6.30.2014 10Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-Q 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From              To             
Commission file number 1-14122
 
D.R. Horton, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
 
Delaware
 
75-2386963
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
301 Commerce Street, Suite 500,
Fort Worth, Texas
 
76102
(Address of principal executive offices)
 
(Zip Code)
(817) 390-8200
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
 
Accelerated filer ¨
 
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
 
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common stock, $.01 par value – 364,472,463 shares as of July 21, 2014



D.R. HORTON, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
D.R. HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
June 30,
2014
 
September 30,
2013
 
(In millions)
(Unaudited)
ASSETS
 
 
 
Homebuilding:
 
 
 
Cash and cash equivalents
$
538.5

 
$
913.3

Restricted cash
20.1

 
77.8

Inventories:
 
 
 
Construction in progress and finished homes
3,382.2

 
2,498.0

Residential land and lots — developed and under development
3,597.5

 
3,227.3

Land held for development
395.9

 
472.1

 
7,375.6

 
6,197.4

Deferred income taxes, net of valuation allowance of $33.7 million and $31.0 million at June 30, 2014 and September 30, 2013, respectively
582.6

 
586.6

Property and equipment, net
132.9

 
106.7

Other assets
460.4

 
460.5

Goodwill
94.8

 
38.9

 
9,204.9

 
8,381.2

Financial Services:
 
 
 
Cash and cash equivalents
36.5

 
23.2

Mortgage loans held for sale
419.2

 
395.1

Other assets
56.0

 
56.9

 
511.7

 
475.2

Total assets
$
9,716.6

 
$
8,856.4

LIABILITIES
 
 
 
Homebuilding:
 
 
 
Accounts payable
$
375.6

 
$
346.4

Accrued expenses and other liabilities
879.4

 
886.0

Notes payable
3,142.4

 
3,270.4

 
4,397.4

 
4,502.8

Financial Services:
 
 
 
Accounts payable and other liabilities
46.4

 
53.6

Mortgage repurchase facility
302.9

 
238.6

 
349.3

 
292.2

Total liabilities
4,746.7

 
4,795.0

Commitments and contingencies (Note K)


 


EQUITY
 
 
 
Preferred stock, $.10 par value, 30,000,000 shares authorized, no shares issued

 

Common stock, $.01 par value, 1,000,000,000 shares authorized, 371,613,825 shares issued and 364,413,754 shares outstanding at June 30, 2014 and 330,143,689 shares issued and 322,943,618 shares outstanding at September 30, 2013
3.7

 
3.3

Additional paid-in capital
2,607.6

 
2,042.0

Retained earnings
2,487.0

 
2,145.6

Treasury stock, 7,200,071 shares at June 30, 2014 and September 30, 2013, at cost
(134.3
)
 
(134.3
)
Accumulated other comprehensive income
2.2

 
1.9

Total stockholders’ equity
4,966.2

 
4,058.5

Noncontrolling interests
3.7

 
2.9

Total equity
4,969.9

 
4,061.4

Total liabilities and equity
$
9,716.6

 
$
8,856.4

See accompanying notes to consolidated financial statements.

3

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
 
(In millions, except per share data)
(Unaudited)
Homebuilding:
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
Home sales
$
2,090.3

 
$
1,630.8

 
$
5,401.1

 
$
4,222.8

Land/lot sales and other
12.6

 
13.7

 
34.0

 
45.3

 
2,102.9

 
1,644.5

 
5,435.1

 
4,268.1

Cost of sales:
 
 
 
 
 
 
 
Home sales
1,658.0

 
1,281.5

 
4,227.5

 
3,364.2

Land/lot sales and other
10.7

 
13.1

 
27.5

 
38.8

Inventory and land option charges
56.8

 
0.8

 
63.9

 
4.0

 
1,725.5

 
1,295.4

 
4,318.9

 
3,407.0

Gross profit:
 
 
 
 
 
 
 
Home sales
432.3

 
349.3

 
1,173.6

 
858.6

Land/lot sales and other
1.9

 
0.6

 
6.5

 
6.5

Inventory and land option charges
(56.8
)
 
(0.8
)
 
(63.9
)
 
(4.0
)
 
377.4

 
349.1

 
1,116.2

 
861.1

Selling, general and administrative expense
221.9

 
167.5

 
593.2

 
463.3

Interest expense

 

 

 
5.1

Other (income)
(3.1
)
 
(3.8
)
 
(9.2
)
 
(10.3
)
Homebuilding pre-tax income
158.6

 
185.4

 
532.2

 
403.0

Financial Services:
 
 
 
 
 
 
 
Revenues, net of recourse and reinsurance expense
44.1

 
48.3

 
117.4

 
131.3

General and administrative expense
33.8

 
31.3

 
93.7

 
84.9

Interest and other (income)
(2.9
)
 
(2.7
)
 
(7.5
)
 
(5.7
)
Financial services pre-tax income
13.2

 
19.7

 
31.2

 
52.1

Income before income taxes
171.8

 
205.1

 
563.4

 
455.1

Income tax expense
58.7

 
59.1

 
196.1

 
131.9

Net income
$
113.1

 
$
146.0

 
$
367.3

 
$
323.2

Other comprehensive income (loss), net of income tax:
 
 
 
 
 
 
 
Unrealized loss related to available-for-sale securities

 

 

 
(0.2
)
Unrealized gain related to debt securities collateralized by residential real estate

 
1.9

 
0.3

 
1.9

Comprehensive income
$
113.1

 
$
147.9

 
$
367.6

 
$
324.9

Basic net income per common share
$
0.32

 
$
0.45

 
$
1.10

 
$
1.00

Net income per common share assuming dilution
$
0.32

 
$
0.42

 
$
1.05

 
$
0.93

Cash dividends declared per common share
$
0.0375

 
$

 
$
0.0750

 
$
0.1875



See accompanying notes to consolidated financial statements.

