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HORTON D R INC 10-K 2008 Documents found in this filing:Table of Contents
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. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in
Rule 12b-2
of the Exchange Act.
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Smaller reporting company
o
(Do not check if a smaller reporting company)
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, 2008, the aggregate market value of the
registrant’s common stock held by non-affiliates of the
registrant was approximately $4,533,399,000 based on the closing
price as reported on the New York Stock Exchange.
As of November 20, 2008, there were 320,315,508 shares
of the registrant’s common stock, par value $.01 per share,
issued and 316,660,275 shares outstanding.
Portions of the registrant’s definitive Proxy Statement for
the 2009 Annual Meeting of Stockholders are incorporated herein
by reference in Part III.
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D.R. Horton, Inc. is the largest homebuilding company in the
United States, based on homes closed during the twelve months
ended September 30, 2008. We construct and sell high
quality homes through our operating divisions in 27 states
and 77 metropolitan markets of the United States, primarily
under the name of D.R. Horton, America’s Builder. We
are 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. The growth of our company over the
years was achieved by investing available capital into our
existing homebuilding markets and into
start-up
operations in new markets. Additionally, we acquired numerous
other homebuilding companies, which strengthened our market
position in existing markets and expanded our geographic
presence and product offerings in other markets. Our homes
generally range in size from 1,000 to 5,000 square feet and
in price from $90,000 to $900,000. The current downturn in our
industry has resulted in a decrease in the size of our
operations during fiscal 2007 and 2008, as we have been affected
by, and have reacted to, the significantly weakened market for
new homes. For the year ended September 30, 2008, we closed
26,396 homes with an average closing sales price of
approximately $233,500.
Through our financial services operations, we provide mortgage
financing 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. We generally do not seek to retain or service
the mortgages we originate but, rather, seek to sell the
mortgages and related servicing rights to investors. Our
subsidiary title companies serve as title insurance agents by
providing title insurance policies, examination and closing
services, primarily to the purchasers of our homes.
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, which
were $6.6 billion in fiscal 2008. Our homebuilding
operations 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, we 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 77%, 81%, and 80% of home
sales revenues in fiscal 2008, 2007 and 2006, 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 (SEC). These reports
include our annual report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
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 SEC filings are also available to the public over the
Internet at the SEC’s website at www.sec.gov, and the
public may read and copy any document we file at the SEC’s
public reference room located at 100 F Street NE,
Washington, D.C. 20549. Please call the SEC at
1-800-SEC-0330
for further information on the operation of the public reference
room.
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.
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Operating
Strategy
For the greatest part of our company’s existence, we
maintained significant year-over-year growth and profitability.
We achieved this growth through an operating strategy focused on
capturing greater market share, while also maintaining a strong
balance sheet. To execute our strategy, we invested available
capital in our existing homebuilding markets and
opportunistically entered new markets. We also actively
evaluated homebuilding acquisition opportunities as they arose,
some of which resulted in acquisitions and contributed to our
growth.
Due to the progressive weakening of demand in our homebuilding
markets over the past few years, we have experienced declines in
revenues and gross profit, sustained significant asset
impairment charges and incurred losses in fiscal 2007 and 2008.
Although we believe the long-term fundamentals which support
housing demand, namely population growth and household
formation, remain solid and the current negative conditions will
moderate over time, the timing of a recovery in the housing
market is unclear. Consequently, our primary focus while market
conditions are weak is to strengthen our financial condition by
reducing inventories of homes and land, controlling and reducing
construction and overhead costs, generating positive cash flows
from operations, reducing outstanding debt and maintaining
strong 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 77 markets. This provides us with geographic diversification
in our homebuilding inventory investments and our sources of
revenues and earnings. We believe our diversification strategy
helps to mitigate the effects of local and regional economic
cycles and enhances our long-term potential.
We are the largest homebuilding company in the United States in
terms of number of homes closed in fiscal 2008. By the same
measure, we are also either the largest or one of the five
largest builders in many of our markets in fiscal 2008. 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:
We decentralize our homebuilding activities to give operating
flexibility to our local division presidents on certain key
operating decisions. At September 30, 2008, we had 34
separate homebuilding operating divisions, 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,
generally 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.
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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 four
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 nine 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:
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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.
As negative market conditions in the housing industry persist,
we remain focused on strengthening our balance sheet and
maintaining strong liquidity. However, we will continue to
evaluate opportunities for strategic acquisitions. We believe
that the current housing industry downturn may provide us
selected opportunities to enhance our operations through the
acquisition of existing homebuilding companies at attractive
valuations. In certain instances, such acquisitions can provide
us benefits not found in
start-up
operations, such as: established land positions and inventories;
and existing relationships with municipalities, land owners,
developers, subcontractors and suppliers. We seek to limit the
risks associated with acquiring other 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.
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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. Our
homebuilding operating divisions are aggregated into six
reporting segments, which are comprised of the markets below.
Our financial statements contain additional information
regarding segment performance.
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When evaluating new or existing homebuilding markets for
purposes of capital allocation, 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 land and lots to other developers and homebuilders where we
have excess land and lot positions. In line with our current
initiative to reduce land and lot supply to match our future
expectations of closings, we completed a significant number of
land and lot sales during fiscal 2008, particularly in the
fourth quarter. In addition to generating cash flows, reducing
our future carrying costs and land development obligations, and
lowering our inventory supply in certain markets, consummating
these transactions during the current fiscal year allowed us to
monetize a larger portion of our deferred tax assets through a
loss carryback to fiscal 2006 resulting in an increase in our
expected tax refund.
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 and any preacquisition due diligence costs incurred
by us. This enables us to control land and lot positions with
limited capital investment, which substantially reduces the
risks associated with land ownership and development.
Almost all of our land and lot positions are acquired directly
by us. We have avoided 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:
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The benefits of this strategy have been limited by the current,
deteriorating conditions in the homebuilding industry.
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. In
some markets, we have adjusted our product offerings to address
affordability issues, which have become increasingly important
in the current weak market conditions.
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. Generally, 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 our customers are typically first-time or
move-up
homebuyers, we attempt to adjust our product mix and pricing
within our homebuilding markets to keep our homes affordable. 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 most markets.
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We advertise in our local markets as necessary through
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 selected markets and
projects 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 have sold a
substantial majority of our speculative homes while they are
under construction or soon after completion; however, the
significant weakness in our housing markets and related high
cancellation rates during fiscal 2006, 2007 and 2008 have caused
our speculative homes inventory to remain higher than our target
levels. While we plan to reduce both total and speculative homes
in inventory from current levels, we do expect to maintain a
level of speculative home inventory in our markets which will be
based on our expectations of future sales and closings volume.
We believe these speculative homes help to provide us with
opportunities to sell additional homes, reduce our inventory of
developed lots and generate positive cash flows.
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. As a percentage of gross sales orders, cancellations of
sales contracts in fiscal 2008 were 40%. Our cancellation rate
continues to be significantly higher than our historical rate of
approximately 20% before the downturn in the homebuilding
industry, reflecting the continuing weak housing market
conditions. The length of time between the signing of a sales
contract for a home and delivery of the home to the buyer
(closing) averages from two to six months.
Our operating divisions are responsible for pre-closing quality
control inspections and responding to customers’
post-closing needs. We believe that a 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 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
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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, 2008, approximately 92% of DHI
Mortgage’s loan volume related to homes closed by our
homebuilding operations, and DHI Mortgage provided mortgage
financing services for approximately 61% of our total homes
closed.
To limit the risks associated with our mortgage operations, DHI
Mortgage only originates loan products that it believes may be
sold to third-party investors. DHI Mortgage generally packages
and sells the loans and their servicing rights to third-party
investors shortly after origination with limited recourse
provisions. 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.
Through our subsidiary title companies, 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. We currently assume little or no
underwriting risk associated with these title policies.
At September 30, 2008, we employed 3,800 persons, of
whom 865 were sales and marketing personnel, 1,293 were
executive, administrative and clerical personnel, 953 were
involved in construction and 689 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. In the current weak
housing conditions, competition among homebuilders has greatly
intensified, especially as to pricing and incentives, as
builders attempt to maximize sales volume despite the weakness
in housing demand. The current market conditions have also led
to a large number of foreclosed homes being offered for sale,
which has increased competition for homebuyers and affected
pricing. 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, 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.
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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. Prior to
the current downturn in the homebuilding industry, 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 increased
our working capital requirements for our homebuilding operations
during the third and fourth fiscal quarters and increased our
funding requirements for the mortgages we originated in our
financial services segment at the end of these quarters. As a
result of seasonal activity, our results of operations and
financial position at the end of a particular fiscal quarter are
not necessarily representative of the balance of our fiscal year.
In contrast to our typical seasonal results, due to further
deterioration of homebuilding market conditions during the last
two years, we incurred consolidated operating losses in our
third and fourth quarters of fiscal 2007 and in all quarters of
fiscal 2008. These results were primarily due to recording
significant inventory and goodwill impairment charges. Also, the
increasingly challenging market conditions caused declines in
sales volume, pricing and margins that mitigated our historical
seasonal variations. Although we may experience our typical
historical seasonal pattern in the future, given the current
market conditions, we can make no assurances as to when or
whether this pattern will recur.
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.
The downturn in the homebuilding industry is in its third year
and it has become one of the most severe housing downturns in
U.S. history. The significant declines in the demand for
new homes, the significant oversupply of homes on the market and
the significant reductions in the availability of financing for
homebuyers that have marked the downturn are continuing. We have
experienced material reductions in our home sales and
homebuilding revenues, and we have incurred material inventory
and goodwill impairments and other write-offs. Our gross margins
have declined significantly, and we incurred substantial losses
for our 2007 and 2008 fiscal years. It is not clear when these
trends will reverse or when we will return to profitability.
Our ability to respond to the downturn has been limited by
adverse market and economic conditions. Recently, the growing
number of home mortgage foreclosures has increased supply and
driven down prices, making the purchase of a foreclosed home an
attractive alternative to purchasing a new home. Homebuilders
have responded to declining sales and increased cancellation
rates with significant concessions, further adding to the price
declines. With the decline in the values of homes and in the
ability of homeowners to make their mortgage payments, the
credit markets have been significantly disrupted, putting
strains on many households and businesses. In the face of these
conditions, fears of recession and the loss of jobs have
increased, and consumer confidence has reached its lowest level
in decades. As a result, the decision to buy a new home has
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become more difficult, and demand for new homes has declined
significantly. Moreover, the government’s legislative and
administrative measures aimed at restoring liquidity to the
credit markets and providing relief to homeowners facing
foreclosure have only recently begun. It is unclear whether
these measures will effectively stabilize prices and home values
or restore confidence and increase demand in the homebuilding
industry.
These challenging conditions are complex and interrelated. We
cannot predict their duration or ultimate severity. Nor can we
provide assurance that our responses to the downturn or the
government’s attempts to address the troubles in the
economy will be successful.
During this downturn in the homebuilding industry, we have
relied principally on the positive operating cash flow we have
generated to meet our working capital needs and repay
outstanding indebtedness. We generated $1.88 billion and
$1.36 billion in operating cash flow in fiscal years 2008
and 2007, respectively. We anticipate significant positive
operating cash flow for fiscal 2009, principally through the
receipt of federal income tax refunds and from home and land
sales, though at a reduced level. However, the downturn and the
disruption in the credit markets have reduced other sources of
liquidity available to us.
In fiscal 2008, our senior debt ratings were lowered below
investment grade by the three ratings agencies, and the terms of
our revolving credit facility now restrict our future borrowings
to borrowing base limitations. Though we had no cash borrowings
outstanding under the facility at September 30, 2008, the
borrowing base limitations currently have reduced availability
under the facility to $52.8 million until we repay
outstanding homebuilding debt at a faster pace than further
inventory reductions, or the limitations are amended. We are
currently exploring alternatives with regard to our revolving
credit facility, which could potentially include an amendment to
the current agreement, but consummating an amendment may be
difficult in the current credit market. We believe that any
amendment will require an increase in the costs of borrowing, a
reduction in the overall credit commitment and possibly
additional restrictions on us. We do not currently anticipate a
need to borrow from the facility, and we plan to fund our
short-term working capital needs and our fiscal 2009 debt
maturities through existing cash resources and cash flows
generated from operations during fiscal 2009.
As of September 30, 2008, we had $549.7 million of
senior notes that mature in January and February 2009. We have
sufficient cash on hand to make these payments. However, current
market conditions would significantly limit our ability to
refinance this indebtedness if we chose to do so. Pricing in the
public debt markets has increased substantially, and the
indenture terms available in these markets are generally more
restrictive than those in our current indentures. Moreover, our
senior debt ratings, the impact of our recent results on
measures used by debt investors and the uncertainties facing the
homebuilding industry could reduce our ability to access these
markets even if acceptable pricing or terms are available to
other issuers. In addition, the significant decline in our stock
price, the ongoing volatility in the stock markets and the
reduction in our stockholders’ equity relative to our debt
could also impede our access to the equity markets or increase
the amount of dilution our stockholders would experience should
we seek to raise capital through issuance of equity.
Our financial services segment uses a $275 million mortgage
repurchase facility to finance many of the loans it originates.
The facility must be renewed annually, and the current facility
expires in March 2009. A continuation of current market
conditions could make the renewal more difficult or could result
in an increase in the cost of the facility or a decrease in its
committed availability. Such conditions may also make it more
difficult or costly to sell the mortgages that we originate. We
have reduced our mortgage products to only those we expect to be
able to sell.
While we believe we can meet our capital requirements from our
cash resources, future cash flow and the sources of financing
that we anticipate will be available to us, we can provide no
assurance that we will continue to be able to do so,
particularly if current market or economic conditions continue
or deteriorate further. The future effects on our business,
liquidity and financial results of these conditions could be
material and adverse to us, both in ways described above and in
other ways that we do not currently foresee.
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Most of our customers finance their home purchases through
lenders providing mortgage financing. Prior to the recent
volatility in the financial markets, mortgage interest rates
were at historical lows and a variety of mortgage products were
available. As a result, homeownership became more accessible.
The mortgage products available included features that allowed
buyers to obtain financing for a significant portion, up to all,
of the purchase price of the home, had very limited underwriting
requirements or provided for lower initial monthly payments. As
a result, more people were able to qualify for mortgage
financing. Mortgage interest rates have increased, and the range
of mortgage products to homebuyers has decreased from those
previously available.
