DR HORTON Results of Operations - Overview
Fiscal 2020 Operating Results
In fiscal 2020, our number of homes closed and home sales revenues increased 15% and 16%, respectively, compared to the prior year, and our consolidated revenues increased 15% to$20.3 billion compared to$17.6 billion in the prior year. Our pre-tax income was$3.0 billion in fiscal 2020 compared to$2.1 billion in fiscal 2019, and our pre-tax operating margin was 14.7% compared to 12.1%. Net income was$2.4 billion in fiscal 2020 compared to$1.6 billion in the prior year. The current year results include a tax benefit of$93.4 million related to the retroactive reinstatement of the federal energy efficient homes tax credit. Cash provided by our homebuilding operations was$1.9 billion in fiscal 2020 compared to$1.4 billion in fiscal 2019. In fiscal 2020, our return on equity (ROE) was 22.1% compared to 17.2% in fiscal 2019, and our homebuilding return on inventory (ROI) was 24.6% compared to 18.1%. ROE is calculated as net income attributable toD.R. Horton for the year divided by average stockholders' equity, where average stockholders' equity is the sum of ending stockholders' equity balances of the trailing five quarters divided by five. Homebuilding ROI is calculated as homebuilding pre-tax income for the year divided by average inventory, where average inventory is the sum of ending homebuilding inventory balances for the trailing five quarters divided by five. Within our homebuilding land and lot portfolio, our lots controlled under purchase contracts represent 70% of the lots owned and controlled atSeptember 30, 2020 compared to 60% atSeptember 30, 2019 . Our relationship with Forestar and expanded relationships with other land developers across the country have allowed us to increase the controlled portion of our finished lot pipeline. COVID-19 During the latter part ofMarch 2020 , the impacts of C-19 and the related widespread reductions in economic activity acrossthe United States began to adversely affect our business. However, residential construction and financial services were designated as essential businesses in almost all of our markets, which allowed us to continue to operate during that time. We implemented operational protocols to comply with social distancing and other health and safety standards as required by federal, state and local government agencies, taking into consideration guidelines of theCenters for Disease Control and Prevention and other public health authorities. DuringApril 2020 when restrictive stay-at-home orders were in place for many markets acrossthe United States , we experienced increases in sales cancellations and decreases in sales orders, and net sales orders for April were 1% lower than the same month in the prior year. However, as economic activity began to resume and restrictive orders began to be lifted, our weekly sales pace increased significantly, and our cancellation rate returned to normal levels. For the third and fourth quarters of fiscal 2020, our net sales orders increased by 38% and 81%, respectively, compared to the prior year quarters. We believe the increase in demand in the second half of the year was fueled by increased buyer urgency due to lower interest rates on mortgage loans, the limited supply of homes at affordable price points across most of our markets and to some extent the lower levels of home sales from mid-March through early April, which caused some pent-up demand. We were and remain well positioned for increased demand with our affordable product offerings, lot supply and housing inventory. However, even with the resurgence of demand in our third and fourth quarters, we remain cautious as to the ongoing impact of C-19 on our operations and on the overall economy. There is significant uncertainty regarding the extent to which and how long C-19 and its related effects will impact theU.S. economy and level of employment, capital markets, secondary mortgage markets, consumer confidence, demand for our homes and availability of mortgage loans to homebuyers. The extent to which this impacts our operational and financial performance will depend on future developments, including the duration and spread of C-19 and the impact on our customers, trade partners and employees, all of which are highly uncertain and cannot be predicted. 28
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We believe our strong balance sheet and liquidity position provide us with the flexibility to operate effectively through changing economic conditions. We plan to continue to generate strong cash flows from our homebuilding operations and manage our product offerings, incentives, home pricing, sales pace and inventory levels to optimize the return on our inventory investments in each of our communities based on local housing market conditions.
Strategy
Our operating strategy focuses on enhancing long-term value to our shareholders
by leveraging our financial and competitive position in our core homebuilding
business to increase the returns on our inventory investments and generate
strong profitability and cash flows, while managing risk and maintaining
financial flexibility to navigate changing economic conditions and make
opportunistic strategic investments. We have made operational adjustments as a
result of C-19; however, our strategy remains consistent and includes the
following initiatives:
•Developing and retaining highly experienced and productive teams of personnel
throughout our company that are aligned and focused on continuous improvement in
our operational execution and financial performance.
•Maintaining a strong cash balance and overall liquidity position and
controlling our level of debt.
•Allocating and actively managing our inventory investments across our operating
markets to diversify our geographic risk.
•Offering new home communities that appeal to a broad range of entry-level,
move-up, active adult and luxury homebuyers based on consumer demand in each
market.
•Modifying product offerings, sales pace, home prices and sales incentives as
necessary in each of our markets to meet consumer demand and maintain
affordability.
•Delivering high quality homes and a positive experience to our customers both
during and after the sale.
•Managing our inventory of homes under construction relative to demand in each
of our markets including starting construction on unsold homes to capture new
home demand and actively controlling the number of unsold, completed homes in
inventory.
•Investing in land and land development in desirable markets, while controlling
the level of land and lots we own in each market relative to the local new home
demand.
•Continuing to seek opportunities to expand the portion of our land and finished
lots controlled through purchase contracts by assisting Forestar with its
operations and expanding our relationships with land developers across the
country.
•Controlling the cost of goods purchased from both vendors and subcontractors.
•Improving the efficiency of our land development, construction, sales and other
key operational activities.
•Controlling our selling, general and administrative (SG&A) expense
infrastructure to match production levels.
•Opportunistically evaluating potential acquisitions to enhance our operations
and improve returns.
•Ensuring that our financial services business provides high quality mortgage
and title services to homebuyers efficiently and effectively.
•Investing in the construction of single-family and multi-family rental
properties to meet rental demand in high growth suburban markets and selling
these properties profitably.
We believe our operating strategy, which has produced positive results in recent
years, will allow us to successfully operate through changing economic
conditions to maintain and improve our financial and competitive position.
However, we cannot provide any assurances that the initiatives listed above will
continue to be successful, and we may need to adjust components of our strategy
to meet future market conditions.
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Key Results
Key financial results as of and for our fiscal year ended
Homebuilding:
•Homebuilding revenues increased 15% to$19.6 billion compared to$17.0 billion . •Homes closed increased 15% to 65,388 homes, and the average closing price of those homes was$299,100 . •Net sales orders increased 39% to 78,458 homes, and the value of net sales orders increased 40% to$23.6 billion . •Sales order backlog increased 96% to 26,683 homes, and the value of sales order backlog increased 98% to$8.2 billion . •Home sales gross margin was 21.8% compared to 20.2%. •Homebuilding SG&A expense was 8.2% of homebuilding revenues compared to 8.7%. •Homebuilding pre-tax income was$2.7 billion compared to$1.9 billion . •Homebuilding pre-tax income was 13.6% of homebuilding revenues compared to 11.2%. •Homebuilding return on inventory was 24.6% compared to 18.1%. •Cash provided by homebuilding operations was$1.9 billion compared to$1.4 billion . •Homebuilding cash and cash equivalents totaled$2.6 billion compared to$1.0 billion . •Homebuilding inventories totaled$11.0 billion compared to$10.3 billion . •Homes in inventory totaled 38,000 compared to 27,700. •Owned lots totaled 112,600 compared to 121,400, and lots controlled through purchase contracts increased to 264,300 from 185,900. •Homebuilding debt was$2.5 billion compared to$2.0 billion . •Homebuilding debt to total capital was 17.5% compared to 17.0%. 30 -------------------------------------------------------------------------------- Table of Contents Forestar: •Forestar's revenues increased 118% to$931.8 million compared to$428.3 million . Revenues in fiscal 2020 and 2019 included$887.4 million and$326.6 million , respectively, of revenue from land and lot sales to our homebuilding segment. •Forestar's lots sold increased 151% to 10,373 compared to 4,132. Lots sold toD.R. Horton totaled 10,164 compared to 3,728. •Forestar's pre-tax income was$78.1 million compared to$45.7 million . •Forestar's pre-tax income was 8.4% of Forestar revenues compared to 10.7%. •Forestar's cash and cash equivalents totaled$394.3 million compared to$382.8 million . •Forestar's inventories totaled$1.3 billion compared to$1.0 billion . •Forestar's owned and controlled lots totaled 60,500 compared to 38,300. Of these lots, 30,400 were under contract to sell to or subject to a right of first offer withD.R. Horton compared to 23,400. •Forestar's debt was$641.1 million compared to$460.5 million .
•Forestar's debt to total capital was 42.4% compared to 36.3%.