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Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Nine Months Ended
June 30,
 
2014
 
2013
 
(In millions)
(Unaudited)
OPERATING ACTIVITIES
 
 
 
Net income
$
367.3

 
$
323.2

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Depreciation and amortization
26.6

 
16.0

Amortization of discounts and fees
25.4

 
29.7

Stock based compensation expense
17.6

 
13.1

Excess income tax benefit from employee stock awards
(1.6
)
 

Deferred income taxes
3.8

 
79.5

Gain on sale of marketable securities

 
(0.2
)
Inventory and land option charges
63.9

 
4.0

Changes in operating assets and liabilities:
 
 
 
Increase in construction in progress and finished homes
(759.4
)
 
(692.1
)
Increase in residential land and lots – developed, under development, and held for development
(327.8
)
 
(1,046.5
)
Decrease (increase) in other assets
34.8

 
(7.1
)
Decrease in income taxes receivable

 
14.4

Increase in mortgage loans held for sale
(24.1
)
 
(12.9
)
(Decrease) increase in accounts payable, accrued expenses and other liabilities
(1.6
)
 
142.6

Net cash used in operating activities
(575.1
)
 
(1,136.3
)
INVESTING ACTIVITIES
 
 
 
Purchases of property and equipment
(49.9
)
 
(40.6
)
Purchases of marketable securities

 
(28.9
)
Proceeds from the sale or maturity of marketable securities

 
325.4

Decrease (increase) in restricted cash
57.7

 
(19.3
)
Net principal increase of other mortgage loans and real estate owned
(2.8
)
 
(1.0
)
Purchases of debt securities collateralized by residential real estate

 
(18.6
)
Principal payments received on debt securities collateralized by
residential real estate

 
1.4

Payments related to acquisition of a business
(222.7
)
 
(9.4
)
Net cash (used in) provided by investing activities
(217.7
)
 
209.0

FINANCING ACTIVITIES
 
 
 
Proceeds from notes payable
686.3

 
892.0

Repayment of notes payable
(273.9
)
 
(342.1
)
Proceeds from stock associated with certain employee benefit plans
43.1

 
27.9

Excess income tax benefit from employee stock awards
1.6

 

Cash dividends paid
(25.8
)
 
(60.2
)
Net cash provided by financing activities
431.3

 
517.6

DECREASE IN CASH AND CASH EQUIVALENTS
(361.5
)
 
(409.7
)
Cash and cash equivalents at beginning of period
936.5

 
1,047.7

Cash and cash equivalents at end of period
$
575.0

 
$
638.0

Supplemental disclosures of non-cash activities:
 
 
 
Notes payable issued for inventory
$

 
$
11.4

Stock issued under employee incentive plans
$
5.5

 
$
3.9

Note receivable related to sale of land
$
5.0

 
$

Conversion of 2% convertible senior notes into equity
$
498.6

 
$

Accrual for holdback payment related to acquisition
$
21.4

 
$

See accompanying notes to consolidated financial statements.

5

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2014



NOTE A – BASIS OF PRESENTATION

The accompanying unaudited, consolidated financial statements include the accounts of D.R. Horton, Inc. and all of its 100% owned, majority-owned and controlled subsidiaries (which are referred to as the Company, unless the context otherwise requires). All significant intercompany accounts, transactions and balances have been eliminated in consolidation. The financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments considered necessary for a fair statement have been included. These financial statements do not include all of the information and notes required by GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2013.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates.

Reclassifications

See Note N for a discussion of the revisions to the condensed consolidating statements of cash flows.

Seasonality

Historically, the homebuilding industry has experienced seasonal fluctuations; therefore, the operating results for the three and nine months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2014 or subsequent periods.

Variable Interests

The Company enters into land and lot option purchase contracts to acquire land or lots for the construction of homes. Under these contracts, the Company will fund a stated deposit in consideration for the right, but not the obligation, to purchase land or lots at a future point in time with predetermined terms. Under the terms of many of the option purchase contracts, the option deposits are not refundable in the event the Company elects to terminate the contract.

Option purchase contracts can result in the creation of a variable interest in the entity holding the land parcel under option. There were no variable interest entities reported in the consolidated balance sheets at June 30, 2014 and September 30, 2013 because the Company determined it did not control the activities that most significantly impact the variable interest entity’s economic performance, and it did not have an obligation to absorb losses of or the right to receive benefits from the entity. The maximum exposure to losses related to the Company’s variable interest entities is limited to the amounts of the Company’s related option deposits. At June 30, 2014 and September 30, 2013, the amount of option deposits related to these contracts totaled $44.0 million and $36.9 million, respectively, and are included in homebuilding other assets in the consolidated balance sheets.


6

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


Acquisitions

In October 2013, the Company acquired the homebuilding operations of Regent Homes, Inc. for $34.5 million in cash. Regent Homes operates in Charlotte, Greensboro and Winston-Salem, North Carolina. The assets acquired included approximately 240 homes in inventory, 300 lots and control of approximately 600 additional lots through option contracts. The Company also acquired a sales order backlog of 213 homes. All of the assets acquired were recorded at their estimated fair values by the Company. The acquisition of the homebuilding operations of Regent Homes was not material to the Company's results of operations or its financial condition.

In May 2014, the Company acquired the homebuilding operations of Crown Communities for $209.6 million in cash, of which $21.4 million was paid subsequent to June 30, 2014. Crown Communities operates in Georgia, South Carolina and eastern Alabama. The assets acquired included approximately 640 homes in inventory, 2,350 lots and control of approximately 3,400 additional lots through option contracts. The Company also acquired a sales order backlog of 431 homes. Subsequent to the acquisition, Crown Communities closed 254 homes and generated home sales revenues of $65.8 million during the period ended June 30, 2014. The acquired assets and assumed liabilities were recorded by the Company at their estimated fair values.