During fiscal 2007 and 2008, the mortgage lending industry
experienced significant instability, beginning with increased
defaults on subprime loans and other nonconforming loans and
compounded by expectations of increasing interest payment
requirements and further defaults. This in turn resulted in a
decline in the market value of many mortgage loans and related
securities. Lenders, regulators and others questioned the
adequacy of lending standards and other credit requirements for
several loan products and programs offered in recent years.
Credit requirements tightened, and investor demand for mortgage
loans and mortgage-backed securities declined. The deterioration
in credit quality has caused almost all lenders to eliminate
subprime mortgages and most other loan products that are not
eligible for sale to Fannie Mae or Freddie Mac or loans that do
not meet Federal Housing Administration (FHA) and Veterans
Administration (VA) requirements. Fewer loan products, tighter
loan qualifications and a reduced willingness of lenders to make
loans in turn have made it more difficult for many buyers to
finance the purchase of our homes. These factors have served to
reduce the pool of qualified homebuyers and made it more
difficult to sell to first time and
move-up
buyers which have long made up a substantial part of our
customers. These reductions in demand have adversely affected
our operations and financial results, and the duration and
severity of the effects are uncertain.
We believe that the liquidity provided by Fannie Mae and Freddie
Mac to the mortgage industry has been very important to the
housing market. These entities have recently required
substantial injections of capital from the federal government.
These injections have been accompanied by criticism that the
pool of homebuyers these institutions seek to assist should be
reduced. Any reduction in the availability of the financing
provided by these institutions could adversely affect interest
rates, mortgage availability and our sales of new homes and
mortgage loans.
In recent years a growing number of our homebuyers used down
payment assistance programs, which allowed them to receive gift
funds from non-profit corporations as a down payment.
Homebuilders had been a source of funding for these programs.
However, the American Housing Rescue and Foreclosure Prevention
Act of 2008 eliminated seller-funded down payment assistance on
FHA-insured loans approved on or after October 1, 2008.
With the elimination of these gift fund programs, we will seek
other financing alternatives, and seek down payment programs for
those customers who meet applicable guidelines. There can be no
assurance, however, that any such alternative programs are
available or as attractive to our customers as the programs
previously offered, and our sales could suffer.
Because of the decline in the availability of other mortgage
products, FHA and VA mortgage financing support has become a
more important factor in marketing our homes. The American
Housing Rescue and Foreclosure Prevention Act of 2008, however,
includes a provision that increases a buyer’s down payment
from at least 3.0% to at least 3.5% of the appraised value of
the property on FHA insured loans. This down payment requirement
may impact the ability of our customers that meet the FHA
guidelines to obtain financing. Additionally, this limitation
and other limitations or restrictions on the availability of FHA
and VA financing could adversely affect interest rates, mortgage
availability and our sales of new homes and mortgage loans.
Even if potential customers do not need financing, changes in
interest rates and the availability of mortgage products may
make it harder for them to sell their current homes to potential
buyers who need financing.
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The decreases in mortgage availability have also been reflected
in higher mortgage interest rates. Despite recent rate cuts by
the Federal Reserve, mortgage rates remain above their lows of
the past few years and these interest rates may increase
further. If these rates remain high or increase, the costs of
owning a home will be affected and could result in further
reductions in the demand for our homes.
Our
strategies in responding to the adverse conditions in the
homebuilding industry have had limited success, and the
continued implementation of these and other strategies may not
be successful.
While we have been successful in generating positive operating
cash flow and reducing our inventories in fiscal 2007 and 2008,
we have done so at significantly reduced gross profit levels and
have incurred significant asset impairment charges. These
contributed to the net losses we recognized in fiscal 2007 and
2008. Also, in fiscal 2007 and 2008, notwithstanding our sales
strategies, we continued to experience an elevated rate of sales
contract cancellations. We believe that the increase in the
cancellation rate is largely due to a decrease in homebuyer
confidence, due principally to continued price declines, the
growing number of foreclosures and reduced consumer confidence.
A more restrictive mortgage lending environment and the
inability of some buyers to sell their existing homes have also
impacted cancellations. Many of these factors, which affect new
sales and cancellation rates, are beyond our control. It is
uncertain how long the reduction in sales and the increased
level of cancellations will continue.
Cyclical Industry. The homebuilding industry
has been cyclical historically and continues to be significantly
affected by changes in industry conditions, as well as in
general and local economic conditions, such as:
These may occur on a national scale, like the current downturn,
or may affect some of the regions or markets in which we operate
more than others. When adverse conditions affect any of our
larger markets, they could have a proportionately greater impact
on us than on some other homebuilding companies. Our operations
in previously strong markets, particularly California, Florida,
Nevada and Arizona, where we have significant inventory, have
more adversely affected our financial results than our other
markets in the current downturn.
An oversupply of alternatives to new homes, including foreclosed
homes, homes held for sale by investors and speculators, other
existing homes and rental properties, can also reduce our
ability to sell new homes and depress new home prices and reduce
our margins on the sales of new homes.
Inventory Risks. Inventory risks are
substantial for our homebuilding business. 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 the
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present weak market conditions, we have sold homes and land for
lower margins or at a loss and we have recorded significant
inventory impairment charges.
Historically, 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 encountered since
fiscal 2006, we significantly slowed our purchases of land and
lots and made substantial land and lot sales as part of our
strategy to reduce our inventory to better match our reduced
rate of production. We also terminated numerous land option
contracts and wrote off earnest money deposits and
pre-acquisition costs related to these option contracts. Because
future market conditions are uncertain, we cannot provide
assurance that these measures will be successful in managing our
future inventory risks.
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,
wildfires, volcanic activity, droughts, and floods, 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.
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 economy.
Consequences. As a result of the foregoing
matters, potential customers may be less able or willing to buy
our homes, or we may take longer or incur more costs to build
them. Because of current market conditions, we have not been
able to recapture any increased costs by raising prices. In the
future, our ability to do so may also be limited by 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.
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. An increase in the default rate on the mortgages
we originate may adversely affect our ability to sell the
mortgages or the pricing we receive upon the sale of mortgages
or may increase our repurchase obligations for previous
originations.
Significant expenses of owning a home, including mortgage
interest 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
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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.
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 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. New housing developments may also be subject to
various assessments for schools, parks, streets and other public
improvements. 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 home construction.
We are also 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, mitigation and other costs,
and can prohibit or severely restrict development and
homebuilding activity in environmentally sensitive regions or
areas.
Our financial services operations are 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.
In November 2008, HUD issued a final rule modifying certain
aspects of the Real Estate Settlement Procedures Act. The rule
is scheduled to become effective in January 2009. As part of the
changes, new limitations were placed on non-settlement service
providers, such as homebuilders, from providing incentives tied
to the use of affiliated settlement service providers. The new
rule does not prevent settlement service providers from offering
discounts or incentives, however this change could negatively
impact the number of loans, closings and profitability of our
financial services entities.
The turmoil caused by the increasing number of defaults in
subprime and other loans has encouraged the investigation of
financial services industry practices by governmental
authorities. These have only recently begun, and they could
include the examination of consumer lending practices, sales of
mortgages to financial institutions and other investors and the
practices in the financial services segments of homebuilding
companies. We are unable to assess whether these governmental
inquiries will result in changes in government regulation,
homebuilding industry practices or adversely affect the costs or
potential profitability of homebuilding companies.
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We have a significant amount of debt. As of September 30,
2008, our consolidated debt was $3,748.4 million. As of
September 30, 2008, the scheduled maturities of principal
on our outstanding debt for the subsequent 12 months
totaled $780.9 million.
Possible Consequences. The amount and the
maturities of our debt could have important consequences. For
example, they could:
Dependence on Future Performance. Our ability
to meet our debt service and other obligations will depend, in
part, upon our future financial performance. Our future results
are subject to the risks and uncertainties described in this
report. These have been compounded by the current industry and
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, 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.
Credit Facility and Other Restrictions. Our
revolving credit facility imposes restrictions on our operations
and activities by requiring us to maintain certain levels of
leverage, tangible net worth and components of inventory. If we
do not maintain the requisite levels, we may not be able to pay
dividends or available financing could be reduced or terminated.
Also, in the current conditions, the margins by which we have
met the financial covenants in our revolving credit facility
have been reduced. If they are further reduced significantly in
the future, we or our lenders may seek to negotiate revised
terms for the facility that could increase the cost, reduce the
availability or change other conditions of the facility. In
addition, the indentures governing our senior notes and senior
subordinated notes impose restrictions on the creation of
secured debt.
The mortgage repurchase facility for our financial services
subsidiaries also requires the maintenance of minimum levels of
tangible net worth, ratio of debt to tangible net worth and net
income by our financial services subsidiaries. A failure to
comply with these requirements could allow the lending banks to
terminate the availability of funds to the financial services
subsidiaries or cause their debt to become due and payable prior
to maturity.
Changes in Debt Ratings. In fiscal 2008, all
three of the agencies that rate our senior unsecured debt
lowered our ratings to a level below investment grade, and two
of the agencies lowered it even further during the year. Because
we no longer maintain our investment grade credit ratings from
at least two of these agencies, credit under our revolving
credit facility is currently limited to specified percentages of
unencumbered inventory and the amount of other senior unsecured
indebtedness. Additionally, we are now subject to limitation on
the number of unsold homes and the amount of developed lots and
lots under development included in inventory. The cost of such
capital has increased and could increase more with further
lowering of our debt ratings. The further lowering of our debt
ratings could also make accessing the public capital markets
more difficult and expensive.
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, which
constituted $1.6 billion principal amount in the aggregate
as of September 30, 2008, we would be required to offer to
purchase such notes at
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101% of their principal amount, together with all accrued and
unpaid interest, if any. Moreover, a change of control as
defined in our credit facilities may also result in the
acceleration of our revolving credit facility or our financial
services facility. If purchase offers were required under the
indentures for these notes or these facilities were accelerated,
we can give no assurance that we would have sufficient funds to
pay the amounts that we would be required to purchase or repay.
At September 30, 2008, we did not have sufficient funds
available to purchase or pay 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 subsidiaries to
provide funds to our homebuilding operations, however, is
subject to restrictions in their mortgage repurchase facility.
These funds would not be available to us upon the occurrence and
during the continuance of defaults under this facility.
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.
Our revolving credit facility requires us to maintain certain
financial covenants based on leverage, tangible net worth and
components of inventory. The facility also includes a borrowing
base requirement that is currently in effect which limits
availability based upon certain levels of inventory and the
amount of other senior unsecured indebtedness. If we do not
maintain the requisite covenants, we may not be able to pay
dividends or available financing could be terminated. The
borrowing base limitation currently in effect limits
availability under the facility to $52.8 million until we
repay outstanding homebuilding debt at a faster pace than
further inventory reductions, or the limitations are amended. In
addition, if non-compliance with these covenants were to result
in an event of default, the lenders could cease any further
funding under the facility, declare any outstanding amounts due
and payable and require us to provide cash as collateral for any
outstanding letters of credit not already collateralized. The
lenders could also seek to renegotiate the terms of the facility
or impose further restrictions on our ability to pay dividends,
obtain other financing or engage in other activities.
In addition, our mortgage subsidiary’s mortgage repurchase
facility contains financial covenants applicable to that
subsidiary. If our mortgage subsidiary does not comply with
those covenants and that results in an event of default, the
counterparties could cease further purchases under the facility
and declare any outstanding amounts due and payable. The
counterparties could also seek to renegotiate the terms of the
facility, and the renewal of the facility could be more
difficult.
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,
often within larger subdivisions designed, planned and developed
by such homebuilders. We also compete with existing home sales,
foreclosures and rental properties. The competitive conditions
in the homebuilding industry can result in:
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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 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. In
the current downturn in the homebuilding industry, the reactions
of our competitors may have reduced the effectiveness of our
efforts to achieve pricing stability and reduce our inventory
levels.
Although we focused on internal growth in recent years before
the downturn in the homebuilding industry, we may make strategic
acquisitions of homebuilding companies or their assets in the
future. Successful strategic acquisitions can 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 valuation risks,
including 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, as evidenced by the goodwill
impairment charges we recognized in fiscal 2007 and 2008.
Moreover, we may not be able to implement successfully our
operating and any future growth strategies within our existing
markets.
As of September 30, 2008, we have a deferred income tax
asset of $213.5 million which is net of a valuation
allowance of $961.3 million. The ultimate realization of
the deferred income tax asset is dependent upon the taxable
income available in current statutory carryback periods,
reversals of existing taxable temporary differences, tax
planning strategies and our ability to generate taxable income
within the statutory carryforward periods. Based on our
assessment, including the implementation of certain tax planning
strategies, the realization of approximately $961.3 million
of our deferred income tax asset is dependent upon the
generation of future taxable income during the statutory
carryforward periods in which the related temporary differences
become deductible. The use of net operating loss carryforwards
is also subject to limitations should there be more than a 50%
change in ownership of our common stock within a three-year
period as measured under the applicable tax regulations. The
remaining deferred income tax asset of $213.5 million for
which there are no valuation allowances relate to amounts that
are expected to be primarily realized through net operating loss
carrybacks to tax year 2007.
The accounting for deferred income taxes is based upon an
estimate of future results, and the valuation allowance may be
increased or decreased as conditions change or if we are unable
to implement certain tax planning strategies. Differences
between the anticipated and actual outcomes of these future tax
consequences could have a material impact on our consolidated
results of operations or financial position. Changes in tax laws
could also affect actual tax results and the valuation of
deferred income tax assets over time.
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
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coverage limits. Additionally, the coverage offered by and the
availability of product liability insurance for construction
defects is 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.
None.
In addition to our inventories of land, lots and homes, we own
several office buildings totaling approximately
213,000 square feet, and we lease approximately
1,341,000 square feet of office space under leases expiring
through January 2015. These properties are located in our
various operating markets to house our homebuilding and
financial services operating divisions and our regional and
corporate offices.
We are involved in lawsuits and other contingencies in the
ordinary course of business. While the outcome of such
contingencies cannot be predicted with certainty, we believe
that the liabilities arising from these matters will not have a
material adverse effect on our consolidated financial position,
results of operations or cash flows. However, to the extent the
liability arising from the ultimate resolution of any matter
exceeds our estimates reflected in the recorded reserves
relating to such matter, we could incur additional charges that
could be significant.
On June 15, 2007, a putative class action, John R.