Financial Services: •Financial services revenues increased 32% to$584.9 million compared to$441.7 million . •Financial services pre-tax income increased 47% to$245.2 million compared to$166.3 million . •Financial services pre-tax income was 41.9% of financial services revenues compared to 37.6%. Consolidated Results: •Consolidated pre-tax income increased 40% to$3.0 billion compared to$2.1 billion . •Consolidated pre-tax income was 14.7% of consolidated revenues compared to 12.1%. •Income tax expense was$602.5 million compared to$506.7 million . •Net income attributable toD.R. Horton increased 47% to$2.4 billion compared to$1.6 billion . •Diluted net income per common share attributable toD.R. Horton increased 49% to$6.41 compared to$4.29 . •Cash provided by operations was$1.4 billion compared to$892.1 million . •Stockholders' equity was$11.8 billion compared to$10.0 billion . •Book value per common share increased to$32.53 compared to$27.20 . •Debt to total capital was 26.6% compared to 25.3%. 31 -------------------------------------------------------------------------------- Table of Contents Results of Operations - Homebuilding Our operating segments are our 53 homebuilding divisions, our majority-owned Forestar lot development operations, our financial services operations and our other business activities. The homebuilding operating segments are aggregated into six reporting segments. These reporting segments, which we also refer to as reporting regions, have homebuilding operations located in the following states: East: Delaware, Georgia (Savannah only), Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina and Virginia Midwest: Colorado, Illinois, Indiana, Iowa, Minnesota and Ohio Southeast: Alabama, Florida, Georgia, Mississippi and Tennessee South Central: Louisiana, Oklahoma and Texas Southwest: Arizona and New Mexico West: California, Hawaii, Nevada, Oregon, Utah and Washington The following tables and related discussion set forth key operating and financial data for our homebuilding operations by reporting segment as of and for the fiscal years endedSeptember 30, 2020 and 2019. For similar operating and financial data and discussion of our fiscal 2019 results compared to our fiscal 2018 results, refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Part II of our annual report on Form 10-K for the fiscal year endedSeptember 30, 2019 , which was filed with theSEC onNovember 25, 2019 . Net Sales Orders (1) Year Ended September 30, Net Homes Sold Value (In millions) Average Selling Price % % % 2020 2019 Change 2020 2019 Change 2020 2019 Change East 10,621 7,941 34 %$ 3,202.1 $ 2,291.1 40 %$ 301,500 $ 288,500 5 % Midwest 5,010 3,224 55 % 1,794.8 1,127.8 59 % 358,200 349,800 2 % Southeast 25,216 18,609 36 % 6,995.1 5,011.2 40 % 277,400 269,300 3 %South Central 23,289 16,278 43 % 5,978.5 4,123.5 45 % 256,700 253,300 1 % Southwest 4,180 2,797 49 % 1,219.0 750.6 62 % 291,600 268,400 9 % West 10,142 7,716 31 % 4,416.8 3,539.2 25 % 435,500 458,700 (5) % 78,458 56,565 39 %$ 23,606.3 $ 16,843.4 40 %$ 300,900 $ 297,800 1 % _____________
(1)Net sales orders represent the number and dollar value of new sales contracts executed with customers (gross sales orders), net of cancelled sales orders.
Sales Order Cancellations
Year Ended September 30,
Cancelled Sales Orders Value (In millions) Cancellation Rate (1)
2020 2019 2020 2019 2020 2019
East 2,722 2,155 $ 779.6 $ 607.3 20 % 21 %
Midwest 1,027 680 338.0 229.2 17 % 17 %
Southeast 6,750 5,410 1,856.8 1,444.4 21 % 23 %
South Central 6,140 4,751 1,583.6 1,193.2 21 % 23 %
Southwest 899 969 253.2 247.0 18 % 26 %
West 1,628 1,323 717.7 614.0 14 % 15 %
19,166 15,288 $ 5,528.9 $ 4,335.1 20 % 21 %
_____________(1)Cancellation rate represents the number of cancelled sales orders divided by gross sales orders.
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The number of net sales orders increased 39% during 2020 compared to 2019, with significant increases in all of our regions. The value of net sales orders increased 40% to$23.6 billion (78,458 homes) in 2020 from$16.8 billion (56,565 homes) in 2019. The average selling price of net sales orders during fiscal 2020 was$300,900 , up 1% from the prior year. The markets contributing most to the increases in sales volumes in our regions were as follows: the Carolina markets (particularlyMyrtle Beach andCharlotte ) in the East; theDenver ,Minneapolis andIndiana markets in the Midwest; theFlorida markets (particularlyTampa ) in the Southeast; theHouston andDallas markets in theSouth Central ; thePhoenix market in the Southwest; and theCalifornia andNevada markets in the West.
Our sales order cancellation rate (cancelled sales orders divided by gross sales orders for the period) was 20% in 2020 compared to 21% in 2019.
The increase in our sales orders reflects the increase in demand for our homes
in the second half of the year fueled by increased buyer urgency due to lower
interest rates on mortgage loans, the limited supply of homes at affordable
price points across most of our markets and to some extent the lower levels of
home sales from mid-March through early April, which caused some pent-up demand.
Sales Order Backlog
As of September 30,
Homes in Backlog Value (In millions) Average Selling Price
% % %
2020 2019 Change 2020 2019 Change 2020 2019 Change
East 3,583 1,916 87 % $ 1,137.4 $ 576.1 97 % $ 317,400 $ 300,700 6 %
Midwest 2,016 1,063 90 % 731.5 364.7 101 % 362,800 343,100 6 %
Southeast 8,256 4,277 93 % 2,378.5 1,219.5 95 % 288,100 285,100 1 %
South Central 7,913 4,166 90 % 2,076.9 1,084.0 92 % 262,500 260,200 1 %
Southwest 2,005 815 146 % 596.2 241.6 147 % 297,400 296,400 - %
West 2,910 1,376 111 % 1,265.1 654.2 93 % 434,700 475,400 (9) %
26,683 13,613 96 % $ 8,185.6 $ 4,140.1 98 % $ 306,800 $ 304,100 1 %
Sales Order Backlog
Sales order backlog represents homes under contract but not yet closed at the
end of the period. Many of the contracts in our sales order backlog are subject
to contingencies, including mortgage loan approval and buyers selling their
existing homes, which can result in cancellations. A portion of the contracts in
backlog will not result in closings due to cancellations.
Homes Closed and Home Sales Revenue
Year Ended September 30,
Homes Closed Value (In millions) Average Selling Price
% % %
2020 2019 Change 2020 2019 Change 2020 2019 Change
East 8,954 7,928 13 % $ 2,640.8 $ 2,285.0 16 % $ 294,900 $ 288,200 2 %
Midwest 4,057 3,193 27 % 1,428.0 1,113.8 28 % 352,000 348,800 1 %
Southeast 21,237 18,553 14 % 5,836.1 4,964.0 18 % 274,800 267,600 3 %
South Central 19,542 16,604 18 % 4,985.6 4,191.3 19 % 255,100 252,400 1 %
Southwest 2,990 2,910 3 % 864.4 760.6 14 % 289,100 261,400 11 %
West 8,608 7,787 11 % 3,805.9 3,610.3 5 % 442,100 463,600 (5) %
65,388 56,975 15 % $ 19,560.8 $ 16,925.0 16 % $ 299,100 $ 297,100 1 %
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Home Sales Revenue
Revenues from home sales increased 16% to$19.6 billion (65,388 homes closed) in 2020 from$16.9 billion (56,975 homes closed) in 2019. Home sales revenues increased in all of our regions primarily due to an increase in the number of homes closed. The number of homes closed in fiscal 2020 increased 15% from 2019. The markets contributing most to the increase in closing volumes in our regions were as follows: theNew Jersey ,Myrtle Beach andCharlotte markets in the East; theDenver andIndianapolis markets in the Midwest; theFlorida markets (particularlyTampa ) in the Southeast; theHouston ,Dallas andSan Antonio markets in theSouth Central ; theTucson market in the Southwest; and thePortland andSouthern California markets in the West. Homebuilding Operating Margin Analysis Percentages of Related Revenues Year Ended September 30, 2020 2019 Gross profit - home sales 21.8 % 20.2 % Gross profit - land/lot sales and other 29.8 % 18.3 % Inventory and land option charges (0.1) % (0.3) % Gross profit - total homebuilding 21.7 % 19.9 % Selling, general and administrative expense 8.2 % 8.7 % Other (income) (0.1) % (0.1) % Homebuilding pre-tax income 13.6 % 11.2 % Home Sales Gross Profit Gross profit from home sales increased to$4.3 billion in 2020 from$3.4 billion in 2019 and increased 160 basis points to 21.8% as a percentage of home sales revenues. The percentage increase resulted from improvements of 150 basis points due to a decrease in the average cost of our homes closed while the average selling price increased slightly, 20 basis points from a decrease in the amount of purchase accounting adjustments related to prior year acquisitions and 10 basis points due to a decrease in the amortization of capitalized interest, partially offset by increased warranty and construction defect costs of 20 basis points. We remain focused on managing the pricing, incentives and sales pace in each of our communities to optimize the returns on our inventory investments and adjust to local market conditions and new home demand. These actions could cause our gross profit margins to fluctuate in future periods. If a prolonged economic recession and a resulting decline in new home demand occur due to C-19 or otherwise, we would expect our gross profit margins to decline from current levels.
Land/Lot Sales and Other Revenues
Land/lot sales and other revenues from our homebuilding operations were$83.1 million and$91.9 million in fiscal 2020 and 2019, respectively. We continually evaluate our land and lot supply, and fluctuations in revenues and profitability from land sales occur based on how we manage our inventory levels in various markets. We generally purchase land and lots with the intent to build and sell homes on them. However, some of the land that we purchase includes commercially zoned parcels that we may sell to commercial developers. We may also sell residential lots or land parcels to manage our supply or for other strategic reasons. As ofSeptember 30, 2020 , our homebuilding operations had$28.3 million of land held for sale that we expect to sell in the next twelve months. 34
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Inventory and Land Option Charges
At the end of each quarter, we review the performance and outlook for all of our communities and land inventories for indicators of potential impairment and perform detailed impairment evaluations and analyses when necessary. As ofSeptember 30, 2020 , we performed detailed impairment evaluations of communities with a combined carrying value of$36.1 million and determined that no communities were impaired. Homebuilding impairment charges during fiscal 2020 and 2019 were$1.7 million and$24.9 million , respectively. As we manage our inventory investments across our operating markets to optimize returns and cash flows, we may modify our pricing and incentives, construction and development plans or land sale strategies in individual active communities and land held for development, which could result in the affected communities being evaluated for potential impairment. If the housing market or economic conditions are adversely affected for a prolonged period due to C-19 or otherwise, we may be required to evaluate additional communities for potential impairment. These evaluations could result in additional impairment charges that could be significant.
During fiscal 2020 and 2019, earnest money and pre-acquisition cost write-offs
related to land purchase contracts that we have terminated or expect to
terminate were
Selling, General and Administrative (SG&A) Expense
SG&A expense from homebuilding activities increased 8% to
Employee compensation and related costs represented 75% of SG&A costs in fiscal 2020 compared to 72% in fiscal 2019. These costs increased 13% to$1.2 billion in 2020 from$1.1 billion in 2019. Our homebuilding operations employed 7,281 and 6,810 employees atSeptember 30, 2020 and 2019, respectively.