The following table summarizes the acquired assets and liabilities at their fair values as of the acquisition date (amounts in millions):
Inventories
$
140.5

Property and equipment
1.9

Other assets
4.9

Goodwill
53.6

Intangible assets
11.7

Other liabilities
(3.0
)

As a result of the transaction, the Company recorded goodwill of $53.6 million, all of which is tax deductible. The goodwill relates to expected synergies from increasing the Company's market presence in the Georgia and South Carolina markets, Crown's experienced and knowledgeable workforce and their capital efficient operating processes. The goodwill balance has not yet been allocated to the Company's operating segments; however, the Company expects to complete this process during the fourth quarter of fiscal 2014. The intangible assets will be amortized on a straight-line basis to selling, general and administrative (SG&A) expense over their expected five-year life.

Recent Accounting Pronouncements

In January 2014, the FASB issued ASU 2014-04, “Receivables - Troubled Debt Restructurings by Creditors,” which clarifies when an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan has occurred. This guidance helps determine when a creditor should derecognize a loan receivable and recognize real estate property. The guidance is effective for the Company beginning October 1, 2015 and is not expected to have a material impact on its consolidated financial position, results of operations or cash flows.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. The guidance is effective for the Company beginning October 1, 2017 and allows for both full retrospective or modified retrospective methods of adoption. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations and cash flows.


7

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing - Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures,” which changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Also, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The guidance is effective for the Company beginning January 1, 2015 and is not expected to have a material impact on its consolidated financial position, results of operations or cash flows.

In June 2014, the FASB issued ASU 2014-12, “Compensation - Stock Compensation,” which states that a performance target in a share-based payment that affects vesting and that could be achieved after the requisite service period should be accounted for as a performance condition. The guidance is effective for the Company beginning January 1, 2016 and is not expected to have a material impact on its consolidated financial position, results of operations or cash flows.


NOTE B – SEGMENT INFORMATION

The Company is a national homebuilder that is engaged in the acquisition and development of land and the construction and sale of residential homes on the land, with operations in 79 markets in 27 states across the United States. The Company designs, builds and sells single-family detached homes on lots it develops and on finished lots purchased ready for home construction. To a lesser extent, the Company also builds and sells attached homes, such as town homes, duplexes, triplexes and condominiums. Periodically, the Company sells land and lots to other developers and homebuilders where it has excess land and lot positions. The homebuilding segments generate most of their revenues from the sale of completed homes, and to a lesser extent from the sale of land and lots.

The Company also provides mortgage financing and title agency services, primarily to its homebuilding customers, and generally sells the mortgages it originates and the related servicing rights to third-party purchasers. The financial services segment generates its revenues from originating and selling mortgages and collecting fees for title insurance agency and closing services.

The Company’s 35 homebuilding operating divisions and its financial services operation are its operating segments. The homebuilding operating segments are aggregated into six reporting segments and the financial services operating segment is its own reporting segment. The Company’s reportable homebuilding segments are: East, Midwest, Southeast, South Central, Southwest and West. These reporting segments 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 and Minnesota
 
Southeast:
 
Alabama, Florida, Georgia, Mississippi and Tennessee
 
South Central:
 
Louisiana, New Mexico (Las Cruces only), Oklahoma and Texas
 
Southwest:
 
Arizona and New Mexico
 
West:
 
California, Hawaii, Nevada, Oregon, Utah and Washington


8

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


The accounting policies of the reporting segments are described throughout Note A included in the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2013. Financial information relating to the Company's reporting segments is as follows:
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(In millions)
Revenues
 
 
 
 
 
 
 
 
Homebuilding revenues:
 
 
 
 
 
 
 
 
East
 
$
251.3

 
$
163.3

 
$
644.6

 
$
454.4

Midwest
 
133.1

 
147.6

 
338.8

 
329.9

Southeast
 
584.4

 
425.6

 
1,503.0

 
1,050.3

South Central
 
533.3

 
414.5

 
1,384.9

 
1,089.1

Southwest
 
74.1

 
86.1

 
207.8

 
241.0

West
 
526.7

 
407.4

 
1,356.0

 
1,103.4

Homebuilding revenues
 
2,102.9

 
1,644.5

 
5,435.1

 
4,268.1

Financial services revenues
 
44.1

 
48.3

 
117.4

 
131.3

Total revenues
 
$
2,147.0

 
$
1,692.8

 
$
5,552.5

 
$
4,399.4

Inventory Impairments
 
 
 
 
 
 
 
 
East
 
$
2.0

 
$

 
$
2.0

 
$

Midwest
 
48.8

 

 
48.8

 

Southeast
 
0.7

 

 
2.8

 

South Central
 

 

 

 

Southwest
 

 

 

 

West
 
3.2

 

 
3.4

 

Total inventory impairments
 
$
54.7

 
$

 
$
57.0

 
$

Income Before Income Taxes (1)
 
 
 
 
 
 
 
 
Homebuilding pre-tax income:
 
 
 
 
 
 
 
 
East
 
$
13.3

 
$
11.4

 
$
39.0

 
$
26.9

Midwest
 
(37.2
)
 
15.6

 
(18.1
)
 
23.5

Southeast
 
52.3

 
48.5

 
156.0

 
96.1

South Central
 
54.0

 
44.7

 
143.0

 
102.4

Southwest
 
8.2

 
7.7

 
19.7

 
24.6

West
 
68.0

 
57.5

 
192.6

 
129.5

Homebuilding pre-tax income
 
158.6

 
185.4

 
532.2

 
403.0

Financial services pre-tax income
 
13.2

 
19.7

 
31.2

 
52.1

Income before income taxes
 
$
171.8

 
$
205.1

 
$
563.4

 
$
455.1

________________
(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 the Company’s corporate office. The amortization of capitalized interest and property taxes is allocated to each segment based on the segment’s revenue, while those expenses associated with the corporate office are allocated to each segment based on the segment’s inventory balances.