Yeatman, et al. v. D.R. Horton, Inc., et al., was filed
by one of our customers against us and our affiliated mortgage
company subsidiary in the United States District Court for the
Southern District of Georgia. The complaint sought certification
of a class alleged to include persons who, within the year
preceding the filing of the suit, purchased a home from us and
obtained a mortgage for such purchase from our affiliated
mortgage company subsidiary. The complaint alleged that we
violated Section 8 of the Real Estate Settlement Procedures
Act by effectively requiring our homebuyers to use our
affiliated mortgage company to finance their home purchases by
offering certain discounts and incentives. The action sought
damages in an unspecified amount and injunctive relief. On
April 23, 2008, the Court ruled on our motion to dismiss
and dismissed this complaint with prejudice. The plaintiffs
filed a notice of appeal, which is currently pending.
On March 24, 2008, a putative class action, James
Wilson, et al. v. D.R. Horton, Inc., et al., was filed
by five customers of Western Pacific Housing, Inc., one of our
wholly-owned subsidiaries, against us, Western Pacific Housing,
Inc., and our affiliated mortgage company subsidiary, in the
United States District Court for the Southern District of
California. The complaint seeks certification of a class alleged
to include persons who, within the four years preceding the
filing of the suit, purchased a home from us, or any of our
subsidiaries, and obtained a mortgage for such purchase from our
affiliated mortgage company subsidiary. The complaint alleges
that we violated Section 1 of the Sherman Antitrust Act and
Sections 16720, 17200 and 17500 of the California Business
and Professions Code by effectively requiring our homebuyers to
apply for a loan through our affiliated mortgage company. The
complaint alleges that the homebuyers were either deceived about
loan costs charged by our affiliated mortgage company or coerced
into using our affiliated mortgage company, or both, and that
discounts and incentives offered by us or our subsidiaries to
buyers who obtained financing from our affiliated mortgage
company were illusory. The action seeks treble damages in an
unspecified amount and injunctive relief. Management believes
the claims alleged in this action are without merit and will
defend them vigorously. However, as the action is still in its
early stages, we are unable to express an opinion as to the
likelihood of an unfavorable outcome or the amount of damages,
if any. Consequently, we have not recorded any liabilities for
damages in the accompanying consolidated balance sheet.
None.
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Our common stock is listed on the New York Stock Exchange (NYSE)
under the symbol “DHI.” The following table sets
forth, for the periods indicated, the range of high and low
sales prices for our common stock, as reported by the NYSE, and
the quarterly cash dividends declared per common share.
As of November 20, 2008, the closing price of our common
stock on the NYSE was $4.52, and there were approximately 613
holders of record.
The declaration of future cash dividends is at the discretion of
our Board of Directors and will depend upon, among other things,
future earnings, cash flows, capital requirements, our financial
condition and general business conditions, as well as compliance
with covenants contained in our revolving credit agreement. We
reduced the amount of our quarterly dividend during the third
quarter of fiscal 2008, and we have further reduced our dividend
amount during the first quarter of fiscal 2009.
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 2008, 2007 and 2006, we did not sell any
securities that were not registered under the Securities Act of
1933, as amended.
In November 2007, our Board of Directors extended its
authorization for the repurchase of up to $463.2 million of
our common stock to November 30, 2008. We made no
repurchases of common stock under the share repurchase program
during fiscal 2008, and therefore, all of the
$463.2 million authorization was remaining at
September 30, 2008. Upon expiration of the November 2007
authorization, our Board of Directors has authorized the
repurchase of up to $100 million of our common stock. The
new authorization is effective from December 1, 2008 to
November 30, 2009.
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The following graph illustrates the cumulative total stockholder
return on D.R. Horton common stock for the last five fiscal
years through September 30, 2008, compared to the S&P
500 Index and the S&P 500 Homebuilding Index. The
comparison assumes a hypothetical investment in D.R. Horton
common stock and in each of the foregoing indices of $100 at
September 30, 2003, and assumes that all dividends were
reinvested. Shareholder returns over the indicated period are
based on historical data and should not be considered indicative
of future shareholder returns. The graph and related disclosure
in no way reflect our forecast of future financial performance.
Comparison
of Five-Year Cumulative Total Return
Among D.R. Horton, Inc., S&P 500 Index and S&P 500 Homebuilding Index 
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The following selected consolidated financial data are derived
from our Consolidated Financial Statements. The data should be
read in conjunction with Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations,” Item 1A, “Risk Factors,”
Item 8, “Consolidated Financial Statements and related
Notes,” and all other financial data contained in this
annual report on
Form 10-K.
These historical results are not necessarily indicative of the
results to be expected in the future.
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Results
of Operations — Fiscal Year 2008 Overview
Our fiscal 2008 results reflect the challenges that the
homebuilding industry faced during the year. During fiscal 2008
the factors hurting demand for new homes became more intense and
pervasive across the United States. As a result, the already
difficult conditions within the industry became progressively
more challenging. High inventory levels of both new and existing
homes, elevated cancellation rates, low sales absorption rates
and overall weak consumer confidence persisted throughout the
year. The effects of these factors were further magnified by
credit tightening in the mortgage markets, increasing home
foreclosures and severe shortages of liquidity in the financial
markets. The liquidity shortage has caused concern about the
viability of many financial institutions and has negatively
impacted the already weakening economy, which has created fears
of a prolonged recession. These factors, combined with our
continued elevated sales cancellation rate, caused our sales
volume to be significantly reduced. Also, our gross profit from
home sales revenues continued to decline as we offered higher
levels of incentives and price concessions in attempts to
stimulate demand in our communities.
As we progressed though fiscal 2008, our disappointing sales
results, further declines in our sales order prices, continued
declines in our gross profit from home sales revenues and the
more challenging market conditions caused our outlook for the
homebuilding industry to remain cautious. We believe that
housing market conditions may continue to deteriorate, and that
the timing of a recovery in the housing market remains unclear.
Our outlook incorporates several factors, including continued
margin pressure from sales price reductions and incentives;
continued high levels of new and existing homes available for
sale; weak demand from new home consumers; continued high sales
cancellations; significant restrictions on the availability of
certain mortgage products and an overall increase in the
underwriting requirements for home financing as a result of the
recent credit tightening in the mortgage markets.
During fiscal 2008, particularly in the fourth quarter, we sold
a significant amount of land and lots through numerous
transactions to generate cash flows, reduce our future carrying
costs and land development obligations, and lower our inventory
supply in certain markets to match our expectations of future
demand. Consummating these transactions during the current
fiscal year allowed us to monetize a larger portion of our
deferred tax assets through a loss carryback to fiscal 2006
resulting in an increase in our expected tax refund.
Due to the declining market conditions discussed above, we
evaluated a significant portion of our inventory in our
quarterly impairment analyses during fiscal 2008. Additionally,
we evaluated the recoverability of our goodwill. Our goodwill
and inventory impairment evaluations reflected our expectation
of continued and increasing challenges in the homebuilding
industry, and our belief that these challenging conditions will
persist for some time. Based on our evaluations and as a result
of our fourth quarter land and lot sales, we recorded
significant impairment charges to our inventory and goodwill
balances during the year, which materially affected our
operating results during fiscal 2008.
We believe the long-term fundamentals which support housing
demand, namely population growth and household formation, remain
solid. We also believe the negative effects of the current
market conditions, although unyielding in the near term, will
moderate over the long term. In the interim, we remain committed
to the following initiatives related to our operating strategy
in the current homebuilding business environment:
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These initiatives allowed us to generate significant cash flows
from operations during fiscal 2007 and 2008, which we utilized
to reduce our outstanding debt and increase our liquidity.
Although we cannot provide any assurances that these initiatives
will be successful, we expect that our operating strategy will
allow us to continue to maintain a strong balance sheet and
liquidity position in fiscal 2009.
Key financial results as of and for our fiscal year ended
September 30, 2008, as compared to fiscal 2007, were as
follows:
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Results
of Operations — Homebuilding
Our operating segments are our 34 homebuilding operating
divisions, which we aggregate into six reporting segments.
Previously, we presented seven homebuilding reporting segments,
based on our seven operating regions which had been determined
to be our operating segments. During the fourth quarter of
fiscal 2008, we reassessed the level at which the Statement of
Financial Accounting Standards (SFAS) No. 131 operating
segment criteria is met, and as a result, changed our operating
segments from the operating regions to the operating divisions.
As a result of this change, the composition of our reporting
segments was also revised. The California markets, which were
previously presented as a separate reporting segment are now
included in our West reporting segment. Additionally, the Salt
Lake City, Utah market, which was previously included in our
Southwest reporting segment, is now included in our West
reporting segment. Furthermore, the name of our Northeast
reporting segment has been changed to our East reporting
segment, although the markets comprising it remain the same. All
prior year segment information has been restated to conform to
the fiscal 2008 presentation. These reporting segments, which we
also refer to as reporting regions, have homebuilding operations
located in the following states:
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Fiscal
Year Ended September 30, 2008 Compared to Fiscal Year Ended
September 30, 2007
The following tables set forth key operating and financial data
for our homebuilding operations by reporting segment as of and
for the fiscal years ended September 30, 2008 and 2007. We
have restated the 2007 amounts between reporting segments to
conform to the 2008 presentation.
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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 43%, to
$4,677.2 million (21,251 homes) in 2008 from
$8,230.6 million (33,687 homes) in 2007. The value of net
sales orders decreased 35%, to $852.3 million (3,977 homes)
in the fourth quarter of fiscal 2008 from $1,309.5 million
(6,374 homes) in the same period of fiscal 2007. The decreases
in our net sales orders reflect the continued reduction 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 a continued
high level of new and existing homes for sale, which includes
foreclosed homes for sale, a decrease in the availability of
mortgage financing for many potential homebuyers which has been
further impacted by the recent uncertainty in the financial
markets and a decline in homebuyer consumer confidence. Many
prospective homebuyers continue to approach the purchase
decision more tentatively due to continued increases in price
concessions and sales incentives offered on both new and
existing homes, concern over their ability to sell an existing
home or obtain mortgage financing and the general uncertainty
surrounding the housing market and weakness in the overall
economy. We have attempted to increase sales by providing
increased sales incentives and lowering prices, but the factors
above, combined with the continued pricing responses of our
competitors, have limited the impact of our pricing efforts.
Reflecting the recent significant erosion of consumer
confidence, our sales results during the fourth quarter worsened
at the end of the quarter. The elimination of seller-funded down
payment assistance on FHA loans as of October 1, 2008 will
likely have a negative effect on future sales trends as further
discussed below. Subsequent to fiscal year 2008, the volume of
our net sales orders for the month ended October 31, 2008
continued the weakness experienced at the end of the fourth
quarter and decreased 23% compared to the month ended
October 31, 2007.
In comparing fiscal 2008 to fiscal 2007, the value of net sales
orders decreased significantly in all six of our market regions.
These decreases were primarily due to substantially similar
decreases in the number of homes sold in the respective region.
Particularly in our West region, the decline in average selling
price also contributed to the decline in the value of net sales
orders.
The average price of our net sales orders decreased 10%, to
$220,100 in 2008 from $244,300 in 2007. The average price of our
net sales orders decreased significantly in our West region, and
to a lesser extent in our Midwest and Southeast regions, due
primarily to price reductions and increased incentives in our
California, Las Vegas, Denver and Florida markets. In general,
our pricing is dependent on the demand for our homes, and
declines in our average selling prices during fiscal 2008 were
due in large part to increases in the use of price reductions
and sales incentives in order to attempt to achieve an
appropriate sales absorption pace. Further, as the inventory of
existing homes for sale, which includes an increasing number of
foreclosed homes, has continued to be high, it has led to the
need to ensure our pricing is competitive with comparable
existing home sales prices. We monitor and may adjust our
product mix, 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. To a lesser extent than the competitive factors
discussed above, this has also contributed to decreases in the
average selling price.
Our annual cancellation rate (cancelled sales orders divided by
gross sales orders for the period) was 40% in fiscal 2008,
compared to 38% in fiscal 2007. Our cancellation rate in the
fourth quarter of fiscal 2008 was 47% and in the month ended
October 31, 2008 was 41%. The higher cancellation rate
during the fourth quarter of fiscal 2008, was primarily
attributable to cancellations in our Southwest region,
particularly in our Arizona markets. These elevated cancellation
rates reflect the ongoing challenges in most of our homebuilding
markets, including the inability of many prospective homebuyers
to sell their existing homes, the continued erosion of buyer
confidence and further credit tightening in the mortgage
markets. The impact of the credit tightening became apparent in
our cancellation rates in late fiscal 2007 and into fiscal 2008
as the mortgage products many buyers had selected were no longer
available or the buyers could no longer qualify due to stricter
underwriting guidelines. The shortage of liquidity in the
financial markets during fiscal 2008 has
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further restricted the availability of credit. We anticipate
that cancellation rates will remain elevated and may continue to
fluctuate substantially until market conditions improve.
In July 2008, Congress passed and the President signed into law
H.R. 3221, which includes the “American Housing Rescue and
Foreclosure Prevention Act of 2008.” Among other
provisions, this law eliminates seller-funded down payment
assistance on FHA insured loans approved on or after
October 1, 2008. Of our total home closings in fiscal 2008,
approximately 25% were funded with mortgage loans whereby the
homebuyer used a seller-financed down payment assistance
program. This is a significantly higher percentage of closings
than experienced in prior years. The use of such programs during
fiscal 2008 was highest in our South Central and Southwest
regions. While we will seek other down payment assistance and
mortgage financing alternatives for our buyers, we expect the
elimination of the seller-financed down payment assistance
programs to have a negative impact on our future sales and
revenues.
Sales order backlog represents homes under contract but not yet
closed at the end of the period. Many of the contracts in our
sales order backlog are subject to contingencies, including
mortgage loan approval and buyers selling their existing homes,
which can result in cancellations. Before the current housing
downturn, our backlog had been an indicator of the level of home
closings in our two subsequent fiscal quarters; however, due to
our current elevated cancellation rates, higher levels of unsold
homes in inventory and difficult conditions in our markets, this
relationship between backlog and future home closings has
changed.
At September 30, 2008, the value of our backlog of sales
orders was $1,207.4 million (5,297 homes), a decrease of
55% from $2,694.4 million (10,442 homes) at
September 30, 2007. The average sales price of homes in
backlog was $227,900 at September 30, 2008, down 12% from
the $258,000 average at September 30, 2007. The value of
our sales order backlog decreased significantly across all of
our market regions, reflecting the severity and geographic reach
of the national housing downturn.
Revenues from home sales decreased 43%, to $6,164.3 million
(26,396 homes closed) in 2008 from $10,721.2 million
(41,370 homes closed) in 2007. The average selling price of
homes closed during 2008 was $233,500, down 10% from $259,200 in
2007. During fiscal 2008, home sales revenues decreased
significantly in all of our market regions, reflecting continued
weak demand and the resulting decline in net sales order volume
and pricing during the year.