We attempt to control our SG&A costs while ensuring that our infrastructure adequately supports our operations; however, we cannot make assurances that we will be able to maintain or improve upon the current SG&A expense as a percentage of revenues.
Interest Incurred
We capitalize interest costs incurred to inventory during active development and construction (active inventory). Capitalized interest is charged to cost of sales as the related inventory is delivered to the buyer. Interest incurred by our homebuilding operations decreased 11% to$93.0 million in fiscal 2020 from$104.7 million in fiscal 2019. The decrease was due to lower average interest rates on our homebuilding debt, as well as a 2% decrease in our average homebuilding debt in fiscal 2020 compared to the prior year. Interest charged to cost of sales was 0.8% and 0.9% of total cost of sales (excluding inventory and land option charges) in fiscal 2020 and 2019, respectively.
Other Income
Other income, net of other expenses, included in our homebuilding operations was$11.7 million in fiscal 2020 compared to$9.5 million in fiscal 2019. Other income consists of interest income, rental income and various other types of ancillary income, gains, expenses and losses not directly associated with sales of homes, land and lots. The activities that result in this ancillary income are not significant, either individually or in the aggregate.
Business Acquisition
InOctober 2020 , we acquired the homebuilding operations ofBraselton Homes for approximately$23 million in cash.Braselton Homes operates inCorpus Christi, Texas . The assets acquired included approximately 90 homes in inventory, 95 lots and control of approximately 840 additional lots through purchase contracts. We also acquired a sales order backlog of approximately 125 homes. 35 -------------------------------------------------------------------------------- Table of Contents Homebuilding Results byReporting Region Year Ended September 30, 2020 2019 Homebuilding Homebuilding Homebuilding Pre-tax % of Homebuilding Pre-tax % of Revenues Income (1) Revenues Revenues Income (1) Revenues (In millions)
East$ 2,642.3 $ 357.0 13.5 %$ 2,290.2 $ 238.8 10.4 % Midwest 1,429.0 128.8 9.0 % 1,123.1 57.7 5.1 % Southeast 5,845.2 841.0 14.4 % 4,977.8 584.7 11.7 % South Central 4,998.1 758.0 15.2 % 4,202.4 551.1 13.1 % Southwest 881.6 136.9 15.5 % 772.6 100.4 13.0 % West 3,847.7 443.3 11.5 % 3,650.8 378.0 10.4 %$ 19,643.9 $ 2,665.0 13.6 %$ 17,016.9 $ 1,910.7 11.2 % _____________ (1)Expenses maintained at the corporate level consist primarily of interest and property taxes, which are capitalized and amortized to cost of sales or expensed directly, and the expenses related to operating our corporate office. The amortization of capitalized interest and property taxes is allocated to each segment based on the segment's cost of sales, while expenses associated with the corporate office are allocated to each segment based on the segment's inventory balances.East Region - Homebuilding revenues increased 15% in fiscal 2020 compared to fiscal 2019, primarily due to increases in the number of homes closed in ourNew Jersey ,Myrtle Beach andCharlotte markets. The region generated pre-tax income of$357.0 million in 2020 compared to$238.8 million in 2019. Gross profit from home sales as a percentage of home sales revenue (home sales gross profit percentage) increased by 250 basis points in 2020 compared to 2019, due to an increase in the average selling price of homes closed and a decrease in the average cost of those homes. As a percentage of homebuilding revenues, SG&A expenses decreased by 50 basis points in 2020 compared to 2019, primarily due to the increase in homebuilding revenues.Midwest Region - Homebuilding revenues increased 27% in fiscal 2020 compared to fiscal 2019, primarily due to increases in the number of homes closed in ourDenver andIndianapolis markets. The region generated pre-tax income of$128.8 million in 2020 compared to$57.7 million in 2019. Home sales gross profit percentage increased by 270 basis points in 2020 compared to 2019, due to decreases in purchase accounting adjustments in the current year related to the acquisitions ofWestport Homes andClassic Builders . As a percentage of homebuilding revenues, SG&A expenses decreased by 110 basis points in 2020 compared to 2019, primarily due to the increase in homebuilding revenues.Southeast Region - Homebuilding revenues increased 17% in fiscal 2020 compared to fiscal 2019, primarily due to increases in the number of homes closed in all of our markets. The region generated pre-tax income of$841.0 million in 2020 compared to$584.7 million in 2019. Home sales gross profit percentage increased by 220 basis points in 2020 compared to 2019, primarily due to the average selling price of homes closed increasing by more than the average cost of those homes. As a percentage of homebuilding revenues, SG&A expenses decreased by 40 basis points in 2020 compared to 2019, primarily due to the increase in homebuilding revenues.South Central Region - Homebuilding revenues increased 19% in fiscal 2020 compared to fiscal 2019, primarily due to increases in the number of homes closed in ourHouston ,Dallas andSan Antonio markets. The region generated pre-tax income of$758.0 million in 2020 compared to$551.1 million in 2019. Home sales gross profit percentage increased by 130 basis points in 2020 compared to 2019, primarily due to an increase in the average selling price of homes closed and a decrease in the average cost of those homes. As a percentage of homebuilding revenues, SG&A expenses decreased by 70 basis points in 2020 compared to 2019, primarily due to the increase in homebuilding revenues. 36
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Southwest Region - Homebuilding revenues increased 14% in fiscal 2020 compared to fiscal 2019, primarily due to increases in the average selling price of homes closed in all markets. The region generated pre-tax income of$136.9 million in 2020 compared to$100.4 million in 2019. Home sales gross profit percentage increased by 190 basis points in 2020 compared to 2019, primarily due to the average selling price of homes closed increasing by more than the average cost of those homes. As a percentage of homebuilding revenues, SG&A expenses decreased by 40 basis points in 2020 compared to 2019, primarily due to the increase in homebuilding revenues.West Region - Homebuilding revenues increased 5% in fiscal 2020 compared to fiscal 2019, due to increases in the number of homes closed in ourPortland ,Southern California ,Las Vegas andSpokane markets, partially offset by decreases in the average selling price of homes closed in many markets. The region generated pre-tax income of$443.3 million in 2020 compared to$378.0 million in 2019. Home sales gross profit percentage decreased by 10 basis points in 2020 compared to 2019, primarily due to the average selling price of homes closed decreasing by more than the average cost of those homes. The region also benefited from lower inventory and land option charges, which were$4.3 million in 2020 compared to$24.2 million in 2019. As a percentage of homebuilding revenues, SG&A expenses decreased by 60 basis points in 2020 compared to 2019, primarily due to the increase in homebuilding revenues. 37 -------------------------------------------------------------------------------- Table of Contents Homebuilding Inventories, Land and Lot Position and Homes in Inventory We routinely enter into contracts to purchase land or developed residential lots at predetermined prices on a defined schedule commensurate with planned development or anticipated new home demand. At the time of purchase, the undeveloped land is generally vested with the rights to begin development or construction work, and we plan and coordinate the development of our land into residential lots for use in our homebuilding business. We manage our inventory of owned land and lots and homes under construction relative to demand in each of our markets, including starting construction on unsold homes to capture new home demand and actively controlling the number of unsold, completed homes in inventory. Our homebuilding segment's inventories atSeptember 30, 2020 and 2019 are summarized as follows: September 30, 2020 Residential Land/Lots Construction in Developed Progress and and Under Land Held Land Held Finished Homes Development for Development for Sale Total Inventory (In millions) East $ 785.3$ 531.2 $ 5.5$ 6.3 $ 1,328.3 Midwest 497.0 459.0 1.8 0.7 958.5 Southeast 1,655.5 1,231.5 32.3 0.6 2,919.9 South Central 1,596.3 1,282.3 0.3 1.0 2,879.9 Southwest 244.2 449.7 1.6 0.3 695.8 West 1,137.3 847.1 5.7 19.0 2,009.1 Corporate and unallocated (1) 121.9 100.6 0.6 0.4 223.5$ 6,037.5 $ 4,901.4 $ 47.8$ 28.3 $ 11,015.0 September 30, 2019 Residential Land/Lots Construction in Developed Progress and and Under Land Held Land Held Finished Homes Development for Development for Sale Total Inventory (In millions) East $ 697.1$ 581.2 $ 10.5 $ -$ 1,288.8 Midwest 473.9 361.1 1.8 - 836.8 Southeast 1,434.7 1,299.9 31.8 1.6 2,768.0 South Central 1,215.4 1,317.5 0.3 - 2,533.2 Southwest 221.8 335.6 1.6 15.4 574.4 West 1,089.0 950.6 13.9 2.5 2,056.0 Corporate and unallocated (1) 117.1 110.2 0.8 0.3 228.4$ 5,249.0 $ 4,956.1 $ 60.7$ 19.8 $ 10,285.6 _____________
(1)Corporate and unallocated inventory consists primarily of capitalized interest and property taxes.
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Our homebuilding segment's land and lot position and homes in inventory at
September 30, 2020
Lots Controlled Under Total Land/Lots
Land/Lots Land and Lot Purchase Owned and Homes in
Owned (1) Contracts (2)(3) Controlled Inventory (4)
East 11,300 50,500 61,800 4,900
Midwest 8,000 17,800 25,800 2,600
Southeast 28,700 95,700 124,400 11,500
South Central 40,100 65,200 105,300 12,600
Southwest 7,200 7,600 14,800 1,800
West 17,300 27,500 44,800 4,600
112,600 264,300 376,900 38,000
30 % 70 % 100 %
September 30, 2019
Lots Controlled Under Total Land/Lots
Land/Lots Land and Lot Purchase Owned and Homes in
Owned (1) Contracts (2)(3) Controlled Inventory (4)
East 11,000 30,500 41,500 3,900
Midwest 8,300 10,900 19,200 2,200
Southeast 34,800 73,300 108,100 8,900
South Central 41,600 51,400 93,000 7,900
Southwest 6,700 5,800 12,500 1,300
West 19,000 14,000 33,000 3,500
121,400 185,900 307,300 27,700
40 % 60 % 100 %
_____________
(1)Land/lots owned include approximately 33,800 and 36,100 owned lots that are
fully developed and ready for home construction at September 30, 2020 and 2019,
respectively. Land/lots owned also include land held for development
representing 1,600 and 1,700 lots at September 30, 2020 and 2019, respectively.