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Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



 
 
June 30,
2014
 
September 30,
2013
 
 
(In millions)
Homebuilding Inventories (1)
 
 
 
 
East
 
$
845.2

 
$
742.9

Midwest
 
440.0

 
412.2

Southeast
 
1,860.3

 
1,508.5

South Central
 
1,643.9

 
1,443.6

Southwest
 
282.9

 
262.4

West
 
2,079.4

 
1,668.2

Corporate and unallocated (2)
 
223.9

 
159.6

Total homebuilding inventory
 
$
7,375.6

 
$
6,197.4

________________

(1)
Homebuilding inventories are the only assets included in the measure of homebuilding segment assets used by the Company’s chief operating decision makers.
(2)
Corporate and unallocated consists primarily of capitalized interest and property taxes.

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D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


NOTE C – INVENTORY

At June 30, 2014, the Company reviewed the performance and outlook for all of its land inventories and communities for indicators of potential impairment and performed detailed impairment evaluations and analyses when necessary.

The Company performed detailed impairment evaluations of communities with a combined carrying value of $284.2 million and recorded impairment charges of $54.7 million to reduce the carrying value of impaired communities to their estimated fair value. Of the total impairment charges, $48.8 million occurred in the Midwest region, primarily related to communities in Chicago that were purchased predominantly in 2004 through 2007 and had been previously impaired. In contrast to most of the Company's markets, the Chicago housing market remains very weak with sales absorptions and returns in these communities performing below management’s expectations given the size of the Company’s investments. During the current quarter, the Company reduced home prices and identified land parcels it intends to sell in these communities in an effort to increase sales pace, reduce inventories and improve cash flows and returns. During the nine months ended June 30, 2014, impairment charges totaled $57.0 million. There were no impairment charges recorded in the three and nine months ended June 30, 2013.

During the three months ended June 30, 2014 and 2013, the Company wrote off $2.1 million and $0.8 million, respectively, of earnest money deposits and pre-acquisition costs related to land option contracts that are expected to be terminated. During the nine months ended June 30, 2014 and 2013, the Company wrote off $6.9 million and $4.0 million, respectively, of these deposits and costs.

At June 30, 2014 and September 30, 2013, the Company had $18.9 million and $34.0 million, respectively, of inventories that met the criteria of land held for sale, which is primarily included in land held for development and residential land and lots developed and under development in the consolidated balance sheets.


NOTE D – NOTES PAYABLE

The Company’s notes payable at their principal amounts, net of any unamortized discounts, consist of the following:
 
 
June 30,
2014
 
September 30,
2013
 
 
(In millions)
Homebuilding:
 
 
 
 
Unsecured:
 
 
 
 
Revolving credit facility, maturing 2018
 
$

 
$

6.125% senior notes due 2014, net
 

 
145.8

2% convertible senior notes due 2014, net
 

 
478.7

5.625% senior notes due 2014, net
 
137.9

 
137.8

5.25% senior notes due 2015, net
 
157.6

 
157.5

5.625% senior notes due 2016, net
 
169.9

 
169.7

6.5% senior notes due 2016, net
 
372.6

 
372.5

4.75% senior notes due 2017
 
350.0

 
350.0

3.625% senior notes due 2018
 
400.0

 
400.0

3.75% senior notes due 2019
 
500.0

 

4.375% senior notes due 2022
 
350.0

 
350.0

4.75% senior notes due 2023
 
300.0

 
300.0

5.75% senior notes due 2023
 
400.0

 
400.0

Other secured
 
4.4

 
8.4

 
 
$
3,142.4

 
$
3,270.4

Financial Services:
 
 
 
 
Mortgage repurchase facility, maturing 2015
 
$
302.9

 
$
238.6


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



Homebuilding:

The Company has a $725 million senior unsecured revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to $1.0 billion, subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit. Letters of credit issued under the facility reduce available borrowing capacity and may total no more than $362.5 million in the aggregate. The interest rate on borrowings under the revolving credit facility may be based on either the Prime Rate or London Interbank Offered Rate (LIBOR) plus an applicable margin, as defined in the credit agreement governing the facility. The maturity date of the facility is September 7, 2018. At June 30, 2014, there were no borrowings outstanding and $68.0 million of letters of credit issued under the revolving credit facility.

The Company's revolving credit facility imposes restrictions on its operations and activities, including requiring the maintenance of a minimum level of tangible net worth, a maximum allowable ratio of debt to tangible net worth and a borrowing base restriction if the Company's ratio of debt to tangible net worth exceeds a certain level. 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. In addition, the credit agreement governing the facility and the indentures governing the senior notes impose restrictions on the creation of secured debt and liens. At June 30, 2014, the Company was in compliance with all of the covenants, limitations and restrictions of its revolving credit facility and public debt obligations.

The Company has an automatically effective universal shelf registration statement, filed with the Securities and Exchange Commission (SEC) in September 2012, registering debt and equity securities that the Company may issue from time to time in amounts to be determined.

On January 15, 2014, the Company repaid the remaining $145.9 million principal amount of its 6.125% senior notes which were due on that date. In February 2014, the Company issued $500 million principal amount of 3.75% senior notes due March 1, 2019, with interest payable semi-annually. The notes represent unsecured obligations of the Company. The annual effective interest rate of the senior notes after giving effect to the amortization of financing costs is 3.9%.

During April and May of 2014, the Company's outstanding 2% convertible senior notes were converted into 38.6 million shares of the Company's common stock. The conversion rate was 77.18004 shares of the Company's common stock per $1,000 principal amount of senior notes, which was equivalent to a conversion price of approximately $12.96 per share of common stock.