The number of homes closed in 2008 decreased 36% due to
decreases in all of our market regions. As a result of the
decline in net sales orders during the year and the decline in
our sales order backlog, we expect to close fewer homes in
fiscal 2009 than we did in fiscal 2008. As conditions change in
the housing markets in which we operate, our ongoing level of
net sales orders will determine the number of home closings and
amount of revenue we will generate.
Revenues from home sales in fiscal 2008 and 2007 were increased
by $26.8 million and $58.0 million, respectively, from
changes in profit deferred pursuant to 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, 2008, the
balance of deferred profit related to these mortgage loans held
for sale was $5.8 million, compared to $32.6 million
at September 30, 2007. The decline is mainly due to the
reduced availability of the mortgage types whose use generally
resulted in the SFAS No. 66 profit deferral.
Gross profit from home sales decreased by 63%, to
$691.2 million in 2008, from $1,848.9 million in 2007,
and, as a percentage of home sales revenues, decreased
600 basis points, to 11.2%. The primary factor reducing our
home sales gross profit margin was the difficult market
conditions discussed above, which narrowed the range between our
selling prices and costs of our homes in most of our markets,
causing a decline of approximately 430 basis points in home
sales gross profit as a percentage of home sales revenues. Due
to the current sales environment in many of our markets, we have
offered a variety of incentives and price concessions, which
affect our gross profit margin by reducing the selling price of
the home or increasing
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the cost of the home without a proportional increase in the
selling price. We are also offering greater discounts and
incentives to sell our inventory of completed homes, which is at
a higher than desired level. This strategy helped reduce our
completed homes in inventory, but also contributed to a decline
in our home sales gross profit. Additionally, our home sales
gross margin decreased approximately 210 basis points due
to an increase in the amortization of capitalized interest and
property taxes as a percentage of home sales revenues, and
10 basis points due to the recognition of a lesser amount
of previously deferred gross profit during 2008 compared to
2007. These decreases were partially offset by an improvement of
50 basis points due to a decrease in warranty and
construction defect expenses as a percentage of home sales
revenues.
During fiscal 2008, when we performed our quarterly inventory
impairment analyses, the assumptions utilized reflected our
outlook for the homebuilding industry and its impact on our
business. This outlook incorporates our belief that housing
market conditions may continue to deteriorate, and that these
challenging conditions will persist for some time. Accordingly,
our impairment evaluation as of September 30, 2008 again
indicated a significant number of communities with impairment
indicators. Communities with a combined carrying value of
$2,186.2 million as of September 30, 2008, had
indicators of potential impairment and were evaluated for
impairment. The analysis of each of these communities generally
assumed that sales prices in future periods will be equal to or
lower than current sales order prices in each community or for
comparable communities in order to generate an acceptable
absorption rate. While it is difficult to determine a timeframe
for a given community in the current market conditions, we
estimated the remaining lives of these communities to range from
six months to in excess of ten years. Through this evaluation
process, we determined that communities with a carrying value of
$967.8 million as of September 30, 2008, the largest
portions of which were in the West and Southeast regions, were
impaired. As a result, during the fourth quarter of fiscal 2008,
we recorded impairment charges of $364.7 million to reduce
the carrying value of the impaired communities to their
estimated fair value.
Due to the significant decline in demand for new homes, we have
reduced our expectations of future home closing volumes, as well
as our expected need for land and lots in the future.
Consequently, during the fourth quarter of fiscal 2008, we sold
a significant amount of land and lots. In connection with these
land and lot sales, we recorded impairment charges of
$624.2 million to reduce the $814.4 million carrying
value of this inventory to its net realizable value. Including
impairments related to land sales, impairment charges during the
fourth quarter of fiscal 2008 totaled $988.9 million, as
compared to $278.3 million in the prior year period. The
fourth quarter charges combined with impairment charges recorded
earlier in the year resulted in total inventory impairment
charges of $2,372.6 million and $1,222.2 million
during fiscal 2008 and 2007, respectively. We perform our
impairment analysis based on total inventory at the community
level. When an impairment charge for a community is determined,
the charge is then allocated to each lot in the community in the
same manner as land and development costs are allocated to each
lot. The inventory within each community is categorized as
construction in progress and finished homes, residential land
and lots — developed and under development, and land
held for development, based on the stage of production or plans
for future development. During fiscal 2008, excluding
impairments related to land sales, approximately 79% of the
impairment charges were recorded to residential land and lots
and land held for development, and approximately 21% of the
charges were recorded to residential construction in progress
and finished homes inventory, compared to 74% and 26%,
respectively, in fiscal 2007.
Of the remaining $1,218.4 million of projects with
impairment indicators which were determined not to be impaired
at September 30, 2008, the largest concentrations were in
Florida (18%), Texas (13%) and California (12%). It is possible
that our estimate of undiscounted cash flows from these
communities may change and could result in a future need to
record impairment charges to write these assets down to fair
value. Additionally, if conditions in the broader economy,
homebuilding industry or specific markets in which we operate
worsen beyond current expectations, and as we re-evaluate
specific community pricing and incentives and our land sale
strategies, we may be required to evaluate additional
communities or re-evaluate previously impaired communities for
potential impairment. These evaluations may result in additional
impairment charges, which could be material.
Based on a quarterly review of land and lot option contracts, we
have written off earnest money deposits and pre-acquisition
costs related to land and lot option contracts which we no
longer plan to pursue. During
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fiscal 2008 and 2007, we wrote off $111.9 million and
$107.3 million, respectively, of earnest money deposits and
pre-acquisition costs related to land option purchase contracts.
Should the current weak homebuilding market conditions persist
and we are unable to successfully renegotiate certain land
purchase contracts, we may write off additional earnest money
deposits and pre-acquisition costs.
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 3,810 basis points in fiscal 2008, compared
to 1,200 basis points in fiscal 2007.
Land sales revenues decreased 4% to $354.3 million in 2008,
from $367.6 million in 2007. The gross profit percentage
from land sales decreased to 8.5% in 2008, from 22.9% in 2007.
Due to the significant decline in demand for new homes, we have
reduced our expectations of future home closing volumes, as well
as our expected need for land and lots in the future.
Consequently, during the fourth quarter of fiscal 2008, we sold
a significant amount of land and lots through numerous
transactions to generate cash flows, reduce our future carrying
costs and land development obligations, and lower our inventory
supply in certain markets. Consummating these transactions
during the current fiscal year allowed us to monetize a larger
portion of our deferred tax assets through a loss carryback to
fiscal 2006 resulting in an increase in our expected tax refund.
The terms of certain of these land and lot sales, primarily
related to our continuing involvement with the properties,
resulted in the deferral of the recognition of the sale
transaction in some cases. Consequently, $21.7 million of
inventory, reflecting its current fair value, is recorded as a
component of inventory not owned. In markets where we own more
land and lots than our expected needs in the next few years, we
plan to attempt to sell these excess lots and land parcels. As
of September 30, 2008, we had $39.4 million of land
held for sale which we expect to sell in the next 12 months.
SG&A expense from homebuilding activities decreased by
$349.7 million, or 31%, to $791.8 million in 2008 from
$1,141.5 million in 2007. As a percentage of homebuilding
revenues, SG&A expense increased 180 basis points, to
12.1% in 2008 from 10.3% in 2007, due to a decrease in revenues.
The largest component of our homebuilding SG&A expense is
employee compensation and related costs, which represented 53%
and 59% of SG&A costs in 2008 and 2007, respectively. Those
costs decreased $254.2 million, or 38%, to
$417.9 million in 2008 from $672.2 million in 2007,
largely due to our continued efforts to align the number of
employees to match our current and anticipated home closing
levels, as well as a decrease in incentive compensation, which
is primarily based on profitability. Our homebuilding operations
employed approximately 3,100 and 5,100 employees at
September 30, 2008 and 2007, respectively.
We continue to adjust our SG&A infrastructure to support
our expected closings volume; however, we cannot make assurances
that our actions will permit us to maintain or improve upon the
current SG&A expense as a percentage of revenues. It may
become more difficult to reduce SG&A expense as the size of
our operations decreases. If revenues continue to decrease and
we are unable to sufficiently adjust our SG&A, future
SG&A expense as a percentage of revenues may increase
further.
We capitalize homebuilding interest costs to inventory during
development and construction. During fiscal 2007, our inventory
eligible for interest capitalization (“active
inventory”) exceeded our debt levels; therefore, we
capitalized all interest from homebuilding debt. However, due to
our inventory reduction strategies, slowing or suspending land
development in certain communities and limiting the construction
of unsold homes, our active inventory has been lower than our
debt level in recent quarters. As a result, we expensed
$39.0 million of interest incurred during fiscal 2008.
Interest amortized to cost of sales, excluding interest written
off with inventory impairment charges, was 3.9% of total home
and land/lot cost of sales in 2008, compared to 2.4% in 2007.
The increase in the rate of interest amortized to cost of sales
was primarily due to a greater decline in our home closings
volume as
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compared to the decline in our interest incurred during the
year, and a more rapid reduction in our active inventory levels
than our interest incurred over the time period in which fiscal
2008 closings were active versus the prior year closings.
Interest incurred is directly related to the average level of
our homebuilding debt outstanding during the period. Comparing
fiscal 2008 with fiscal 2007, interest incurred related to
homebuilding debt decreased by 22%, to $236.7 million,
primarily due to a 23% decrease in our average homebuilding debt.
In fiscal 2008, we recorded a loss on early retirement of debt
of $2.6 million, which was primarily due to the write-off
of unamortized fees associated with reducing the size of our
revolving credit facility in June 2008. In fiscal 2007, in
connection with the early retirement of our 8.5% senior
notes due 2012, we recorded a loss of $12.1 million for the
call premium and the unamortized discount and fees related to
the redeemed notes.
Other income, net of other expenses, associated with
homebuilding activities was $9.1 million in 2008, compared
to $4.0 million in 2007. The increase in other income in
fiscal 2008 was primarily due to an increase in interest income.
In performing our annual impairment analysis as of
September 30, 2008, we estimated the fair value of our
operating segments utilizing the expected present values of
future cash flows. As a result of this analysis, we determined
that the goodwill balance related to each operating segment in
our Southwest reporting region was impaired. Consequently,
during the fourth quarter, we recorded a goodwill impairment
charge of $79.4 million.
As of September 30, 2008, our remaining goodwill balance
was $15.9 million, all of which related to our South
Central reporting segment. As of September 30, 2007,
allocation of our remaining goodwill balance of
$95.3 million was as follows: South Central
$15.9 million and Southwest $79.4 million.
The goodwill assessment procedures of SFAS No. 142
require us to make comprehensive estimates of future revenues
and costs. Due to the uncertainties associated with such
estimates, actual results could differ from such estimates.
SFAS No. 109, “Accounting for Income Taxes,”
requires a reduction of the carrying amounts of deferred tax
assets by a valuation allowance if, based on the available
evidence, it is more likely than not that such assets will not
be realized. Accordingly, we periodically assess the need to
establish valuation allowances for deferred tax assets based on
the SFAS No. 109 more-likely-than-not realization
threshold criterion. In the assessment for a valuation
allowance, appropriate consideration is given to all positive
and negative evidence related to the realization of the deferred
tax assets. This assessment considers, among other matters, the
taxable income available in current statutory carryback periods;
reversals of existing taxable temporary differences; tax
planning strategies; the nature, frequency and severity of
current and cumulative losses; the duration of statutory
carryforward periods; our historical experience in generating
operating profits; and expectations for future profitability. In
making such judgments, significant weight is given to evidence
that can be objectively verified. SFAS No. 109
provides that a cumulative loss in recent years is significant
negative evidence in considering whether deferred tax assets are
realizable and also restricts the amount of reliance on
projections of future taxable income to support the recovery of
deferred tax assets.
Due to the challenging market conditions in the homebuilding
industry during the past two years, we have recorded significant
impairment charges for both inventory and goodwill, and are in a
three-year cumulative pre-tax loss position for fiscal years
2006 through 2008. While we have a long history of profitable
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operations prior to the current downturn in the homebuilding
industry, the expected cumulative loss position is significant
negative evidence in assessing the recoverability of our
deferred tax assets. Therefore, we recorded a valuation
allowance on our deferred tax assets, representing those
deferred tax asset amounts for which ultimate realization is
dependent upon the generation of future taxable income during
the periods in which the related temporary differences become
deductible. The remaining deferred tax assets of
$213.5 million for which there are no valuation allowances
relate to amounts that are expected to be primarily realized
through net operating loss carrybacks to tax year 2007.
The accounting for deferred taxes is based upon an estimate of
future results. Differences between the anticipated and actual
outcomes of these future tax consequences could have a material
impact on our consolidated results of operations or financial
position. Changes in existing tax laws could also affect actual
tax results and the valuation of deferred tax assets over time.
During fiscal 2008, particularly in the fourth quarter, we sold
a significant amount of land and lots through numerous
transactions to generate cash flows, reduce our future carrying
costs and land development obligations, and lower our inventory
supply in certain markets to match our expectations of future
demand. These transactions, combined with the results of all of
our operations in this difficult housing environment, generated
a net operating tax loss that can be carried back to fiscal 2006
and will result in a federal income tax refund. Consequently, we
recorded a $676.2 million federal income tax receivable
relating to the net operating loss carryback refund claim at
September 30, 2008.
On October 1, 2007, we adopted the provisions of FASB
Interpretation No. 48 (FIN 48), “Accounting for
Uncertainty in Income Taxes — an interpretation of
FASB Statement No. 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 the minimum
recognition threshold a tax position is required to meet before
being recognized in the financial statements. The cumulative
effect of adopting FIN 48 had no impact on our beginning
retained earnings. Effective with our adoption of FIN 48,
interest and penalties related to unrecognized tax benefits are
recognized in the financial statements as a component of the
income tax provision. Interest and penalties related to
unrecognized tax benefits were previously included in interest
expense and in selling, general and administrative expense,
respectively. During fiscal 2008, we recognized interest and
penalties of $4.0 million in our consolidated statement of
operations, and at September 30, 2008, our total accrued
interest and penalties relating to unrecognized income tax
benefits was $4.9 million. As of September 30, our
total unrecognized income tax benefits were $18.7 million.
All tax positions, if recognized, would affect our effective
income tax rate. We do not expect the total amount of
unrecognized tax benefits to significantly decrease or increase
within twelve months of the current reporting date.