(2)The total remaining purchase price of lots controlled through land and lot
purchase contracts at September 30, 2020 and 2019 was $9.9 billion and $7.2
billion , respectively, secured by earnest money deposits of $653.4 million and
$515.4 million , respectively. The total remaining purchase price of lots
controlled through land and lot purchase contracts at September 30, 2020 and
2019 included $1.0 billion and $953.8 million , respectively, related to lot
purchase contracts with Forestar, secured by $98.2 million and $88.7 million ,
respectively, of earnest money.
(3)Lots controlled at September 30, 2020 include approximately 30,400 lots owned
or controlled by Forestar, 14,000 of which our homebuilding divisions have under
contract to purchase and 16,400 of which our homebuilding divisions have a right
of first offer to purchase. Of these, approximately 15,400 lots were in our
Southeast region, 5,000 lots were in our South Central region, 4,200 lots were
in our West region, 2,600 lots were in our East region, 2,000 lots were in our
Southwest region and 1,200 lots were in our Midwest region. Lots controlled at
September 30, 2019 included approximately 23,400 lots owned or controlled by
Forestar, 12,800 of which our homebuilding divisions had under contract to
purchase and 10,600 of which our homebuilding divisions had a right of first
offer to purchase.
(4)Approximately 14,900 and 16,000 of our homes in inventory were unsold at
September 30, 2020 and 2019, respectively. At September 30, 2020 , approximately
1,900 of our unsold homes were completed, of which approximately 300 homes had
been completed for more than six months. At September 30, 2019 , approximately
5,200 of our unsold homes were completed, of which approximately 800 homes had
been completed for more than six months. Homes in inventory exclude
approximately 1,800 and 1,900 model homes at September 30, 2020 and 2019,
respectively.
39
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Table of Contents
Results of Operations - Forestar
In October 2017 , we acquired 75% of the outstanding shares of Forestar and at
September 30, 2020 , we owned 65% of its outstanding shares. Forestar is a
publicly traded residential lot development company with operations in 49
markets across 21 states as of September 30, 2020 . Forestar's segment results
are presented on their historical cost basis, consistent with the manner in
which management evaluates segment performance. (See Note B for additional
Forestar segment information and purchase accounting adjustments.)
Results of operations for the Forestar segment for the fiscal years ended
Year Ended September 30,
2020 2019
(In millions)
Residential land and lot sales $ 928.9 $ 407.5
Commercial tract sales 2.5 18.5
Other 0.4 2.3
Total revenues 931.8 428.3
Cost of sales 813.7 362.7
Selling, general and administrative expense 45.7 28.9
Equity in earnings of unconsolidated entities (0.7) (0.5) Gain on sale of assets (0.1) (3.0) Other (income) expense (4.9) (5.5) Income before income taxes$ 78.1 $ 45.7 AtSeptember 30, 2020 , Forestar owned directly or controlled through land and lot purchase contracts approximately 60,500 residential lots, of which approximately 5,000 are fully developed. Approximately 30,400 of these lots are under contract to sell toD.R. Horton or subject to a right of first offer under the master supply agreement withD.R. Horton . Approximately 400 of these lots are under contract to sell to other builders. Residential land and lot sales primarily consist of the sale of single-family lots to local, regional and national homebuilders. During fiscal 2020 and 2019, Forestar's land and lot sales, including the portion sold toD.R. Horton and the revenues generated from those sales, were as follows. Year Ended September 30, 2020 2019 ($ in millions) Total residential single-family lots sold 10,373 4,132 Residential single-family lots sold to D.R. Horton 10,164 3,728 Residential lot sales revenues from sales to D.R. Horton$ 861.8 $ 315.7 Residential tract acres sold to D.R. Horton 143 290 Residential land sales revenues from sales to D.R. Horton $
25.6
SG&A expense for fiscal 2020 and 2019 includes charges of$5.0 million and$2.1 million , respectively, related to the shared services agreement between Forestar andD.R. Horton wherebyD.R. Horton provides Forestar with certain administrative, compliance, operational and procurement services. 40 -------------------------------------------------------------------------------- Table of Contents Results of Operations - Financial Services The following tables and related discussion set forth key operating and financial data for our financial services operations, comprisingDHI Mortgage and our subsidiary title companies, for the fiscal years endedSeptember 30, 2020 and 2019.
Year Ended
2020 2019 % Change
Number of first-lien loans originated or brokered by
44,600 33,024 35 %
Number of homes closed by D.R. Horton 65,388 56,975 15 %
Percentage of D.R. Horton homes financed by DHI Mortgage 68 % 58 %
Number of total loans originated or brokered by
44,738 33,114 35 %
Total number of loans originated or brokered by
46,010 33,827 36 %
Captive business percentage 97 % 98 %
Loans sold by DHI Mortgage to third parties 44,423 32,849 35 %
Year Ended September 30,
2020 2019 % Change
(In millions)
Loan origination fees $ 3.0 $ 11.7 (74) %Sale of servicing rights and gains from sale of mortgage loans
437.2 319.4 37 %
Other revenues 36.5 24.4 50 %
Total mortgage operations revenues 476.7 355.5 34 %
Title policy premiums 108.2 86.2 26 %
Total revenues 584.9 441.7 32 %
General and administrative expense 364.7 293.0 24 %
Other (income) expense (25.0) (17.6) 42 %
Financial services pre-tax income $ 245.2 $ 166.3 47 %
Financial Services Operating Margin Analysis
Percentages of
Financial Services Revenues
Year Ended September 30,
2020 2019
General and administrative expense 62.4 % 66.3 %
Other (income) expense (4.3) % (4.0) %
Financial services pre-tax income 41.9 % 37.6 %
41-------------------------------------------------------------------------------- Table of Contents Mortgage Loan Activity The volume of loans originated by our mortgage operations is directly related to the number of homes closed by our homebuilding operations. In fiscal 2020, the volume of first-lien loans originated or brokered byDHI Mortgage for our homebuyers increased 35% from the prior year, due to an increase in the percentage of homes closed for whichDHI Mortgage handled the homebuyers' financing, as well a 15% increase in the number of homes closed by our homebuilding operations. The percentage of homes closed for whichDHI Mortgage handled the homebuyers' financing was 68% in fiscal 2020 compared to 58% in the prior year. The increase in this percentage was primarily due to the Company's program to offer below market interest rates toD.R. Horton homebuyers, expanded coverage in certain markets and increased efficiencies resulting from technology advances.
Homes closed by our homebuilding operations constituted 97% and 98% of
The number of loans sold increased 35% in fiscal 2020 compared to the prior year. Virtually all of the mortgage loans held for sale onSeptember 30, 2020 were eligible for sale to Fannie Mae, Freddie Mac orGinnie Mae . During fiscal 2020, approximately 66% of our mortgage loans were sold directly to Fannie Mae or into securities backed byGinnie Mae and 28% were sold to two other major financial entities. Changes in market conditions could result in a greater concentration of our mortgage sales in future periods to fewer financial entities and directly to Fannie Mae orGinnie Mae , and we may need to make other adjustments to our mortgage operations. Due to the disruption in the secondary mortgage markets beginning in lateMarch 2020 caused by C-19 and the uncertainty of the impact of the CARES Act, many financial entities began offering lower pricing and limiting their purchases of our mortgages and servicing rights. As a result of the rapid decline in servicing values at the end of March, we began retaining the servicing rights on a portion of our loan originations. Servicing values have since improved, and we expect to sell these rights to third parties.
Financial Services Revenues and Expenses
Revenues from our mortgage operations increased 34% to$476.7 million in fiscal 2020 from$355.5 million in fiscal 2019, primarily due to a 36% increase in loan originations. During the fourth quarter, due to better clarity related to the CARES Act, pricing and execution in the secondary market improved from the previous nine months endedJune 30, 2020 , which caused revenues in the fourth quarter to increase at a higher rate than origination volume. Revenues from our title operations increased 26% to$108.2 million in fiscal 2020 from$86.2 million in fiscal 2019, primarily due to a 28% increase in escrow closings. General and administrative (G&A) expense related to our financial services operations increased 24% to$364.7 million in fiscal 2020 from$293.0 million in the prior year. The increase was primarily due to an increase in employee related costs to support a higher volume of transactions. Our financial services operations employed 2,163 and 1,924 employees atSeptember 30, 2020 and 2019, respectively. As a percentage of financial services revenues, G&A expense was 62.4% in fiscal 2020 compared to 66.3% in the prior year. Fluctuations in financial services G&A expense as a percentage of revenues occur because some components of revenue fluctuate differently than loan volumes, and some expenses are not directly related to mortgage loan volume or to changes in the amount of revenue earned.
Other income, net of other expense, included in our financial services operations consists primarily of the interest income of our mortgage subsidiary.
As a result of the revenue increases from higher volumes of mortgage originations and escrow closings, which also allowed us to better leverage our G&A expenses, pre-tax income from our financial services operations increased 47% to$245.2 million in fiscal 2020 from$166.3 million in fiscal 2019. 42 -------------------------------------------------------------------------------- Table of Contents Results of Operations - Other Businesses The combined pre-tax income of all of our subsidiaries engaged in other business activities was$55.1 million in fiscal 2020 compared to$55.5 million in fiscal 2019. Income generated by our other businesses can vary significantly based on the timing of sales of multi-family rental properties. Through DHI Communities, a 100% owned subsidiary, we develop, construct and own multi-family residential properties that produce rental income. DHI Communities is primarily focused on constructing garden style multi-family communities, which typically accommodate 200 to 400 dwelling units, in high growth suburban markets. After DHI Communities has completed construction and achieved a stabilized level of leased occupancy, the property is typically marketed for sale. During fiscal 2020 and 2019, DHI Communities sold multi-family rental properties for a total of$128.5 million and$133.4 million , respectively, and recorded gains on sale totaling$59.4 million and$51.9 million . DHI Communities had five projects under active construction and one project that was substantially complete atSeptember 30, 2020 . These six projects represent 1,730 multi-family units, including 1,430 units under active construction and 300 completed units.