Effective August 1, 2013, the Board of Directors authorized the repurchase of up to $500 million of the Company's debt securities effective through July 31, 2014. All of the $500 million authorization was remaining at June 30, 2014. On July 22, 2014, the Board of Directors authorized the repurchase of up to $500 million of the Company's debt securities, which replaced the previous authorization and is effective through July 31, 2015.

Financial Services:

The Company’s mortgage subsidiary, DHI Mortgage, has a mortgage repurchase facility that is accounted for as a secured financing. The mortgage repurchase facility provides financing and liquidity to DHI Mortgage by facilitating purchase transactions in which DHI Mortgage transfers eligible loans to the counterparties against the transfer of funds by the counterparties, thereby becoming purchased loans. DHI Mortgage then has the right and obligation to repurchase the purchased loans upon their sale to third-party purchasers in the secondary market or within specified time frames from 45 to 120 days in accordance with the terms of the mortgage repurchase facility. The total capacity of the facility is $300 million; however, the capacity can be increased up to $400 million subject to the availability of additional commitments. In February 2014, the mortgage repurchase facility was renewed and amended. This renewal and amendment extends the maturity date of the facility to February 27, 2015 and allows for the capacity of the facility to be increased, without requiring additional commitments, from

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June 30, 2014


$300 million to $325 million on the last five days of any fiscal quarter and the first twenty-five days of the following fiscal quarter, excluding the quarter ending December 31, 2014.

As of June 30, 2014, $383.3 million of mortgage loans held for sale with a collateral value of $367.2 million were pledged under the mortgage repurchase facility. As a result of advance paydowns totaling $64.3 million, DHI Mortgage had an obligation of $302.9 million outstanding under the mortgage repurchase facility at June 30, 2014 at a 2.6% annual interest rate.

The mortgage repurchase facility is not guaranteed by D.R. Horton, Inc. or any of the subsidiaries that guarantee the Company’s homebuilding debt. The facility contains financial covenants as to the mortgage subsidiary’s minimum required tangible net worth, its maximum allowable ratio of debt to tangible net worth and its minimum required liquidity. These covenants are measured and reported monthly. At June 30, 2014, DHI Mortgage was in compliance with all of the conditions and covenants of the mortgage repurchase facility.


NOTE E – CAPITALIZED INTEREST

The Company capitalizes 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. During much of the last few years, the Company’s active inventory was lower than its debt level and therefore, a portion of the interest incurred was reflected as interest expense. However, since the third quarter of fiscal 2013, the Company's active inventory has exceeded its debt level, and all interest incurred during those periods was capitalized to inventory.

The following table summarizes the Company’s interest costs incurred, capitalized, expensed as interest expense and charged to cost of sales during the three and nine months ended June 30, 2014 and 2013:
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(In millions)
Capitalized interest, beginning of period
 
$
183.7

 
$
103.8

 
$
137.1

 
$
82.3

Interest incurred (1)
 
45.1

 
44.4

 
144.0

 
125.5

Interest expensed:
 
 
 
 
 
 
 
 
Directly to interest expense
 

 

 

 
(7.1
)
Amortized to cost of sales
 
(34.2
)
 
(28.6
)
 
(86.5
)
 
(81.1
)
Written off with inventory impairments
 
(1.1
)
 

 
(1.1
)
 

Capitalized interest, end of period
 
$
193.5

 
$
119.6

 
$
193.5

 
$
119.6

_______________
(1)
Interest incurred includes interest incurred on the Company's financial services mortgage repurchase facility of $1.2 million and $3.0 million in the three and nine months ended June 30, 2014, respectively, and $1.4 million and $3.4 million in the same periods of 2013.


NOTE F – MORTGAGE LOANS

Mortgage Loans Held for Sale
Mortgage loans held for sale consist primarily of single-family residential loans collateralized by the underlying property. At June 30, 2014, mortgage loans held for sale had an aggregate fair value of $419.2 million and an aggregate outstanding principal balance of $408.2 million. At September 30, 2013, mortgage loans held for sale had an aggregate fair value of $395.1 million and an aggregate outstanding principal balance of $381.1 million. The Company had net gains on sales of loans and servicing rights of $26.6 million and $71.0 million during the three and nine months ended June 30, 2014, respectively, compared to $32.3 million and $86.5 million in the same periods of fiscal 2013. Net gains on sales of loans and servicing rights

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June 30, 2014


are included in financial services revenues in the consolidated statements of operations. Approximately 91% of the mortgage loans sold by DHI Mortgage during the nine months ended June 30, 2014 were sold to four major financial institutions, the largest of which represented 31% of the total loans sold.

To manage the interest rate risk inherent in its mortgage operations, the Company hedges its risk using derivative instruments, generally forward sales of mortgage-backed securities (MBS), which are referred to as “hedging instruments” in the following discussion. The Company does not enter into or hold derivatives for trading or speculative purposes.

Newly originated loans that have been closed but not committed to third-party purchasers are hedged to mitigate the risk of changes in their fair value. Hedged loans are committed to third-party purchasers typically within three days after origination. The notional amounts of the hedging instruments used to hedge mortgage loans held for sale vary in relationship to the underlying loan amounts, depending on the movements in the value of each hedging instrument relative to the value of the underlying mortgage loans. The fair value change related to the hedging instruments generally offsets the fair value change in the mortgage loans held for sale. The net fair value change, which for the three and nine months ended June 30, 2014 and 2013 was not significant, is recognized in financial services revenues in the consolidated statements of operations. As of June 30, 2014, the Company had $212.5 million in mortgage loans held for sale not committed to third-party purchasers, and the notional amounts of the hedging instruments related to those loans totaled $211.6 million.

