issued Staff Accounting Bulletin (SAB) No. 108,
“Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial
Statements,” which addresses how the effects of prior-year
uncorrected financial statement misstatements should be
considered in current-year financial statements. The SAB
requires registrants to quantify misstatements using both
balance-sheet and income-statement approaches and to evaluate
whether either approach results in quantifying an error that is
material in light of relative quantitative and qualitative
factors. The requirements of SAB No. 108 are effective
for annual financial statements covering the first fiscal year
ending after November 15, 2006. We are currently evaluating
the impact of the adoption of SAB No. 108; however, it
is not expected to have a material impact on our consolidated
financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48
(FIN 48), “Accounting for Uncertainty in Income
Taxes — an interpretation of FASB
Statement 109.” FIN 48 prescribes a comprehensive
model for recognizing, measuring, presenting and disclosing in
the financial statements tax positions taken or expected to be
taken on a tax return, including a decision whether to file or
not to file in a particular jurisdiction. FIN 48 is
effective for fiscal years beginning after December 15,
2006. We are currently evaluating the impact of the adoption of
FIN 48; however, it is not expected to have a material
impact on our consolidated financial position, results of
operations or cash flows.
In March 2006, the FASB issued SFAS No. 156,
“Accounting for Servicing of Financial Assets —
an amendment of FASB Statement No. 140,” which
provides an approach to simplify efforts to obtain hedge-like
(offset) accounting by allowing a company the option to carry
mortgage servicing rights at fair value. This new Statement
amends SFAS No. 140, “Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of
Liabilities — a replacement of FASB Statement
No. 125,” with respect to the accounting for
separately recognized servicing assets and servicing
liabilities. SFAS No. 156 is effective for all
separately recognized servicing assets and liabilities as of the
beginning of an entity’s fiscal year that begins after
September 15, 2006, with earlier adoption permitted in
certain circumstances. Since we do not retain the servicing
rights when we sell our mortgage loans held for sale, the
adoption of SFAS No. 156 is not expected to have a
material impact on our consolidated financial position, results
of operations or cash flows.
In May 2005, the FASB issued SFAS No. 154,
“Accounting Changes and Error Corrections, a replacement of
APB Opinion No. 20 and FASB Statement No. 3.”
This statement changes the requirements for the accounting for
and reporting of a change in accounting principle, and 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 us for accounting changes and corrections of
errors made after October 1, 2006, the beginning of our
fiscal year 2007. The adoption of SFAS No. 154 is not
expected to have a material impact on our consolidated financial
position, results of operations or cash flows.
We are subject to interest rate risk on our long-term debt. We
monitor our exposure to changes in interest rates and utilize
both fixed and variable rate debt. For fixed rate debt, changes
in interest rates generally affect the value of the debt
instrument, but not our earnings or cash flows. Conversely, for
variable rate debt, changes in interest rates generally do not
impact the fair value of the debt instrument, but may affect our
future earnings and cash flows. We have mitigated our exposure
to changes in interest rates on our variable rate bank debt by
entering into interest rate swap agreements to obtain a fixed
interest rate for a portion of the variable rate borrowings. We
generally do not have an obligation to prepay fixed-rate debt
prior to maturity and, as a result, interest rate risk and
changes in fair value would not have a significant impact on our
cash flows related to our fixed-rate debt until such time as we
are required to refinance, repurchase or repay such debt.
Our interest rate swaps are not designated as hedges under
SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” We are exposed to
interest rate risk associated with changes in the fair values of
the swaps, and such changes must be reflected in our income
statements.
Our mortgage company is exposed to interest rate risk associated
with its mortgage loan origination services. Interest rate lock
commitments (IRLCs) are extended to borrowers who have applied
for loan funding and who meet defined credit and underwriting
criteria. Typically, the IRLCs have a duration of less than six
months. Some IRLCs are committed immediately to a specific
investor through the use of best-efforts whole loan delivery
commitments, while other IRLCs are funded prior to being
committed to third-party investors. We manage interest rate risk
related to uncommitted IRLCs through the use of forward sales of
mortgage-backed securities (FMBS) and the purchase of Eurodollar
Futures Contracts (EDFC) on certain loan types. FMBS and EDFC
related to IRLCs are classified and accounted for as
non-designated derivative instruments, with gains and losses
recognized in current earnings. FMBS and EDFC related to funded,
uncommitted loans are designated as fair value hedges, with
changes in the value of the derivative instruments recognized in
current earnings, along with changes in the value of the funded,
uncommitted loans. The effectiveness of the fair value hedges is
continuously monitored and any ineffectiveness, which for the
years ended September 30, 2006, 2005 and 2004 was not
significant, is recognized in current earnings. At
September 30, 2006, FMBS and EDFC to mitigate interest rate
risk related to uncommitted mortgage loans held for sale and
uncommitted IRLCs totaled $1,007.5 million. Uncommitted
IRLCs, the duration of which are generally less than six months,
totaled approximately $256.1 million, and uncommitted
mortgage loans held for sale totaled approximately
$368.5 million at September 30, 2006. The fair value
of the FMBS, EDFC and IRLCs at September 30, 2006 was an
insignificant amount.
In an effort to stimulate home sales by potentially offering
homebuyers a below market interest rate on their home financing,
we began a program during fiscal 2006 which protects us from
future increases in interest rates related to potential mortgage
originations of approximately $599 million. To accomplish
this, we purchase forward rate agreements (FRAs) and economic
interest rate hedges in the form of FMBS and put options on both
EDFC and mortgage-backed securities (MBS). At September 30,
2006, the notional amount of the FRAs was $354 million,
while economic interest rate hedges totaled $2.4 billion in
EDFC put options and $104 million in MBS put options,
hedging a notional principal of $245 million in mortgage
loan commitments. Both the FRAs and economic interest rate
hedges have various maturities not exceeding twelve months.
These instruments are considered non-designated derivatives and
are accounted for at fair value with gains and losses recognized
in current earnings. The gains and losses for the year ended
September 30, 2006 were not significant.
The following table sets forth principal cash flows by expected
maturity, weighted average interest rates and estimated fair
value of our debt obligations as of September 30, 2006. In
addition, the table sets forth the notional amounts, weighted
average interest rates and estimated fair value of our interest
rate swaps. Because the mortgage warehouse credit facility and
CP conduit facility are secured by certain mortgage loans held
for sale which are typically sold within 60 days, the
outstanding balances at September 30, 2006 are included in
the variable rate maturities for the fiscal year ending
September 30, 2007. At September 30, 2006, the fair
value of the interest rate swaps was a $0.1 million
liability.
The Board of Directors
D.R. Horton, Inc.
We have audited the accompanying consolidated balance sheets of
D.R. Horton, Inc. and subsidiaries (the “Company”) as
of September 30, 2006 and 2005, and the related
consolidated statements of income, stockholders’ equity,
and cash flows for each of the three years in the period ended
September 30, 2006. These financial statements are the
responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of D.R. Horton, Inc. and subsidiaries at
September 30, 2006 and 2005, and the consolidated results
of their operations and their cash flows for each of the three
years in the period ended September 30, 2006, in conformity
with U.S. generally accepted accounting principles.
As discussed in Note H, the Company has restated its
segment disclosures.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of D.R. Horton, Inc.’s internal control over
financial reporting as of September 30, 2006, based on
criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated
December 6, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
December 6, 2006
D.R.
HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
See accompanying notes to consolidated financial statements.
D.R.
HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
D.R.
HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
D.R.
HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
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