We are subject to federal income tax and to income tax in
multiple states. The Internal Revenue Service is currently
examining our fiscal years 2004 and 2005 and we are being
audited by various states. The statute of limitations for our
major tax jurisdictions remains open for examination for fiscal
years 2004 through 2008.
In fiscal 2008, the provision for income taxes was
$1.8 million, which reflects the effect of the
establishment of the deferred tax asset valuation allowance. In
fiscal 2007, the benefit from income taxes was
$238.7 million, corresponding to the loss before income
taxes for the year. Our effective tax rate for fiscal 2008
differs from the statutory rate, primarily because of the
establishment of the valuation allowance as discussed above.
East Region — Homebuilding revenues decreased
46% in 2008 compared to 2007, primarily due to a 44% decrease in
the number of homes closed, as well as a slight decrease in the
average selling price of those homes. The region reported a loss
before income taxes of $332.5 million in 2008, compared to
a loss of $66.1 million in 2007. The losses were primarily
due to inventory impairment charges and earnest money and
pre-acquisition cost write-offs totaling $288.4 million and
$81.5 million in fiscal 2008 and 2007, respectively. In
fiscal 2008, inventory impairment charges included
$42.7 million of impairments related to fourth quarter land
sales. In fiscal 2007, goodwill impairment charges of
$39.4 million also contributed to the loss. A
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decrease in the region’s gross profit from home sales as a
percentage of home sales revenue (home sales gross profit
percentage) of 930 basis points in 2008 compared to 2007
also contributed to the increase in loss before income taxes.
The home sales gross profit percentage declined in most of the
region’s markets, many of which have had very high sales
cancellations resulting in unsold homes we aggressively priced
to sell. Despite implementing significant cost control measures,
our revenues declined at a greater rate (46%) than our SG&A
expense (29%), which also contributed to the loss before income
taxes in this region.
Midwest Region — Homebuilding revenues
decreased 51% in 2008 compared to 2007, primarily due to a 46%
decrease in the number of homes closed, as well as a 7% decrease
in the average selling price of those homes. The region reported
a loss before income taxes of $184.3 million in 2008,
compared to a loss of $205.3 million in 2007. The losses
were primarily due to a decline in revenues and inventory
impairment charges and earnest money and pre-acquisition cost
write-offs totaling $163.3 million and $167.3 million
in fiscal 2008 and 2007, respectively, while the region’s
home sales gross profit percentage remained relatively flat. In
fiscal 2008, inventory impairment charges included
$33.6 million of impairments related to fourth quarter land
sales. In fiscal 2007, goodwill impairment charges of
$48.5 million also contributed to the loss. Despite
implementing significant cost control measures, our revenues
declined at a greater rate (51%) than our SG&A expense
(31%), which also contributed to the loss before income taxes in
this region.
Southeast Region — Homebuilding revenues
decreased 44% in 2008 compared to 2007, primarily due to a 41%
decrease in the number of homes closed, as well as a 9% decrease
in the average selling price of those homes. The region reported
a loss before income taxes of $507.7 million in 2008,
compared to a loss of $131.6 million in 2007. The losses
were primarily due to inventory impairment charges and earnest
money and pre-acquisition cost write-offs totaling
$457.5 million and $210.2 million in fiscal 2008 and
2007, respectively. In fiscal 2008, inventory impairment charges
included $116.7 million of impairments related to fourth
quarter land sales. In fiscal 2007, goodwill impairment charges
of $11.5 million also contributed to the loss. A decrease
in the region’s home sales gross profit percentage of
990 basis points in 2008 compared to 2007 also contributed
to the increase in loss before income taxes. The home sales
gross profit percentage declines in our Florida markets had the
greatest impact on the overall decreases. The Florida markets
experienced rapid price increases in previous years which
encouraged speculation in residential real estate, creating an
environment that has shown not to be sustainable. The tightening
in the mortgage environment, high cancellation rates and
existing homes for sale by investors have led to increased
inventory levels, requiring price reductions and increased
levels of sales incentives to compete for the reduced pool of
qualified buyers, resulting in substantial gross profit declines.
South Central Region — Homebuilding revenues
decreased 28% in 2008 compared to 2007, due to a 29% decrease in
the number of homes closed. The region reported a loss before
income taxes of $9.0 million in 2008, compared to income
before income taxes of $122.2 million in 2007. The loss in
fiscal 2008 was primarily due to inventory impairment charges
and earnest money and pre-acquisition cost write-offs totaling
$72.4 million in fiscal 2008, compared to
$24.6 million in 2007. In fiscal 2008, inventory impairment
charges included $29.1 million of impairments related to
fourth quarter land sales. In addition, the region’s home
sales gross profit percentage decreased 130 basis points in
2008 compared to 2007. The decline in home sales gross profit
was largely due to softening in the San Antonio market,
where inventories of new and existing homes have increased,
resulting in increased levels of sales incentives being offered
by builders. The majority of the region’s inventory
impairment charges were also in the San Antonio market.
Southwest Region — Homebuilding revenues
decreased 38% in 2008 compared to 2007, due to a 35% decrease in
the number of homes closed, as well as an 11% decrease in the
average selling price of those homes. The region reported a loss
before income taxes of $366.7 million in 2008, compared to
income before income taxes of $192.9 million in 2007. The
loss in fiscal 2008 was primarily due to inventory impairment
charges and earnest money and pre-acquisition cost write-offs
totaling $330.7 million, compared to $26.8 million in
2007. In fiscal 2008, inventory impairment charges included
$155.4 million of impairments related to fourth quarter
land sales. A decrease in the region’s home sales gross
profit percentage of 720 basis points in 2008 compared to
2007, which was largely due to declines in our Phoenix market,
also contributed to the reduction in income before income taxes.
The Phoenix market experienced rapid price increases in previous
years which encouraged speculation in residential real estate,
creating an environment that has shown
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not to be sustainable. The tightening in the mortgage
environment, high cancellation rates and existing homes for sale
by investors have led to increased inventory levels, requiring
price reductions and increased levels of sales incentives to
compete for the reduced pool of qualified buyers, resulting in
substantial gross profit declines. The increased number of
foreclosed homes being offered for sale in Phoenix has added
further pressure to sales prices. In fiscal 2008, goodwill
impairment charges of $79.4 million also contributed to the
loss.
West Region — Homebuilding revenues decreased
45% in 2008 compared to 2007, due to a 36% decrease in the
number of homes closed, as well as a 17% decrease in the average
selling price of those homes. The region reported a loss before
income taxes of $1.3 billion in 2008, compared to a loss of
$932.1 million in 2007. The losses were primarily due to
inventory impairment charges and earnest money and
pre-acquisition cost write-offs totaling $1.2 billion and
$819.1 million in fiscal 2008 and 2007, respectively. The
majority of the inventory impairments relate to projects in our
California and Las Vegas markets. In fiscal 2008, inventory
impairment charges included $246.7 million of impairments
related to fourth quarter land sales. In fiscal 2007, goodwill
impairment charges of $374.7 million also contributed to
the loss. A decrease in the region’s home sales gross
profit percentage of 920 basis points in 2008 compared to
2007 also contributed to the increase in loss before income
taxes. Although all of the region’s markets have
experienced weak market conditions, the home sales gross profit
percentage decline in our California and Las Vegas markets had
the greatest impact on the overall decreases for the region. The
California and Las Vegas markets experienced rapid, significant
home price increases in previous years which contributed to
gross profit increases in 2005 and continued elevated gross
profits in 2006, but these price increases also strained housing
affordability for many potential homebuyers there. Credit
tightening in the mortgage markets has also significantly
limited the availability of many mortgage products used
extensively by California and Las Vegas homebuyers in previous
years. Increased levels of sales incentives and home price
reductions have been typical in these markets, as builders have
attempted to increase demand for homes to reduce high inventory
levels and to address affordability concerns, resulting in
substantial gross profit declines. The increased number of
foreclosed homes being offered for sale in California and Las
Vegas has added further pressure to sales prices.
Fiscal
Year Ended September 30, 2007 Compared to Fiscal Year Ended
September 30, 2006
The following tables set forth key operating and financial data
for our homebuilding operations by reporting segment as of and
for the fiscal years ended September 30, 2007 and 2006.
Based on our revised operating segments and the operating
divisions within those segments, we have restated the 2007 and
2006 amounts between reporting segments to conform to the 2008
presentation.
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37
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The value of net sales orders decreased 41%, to
$8,230.6 million (33,687 homes) in 2007 from
$13,895.2 million (51,980 homes) in 2006, reflecting the
continued softening of demand for new homes in most homebuilding
markets. Factors that contributed to the slowing of demand
included 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, a
decrease in the availability of mortgage financing for many
potential homebuyers and a decline in homebuyer consumer
confidence.
In comparing fiscal 2007 to fiscal 2006, the value of net sales
orders decreased significantly in all six of our market regions.
These decreases were primarily due to substantially similar
decreases in the number of homes sold in each region, although
in our Southeast, Southwest and West regions, a decline in
average selling prices was also a significant factor. The most
significant decline in net sales orders occurred in our West
region, with 43% fewer homes sold in fiscal 2007 than in fiscal
2006. We believe that home sales in our California markets were
negatively impacted, to a greater extent than our other markets,
by a reduction in the pool of qualified buyers due to a lack of
housing affordability and the decline of mortgage availability.
The average price of our net sales orders in fiscal 2007 was
$244,300, a decrease of 9% from the $267,300 average in fiscal
2006. The average price of our net sales orders decreased
significantly in our Southeast, Southwest and West regions, due
primarily to price reductions and increased incentives in our
Florida, Arizona and California markets. In general, our pricing
is dependent on the demand for our homes, and declines in our
average selling prices during the year were due in large part to
increases in the use of price reductions and sales incentives.
Further, as the inventory of existing homes for sale continued
to rise, it led to the need to ensure that our pricing was
competitive with comparable existing home sales prices. As part
of our efforts to keep our core product offerings affordable for
our target customer base, adjustments to our product and
geographic mix and pricing within our homebuilding markets also
contributed to decreases in the average selling price.
Our annual cancellation rate was 38% in fiscal 2007, compared to
28% in fiscal 2006. The higher overall cancellation rate for
fiscal 2007 was primarily attributable to cancellations in many
of our Arizona, California and Florida markets. These elevated
cancellation rates reflect the ongoing challenges in most
homebuilding markets, including the inability of many
prospective homebuyers to sell their existing homes, the
increasing level of sales incentives and home price reductions
in our markets continuing to erode buyer confidence and further
credit tightening in the mortgage markets. The impact of the
credit tightening became apparent in our cancellation rates in
late fiscal 2007 as the mortgage products many buyers had
selected were no longer available or they could not qualify due
to stricter underwriting guidelines.
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At September 30, 2007, the value of our backlog of sales
orders was $2,694.4 million (10,442 homes), a decrease of
48% from $5,185.1 million (18,125 homes) at
September 30, 2006. The average sales price of homes in
backlog was $258,000 at September 30, 2007, down 10% from
the $286,100 average at September 30, 2006. The value of
our sales order backlog decreased significantly in all of our
market regions.
Revenues from home sales decreased 26%, to
$10,721.2 million (41,370 homes closed) in 2007 from
$14,545.4 million (53,099 homes closed) in 2006. Revenues
from home sales decreased in all six of our market regions, led
by the Midwest and West regions, with decreases of 41% and 36%,
respectively. The number of homes closed in 2007 decreased 22%
and the average selling price of those homes decreased 5%. These
decreases were the result of slowing demand and the resulting
decline in net sales order volume and pricing during fiscal 2007.
Revenues from home sales in fiscal 2007 and 2006 were increased
by $58.0 million and $1.6 million, respectively, from
changes in profit deferred pursuant to SFAS No. 66. As
of September 30, 2007, the balance of deferred profit was
$32.6 million, compared to $90.6 million at
September 30, 2006. The decline was attributable to both
the drop in the number of homes closed and a decline in the
availability of the mortgage types whose use generally resulted
in the SFAS No. 66 profit deferral.
Total homebuilding gross profit decreased by 82%, to
$603.7 million in 2007 from $3,342.2 million in 2006.
Including sales of both homes and land/lots, as well as
impairment charges and land option cost write-offs, total
homebuilding gross profit as a percentage of homebuilding
revenues decreased 1,720 basis points, to 5.4% in 2007 from
22.6% in 2006. Approximately 1,020 basis points of the
decrease was due to the effect of inventory impairment charges
and land option cost write-offs. As a percentage of homebuilding
revenues, these were 12.0% in fiscal 2007 versus 1.8% in fiscal
2006.
Gross profit from home sales decreased by 47%, to
$1,848.9 million in 2007, from $3,497.6 million in
2006, and, as a percentage of home sales revenues, decreased
680 basis points, to 17.2%. The primary factor reducing our
home sales gross profit margin was the difficult market
conditions discussed above, which narrowed the range between our
selling prices and costs of our homes in most of our markets,
causing a decline of approximately 650 basis points in home
sales gross profit as a percentage of home sales revenues. Due
to declining sales in many of our markets, we offered a variety
of incentives and price concessions, which affected our gross
profit margin by reducing the selling price of the home or
increasing the cost of the home without a proportional increase
in the selling price. We also offered greater discounts and
incentives to sell our inventory of homes, which was at a higher
than desired level. This strategy helped reduce our total homes
in inventory by approximately 8,600 units during fiscal
2007, but also contributed to a decline in our home sales gross
profit. Additionally, our home sales gross margin decreased
approximately 60 basis points due to an increase in the
amortization of capitalized interest and 30 basis points
due to an increase in warranty and construction defect expenses
as a percentage of home sales revenues. These decreases were
partially offset by improvements in home sales gross margin of
20 basis points due primarily to an increase in the
relative number of home closings in our more profitable markets,
and 40 basis points resulting from the recognition of
$58.0 million of previously deferred gross profit during
2007, compared to $1.6 million in 2006.
During fiscal 2007, the difficult conditions within the
homebuilding industry became more challenging. High inventory
levels of both new and existing homes, elevated cancellation
rates, low sales absorption rates, affordability issues and
overall weak consumer confidence persisted throughout the year.
The effects of these factors were further magnified by a decline
in availability of mortgage products and higher mortgage
interest rates on certain loan products, due to credit
tightening in the mortgage markets. These factors, combined with
our disappointing sales results, further declines in sales order
prices and continued declines in gross profit from home sales
revenues throughout the year, caused our outlook for the
homebuilding industry and its impact on our business to become
more cautious as the year progressed.
During fiscal 2007, when we performed our quarterly inventory
impairment analyses, the assumptions utilized incorporated our
outlook, which reflected the expectation that the challenging
conditions in the homebuilding industry would persist and have a
greater impact than we believed when the year began.