Other Mortgage Loans and Loss Reserves

Mortgage loans are sold with limited recourse provisions derived from industry-standard representations and warranties in the relevant agreements. Primarily, these representations and warranties involve the absence of misrepresentations by the borrower or other parties, the appropriate underwriting of the loan and in some cases, a required minimum number of payments to be made by the borrower. The Company generally does not retain any other continuing interest related to mortgage loans sold in the secondary market. Other mortgage loans generally consist of loans repurchased due to these limited recourse obligations. Typically, these loans are impaired and some become real estate owned through the foreclosure process. At June 30, 2014 and September 30, 2013, the Company’s total other mortgage loans and real estate owned, before loss reserves, were as follows:
 
 
June 30,
2014
 
September 30,
2013
 
 
(In millions)
Other mortgage loans
 
$
38.1

 
$
35.9

Real estate owned
 
1.0

 
1.3

 
 
$
39.1

 
$
37.2


The Company has recorded reserves for estimated losses on other mortgage loans, real estate owned and future loan repurchase obligations due to the limited recourse provisions, all of which are recorded as reductions of financial services revenue. The loss reserve for loan recourse obligations is estimated based on an analysis of loan repurchase requests received, actual repurchases and losses through the disposition of such loans or requests, discussions with mortgage purchasers and analysis of mortgages originated. The reserve balances at June 30, 2014 and September 30, 2013 were as follows:
 
 
June 30,
2014
 
September 30,
2013
 
 
(In millions)
Loss reserves related to:
 
 
 
 
Other mortgage loans
 
$
2.2

 
$
3.2

Real estate owned
 
0.1

 
0.2

Loan repurchase and settlement obligations – known and expected
 
24.3

 
25.9

 
 
$
26.6

 
$
29.3



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


Other mortgage loans and real estate owned and the related loss reserves are included in financial services other assets, while loan repurchase obligations are included in financial services accounts payable and other liabilities in the accompanying consolidated balance sheets.

Loan Commitments and Related Derivatives

The Company is party to interest rate lock commitments (IRLCs), which are extended to borrowers who have applied for loan funding and meet defined credit and underwriting criteria. At June 30, 2014, the notional amount of IRLCs, which are accounted for as derivative instruments recorded at fair value, totaled $395.4 million.

The Company manages interest rate risk related to its IRLCs through the use of best-efforts whole loan delivery commitments and hedging instruments. These instruments are considered derivatives in an economic hedge and are accounted for at fair value with gains and losses recognized in financial services revenues in the consolidated statements of operations. As of June 30, 2014, the Company had a notional amount of approximately $28.0 million of best-efforts whole loan delivery commitments and a notional amount of $327.4 million of hedging instruments related to IRLCs not yet committed to purchasers.


NOTE G – INCOME TAXES

The Company’s income tax expense for the three and nine months ended June 30, 2014 was $58.7 million and $196.1 million, respectively, compared to $59.1 million and $131.9 million in the same periods of fiscal 2013. The effective tax rate was 34.2% and 34.8% for the three and nine months ended June 30, 2014, respectively, compared to 28.8% and 29.0% in the same periods of fiscal 2013. The effective tax rates for the three and nine months ended June 30, 2014 include a tax benefit for the domestic production activities deduction that is offset by a similar amount of expense for state income taxes. The Company’s tax benefit for the domestic production activities deduction was limited in fiscal 2013 because of utilization of a net operating loss (NOL) carryforward. The low effective tax rates during the 2013 periods were primarily due to a $9.3 million reduction in unrecognized tax benefits during the third quarter, while the nine-month period also included the effect of an $18.7 million reduction in the Company's valuation allowance on its deferred tax assets during the second quarter.

At June 30, 2014 and September 30, 2013, the Company had deferred tax assets, net of deferred tax liabilities, of $616.3 million and $617.6 million, respectively, partially offset by valuation allowances of $33.7 million and $31.0 million, respectively. The valuation allowance for both periods relates to the Company’s state deferred tax assets for NOL carryforwards. The Company believes it is more likely than not that a portion of its state NOL carryforwards will not be realized because some state NOL carryforward periods are too brief to realize the related deferred tax assets.
 
When assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of its deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of sufficient taxable income in future periods. The Company records a valuation allowance when it determines it is more likely than not that a portion of the deferred tax assets will not be realized. 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 the Company's 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 the Company's deferred tax assets.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



NOTE H – EARNINGS PER SHARE

The following table sets forth the numerators and denominators used in the computation of basic and diluted earnings per share. Options to purchase 9.1 million and 1.9 million shares of common stock were excluded from the computation of diluted earnings per share for the fiscal 2014 and 2013 periods, respectively, because the exercise price of the options was greater than the average market price of the common shares and, therefore, their effect would have been antidilutive.
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(In millions)
Numerator:
 
 
 
 
 
 
 
 
Net income
 
$
113.1

 
$
146.0

 
$
367.3

 
$
323.2

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Interest and amortization of issuance costs associated with convertible senior notes, net of tax
 
2.8

 
6.0

 
16.5

 
17.5

Numerator for diluted earnings per share after assumed conversions
 
$
115.9

 
$
152.0

 
$
383.8

 
$
340.7

Denominator:
 
 
 
 
 
 
 
 
Denominator for basic earnings per share — weighted average common shares
 
349.7

 
322.6

 
332.4

 
321.8

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Employee stock awards
 
3.2

 
4.4

 
3.1

 
4.6

Convertible senior notes
 
14.9

 
38.6

 
30.7

 
38.6

Denominator for diluted earnings per share — adjusted weighted average common shares
 
367.8

 
365.6

 
366.2

 
365.0



NOTE I – STOCKHOLDERS’ EQUITY

The Company has an automatically effective universal shelf registration statement, filed with the SEC in September 2012, registering debt and equity securities that it may issue from time to time in amounts to be determined.

During April and May of 2014, the Company's outstanding 2% convertible senior notes were converted into 38.6 million shares of the Company's common stock. The conversion rate was 77.18004 shares of the Company's common stock per $1,000 principal amount of senior notes, which was equivalent to a conversion price of approximately $12.96 per share of common stock.