Results of Operations - Consolidated
Income before Income Taxes
Pre-tax income was$3.0 billion in fiscal 2020 compared to$2.1 billion in fiscal 2019. The increase was primarily due to an increase in pre-tax income generated by our homebuilding operations as a result of higher revenues from increased home closings and an increase in home sales gross margin. In fiscal 2020, our homebuilding, financial services and other businesses generated pre-tax income of$2.7 billion ,$245.2 million and$55.1 million , respectively, compared to pre-tax income of$1.9 billion ,$166.3 million and$55.5 million , respectively, in fiscal 2019.
Income Taxes
Our income tax expense was$602.5 million and$506.7 million in fiscal 2020 and 2019, respectively, and our effective tax rate was 20.2% and 23.8% in those years. The effective tax rate for fiscal 2020 includes a tax benefit of$93.4 million from the enactment of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 (the Act). The Act retroactively reinstated the federal energy efficient homes tax credit that expired onDecember 31, 2017 to homes closed fromJanuary 1, 2018 toDecember 31, 2020 . The effective tax rate for fiscal 2020 also includes a tax benefit of$11.2 million related to the release of a valuation allowance against our state deferred tax assets. The effective tax rates for both years include an expense for state income taxes, reduced by tax benefits related to stock-based compensation. Our deferred tax assets, net of deferred tax liabilities, were$152.4 million atSeptember 30, 2020 compared to$181.8 million atSeptember 30, 2019 . We have a valuation allowance of$7.5 million and$18.7 million atSeptember 30, 2020 and 2019, respectively, related to state deferred tax assets for net operating loss (NOL) carryforwards that are more likely than not to expire before being realized. The decrease in the valuation allowance is primarily attributable to our determination that we will have sufficient future taxable income in certain state tax jurisdictions to realize a portion of our state NOL carryforwards. We will continue to evaluate both the positive and negative evidence in determining the need for a valuation allowance with respect to our remaining state NOL carryforwards. Any reversal of the valuation allowance in future periods will impact our effective tax rate.D.R. Horton has$15.8 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction. Of the total amount,$5.4 million of the tax benefits expire over the next ten years and the remaining$10.4 million expires from fiscal years 2031 to 2040. Forestar has$1.7 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction. The accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcomes of these future results could have a material impact on our consolidated results of operations or financial position. Also, changes in existing federal and state tax laws and tax rates could affect future tax results and the valuation of our deferred tax assets. 43
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Table of Contents
Unrecognized tax benefits are the differences between tax positions taken or
expected to be taken in a tax return and the benefits recognized in our
financial statements. Our unrecognized tax benefits totaled
D.R. Horton is subject to federal income tax and state income tax in multiple jurisdictions. The statute of limitations forD.R. Horton's major tax jurisdictions remains open for examination for fiscal years 2017 through 2020.D.R. Horton is not currently under audit for federal income tax, but is under audit by various states. We are not aware of any significant findings by the state taxing authorities. Forestar is subject to federal income tax and state income tax in multiple jurisdictions. The statute of limitations for Forestar's major tax jurisdictions remains open for examination for tax years 2016 through 2020. Forestar is not currently under audit for federal or state income taxes. 44 -------------------------------------------------------------------------------- Table of Contents Capital Resources and Liquidity We have historically funded our operations with cash flows from operating activities, borrowings under bank credit facilities and the issuance of new debt securities. Our current levels of cash, borrowing capacity and balance sheet leverage provide us with the operational flexibility to adjust to changes in economic and market conditions. We remain cautious as to the ongoing impact of C-19 on theU.S. economy and will adjust our strategy as appropriate should market conditions change due to the pandemic or otherwise. In the current market, we are increasing our investments in homebuilding inventories and single-family and multi-family rental properties to expand our operations and grow our revenues and profitability, as well as considering opportunistic strategic investments as they arise. We are also maintaining higher homebuilding cash balances than in prior years to support the increased scale and level of activity in our business and to provide flexibility to adjust to changing conditions and opportunities. AtSeptember 30, 2020 , our ratio of debt to total capital (notes payable divided by stockholders' equity plus notes payable) was 26.6% compared to 25.3% atSeptember 30, 2019 . Our ratio of homebuilding debt to total capital (homebuilding notes payable divided by stockholders' equity plus homebuilding notes payable) was 17.5% compared to 17.0% atSeptember 30, 2019 . Over the long term, we intend to maintain our ratio of homebuilding debt to total capital below 35%, and we expect it to remain significantly lower than 35% throughout fiscal 2021. We believe that the ratio of homebuilding debt to total capital is useful in understanding the leverage employed in our homebuilding operations and comparing our capital structure with other homebuilders. We exclude the debt of Forestar and our financial services business because they are separately capitalized and not guaranteed by our parent company or any of our homebuilding entities. We regularly assess our projected capital requirements to fund growth in our business, repay debt obligations, pay dividends, repurchase our common stock and maintain sufficient cash levels to support our other operational needs, and we regularly evaluate our opportunities to raise additional capital.D.R. Horton has an automatically effective universal shelf registration statement filed with theSEC inAugust 2018 , registering debt and equity securities that may be issued from time to time in amounts to be determined. Forestar also has an effective shelf registration statement filed with theSEC inSeptember 2018 , registering$500 million of equity securities. AtSeptember 30, 2020 ,$394.3 million remained available under Forestar's shelf registration statement,$100 million of which is reserved for sales under its at-the-market equity offering program. As market conditions permit, we may issue new debt or equity securities through the capital markets or obtain additional bank financing to fund our projected capital requirements or provide additional liquidity. We believe that our existing cash resources, revolving credit facilities, mortgage repurchase facility and ability to access the capital markets or obtain additional bank financing will provide sufficient liquidity to fund our near-term working capital needs and debt obligations, including the maturity of$400 million aggregate principal amount of our homebuilding senior notes in fiscal 2021. However, due to the current economic uncertainties related to C-19, we may be limited in accessing the capital markets or obtaining additional bank financing or the cost of accessing this financing could become more expensive for funding our longer-term capital needs.
Capital Resources - Homebuilding
Cash and Cash Equivalents - At
Bank Credit Facilities - We have a$1.59 billion senior unsecured homebuilding revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to$2.5 billion , subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit with a sublimit equal to 100% of the revolving credit commitment. Letters of credit issued under the facility reduce the available borrowing capacity. The interest rate on borrowings under the revolving credit facility may be based on either the Prime Rate orLondon Interbank Offered Rate (LIBOR) plus an applicable margin, as defined in the credit agreement governing the facility. The maturity date of the facility isOctober 2, 2024 . Borrowings and repayments under the facility totaled$1.06 billion each during fiscal 2020. AtSeptember 30, 2020 , there were no borrowings outstanding and$142.9 million of letters of credit issued under the revolving credit facility, resulting in available capacity of approximately$1.45 billion . 45 -------------------------------------------------------------------------------- Table of Contents InMay 2020 , we entered into a credit agreement providing for a$375 million 364-day senior unsecured homebuilding revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to$550 million , subject to certain conditions and availability of additional bank commitments. The interest rate on borrowings under the 364-day revolving credit facility may be based on either the Prime Rate or LIBOR plus an applicable margin, as defined in the credit agreement governing the facility. The maturity date of the facility isMay 27, 2021 . There were no borrowings under the facility for the period from its inception throughSeptember 30, 2020 . Our homebuilding revolving credit facilities impose restrictions on our operations and activities, including requiring the maintenance of a maximum allowable leverage ratio and a borrowing base restriction if our leverage ratio exceeds a certain level. Both facilities include substantially the same affirmative and negative covenants, events of default and financial covenants. These covenants are measured as defined in the credit agreements governing the facilities and are reported to the lenders quarterly. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facilities or cause any outstanding borrowings to become due and payable prior to maturity. The credit agreements governing the facilities impose restrictions on the creation of secured debt and liens. AtSeptember 30, 2020 , we were in compliance with all of the covenants, limitations and restrictions of our homebuilding revolving credit facilities. Public Unsecured Debt - We have$2.45 billion principal amount of homebuilding senior notes outstanding as ofSeptember 30, 2020 that mature fromDecember 2020 throughOctober 2025 . InOctober 2019 , we issued$500 million principal amount of 2.5% senior notes dueOctober 15, 2024 , with interest payable semi-annually. The annual effective interest rate of these notes after giving effect to the amortization of the discount and financing costs is 2.7%. InFebruary 2020 , we repaid$500 million principal amount of our 4.0% senior notes at maturity. InMay 2020 , we issued$500 million principal amount of 2.6% senior notes dueOctober 15, 2025 with interest payable semi-annually. The annual effective interest rate of these notes after giving effect to the amortization of the discount and financing costs is 2.8%. The indentures governing our senior notes impose restrictions on the creation of secured debt and liens. AtSeptember 30, 2020 , we were in compliance with all of the limitations and restrictions associated with our public debt obligations. InOctober 2020 , we issued$500 million principal amount of 1.4% senior notes dueOctober 15, 2027 , with interest payable semi-annually. The annual effective interest rate of these notes after giving effect to the amortization of the discount and financing costs is 1.6%.
Repurchases of Common Stock - During fiscal 2020, we repurchased 7.0 million
shares of our common stock for
Debt and Equity Repurchase Authorizations - EffectiveJuly 30, 2019 , our Board of Directors authorized the repurchase of up to$500 million of debt securities and$1.0 billion of our common stock. AtSeptember 30, 2020 , the full amount of the debt repurchase authorization was remaining, and$535.3 million of the equity repurchase authorization was remaining. These authorizations have no expiration date.
Capital Resources - Forestar
Forestar's ability to achieve its long-term growth objectives will depend on its ability to obtain financing in sufficient capacities. As market conditions permit, Forestar may issue new debt or equity securities through the capital markets or obtain additional bank financing to provide capital for future growth and additional liquidity.