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Consequently, our strategy to reduce our inventory and lot
position in a number of markets would likely take longer and
require additional price concessions and incentives than
previously anticipated. Therefore, our impairment evaluations
during the fourth quarter of fiscal 2007 indicated a significant
number of projects with impairment indicators. Communities with
a combined carrying value of $2,622.4 million as of
September 30, 2007, had indicators of potential impairment
and were evaluated for impairment. The analysis of each of these
projects generally assumed that sales prices in future periods
will be equal to or lower than current sales order prices in
each project or for comparable projects in order to generate an
acceptable absorption rate. While it is difficult to determine a
timeframe for a given project in the current market conditions,
we estimated the remaining lives of these projects to range from
six months to in excess of ten years. Through these evaluations,
we determined that projects with a carrying value of
$940.5 million as of September 30, 2007, the largest
portions of which were in the West and Southeast regions, were
impaired. As a result, during the fourth quarter of fiscal 2007,
we recorded impairment charges totaling $278.3 million to
reduce the carrying value of the impaired projects to their
estimated fair value. These fourth quarter charges combined with
impairment charges recorded earlier in the year resulted in
total inventory impairment charges of $1,222.2 million
during fiscal 2007. Approximately 74% of these impairment
charges were recorded to residential land and lots and land held
for development, and approximately 26% of these charges were
recorded to residential construction in progress and finished
homes in inventory. During fiscal 2006, we recorded impairment
charges totaling $146.2 million related to projects with a
carrying value of $459.3 million, the majority of which
were in California. Of the remaining $1,681.9 million of
projects with impairment indicators which were determined not to
be impaired at September 30, 2007, the largest
concentrations were in California (28%), Florida (20%), and
Arizona (16%).
During fiscal 2007 and 2006, we wrote off $107.3 million
and $124.7 million, respectively, of earnest money deposits
and pre-acquisition costs related to land option purchase
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
1,200 basis points in fiscal 2007, compared to
180 basis points in fiscal 2006.
SG&A expense from homebuilding activities decreased by
$315.1 million, or 22%, to $1,141.5 million in 2007
from $1,456.6 million in 2006. As a percentage of
homebuilding revenues, SG&A expense increased 40 basis
points, to 10.3% in 2007 from 9.9% in 2006, due to a decrease in
revenues. The largest component of our homebuilding SG&A
expense is employee compensation and related costs, which
represented 59% and 64% of SG&A costs in 2007 and 2006,
respectively. Those costs decreased $260.2 million, or 28%,
to $672.2 million in 2007 from $932.4 million in 2006,
largely due to our efforts to align the number of employees to
match our home closing levels, as well as a decrease in
incentive compensation, which is primarily based on
profitability. Our homebuilding operations employed
approximately 5,100 and 7,100 employees at
September 30, 2007 and 2006, respectively. The remaining
decrease in SG&A expense of $54.9 million was
primarily attributable to decreases in subdivision maintenance,
advertising costs and professional consulting fees.
We capitalize homebuilding interest costs to inventory during
development and construction. During both fiscal years, our
active inventory exceeded our debt levels; therefore, we
capitalized all interest from homebuilding debt. Interest
amortized to cost of sales, excluding interest written off with
inventory impairment charges, was 2.4% of total home and
land/lot cost of sales in 2007, compared to 2.1% in 2006.
Interest incurred is directly related to the average level of
our homebuilding debt outstanding during the period. Comparing
fiscal 2007 with fiscal 2006, interest incurred related to
homebuilding debt decreased by 6%, to $304.3 million,
primarily due to a 5% decrease in our average homebuilding debt.
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In fiscal 2007, in connection with the early retirement of our
8.5% senior notes due 2012, we recorded a loss of
approximately $12.1 million for the call premium and the
unamortized discount and fees related to the redeemed notes. In
fiscal 2006, in connection with the early retirement of our
9.375% senior subordinated notes due 2011 and our
10.5% senior subordinated notes due 2011, we recorded a
loss of approximately $13.4 million for the call premium
and the unamortized discount and fees, net of any unamortized
premium related to these redeemed notes. Similarly, we recorded
a loss of approximately $4.4 million related to the
unamortized fees associated with the redemption and replacement
of our revolving credit facility in fiscal 2006.
Other income, net of other expenses, associated with
homebuilding activities was $4.0 million in 2007, compared
to $11.0 million in 2006. Major components of other income
in both years were interest income and gain on the sale of
assets, while in fiscal 2006, the increase in the fair value of
our interest rate swaps was also a major component.
At June 30, 2007, we determined that an interim test to
assess the recoverability of goodwill was necessary because of
the significant amount of inventory tested for impairment under
SFAS No. 144, the market conditions in the
homebuilding industry and the decline in our stock price. We
completed the first step of our goodwill impairment analysis as
of June 30, 2007, and concluded an impairment loss was
probable and could be reasonably estimated for our East,
Southeast and West reporting segments. As a result, during the
quarter ended June 30, 2007, we recorded goodwill
impairment charges totaling $425.6 million.
During the quarter ended September 30, 2007, we completed
the second step of our goodwill impairment analysis, through
which we confirmed the appropriateness of our prior quarter
write-offs and determined that the goodwill balance related to
our Midwest reporting segment was completely impaired.
Consequently, the goodwill balance in our Midwest reporting
segment of $48.5 million, which included $13.5 million
transferred from the Southwest reporting segment due to changing
our management structure, was written off in the fourth quarter.
Total goodwill impairment charges for fiscal 2007 were
$474.1 million.
In addition, at September 30, 2007, we completed our annual
impairment test and determined that the fair values of our South
Central and Southwest reporting segments were greater than their
carrying values and no impairment of goodwill existed in those
segments.
Our goodwill balances by reporting segment as of
September 30, 2007 and 2006 were as follows. Prior year
amounts have been restated between reporting segments as
appropriate, to conform to the 2008 presentation.
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In fiscal 2007, the benefit from income taxes was
$238.7 million, corresponding to the loss before income
taxes for the year. In fiscal 2006, the provision for income
taxes was $753.8 million, corresponding to the income
before income taxes for the year.
Our effective income tax rate for fiscal 2007 was 25.1%,
compared to an effective tax rate of 37.9% in fiscal 2006. The
effective tax rate during 2007 was lower than the effective tax
rate in 2006, resulting in a reduced benefit from income taxes
related to the loss in the year, because only approximately 23%
of the $474.1 million goodwill impairment charge recorded
in fiscal 2007 was deductible for tax purposes. Excluding the
goodwill impairment charge, the effective tax rate was 40.9% for
fiscal 2007.
Primarily as a result of recording significant inventory
impairment charges during fiscal 2007, the balance of our
deferred tax asset increased substantially, from
$374.0 million at September 30, 2006 to
$863.8 million at September 30, 2007.
East Region — Homebuilding revenues decreased
22% in 2007 compared to 2006, primarily due to a 22% decrease in
the number of homes closed, as well as a slight decrease in the
average selling price of those homes. The region reported a loss
before income taxes of $66.1 million in 2007, compared to
income of $112.9 million in 2006. The loss in fiscal 2007
was primarily due to inventory impairment charges and earnest
money and pre-acquisition cost write-offs totaling
$81.5 million, and goodwill impairment charges of
$39.4 million. A decrease in the region’s gross profit
from home sales as a percentage of home sales revenue (home
sales gross profit percentage) of 450 basis points in 2007
compared to 2006 also contributed to the reduction in income
before income taxes. The home sales gross profit percentage
decline in our South Carolina and New Jersey markets had the
greatest impact on the overall decrease in the region’s
profitability.
Midwest Region — Homebuilding revenues
decreased 38% in 2007 compared to 2006, primarily due to a 42%
decrease in the number of homes closed, partially offset by a
slight increase in the average selling price of those homes. The
region reported a loss before income taxes of
$205.3 million in 2007, compared to income of
$111.3 million in 2006. The loss in fiscal 2007 was
primarily due to inventory impairment charges and earnest money
and pre-acquisition cost write-offs totaling
$167.3 million, and goodwill impairment charges of
$48.5 million. The majority of the inventory impairments
relate to projects in our Denver market. A decrease in the
region’s home sales gross profit percentage of
210 basis points in 2007 compared to 2006, as well as an
increase in construction defect expense in Denver, also
contributed to the reduction in income before income taxes.
Southeast Region — Homebuilding revenues
decreased 28% in 2007 compared to 2006, primarily due to a 24%
decrease in the number of homes closed, as well as a 6% decrease
in the average selling price of those homes. The region reported
a loss before income taxes of $131.6 million in 2007,
compared to income of $346.4 million in 2006. The loss in
fiscal 2007 was primarily due to inventory impairment charges
and earnest money and pre-acquisition cost write-offs totaling
$210.2 million, and goodwill impairment charges of
$11.5 million. A decrease in the region’s home sales
gross profit percentage of 1,140 basis points in 2007
compared to 2006 also contributed to the reduction in income
before income taxes. The home sales gross profit percentage
decline in our Florida markets had the greatest impact on the
overall decrease. The Florida markets experienced rapid price
increases in previous years which contributed to gross profit
increases in 2005 and continued elevated gross profit in 2006.
In 2007, high inventory levels of new and existing homes and
increased levels of sales incentives and home price reductions
were typical throughout Florida, resulting in substantial gross
profit declines.
South Central Region — Homebuilding revenues
decreased 13% in 2007 compared to 2006, primarily due to a 16%
decrease in the number of homes closed, partially offset by a 5%
increase in the average selling price of those homes. Income
before income taxes for the region was $122.2 million in
2007, down 29% from 2006. Income before income taxes as a
percentage of the region’s revenues (operating margin)
decreased 130 basis points, to 6.1%, from 7.4% in 2006. The
decrease in operating margin in 2007 was primarily due to
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a decrease in the region’s home sales gross profit
percentage of 70 basis points in 2007 compared to 2006. The
home sales gross profit change was largely due to softening in
the San Antonio market, where inventories of new and
existing homes increased, resulting in increased levels of sales
incentives being offered by builders. The recording of inventory
impairment charges and earnest money and pre-acquisition cost
write-offs totaling $24.6 million in fiscal 2007 compared
to $2.2 million in 2006, also contributed to the decline in
the region’s profitability.
Southwest Region — Homebuilding revenues
remained relatively flat, decreasing only 1% in 2007 compared to
2006, due to a 7% decrease in the average selling price of homes
closed, partially offset by a 4% increase in the number of homes
closed. Income before income taxes for the region was
$192.9 million in 2007, down 54% from 2006. Operating
margin decreased 1,160 basis points, to 10.2%, from 21.8%
in 2006. The decrease in operating margin in 2007 was primarily
due to a decrease in the region’s home sales gross profit
percentage of 1,130 basis points in 2007 compared to 2006.
The home sales gross profit change was largely due to declines
in our Phoenix market. The Phoenix market experienced
significant price increases in previous years which contributed
to gross profit increases in 2005 and continued elevated gross
profit in 2006. In 2007, higher inventory levels of new and
existing homes and increased sales incentives and home price
reductions were more common in Phoenix, resulting in gross
profit declines. The recording of inventory impairment charges
and earnest money and pre-acquisition cost write-offs totaling
$26.8 million in fiscal 2007 compared to $4.8 million
in 2006, also contributed to the decline in the region’s
profitability.
West Region — Homebuilding revenues decreased
34% in 2007 compared to 2006, due to a 34% decrease in the
number of homes closed, as well as a slight decrease in the
average selling price of those homes. The region reported a loss
before income taxes of $932.1 million in 2007, compared to
income of $720.6 million in 2006. The loss in fiscal 2007
was primarily due to inventory impairment charges and earnest
money and pre-acquisition cost write-offs totaling
$819.1 million, and goodwill impairment charges of
$374.7 million. The majority of the inventory impairments
relate to projects in our California and Las Vegas markets. A
decrease in the region’s home sales gross profit percentage
of 790 basis points in 2007, compared to 2006 also
contributed to the reduction in income before income taxes. The
home sales gross profit percentage declines in our California
and Las Vegas markets had the greatest impact on the overall
decrease. The California and Las Vegas markets experienced
rapid, significant home price increases in previous years which
contributed to gross profit increases in 2005 and continued
elevated gross profit in 2006, but these price increases also
strained housing affordability for many potential homebuyers in
those markets. Credit tightening in the mortgage markets also
significantly limited the availability of many mortgage products
used extensively by California and Las Vegas homebuyers in the
previous years. In 2006 and 2007, inventory levels of new and
existing homes in these markets were high and increased levels
of sales incentives and home price reductions were typical in
new home communities, as builders attempted to increase demand
for homes and address affordability concerns, resulting in gross
profit declines.
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Results
of Operations — Financial Services
Fiscal
Year Ended September 30, 2008 Compared to Fiscal Year Ended
September 30, 2007
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, 2008 and 2007:
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
decreased by 41% in fiscal 2008 compared to fiscal 2007,
corresponding to
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the decrease in the number of homes closed of 36%. The
percentage decrease in loans originated was greater than the
percentage decrease in homes closed due to a decline in our
mortgage capture rate (the percentage of total home closings by
our homebuilding operations for which DHI Mortgage handled the
homebuyers’ financing), to 61% in 2008, from 66% in 2007,
as DHI Mortgage reduced the number of homebuilding markets it
supports. Home closings from our homebuilding operations
constituted 92% of DHI Mortgage loan originations in 2008,
compared to 95% in 2007, 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 decreased by 50% in 2008 as compared to
2007. The decrease was primarily due to the decrease in the
number of mortgage loans originated.
Consistent with the second half of fiscal 2007, originations
during fiscal 2008 continued to be predominantly traditional
conforming, conventional loans and FHA or VA insured loans.
Revenues from the financial services segment decreased 39%, to
$127.5 million in 2008 from $207.7 million in 2007.
The decrease was primarily due to the decrease in the number of
mortgage loans originated and sold, although during fiscal 2008,
the effect of decreased loan volume was partially offset by the
recognition of an additional $8.8 million of revenues
related to the adoption of Staff Accounting
Bulletin No. 109, “Written Loan Commitments
Recorded at Fair Value Through Earnings”
(SAB 109) on January 1, 2008. SAB 109
requires that the expected net future cash flows related to the
associated servicing of a loan are included in the measurement
of all written loan commitments that are accounted for at fair
value through earnings at the time of commitment. Additionally,
we increased our loan loss reserve from $24.6 million at
September 30, 2007, to $30.5 million at
September 30, 2008 to provide for estimated losses
predominantly on loans held in portfolio and loans held for
sale. Charges related to recourse obligations declined to
$21.9 million in fiscal 2008 from $26.0 million in
fiscal 2007. Recourse expense is included as a component of
gains from sale of mortgages.