Effective August 1, 2013, the Board of Directors authorized the repurchase of up to $100 million of the Company’s common stock effective through July 31, 2014. All of the $100 million authorization was remaining at June 30, 2014, and no common stock has been repurchased subsequent to June 30, 2014. On July 22, 2014, the Board of Directors authorized the repurchase of up to $100 million of the Company's common stock, which replaced the previous authorization and is effective through July 31, 2015.

During the three months ended June 30, 2014, the Board of Directors approved a quarterly cash dividend of $0.0375 per common share, which was paid on May 27, 2014 to stockholders of record on May 15, 2014. In July 2014, the Board of Directors approved a quarterly cash dividend of $0.0625 per common share, payable on August 18, 2014 to stockholders of record on August 8, 2014. During fiscal 2013, total cash dividends were $0.1875 per common share, all of which were approved and paid during the first quarter.



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June 30, 2014



NOTE J – EMPLOYEE BENEFIT PLANS

Stock Options

On March 6, 2014, the Compensation Committee of the Board of Directors approved and granted stock options to executive officers, other officers and employees of the Company. The stock option grants were made to approximately 500 recipients, who collectively may purchase approximately 3.8 million shares of the Company's common stock at an exercise price of $23.86 per share, the closing market price of the Company's common stock on the date of grant. These options generally vest over a five-year period.

Restricted Stock Unit Agreement

In November 2013, the Compensation Committee of the Company's Board of Directors approved and granted awards of 350,000 performance based units (Performance Units) to the Chairman of the Board and the Chief Executive Officer of the Company that will vest at the end of a three-year performance period ending September 30, 2016. The number of units that ultimately vest depends on the Company's relative position as compared to its peers at the end of the three-year period in achieving certain performance criteria and can range from 0% to 200% of the number of units granted. The performance criteria are based on total shareholder return, return on investment, SG&A expense containment and gross profit. The earned awards will have a value equal to the number of earned units multiplied by the closing price of the Company's common stock at the end of the performance period and may be paid in cash, equity or a combination of both. The Compensation Committee has the discretion to reduce the final payout on the Performance Units from the amount earned. The Performance Units have no dividend or voting rights during the performance period. These awards are accounted for as liability awards and compensation expense for these awards is recognized over the vesting period. The liability for these awards of $3.2 million at June 30, 2014 was based on the Company's performance against the peer group, the elapsed portion of the performance period and the Company's stock price at June 30, 2014. Compensation expense related to this grant was $1.3 million and $3.2 million for the three and nine months ended June 30, 2014, respectively.


NOTE K – COMMITMENTS AND CONTINGENCIES

Warranty Claims

The Company typically provides its 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. The Company’s warranty liability is based upon historical warranty cost experience in each market in which it operates, and is adjusted as appropriate to reflect qualitative risks associated with the types of homes built and the geographic areas in which they are built.

Changes in the Company’s warranty liability during the three and nine months ended June 30, 2014 and 2013 were as follows:
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
 
(In millions)
Warranty liability, beginning of period
$
57.3

 
$
57.3

 
$
56.9

 
$
56.8

Warranties issued
9.2

 
7.2

 
23.9

 
18.8

Changes in liability for pre-existing warranties
3.3

 
0.7

 
5.4

 
5.9

Settlements made
(8.5
)
 
(8.0
)
 
(24.9
)
 
(24.3
)
Warranty liability, end of period
$
61.3

 
$
57.2

 
$
61.3

 
$
57.2



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June 30, 2014


Legal Claims and Insurance

The Company is named as a defendant in various claims, complaints and other legal actions in the ordinary course of business. At any point in time, the Company is managing several hundred individual claims related to construction defect matters, personal injury claims, employment matters, land development issues and contract disputes. The Company has 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. The estimated liabilities for these contingencies were $457.6 million and $482.0 million at June 30, 2014 and September 30, 2013, respectively, and are included in homebuilding accrued expenses and other liabilities in the consolidated balance sheets. At both June 30, 2014 and September 30, 2013, approximately 99% of these reserves related to construction defect matters. Expenses related to the Company’s legal contingencies were $15.5 million and $13.3 million in the nine months ended June 30, 2014 and 2013, respectively.

The Company’s reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. As of June 30, 2014, no individual existing claim was material to the Company’s financial statements, and the majority of the Company’s total construction defect reserves consisted of the estimated exposure to future claims on previously closed homes. The Company has closed a significant number of homes during recent years, and as a result the Company 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 the Company operates. 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 the Company operates 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.

Historical trends in construction defect claims have been inconsistent, and the Company believes they may continue to fluctuate over the next several years. Housing market conditions have been volatile across most of the Company's markets over the past ten years, and the Company believes such conditions can affect the frequency and cost of construction defect claims. The Company closed a significant number of homes during its peak operating years from 2003 to 2007. If the ultimate resolution of construction defect claims resulting from closings in the Company's peak operating years varies from current expectations, it could significantly change the Company's 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 the Company's current estimates, they will have a significant negative impact on its future earnings and liquidity.

The Company's reserves for legal claims decreased from $482.0 million at September 30, 2013 to $457.6 million at June 30, 2014 primarily due to payments made for legal claims during the period, net of reimbursements received from subcontractors, and a decrease in the reserves caused by a decrease in the estimated cost to resolve future claims. These decreases were partially offset by an increase in reserves for homes closed during the current year that are subject to possible future construction defect claims. Changes in the Company’s legal claims reserves during the nine months ended June 30, 2014 and 2013 were as follows:
 
Nine Months Ended
June 30,
 
2014
 
2013
 
(In millions)
Reserves for legal claims, beginning of period
$
482.0

 
$
544.9

Decrease in reserves
(5.7
)
 
(13.9
)
Payments
(18.7
)
 
(22.7
)
Reserves for legal claims, end of period
$
457.6

 
$
508.3



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


The Company estimates and records receivables under applicable insurance policies related to its 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, the Company may have the ability to recover a portion of its losses from its subcontractors and their insurance carriers when the Company has been named as an additional insured on their insurance policies. The Company's receivables related to its estimates of insurance recoveries from estimated losses from pending legal claims and anticipated future claims related to previously closed homes totaled $135.8 million, $162.1 million and $192.8 million at June 30, 2014, September 30, 2013 and June 30, 2013, respectively, and are included in homebuilding other assets in the consolidated balance sheets. The decrease in these receivables corresponds to the decrease in the reserve for legal claims.