Cash and Cash Equivalents - At
Bank Credit Facility - Forestar has a$380 million senior unsecured revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to$570 million , subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit with a sublimit equal to the greater of$100 million and 50% of the revolving credit commitment. Borrowings under the revolving credit facility are subject to a borrowing base calculation based on Forestar's book value of its real estate assets and unrestricted cash. Letters of credit issued under the facility reduce the available borrowing capacity. AtSeptember 30, 2020 , there were no borrowings outstanding and$36.0 million of letters of credit issued under the revolving credit facility, resulting in available capacity of$344.0 million . The maturity date of the facility isOctober 2, 2022 , which can be extended by up to one year on up to two additional occasions, subject to the approval of lenders holding a majority of the commitments. 46 -------------------------------------------------------------------------------- Table of Contents The Forestar revolving credit facility includes customary affirmative and negative covenants, events of default and financial covenants. The financial covenants require Forestar to maintain a minimum level of tangible net worth, a minimum level of liquidity and a maximum allowable leverage ratio. These covenants are measured as defined in the credit agreement governing the facility and are reported to the lenders quarterly. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facility or cause any outstanding borrowings to become due and payable prior to maturity. Unsecured Debt - InFebruary 2020 , Forestar issued$300 million principal amount of 5.0% senior notes pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The notes matureMarch 1, 2028 , with interest payable semi-annually, and represent unsecured obligations of Forestar. The annual effective interest rate of these notes after giving effect to the amortization of financing costs is 5.2%. These notes may be redeemed prior to maturity, subject to certain limitations and premiums defined in the indenture agreement. Forestar also has$350 million principal amount of 8.0% senior notes that matureApril 15, 2024 . InMarch 2020 , Forestar repaid$118.9 million principal amount of its 3.75% convertible senior notes in cash at maturity. Forestar's revolving credit facility and its senior notes are not guaranteed byD.R. Horton, Inc. or any of the subsidiaries that guarantee our homebuilding debt. AtSeptember 30, 2020 , Forestar was in compliance with all of the covenants, limitations and restrictions of its revolving credit facility and senior note obligations. Debt Repurchase Authorization - EffectiveApril 30, 2020 , Forestar's Board of Directors authorized the repurchase of up to$30 million of Forestar's debt securities. The authorization has no expiration date. All of the$30 million authorization was remaining atSeptember 30, 2020 .
Capital Resources - Financial Services
Cash and Cash Equivalents - At
Mortgage Repurchase Facility - Our mortgage subsidiary,DHI Mortgage , has a mortgage repurchase facility that provides financing and liquidity toDHI Mortgage by facilitating purchase transactions in whichDHI Mortgage transfers eligible loans to the counterparties upon receipt of funds from the counterparties.DHI Mortgage then has the right and obligation to repurchase the purchased loans upon their sale to third-party purchasers in the secondary market or within specified time frames from 45 to 60 days in accordance with the terms of the mortgage repurchase facility. The total capacity of the facility is$1.35 billion ; however, the capacity increased, without requiring additional commitments, to$1.575 billion for approximately 45 days aroundSeptember 30, 2020 and increases again for approximately 30 days aroundDecember 31, 2020 . The capacity of the facility can also be increased to$1.8 billion subject to the availability of additional commitments. The maturity date of the facility isFebruary 19, 2021 . As ofSeptember 30, 2020 ,$1.42 billion of mortgage loans held for sale with a collateral value of$1.39 billion were pledged under the mortgage repurchase facility. As a result of advance paydowns totaling$255.8 million ,DHI Mortgage had an obligation of$1.13 billion outstanding under the mortgage repurchase facility atSeptember 30, 2020 at a 2.4% annual interest rate. The mortgage repurchase facility is not guaranteed byD.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 leverage ratio and its minimum required liquidity. These covenants are measured and reported to the lenders monthly. AtSeptember 30, 2020 ,DHI Mortgage was in compliance with all of the conditions and covenants of the mortgage repurchase facility. In the past,DHI Mortgage has been able to renew or extend its mortgage credit facility at a sufficient capacity and on satisfactory terms prior to its maturity and obtain temporary additional commitments through amendments to the credit agreement during periods of higher than normal volumes of mortgages held for sale. The liquidity of our financial services business depends upon its continued ability to renew and extend the mortgage repurchase facility or to obtain other additional financing in sufficient capacities. 47 -------------------------------------------------------------------------------- Table of Contents Operating Cash Flow Activities In fiscal 2020, net cash provided by operating activities was$1.4 billion compared to$892.1 million in fiscal 2019. Cash provided by operating activities in the current year primarily consisted of$1.9 billion of cash provided by our homebuilding segment, partially offset by$292.8 million and$168.5 million of cash used in our financial services and Forestar segments, respectively. Cash used to increase construction in progress and finished home inventory was$739.1 million in fiscal 2020 as our homes in inventory increased by approximately 10,300 homes atSeptember 30, 2020 compared toSeptember 30, 2019 . Cash provided from a decrease in construction in progress and finished home inventory was$84.6 million in fiscal 2019 as our homes in inventory atSeptember 30, 2019 remained relatively flat compared toSeptember 30, 2018 . Cash used to increase residential land and lots was$324.4 million in fiscal 2020 compared to$676.4 million in fiscal 2019. Of these amounts,$281.5 million and$513.2 million , respectively, related to Forestar. The most significant source of cash provided by operating activities in both years was net income.
Investing Cash Flow Activities
In fiscal 2020, net cash used in investing activities was$166.1 million compared to$394.0 million in fiscal 2019. In fiscal 2020, uses of cash included expenditures related to our rental properties totaling$190.3 million and purchases of property and equipment totaling$96.5 million , partially offset by proceeds from the sale of assets primarily consisting of$128.5 million related to the sale of two multi-family rental properties. In fiscal 2019, the most significant uses of cash were the purchases of the homebuilding operations ofWestport Homes ,Classic Builders andTerramor Homes . Proceeds from the sale of assets in fiscal 2019 included$133.4 million related to the sale of two multi-family rental properties.
Financing Cash Flow Activities
We expect the short-term financing needs of our operations will be funded with existing cash, cash generated from operations and borrowings under our credit facilities. Long-term financing needs for our homebuilding and Forestar operations may be funded with the issuance of senior unsecured debt securities or equity securities through the capital markets. In fiscal 2020, net cash provided by financing activities was$270.6 million , consisting primarily of note proceeds of$1.1 billion from draws on our homebuilding revolving credit facility, our issuance of$500 million principal amount of 2.5% homebuilding senior notes, our issuance of$500 million principal amount of 2.6% homebuilding senior notes, Forestar's issuance of$300 million principal amount of 5.0% senior notes and net advances of$243.7 million on our mortgage repurchase facility. Note proceeds were partially offset by repayment of amounts drawn on our homebuilding revolving credit facility totaling$1.1 billion , repayment of$500 million principal amount of our 4.0% homebuilding senior notes at maturity, Forestar's repayment of$118.9 million principal amount of its 3.75% convertible senior notes at maturity, cash used to repurchase 7.0 million shares of our common stock for$360.4 million and payment of cash dividends totaling$256.0 million . In fiscal 2019, net cash used in financing activities was$490.1 million , consisting primarily of repayment of amounts drawn on our homebuilding and Forestar revolving credit facilities totaling$2.2 billion , repayment of$500 million principal amount of our 3.75% homebuilding senior notes at maturity, cash used to repurchase 11.9 million shares of our common stock for$479.8 million and payment of cash dividends totaling$223.4 million . These uses of cash were partially offset by note proceeds of$2.2 billion from draws on our homebuilding and Forestar revolving credit facilities, Forestar's issuance of$350 million principal amount of 8.0% senior notes, net advances of$251.2 million on our mortgage repurchase facility and proceeds of$100.7 million from Forestar's issuance of common stock. Our Board of Directors approved and paid quarterly cash dividends of$0.175 per common share in fiscal 2020 and$0.15 per common share in fiscal 2019. InNovember 2020 , our Board of Directors approved a quarterly cash dividend of$0.20 per common share, payable onDecember 14, 2020 , to stockholders of record onDecember 4, 2020 . The declaration of future cash dividends is at the discretion of our Board of Directors and will depend upon, among other things, our future earnings, cash flows, capital requirements, financial condition and general business conditions. 48
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Table of Contents Contractual Cash Obligations, Commercial Commitments and Off-Balance Sheet Arrangements
Our primary contractual cash obligations are payments under our debt agreements and lease payments under operating leases. We expect to fund our contractual obligations in the ordinary course of business through a combination of our existing cash resources, cash flows generated from profits, our credit facilities or other bank financing, and the issuance of new debt or equity securities through the public capital markets as market conditions may permit.
Our future cash requirements for contractual obligations as of
Payments Due by Period
Less Than More Than
Total 1 Year 1 - 3 Years > 3 - 5 Years 5 Years
(In millions)
Notes Payable - Principal (1) $ 4,303.7 $ 1,599.1
487.4 151.9 214.4 84.2 36.9
Operating Leases 39.5 17.4 16.8 5.2 0.1
Purchase Obligations (2) 32.6 30.2 2.4 - -
$ 4,863.2 $ 1,798.6 $ 1,284.3 $ 942.5 $ 837.8
_______________
(1)Notes payable represents principal and interest payments due on our senior
notes, our secured notes, our mortgage subsidiary's repurchase facility and our
homebuilding and Forestar revolving credit facilities. Because the balances of
our revolving credit facilities were zero at September 30, 2020 , we did not
assume any principal or interest payments related to these facilities in future
periods. The interest obligation associated with our mortgage repurchase
facility is based on its annual effective rate of 2.4% and principal balance
outstanding at September 30, 2020 .
(2)Purchase obligations relate to a limited number of land and lot purchase
contracts with $32.6 million of remaining purchase price, subject to specific
performance provisions that may require us to purchase the land or lots upon the
land sellers meeting their respective contractual obligations. Of this amount,
$1.4 million related to contracts between our homebuilding segment and Forestar.