General and administrative (G&A) expense associated with
financial services decreased 35%, to $100.1 million in 2008
from $153.8 million in 2007. The largest component of our
financial services G&A expense is employee compensation and
related costs, which represented 71% and 75% of G&A costs
in 2008 and 2007, respectively. Those costs decreased 38%, to
$70.8 million in 2008 from $114.9 million in 2007, as
we have continued to align the number of employees with current
and anticipated loan origination and title service levels. Our
financial services operations employed approximately 700 and
1,100 employees at September 30, 2008 and 2007,
respectively.
As a percentage of financial services revenues, G&A expense
increased by 450 basis points, to 78.5% in 2008, from 74.0%
in 2007. The increase was primarily due to the reduction in
revenue resulting from the decrease in mortgage loan volume
during fiscal 2008, and was partially offset by the effect of
the additional revenue recognized upon adopting SAB 109 in
fiscal 2008. Fluctuations in financial services G&A expense
as a percentage of revenues can be expected to occur due to
changes in the amount of revenue earned, as some expenses are
not directly related to mortgage loan volume.
Interest expense is directly related to the average level of our
financial services debt outstanding during the period. Comparing
fiscal 2008 with fiscal 2007, interest expense related to
financial services debt decreased by 84%, to $3.7 million,
primarily due to an 87% decrease in our average financial
services debt.
Interest and other income decreased 70%, to $11.4 million
in 2008 from $38.5 million in 2007, primarily due to the
decreased volume of loan originations.
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Fiscal
Year Ended September 30, 2007 Compared to Fiscal Year Ended
September 30, 2006
The following tables set forth key operating and financial data
for our financial services operations for the fiscal years ended
September 30, 2007 and 2006:
Total first-lien loans originated or brokered by DHI Mortgage
for our homebuyers decreased by 24% in fiscal 2007 compared to
fiscal 2006, corresponding to the decrease in the number of
homes closed of 22%. The percentage decrease in loans originated
was greater than the percentage decrease in homes closed due to
a decline in our mortgage capture rate to 66% in 2007, from 68%
in 2006. Home closings from our homebuilding operations
constituted 95% of DHI Mortgage loan originations in 2007,
compared to 94% in
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2006, 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
decreased by 29% in 2007 as compared to 2006. The decrease was
primarily due to the decrease in the number of mortgage loans
originated.
During fiscal 2007, the market for certain non-traditional
mortgage loans changed substantially, resulting in the reduced
availability of some loan products that had previously been
available to borrowers. The affected loan products were
generally characterized by high combined loan-to-value ratios in
combination with less required documentation than traditional
mortgage loans. Such loans constituted approximately half of our
total originations during fiscal 2006, but these products
declined substantially as a percentage of total originations
during fiscal 2007, primarily in the third and fourth quarters.
As a percentage of total loans originated, originations of
traditional conforming, conventional loans and FHA or VA insured
loans increased significantly during the fourth quarter of
fiscal 2007, to approximately 90%, corresponding to the
reduction in non-traditional mortgage loans.
Revenues from the financial services segment decreased 29%, to
$207.7 million in 2007 from $290.8 million in 2006.
The decrease was primarily due to the decrease in the number of
mortgage loans originated and sold. Additionally, we increased
our loan loss reserve from $15.6 million at
September 30, 2006, to $24.6 million at
September 30, 2007 to provide for estimated losses
predominantly on loans held in portfolio and loans held for
sale. The increase in this reserve resulted in a corresponding
decrease to the gains on sale of mortgages, and reflects the
market conditions related to non-traditional products as
described above, as well as potential repurchase obligations
that exist on certain loans previously sold.
G&A expense associated with financial services decreased
24%, to $153.8 million in 2007 from $202.2 million in
2006. The largest component of our financial services G&A
expense is employee compensation and related costs, which
represented 75% and 77% of G&A costs in 2007 and 2006,
respectively. Those costs decreased 26%, to $114.9 million
in 2007 from $155.4 million in 2006, as we aligned the
number of employees with the then current and anticipated loan
origination and title service levels. Our financial services
operations employed approximately 1,100 and 1,700 employees
at September 30, 2007 and 2006, respectively.
As a percentage of financial services revenues, G&A expense
increased by 450 basis points, to 74.0% in 2007, from 69.5%
in 2006. The increase was primarily due to the reduction in
revenue resulting from the decrease in mortgage loan volume
during fiscal 2007 and an increase in loan loss expense
discussed above. Fluctuations in financial services G&A
expense as a percentage of revenues can be expected to occur due
to changes in the amount of revenue earned, as some expenses are
not directly related to mortgage loan volume.
Interest and other income decreased 32%, to $38.5 million
in 2007 from $56.9 million in 2006, primarily due to the
decreased volume of loan originations.
Overview
of Current Capital Resources and Liquidity
We have historically funded 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 have utilized our capital resources
and liquidity to fund our operations, we have focused on
maintaining a strong balance sheet.
At September 30, 2008, our ratio of net homebuilding debt
to total capital was 43.6%, an increase of 340 basis points
from 40.2% at September 30, 2007. 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). The increase in our
ratio of net homebuilding debt to total capital at
September 30, 2008 as compared with the ratio a year
earlier was primarily due to the decrease in retained earnings,
which was partially offset by our higher cash balance and lower
debt balance resulting from the generation of cash flows from
operations. Our ratio of net homebuilding debt to total capital
remains within
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our target operating range of below 45%. We believe that our
strong balance sheet and liquidity position will allow us to be
flexible in reacting to changing market conditions. However,
future period-end net homebuilding debt to total capital ratios
may be higher than the 43.6% ratio achieved at
September 30, 2008.
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 it is separately capitalized and its obligation
under its repurchase agreement is substantially collateralized
and not guaranteed by our parent company or any of our
homebuilding entities. Because of its capital function, we
include homebuilding cash as a reduction of our homebuilding
debt and total capital. For comparison to our ratios of net
homebuilding debt to capital above, at September 30, 2008
and 2007, our ratios of homebuilding debt to total capital,
without netting cash balances, were 55.6% and 41.7%,
respectively.
We believe that we will be able to fund our short-term working
capital needs for our homebuilding and financial services
operations and our fiscal 2009 debt maturities through existing
cash resources and the cash flows from operations we expect to
generate in fiscal 2009. Although we do not currently anticipate
a need to borrow from our revolving credit facility in fiscal
2009, we are currently exploring alternatives with regard to the
facility, which could potentially include an amendment to the
current agreement. For the longer term, in addition to utilizing
existing cash resources and cash flows generated from operations
in the future, we expect to fund our operations through a
renewed or amended credit facility and, if needed, the issuance
of new securities through the public capital markets, subject to
market conditions.
Cash and Cash Equivalents — At
September 30, 2008, we had available homebuilding cash and
cash equivalents of $1.4 billion.
Bank Credit Facility and Indentures — We have a
$1.65 billion unsecured revolving credit facility, which
includes a $1.0 billion letter of credit sub-facility. The
revolving credit facility, which matures on December 16,
2011, has an uncommitted accordion provision of
$400 million which could be used to increase the size of
the facility to $2.05 billion upon obtaining additional
commitments from lenders. Our borrowing capacity, including the
issuance of letters of credit, under this facility is reduced by
the amount of letters of credit outstanding, and is currently
further reduced by the limitations in effect under the borrowing
base arrangement to $52.8 million, as more fully described
below. The facility is guaranteed by substantially all of our
wholly-owned subsidiaries other than our financial services
subsidiaries. Borrowings bear interest at rates based upon the
London Interbank Offered Rate (LIBOR) plus a spread based upon
our leverage ratio as defined in our credit agreement, our ratio
of adjusted EBITDA to adjusted interest incurred and our senior
unsecured debt rating. We may 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, in the past, from the issuance of
public securities. At September 30, 2008, we had no cash
borrowings and $71.6 million of standby letters of credit
outstanding on our homebuilding revolving credit facility and
the interest rate was 5.5%. In addition to the stated interest
rates, the revolving credit facility requires us to pay certain
fees.
In January 2008, through an amendment to the credit agreement,
the size of the revolving credit facility was reduced from
$2.5 billion to $2.25 billion. The amendment also
revised certain financial covenants, including reducing the
required level of minimum tangible net worth and reducing the
maximum leverage ratio. Additionally, the amendment modified the
adjusted EBITDA to adjusted interest incurred covenant such that
it can no longer result in an event of default.
In June 2008, through an amendment to the credit agreement, the
size of the revolving credit facility was reduced from
$2.25 billion to $1.65 billion. The amendment further
reduced the minimum tangible net worth requirement and modified
the leverage ratio calculation. In addition, the amendment
increased the maximum residential land and lots to tangible net
worth ratio and modified tangible net worth to include certain
capital stock. The amendment also changed the pricing terms of
our revolving credit facility, whereby the interest rate spread
on borrowings and on unused committed capacity was increased.
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Under the debt covenants associated with our revolving credit
facility, if we have fewer than two investment grade senior
unsecured debt ratings from Moody’s Investors Service,
Fitch Ratings and Standard and Poor’s Ratings Services, we
are subject to a borrowing base limitation and restrictions on
unsold homes and residential land and lots. During the first
quarter of fiscal 2008 both Standard & Poor’s and
Moody’s downgraded our senior debt rating to below
investment grade status; therefore, these additional limitations
became effective and are currently in effect. During the third
quarter of fiscal 2008, our senior debt rating was downgraded by
all three rating agencies, and on November 26, 2008, was
further downgraded by Moody’s and Standard &
Poor’s to their current levels as follows: Moody’s
(Ba3); Standard & Poor’s (BB−); and
Fitch (BB+).
Under the borrowing base limitation, the sum of our senior debt
and the amount drawn on our revolving credit facility may not
exceed the lesser of (a) certain percentages of the
acquisition cost of various categories of our unencumbered
inventory or (b) certain percentages of the book value of
various categories of our unencumbered inventory, cash and cash
equivalents. At September 30, 2008, the borrowing base
arrangement limited our additional borrowing capacity from any
source, including the issuance of letters of credit, to
$52.8 million. Reductions of outstanding debt will increase
our capacity under the borrowing base, while reductions of
inventory will generally decrease our borrowing base capacity.
Consequently, to the extent our debt balance declines at a
faster pace than further inventory reductions, we would expect
our capacity to increase under the borrowing base. Based on our
current cash balance and expectations for cash flows, we
currently do not anticipate a need to borrow from our revolving
credit facility in the near term; however, we are exploring
alternatives with regard to this credit facility, which could
potentially include an amendment to the current agreement.
The revolving credit facility imposes restrictions on our
operations and activities by requiring us to maintain certain
levels of leverage, tangible net worth and components of
inventory. If we do not maintain the requisite levels, we may
not be able to pay dividends or available financing could be
reduced or terminated. In addition, the indentures governing our
senior notes and senior subordinated notes impose restrictions
on the creation of secured debt.
Based on the terms of the credit agreement as amended in June
2008, the following table presents the revised levels required
to maintain our compliance with the financial covenants
associated with our revolving credit facility, and the levels
achieved as of and for the period ended September 30, 2008.
These covenants are measured at the end of each fiscal quarter.
They are required to be maintained by us and all of our direct
and indirect subsidiaries (collectively, Guarantor
Subsidiaries), other than the financial services subsidiaries
and certain inconsequential subsidiaries (collectively,
Non-Guarantor Subsidiaries).
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51
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Prior to June 20, 2008, our senior subordinated notes
indenture contained restrictions that became operative if our
Consolidated Fixed Charge Coverage Ratio, as defined in the
indenture, for four fiscal quarters was not at least 2.0 to 1.0.
If we failed to satisfy this ratio, we would have been precluded
from making certain restricted payments, including dividends,
and incurring additional debt other than certain refinancing
indebtedness, purchase money indebtedness or other permitted
indebtedness that were not dependent on this ratio, including
$1 billion principal amount of indebtedness under our
revolving credit facility at any time outstanding.
In May 2008, we commenced an offer to exchange any and all of
our outstanding 9.75% senior subordinated notes due 2010
for an equal principal amount of new 9.75% senior notes due
2010. In conjunction with the exchange offer, we solicited
consents to an amendment to the indenture governing the senior
subordinated notes that would eliminate many of the restrictive
covenants applicable to the senior subordinated notes as
described above. For each $1,000 principal amount of senior
subordinated notes tendered prior to the expiration of the
consent solicitation on June 4, 2008, holders received a
consent payment of $10. On June 20, 2008, the exchange
offer and related solicitation of consents to amend the
indenture closed, with $96.8 million principal amount of
the senior subordinated notes having been tendered for exchange,
and $16.7 million principal amount of the 9.75% senior
subordinated notes remaining under the amended indenture. As a
result of the amendment to the indenture, many of the
restrictive covenants contained in the indenture were
eliminated, including the Consolidated Fixed Charge Coverage
Ratio discussed above.
At September 30, 2008, we were in compliance with all of
the financial covenants, limitations and restrictions that form
a part of the bank revolving credit facility and the public debt
obligations. However, the margin by which we have complied with
the tangible net worth covenant of our revolving credit facility
has
52
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declined. If our operating results and inventory impairments
continue at recent levels, our tangible net worth may decline
below the minimum level required by the revolving credit
facility during fiscal 2009. Consequently, we intend to seek an
amendment to our revolving credit facility to modify the
covenant provisions included in the credit facility before our
tangible net worth declines below the minimum required level.
The amendment may also include, among other things, a reduction
in the commitment amount under the facility and price increases
on borrowings and unused commitment amounts. We cannot assure
that we will be successful in these efforts or that the terms or
amount of any revised financing will not have an adverse effect
on us, our business, capital resources or financial results.
Repayments of Public Unsecured Debt — On
December 1, 2007, we repaid the $215 million principal
amount of our 7.5% senior notes which became due on that
date.
In February 2008, through an unsolicited transaction, we
repurchased $36.5 million principal amount of our
9.75% senior subordinated notes due 2010 for a purchase
price of $36.0 million, plus accrued interest. The gain of
$0.5 million is included in homebuilding other income in
our consolidated statements of operations for fiscal 2008.
In the fourth quarter of fiscal 2008, through unsolicited
transactions, we repurchased $35.3 million principal amount
of our 8% senior notes due 2009 at their face value, plus
accrued interest, and $1.40 million principal amount of our
9.75% senior subordinated notes due 2010 for a purchase
price of $1.36 million, plus accrued interest.