Further information about our land purchase contracts is provided in the
"Homebuilding Inventories, Land and Lot Position and Homes in Inventory" section
included herein.
At September 30, 2020 , we had outstanding letters of credit of $178.9 million
and surety bonds of $1.8 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.
49
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Table of Contents
Supplemental Guarantor Financial Information
As of
All of the homebuilding senior notes and the homebuilding revolving credit facilities are fully and unconditionally guaranteed, on a joint and several basis, by certain subsidiaries ofD.R. Horton, Inc. (Guarantors or Guarantor Subsidiaries). Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly, byD.R. Horton, Inc. Our subsidiaries associated with the Forestar lot development operation, financial services operations, multi-family residential construction and certain other subsidiaries do not guarantee the homebuilding senior notes or the homebuilding revolving credit facilities (collectively, Non-Guarantor Subsidiaries). The guarantees are senior unsecured obligations of each Guarantor and rank equal with all existing and future senior debt of such Guarantor and senior to all subordinated debt of such Guarantor. The guarantees are effectively subordinated to any secured debt of such Guarantor to the extent of the value of the assets securing such debt. The guarantees will be structurally subordinated to indebtedness and other liabilities of Non-Guarantor Subsidiaries of the Guarantors. The guarantees by a Guarantor Subsidiary will be automatically and unconditionally released and discharged upon: (1) the sale or other disposition of its common stock whereby it is no longer a subsidiary of ours; (2) the sale or other disposition of all or substantially all of its assets (other than to us or another Guarantor); (3) its merger or consolidation with an entity other than us or another Guarantor; or (4) its ceasing to guarantee any of our publicly traded debt securities and ceasing to guarantee any of our obligations under our homebuilding revolving credit facility. The following tables present summarized financial information forD.R. Horton, Inc. and the Guarantor Subsidiaries on a combined basis after intercompany transactions and balances have been eliminated amongD.R. Horton, Inc. and the Guarantor Subsidiaries, as well as their investment in, and equity in earnings from the Non-Guarantor Subsidiaries. D.R. Horton, Inc. and Guarantor Subsidiaries Summarized Balance Sheet Data September 30, 2020 (In millions) Assets Cash $ 2,498.5 Inventories 10,921.8 Amount due from Non-Guarantor Subsidiaries
524.6
Total assets
15,503.9
Liabilities & Stockholders' Equity
Notes payable $ 2,514.4
Total liabilities 4,746.9
Stockholders' equity 10,757.0
Summarized Statement of Operations Data Year Ended September 30, 2020
(In millions)
Revenues $ 19,630.0
Cost of sales 15,379.2
Selling, general and administrative expense 1,584.4
Income before income taxes 2,666.4
Net income 2,134.7
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A court could void or subordinate any Guarantor's guarantee under the fraudulent conveyance laws if existing or future creditors of any such Guarantor were successful in establishing that: •such guarantee was incurred with fraudulent intent; or •such Guarantor did not receive fair consideration or reasonably equivalent value for issuing its guarantee; and •was insolvent at the time of the guarantee; •was rendered insolvent by reason of the guarantee; •was engaged in a business or transaction for which its assets constituted unreasonably small capital to carry on its business; or •intended to incur, or believed that it would incur, debt beyond its ability to pay such debt as it matured. The measures of insolvency for purposes of determining whether a fraudulent conveyance occurred would vary depending upon the laws of the relevant jurisdiction and upon the valuation assumptions and methodology applied by the court. Generally, however, a company would be considered insolvent for purposes of the foregoing if: •the sum of the company's debts, including contingent, unliquidated and unmatured liabilities, is greater than all of such company's property at a fair valuation; or •the present fair saleable value of the company's assets is less than the amount that will be required to pay the probable liability on its existing debts as they become absolute and matured. The indentures governing our homebuilding senior notes contain a "savings clause," which limits the liability of each Guarantor on its guarantee to the maximum amount that such Guarantor can incur without risk that its guarantee will be subject to avoidance as a fraudulent transfer. This provision may not be effective to protect such guarantees from fraudulent transfer challenges or, if it does, it may reduce such Guarantor's obligation such that the remaining amount due and collectible under the guarantees would not suffice, if necessary, to pay the notes in full when due. On the basis of historical financial information, operating history and other factors, we believe that each of the Guarantors, after giving effect to the issuance of the guarantees when such guarantees were issued, was not insolvent, did not have unreasonably small capital for the business in which it engaged and did not and has not incurred debts beyond its ability to pay such debts as they mature. We cannot assure you, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard. Seasonality Although significant changes in market conditions have impacted our seasonal patterns in the past and could do so again in the future, we generally close more homes and generate greater revenues and operating income in the third and fourth quarters of our fiscal year. The seasonal nature of our business can also cause significant variations in our working capital requirements in our homebuilding, lot development and financial services operations. As a result of seasonal activity, our quarterly results of operations and financial position at the end of a particular fiscal quarter are not necessarily representative of the balance of our fiscal year.
Inflation
We may be adversely affected during periods of high inflation, primarily because
of higher financing, land, labor and material construction costs. We attempt to
offset cost increases in one component with savings in another, and we increase
our sales prices and reduce customer sales incentives when housing market
conditions permit. However, during periods when housing market conditions are
challenging, we may not be able to offset cost increases with higher selling
prices. In addition, higher mortgage interest rates reduce the affordability of
our homes to prospective homebuyers.
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Forward-Looking Statements
Some of the statements contained in this report, as well as in other materials
we have filed or will file with the Securities and Exchange Commission ,
statements made by us in periodic press releases and oral statements we make to
analysts, stockholders and the press in the course of presentations about us,
may be construed as "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are based on management's beliefs as well as
assumptions made by, and information currently available to, management. These
forward-looking statements typically include the words "anticipate," "believe,"
"consider," "continue," "could," "estimate," "expect," "forecast," "goal,"
"intend," "likely," "may," "outlook," "plan," "possible," "potential,"
"predict," "projection," "seek," "should," "strategy," "target," "will," "would"
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:
•the effects of public health issues such as a major epidemic or pandemic,
including the impact of C-19 on the economy and our businesses;
•the cyclical nature of the homebuilding and lot development industries and
changes in economic, real estate and other conditions;
•constriction of the credit and public capital markets, which could limit our
ability to access capital and increase our costs of capital;
•reductions in the availability of mortgage financing provided by government
agencies, changes in government financing programs, a decrease in our ability to
sell mortgage loans on attractive terms or an increase in mortgage interest
rates;
•the risks associated with our land and lot inventory;
•our ability to effect our growth strategies, acquisitions or investments
successfully;
•the impact of an inflationary, deflationary or higher interest rate
environment;
•home warranty and construction defect claims;
•the effects of health and safety incidents;
•supply shortages and other risks of acquiring land, building materials and
skilled labor;
•reductions in the availability of performance bonds;
•increases in the costs of owning a home;
•the effects of governmental regulations and environmental matters on our
homebuilding and land development operations;
•the effects of governmental regulations on our financial services operations;
•competitive conditions within the homebuilding, lot development and financial
services industries;
•our ability to manage and service our debt and comply with related debt
covenants, restrictions and limitations;
•the effects of negative publicity;
•the effects of the loss of key personnel; and
•information technology failures, data security breaches and our ability to
satisfy privacy and data protection laws and regulations.
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
However, any further disclosures made on related subjects in subsequent reports
on Forms 10-K, 10-Q and 8-K should be consulted. Additional information about
issues that could lead to material changes in performance and risk factors that
have the potential to affect us is contained in Item 1A, "Risk Factors" under
Part I of this annual report on Form 10-K.
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Critical Accounting Policies
General - A comprehensive enumeration of the significant accounting policies ofD.R. Horton, Inc. and subsidiaries is presented in Note A to the accompanying financial statements as ofSeptember 30, 2020 and 2019, and for the years endedSeptember 30, 2020 , 2019 and 2018. Each of our accounting policies has been chosen based upon current authoritative literature that collectively comprisesU.S. Generally Accepted Accounting Principles (GAAP). In instances where alternative methods of accounting are permissible under GAAP, we have chosen the method that most appropriately reflects the nature of our business, the results of our operations and our financial condition, and have consistently applied those methods over each of the periods presented in the financial statements. The Audit Committee of our Board of Directors has reviewed and approved the accounting policies selected. Revenue Recognition - We generally recognize homebuilding revenue and related profit at the time of the closing of a sale, when title to and possession of the property are transferred to the buyer. Our performance obligation, to deliver the agreed-upon home, is generally satisfied in less than one year from the original contract date. Proceeds from home closings held for our benefit at title companies are included in homebuilding cash and cash equivalents in the consolidated balance sheets. 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 cancelled. We either retain or refund to the homebuyer deposits on cancelled sales contracts, depending upon the applicable provisions of the contract or other circumstances. We rarely purchase land for resale, but periodically may elect to sell parcels of land that no longer fit into our strategic operating plans. Revenue from land sales is typically recognized on the closing date, which is generally when performance obligations are satisfied. 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. Revenues associated with our mortgage operations primarily include net gains on the sale of mortgage loans and servicing rights. We typically elect the fair value option for our mortgage loan originations whereby mortgage loans held for sale are recorded at fair value based on either sale commitments or current market quotes and loan values are adjusted through revenues for subsequent changes in fair value until the loans are sold. Expected gains and losses from the sale of servicing rights are included in the measurement of all written loan commitments that are accounted for at fair value through revenues at the time of commitment. We sell substantially all of the mortgages we originate and the majority of the related servicing rights to third-party purchasers. Interest income is earned from the date a mortgage loan is originated until the loan is sold. Mortgage loans are sold with limited recourse provisions, which can result in repurchases of loans previously sold to investors or payments to reimburse investors for loan losses. Based on historical experience, discussions with our mortgage purchasers, analysis of the volume of mortgages we originated and current housing and credit market conditions, we estimate and record a loss reserve for mortgage loans held in portfolio and mortgage loans held for sale, as well as known and projected mortgage loan repurchase requests. We collect insurance commissions on homeowner policies placed with third party carriers through our 100% owned insurance agency. We recognize revenue and a contract asset for estimated future renewals of these policies upon issuance of the initial policy, the date at which the performance obligation is satisfied. Inventories and Cost of Sales - Inventory includes the costs of direct land acquisition, land development and home construction, capitalized interest, real estate taxes and direct overhead costs incurred during development and home construction. Costs that we incur after development projects or homes are substantially complete, such as utilities, maintenance, and cleaning, are charged to SG&A expense as incurred. All indirect overhead costs, such as compensation of sales personnel, division and region management, and the costs of advertising and builder's risk insurance are charged to SG&A expense as incurred. 53
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Land and development costs are typically allocated to individual residential
lots on a pro-rata basis, and the costs of residential lots are transferred to
construction in progress when home construction begins. Home construction costs
are specifically identified and recorded to individual homes. Cost of sales for
homes closed includes the specific construction costs of each home and all
applicable land acquisition, land development and related costs (both incurred
and estimated to be incurred) allocated to each residential lot based upon the
total number of homes expected to be closed in each community. Cost of sales for
lots sold includes all applicable land acquisition, land development and related
costs (both incurred and estimated to be incurred) allocated to each residential
lot in the community. Any changes to the estimated total development costs
subsequent to the initial home or lot closings in a community are generally
allocated on a pro-rata basis to the remaining homes or lots in the community
associated with the relevant development activity.
When a home is closed, we generally have not paid all incurred costs necessary
to complete the home. We record a liability and a corresponding charge to cost
of sales for the amount estimated to ultimately be paid related to completed
homes that have been closed. We compare our home construction budgets to actual
recorded costs to determine the additional costs remaining to be paid on each
closed home. We monitor the accrual by comparing actual costs incurred on closed
homes in subsequent months to the amounts previously accrued. Although actual
costs to be paid in the future on previously closed homes could differ from our
current accruals, such differences have not been significant.
At the end of each quarter, we review the performance and outlook for all of our
communities and land inventories for indicators of potential impairment. We
generally review our inventory for impairment indicators at the community level,
and the inventory within each community is categorized as land held for
development, residential land and lots developed and under development, land
held for sale and construction in progress and finished homes, based on the
stage of production or plans for future development or sale. 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 or future plans. In reviewing each of our communities, we
determine if impairment indicators exist on inventory held and used by analyzing
a variety of factors including, but not limited to, the following:
•gross margins on homes closed in recent months;
•projected gross margins on homes sold but not closed;
•projected gross margins based on community budgets;
•trends in gross margins, average selling prices or cost of sales;
•sales absorption rates; and
•performance of other communities in nearby locations.
If indicators of impairment are present for a community, we perform an
impairment evaluation of the community, which includes an analysis to determine
if the undiscounted cash flows estimated to be generated by those assets are
less than their carrying amounts. If so, impairment charges are recorded to cost
of sales if the fair value of such assets is less than their carrying amounts.
These estimates of cash flows are significantly impacted by community specific
factors including estimates of the amounts and timing of future revenues and
estimates of the amount of land development, materials and labor costs which, in
turn, may be impacted by the following local market conditions:
•supply and availability of new and existing homes;
•location and desirability of our communities;
•variety of product types offered in the area;
•pricing and use of incentives by us and our competitors;
•alternative uses for our land or communities such as the sale of land, finished
lots or home sites to third parties;
•amount of land and lots we own or control in a particular market or
sub-market; and
•local economic and demographic trends.
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For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Our determination of fair value is primarily based on discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams. When an impairment charge for a community is determined, the charge is then allocated to each lot in the community in the same manner as land and development costs are allocated to each lot. Impairment charges are also recorded on finished homes in substantially completed communities when events or circumstances indicate that the carrying values are greater than the fair values less estimated costs to sell these homes. We rarely purchase land for resale. However, when we own land or communities under development that do not fit into our development and construction plans, and we determine that we will sell the asset, the project is accounted for as land held for sale if certain criteria are met. We record land held for sale at the lesser of its carrying value or fair value less estimated costs to sell. In performing the impairment evaluation for land held for sale, we consider several factors including, but not limited to, recent offers received to purchase the property, prices for land in recent comparable sales transactions and market analysis studies, which include the estimated price a willing buyer would pay for the land. If the estimated fair value less costs to sell an asset is less than the current carrying value, the asset is written down to its estimated fair value less costs to sell.
The key assumptions relating to inventory valuations are impacted by local market and economic conditions, and are inherently uncertain. Although our quarterly assessments reflect management's best estimates, due to uncertainties in the estimation process, actual results could differ from such estimates.
Warranty Claims - We typically provide our homebuyers with a ten-year limited warranty for major defects in structural elements such as framing components and foundation systems, a two-year limited warranty on major mechanical systems and a one-year limited warranty on other construction components. Since we subcontract our construction work to subcontractors who typically provide us with an indemnity and a certificate of insurance prior to receiving payments for their work, claims relating to workmanship and materials are generally the primary responsibility of the subcontractors. Warranty liabilities have been established by charging cost of sales for each home delivered. The amounts charged are based on management's estimate of expected warranty-related costs under all unexpired warranty obligation periods. Our warranty liability is based upon historical warranty cost experience in each market in which we operate and is adjusted to reflect qualitative risks associated with the types of homes we build and the geographic areas in which we build them. Actual future warranty costs could differ from our currently estimated amounts. A 10% change in the historical warranty rates used to estimate our warranty accrual would not result in a material change in our accrual. Legal Claims and Insurance - We are named as a defendant in various claims, complaints and other legal actions in the ordinary course of business. At any point in time, we are managing several hundred individual claims related to construction defect matters, personal injury claims, employment matters, land development issues, contract disputes and other matters. We have established reserves for these contingencies based on the estimated costs of pending claims and the estimated costs of anticipated future claims related to previously closed homes. Approximately 99% of these reserves related to construction defect matters at bothSeptember 30, 2020 and 2019. Our reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. AtSeptember 30, 2020 and 2019, we had reserves for approximately 260 and 180 pending construction defect claims, respectively, and no individual existing claim was material to our financial statements. During fiscal 2020, we established reserves for approximately 175 new construction defect claims and resolved 95 construction defect claims for a total cost of$25.8 million . We have closed a significant number of homes during recent years, and we may be subject to future construction defect claims on these homes. Although regulations vary from state to state, construction defect issues can generally be reported for up to ten years after the home has closed in many states in which we operate. Historical data and trends regarding the frequency of claims incurred and the costs to resolve claims relative to the types of products and markets where we operate are used to estimate the construction defect liabilities for both existing and anticipated future claims. These estimates are subject to ongoing revision as the circumstances of individual pending claims and historical data and trends change. Adjustments to estimated reserves are recorded in the accounting period in which the change in estimate occurs. 55
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Historical trends in construction defect claims have been inconsistent, and we believe they may continue to fluctuate. We also believe that fluctuations in housing market conditions can affect the frequency and cost of construction defect claims. If the ultimate resolution of construction defect claims resulting from our home closings in prior years varies from current expectations, it could significantly change our estimates regarding the frequency and timing of claims incurred and the costs to resolve existing and anticipated future claims, which would impact the construction defect reserves in the future. If the frequency of claims incurred or costs of existing and future legal claims significantly exceed our current estimates, they will have a significant negative impact on our future earnings and liquidity. We estimate and record receivables under the applicable insurance policies related to our estimated contingencies for known claims and anticipated future construction defect claims on previously closed homes and other legal claims and lawsuits incurred in the ordinary course of business when recovery is probable. Additionally, we may have the ability to recover a portion of our losses from our subcontractors and their insurance carriers when we have been named as an additional insured on their insurance policies. The estimation of losses related to these reserves and the related estimates of recoveries from insurance policies are subject to a high degree of variability due to uncertainties such as trends in construction defect claims relative to our markets and the types of products built, claim frequency, claim settlement costs and patterns, insurance industry practices and legal interpretations, among others. Due to the high degree of judgment required in establishing reserves for these contingencies, actual future costs and recoveries from insurance could differ significantly from current estimated amounts. A 10% increase in the claim frequency and the average cost per claim used to estimate the reserves would result in an increase of approximately$78.7 million in our reserves and a$40.2 million increase in our receivable, resulting in additional expense of$38.5 million . A 10% decrease in the claim frequency and the average cost per claim would result in a decrease of approximately$71.1 million in our reserves and a$33.3 million decrease in our receivable, resulting in a reduction in expense of$37.8 million .
Pending Accounting Pronouncements
InJune 2016 , theFinancial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, "Financial Instruments - Credit Losses," which replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information in determining credit loss estimates. The guidance is effective for us beginningOctober 1, 2020 and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows. InJanuary 2017 , the FASB issued ASU 2017-04, "Intangibles -Goodwill and Other," which simplifies the measurement of goodwill impairment by removing the second step of the goodwill impairment test and requires the determination of the fair value of individual assets and liabilities of a reporting unit. Under the new guidance, goodwill impairment is measured as the amount by which a reporting unit's carrying amount exceeds its fair value with the loss recognized limited to the total amount of goodwill allocated to the reporting unit. The guidance is effective for us beginningOctober 1, 2020 and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows. InDecember 2019 , the FASB issued ASU 2019-12 related to simplifying the accounting for income taxes. The guidance is effective for us beginningOctober 1, 2021 , although early adoption is permitted. We are currently evaluating the impact of this guidance, and it is not expected to have a material impact on our consolidated financial position, results of operations or cash flows. InMarch 2020 , the FASB issued ASU 2020-04, "Reference Rate Reform," which provides optional expedients and exceptions for applyingU.S. GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (LIBOR) or by another reference rate expected to be discontinued. The guidance was effective beginningMarch 12, 2020 and can be applied prospectively throughDecember 31, 2022 . We will adopt this standard when LIBOR is discontinued and do not expect it to have a material impact on our consolidated financial statements or related disclosures. 56
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