In November 2008, through unsolicited transactions, we
repurchased a total of $102.9 million principal amount of
various issues of our senior notes due in 2009 and 2010 for an
aggregate purchase price of $98.2 million.
Shelf Registration Statements — We have an
automatically effective universal shelf registration statement
filed with the SEC, registering debt and equity securities which
we may issue from time to time in amounts to be determined.
Also, at September 30, 2008, 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, 2008, we had available financial services
cash and cash equivalents of $31.7 million.
Mortgage Warehouse Loan Facility — DHI Mortgage
had a $540 million mortgage warehouse loan facility that
matured March 28, 2008. This facility was not renewed upon
maturity, but was replaced with the mortgage repurchase facility
described below.
Commercial Paper Conduit Facility — DHI
Mortgage had a $600 million commercial paper conduit
facility (the “CP conduit facility”) with a maturity
date of June 27, 2009. Effective April 1, 2008, the CP
conduit facility was voluntarily terminated by agreement of the
parties.
Mortgage Repurchase Facility — On
March 28, 2008, DHI Mortgage entered into a mortgage sale
and repurchase agreement (the “mortgage repurchase
facility”), that matures March 26, 2009. The mortgage
repurchase facility, which replaced the mortgage warehouse loan
facility, provides financing and liquidity to DHI Mortgage by
facilitating purchase transactions in which DHI Mortgage
transfers eligible loans to the counterparties against the
transfer of funds by the counterparties, thereby becoming
purchased loans. DHI Mortgage then has the right and obligation
to repurchase the purchased loans upon their sale to third party
investors in the secondary market or upon a specified time per
the terms of the mortgage repurchase facility. As of
September 30, 2008, $333.7 million of mortgage loans
held for sale were pledged under this repurchase arrangement.
The mortgage repurchase facility is accounted for as a secured
financing. The facility has a capacity of $275 million,
subject to an accordion feature that could increase the total
capacity to $500 million based on obtaining increased
committed sums from existing counterparties, new commitments
from prospective counterparties, or a combination of both. In
addition, DHI Mortgage has the option to fund a
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portion of its repurchase obligations in advance. As a result of
advance fundings totaling $106.9 million, DHI Mortgage had
an obligation of $203.5 million outstanding under the
mortgage repurchase facility at September 30, 2008 at a
4.9% interest rate.
The mortgage repurchase facility is not guaranteed by either
D.R. Horton, Inc. or any of the subsidiaries that guarantee our
homebuilding debt. The facility contains financial covenants as
to the mortgage subsidiary’s minimum required tangible net
worth, its maximum allowable ratio of debt to tangible net
worth, its minimum required net income and its minimum required
liquidity. At September 30, 2008, our mortgage subsidiary
was in compliance with all of the conditions and covenants of
the mortgage repurchase facility. However, the margin by which
we have complied with the minimum required net income covenant
of this facility has declined. If our financial services
operating results continue at current levels, this calculation
may decline below the required level before the expiration date
of the facility. Consequently, we intend to seek an amendment to
our mortgage repurchase facility to modify the covenant
provisions included in the facility before then. We cannot
assure that we will be successful in these efforts or that the
terms or amount of any revised financing will not have an
adverse effect on us, our business, capital resources or
financial results.
In the past, we have been able to renew or extend our mortgage
credit facilities 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. The
recent volatility in the credit markets and losses sustained by
many banks will likely make renewing this facility more
challenging and more expensive. The liquidity of our financial
services business depends upon our continued ability to renew
and extend the mortgage repurchase facility or to obtain other
additional financing in sufficient capacities.
During the year ended September 30, 2008, net cash provided
by our operating activities was $1.9 billion, as compared
to $1.4 billion during the prior year. During fiscal 2008,
we continued to limit our investments in inventory, as evidenced
by a $2.1 billion decrease in owned inventory (excluding
the impact of impairments and write-offs) during the fiscal
year, compared to a $737.6 million decrease in fiscal 2007.
In light of the challenging market conditions, we have
substantially slowed our purchases of land and lots and our
development spending on land we own, and have restricted the
number of homes under construction to better match our expected
rate of home sales and closings. We plan to continue to restrict
our number of homes under construction and significantly limit
our development spending during fiscal 2009. Our ability to
reduce our inventory levels is, however, heavily dependent upon
our ability to close a sufficient number of homes during the
year, which may prove difficult given the current market
conditions. To the extent our inventory levels decrease at
planned levels during fiscal 2009, we expect to generate net
positive cash flows from operating activities, should all other
factors remain constant; however, the amount of cash generated
in the future may be less than in prior periods. Additionally,
we expect the receipt of our federal income tax refund of
$676.2 million to contribute to positive cash flow from
operations in fiscal 2009.
Another significant factor affecting our operating cash flows in
fiscal 2008 was the decrease in mortgage loans held for sale of
$171.4 million during the year. The decrease in mortgage
loans held for sale was due to a decrease in the number of loans
originated during the fourth quarter of fiscal 2008 compared to
the fourth quarter of fiscal 2007. 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
amounts of net cash used may be reduced or we may generate
positive cash flows from reductions in the balances of mortgage
loans held for sale as we did in fiscal 2008.
In fiscal 2008 and 2007, 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, but
were reduced in fiscal 2008 in light of the weaker market
conditions.
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The majority of our short-term financing needs have been funded
with cash generated from operations and borrowings available
under our homebuilding and financial services credit facilities.
Long-term financing needs of our homebuilding operations have
been generally funded with the issuance of new senior unsecured
debt securities through the public capital markets. Our
homebuilding senior and senior subordinated notes and borrowings
under our homebuilding revolving credit facility are guaranteed
by substantially all of our wholly-owned subsidiaries other than
our financial services subsidiaries.
During fiscal 2008, our Board of Directors approved two
quarterly cash dividends of $0.15 per common share and two
quarterly cash dividends of $0.075 per common share, the last of
which was paid on August 28, 2008 to stockholders of record
on August 18, 2008. Quarterly cash dividends of $0.15 per
common share were paid in each quarter of fiscal 2007. On
November 20, 2008, our Board of Directors approved a cash
dividend of $0.0375 per common share, payable on
December 18, 2008, to stockholders of record on
December 8, 2008. The declaration of future cash dividends
is at the discretion of our Board of Directors and will depend
upon, among other things, future earnings, cash flows, capital
requirements, our financial condition and general business
conditions, as well as compliance with covenants contained in
our revolving credit agreement.
In November 2007, our Board of Directors extended its
authorizations for the repurchase of up to $463.2 million
of our common stock and the repurchase of debt securities of up
to $500 million to November 30, 2008. Through
unsolicited transactions during fiscal 2008, we repurchased
$37.9 million principal amount of our 9.75% senior
subordinated notes due 2010 and $35.3 million principal
amount of our 8% senior notes due 2009, which reduced the
remaining debt repurchase authorization to $426.8 million
at September 30, 2008. Upon expiration of the November 2007
authorizations, our Board of Directors has authorized the
repurchase of up to $100 million of our common stock and
the repurchase of up to $500 million of debt securities.
The new authorizations are effective from December 1, 2008
to November 30, 2009.
In fiscal 2008, our primary non-operating uses of our available
capital were the repayment of debt, and dividend payments. We
expect the repayment of debt to remain a significant priority
for the use of cash in fiscal 2009. We continue to evaluate our
alternatives for future non-operating uses of our available
capital, including the amounts of planned debt repayments,
dividend payments and maintenance of cash balances, based on
market conditions and other circumstances, and within the
constraints of our balance sheet leverage targets, our liquidity
targets and the restrictions in our bank agreements.
Contractual
Cash Obligations, Commercial Commitments and Off-Balance Sheet
Arrangements
Our primary contractual cash obligations for our homebuilding
and financial services segments are payments under 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 a combination of our existing cash
resources, cash flows generated from operations, renewed or
amended credit facilities and, if needed, the issuance of new
securities through the public capital markets, subject to market
conditions.
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Our future cash requirements for contractual obligations as of
September 30, 2008 are presented below:
At September 30, 2008, our homebuilding operations had
outstanding letters of credit of $71.6 million and surety
bonds of $1.6 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.
Our mortgage subsidiary enters into various commitments related
to the lending activities of our mortgage operations. Further
discussion of these commitments is provided in Item 7A
“Quantitative and Qualitative Disclosures About Market
Risk” under Part II of this annual report on
Form 10-K.
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 limited capital investment and
substantially reduce the risks associated with land ownership
and development. Within the land and lot option purchase
contracts in force at September 30, 2008, there were a
limited number of contracts, representing only
$48.0 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. We consolidated certain variable interest entities
with assets of $21.7 million related to some of our
outstanding land and lot option purchase contracts. Creditors,
if any, of these variable interest entities have no recourse
against us. Additionally, pursuant to SFAS No. 49,
“Accounting for Product Financing Arrangements,” we
recorded $16.9 million of land inventory not owned related
to some of our outstanding land and lot option purchase
contracts. Further discussion of our land option contracts is
provided in the “Land and Lot Position and Homes in
Inventory” section that follows.
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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, 2008 and 2007:
At September 30, 2008, we owned or controlled approximately
125,000 lots, 21% of which were lots under option or similar
contracts, compared with approximately 230,000 lots at
September 30, 2007. Our current strategy is to continue to
reduce our owned and controlled lot position, in line with our
reduced expectations for future home sales and closings, through
the construction and sale of homes and sales of land and lots,
along with critical evaluation of acquiring lots currently
controlled under option or in opportunistically acquired new lot
positions.
At September 30, 2008, we controlled approximately 26,000
lots with a total remaining purchase price of approximately
$732.3 million under land and lot option purchase
contracts, with a total of $50.9 million in earnest money
deposits. Our lots controlled included approximately 8,000
optioned lots with a remaining purchase price of approximately
$247.9 million and secured by deposits totaling
$23.4 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. Consequently, we have written off the
deposits related to these contracts, resulting in a net earnest
money deposit balance of $27.5 million at
September 30, 2008.
We had a total of approximately 12,400 homes in inventory,
including approximately 1,500 model homes at September 30,
2008, compared to approximately 19,900 homes in inventory,
including approximately 2,000 model homes at September 30,
2007. Of our total homes in inventory, approximately 6,900 and
10,600 were unsold at September 30, 2008 and 2007,
respectively. At September 30, 2008, approximately 3,100 of
our unsold homes were completed, of which approximately 1,100
homes had been completed for more than six months. At
September 30, 2007, approximately 5,000 of our unsold homes
were completed, of which approximately 1,100 homes had been
completed for more than six months. Our strategy is to continue
to restrict and adjust our total number of homes in inventory
and our number of unsold homes in inventory during fiscal 2009
as necessary, to match our reduced expectations for future home
sales and closings. In addition, we will continue our efforts to
opportunistically sell excess land and lot positions in certain
markets.
We have typically experienced seasonal variations in our
quarterly operating results and capital requirements. Before the
current housing downturn, 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 increased our working capital
requirements for our homebuilding operations during the third
and fourth fiscal quarters and increased our funding
requirements for the mortgages we originated in our financial
services segment at the end of these quarters. As a result of
seasonal activity, our results of
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operations and financial position at the end of a particular
fiscal quarter are not necessarily representative of the balance
of our fiscal year.
In contrast to our typical seasonal results, due to further
deterioration of homebuilding market conditions during the last
two years, we incurred consolidated operating losses in our
third and fourth quarters of fiscal 2007 and in all quarters of
fiscal 2008. These results were primarily due to recording
significant inventory and goodwill impairment charges. Also, the
increasingly challenging market conditions caused declines in
sales volume, pricing and margins that mitigated our historical
seasonal variations. Although we may experience our typical
historical seasonal pattern in the future, given the current
market conditions, we can make no assurances as to when or
whether this pattern will recur.
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. However, during periods of soft housing market
conditions, we may not be able to offset our cost increases,
particularly higher land costs, with higher selling prices.
Some of the statements contained in this report, as well as in
other materials we have filed or will file with the SEC,
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 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:
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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, 2008 and 2007, and
for the years ended September 30, 2008, 2007 and 2006. 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 Interpretation No. 46,
“Consolidation of Variable Interest Entities — an
interpretation of ARB No. 51” as amended
(FIN 46R), issued by the Financial Accounting Standards
Board (FASB). 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. Also in accordance with
SFAS No. 66, the recognition of land sales is deferred
when the full accrual method criteria is not met. 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. 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, when the loans are sold to third party
investors. As required by SAB 109 issued by the SEC in
November 2007, the expected net future cash flows related to the
associated servicing of a loan are included in the measurement
of all written loan commitments that are accounted for at fair
value through earnings at the time of commitment. SAB 109
was effective for us on January 1, 2008 and has been
applied prospectively to commitments issued or modified after
that date. We generally do not retain or service the mortgages
that we originate but, rather, seek to sell
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the mortgages and related servicing rights to third-party
investors. Interest income is earned from the date a mortgage
loan is originated until the loan is sold.
Mortgage loans held for sale are carried at cost adjusted for
changes in fair value after the date of designation of an
effective accounting hedge, based on either sale commitments or
current market quotes. Some loans are sold with limited recourse
provisions. Based on historical experience and current housing
and credit market conditions, we estimate and record a total
loss reserve predominantly for mortgage loans held in portfolio
and mortgage loans held for sale. Unhedged loans, or those not
in a designated accounting hedge, are stated at the lower of
cost or market. Market is determined by either sales commitments
or current market conditions.
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 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. 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 community. Any changes to
the estimated total development costs subsequent to the initial
home closings in a community are generally allocated on a
pro-rata basis to the remaining homes in the community.
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 previously
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. We generally
review our inventory at the community level and the inventory
within each community may be categorized as land held for
development, residential land and lots developed and under
development, and construction in progress and finished homes,
based on the stage of production or plans for future
development. A particular community often includes inventory in
more than one category. In certain situations, inventory may be
analyzed separately for impairment purposes based on its product
type (e.g. single family homes evaluated separately from
condominium parcels). In reviewing each of our communities, we
determine if impairment indicators exist on inventory held and
used by analyzing a variety of factors including, but not
limited to, the following:
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If indicators of impairment are present for a community,
SFAS No. 144 requires an analysis to determine if the
undiscounted cash flows estimated to be generated by those
assets are less than their carrying amounts, and if so,
impairment charges are 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 community
specific factors including estimates of the amounts and timing
of future revenues and estimates of the amount of land
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