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 the Company's 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, and it is not possible for the Company to make a reasonable estimate of the possible loss or range of loss in excess of its reserves.

Land and Lot Option Purchase Contracts

The Company enters into land and lot option purchase contracts to acquire land or lots for the construction of homes. At June 30, 2014, the Company had total deposits of $47.0 million, consisting of cash deposits of $41.1 million and promissory notes, letters of credit and surety bonds of $5.9 million, to purchase land and lots with a total remaining purchase price of approximately $1.9 billion. A limited number of the land and lot option purchase contracts at June 30, 2014, representing $14.2 million of remaining purchase price, were subject to specific performance clauses which may require the Company to purchase the land or lots upon the land sellers meeting their contractual obligations. The majority of land and lots under contract are currently expected to be purchased within three years.

Other Commitments

At June 30, 2014, the Company had outstanding surety bonds of $829.4 million and letters of credit of $77.9 million to secure performance under various contracts. Of the total letters of credit, $68.0 million were issued under the Company's revolving credit facility, some of which were cash collateralized. The remaining $9.9 million of letters of credit were issued under secured letter of credit agreements requiring the Company to deposit cash as collateral with the issuing banks. At June 30, 2014 and September 30, 2013, the amount of cash restricted to collateralize letters of credit under the revolving credit facility and under secured letter of credit agreements totaled $14.3 million and $73.6 million, respectively, and is included in homebuilding restricted cash in the consolidated balance sheets.


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June 30, 2014



NOTE L – OTHER ASSETS AND ACCRUED EXPENSES AND OTHER LIABILITIES

The Company’s homebuilding other assets at June 30, 2014 and September 30, 2013 were as follows:
 
 
June 30,
2014
 
September 30,
2013
 
 
(In millions)
Insurance receivables
 
$
135.8

 
$
162.1

Earnest money and refundable deposits
 
110.2

 
98.5

Accounts and notes receivable
 
29.7

 
24.1

Prepaid assets
 
43.9

 
49.4

Rental properties
 
50.5

 
41.3

Debt securities collateralized by residential real estate
 
20.8

 
20.3

Other assets
 
69.5

 
64.8

 
 
$
460.4

 
$
460.5


The Company’s homebuilding accrued expenses and other liabilities at June 30, 2014 and September 30, 2013 were as follows:
 
 
June 30,
2014
 
September 30,
2013
 
 
(In millions)
Reserves for legal claims
 
$
457.6

 
$
482.0

Employee compensation and related liabilities
 
138.0

 
130.2

Warranty liability
 
61.3

 
56.9

Accrued interest
 
47.3

 
34.0

Federal and state income tax liabilities
 
15.1

 
29.9

Inventory related accruals
 
55.5

 
46.3

Homebuyer deposits
 
52.6

 
39.3

Accrued property taxes
 
18.8

 
30.0

Other liabilities
 
33.2

 
37.4

 
 
$
879.4

 
$
886.0



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



NOTE M – FAIR VALUE MEASUREMENTS

Fair value measurements are used for the Company's mortgage loans held for sale, debt securities collateralized by residential real estate, IRLCs and other derivative instruments on a recurring basis, and are used for inventories, other mortgage loans and real estate owned on a nonrecurring basis, when events and circumstances indicate that the carrying value may not be recoverable. The fair value hierarchy and its application to the Company’s assets and liabilities is as follows:

Level 1 – Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 – Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active, or by model-based techniques in which all significant inputs are observable in the market. The Company’s assets and liabilities measured at fair value using Level 2 inputs on a recurring basis are as follows:
mortgage loans held for sale;
IRLCs; and
loan sale commitments and hedging instruments.
Level 3 – Valuation is typically derived from model-based techniques in which at least one significant input is unobservable and based on the Company’s own estimates about the assumptions that market participants would use to value the asset or liability.
The Company's assets measured at fair value using Level 3 inputs on a recurring basis are as follows:
debt securities collateralized by residential real estate; and
a limited number of mortgage loans held for sale with some degree of impairment affecting their marketability.
The Company’s assets measured at fair value using Level 3 inputs that are typically reported at the lower of carrying value or fair value on a nonrecurring basis are as follows:
inventory held and used;
inventory available for sale;
certain mortgage loans; and
rental properties and other real estate owned.


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D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


    
The following tables summarize the Company’s assets and liabilities measured at fair value on a recurring basis at June 30, 2014 and September 30, 2013, and the changes in the fair value of the Level 3 assets during the nine months ended June 30, 2014.
 
 
 
 
Fair Value at June 30, 2014
 
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
(In millions)
Homebuilding:
 
 
 
 
 
 
 
 
 
 
Debt securities collateralized by residential real estate (a)
 
Other assets
 
$

 
$

 
$
20.8

 
$
20.8

Financial Services:
 
 
 
 
 
 
 
 
 
 
Mortgage loans held for sale (b)
 
Mortgage loans held for sale
 

 
409.9

 
9.3

 
419.2

Derivatives not designated as hedging instruments (c):
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments
 
Other assets
 

 
3.5

 

 
3.5

Forward sales of MBS
 
Other liabilities
 

 
(4.6
)
 

 
(4.6
)
Best-efforts and mandatory commitments
 
Other liabilities
 

 
(0.8
)
 

 
(0.8
)
 
 
 
 
Fair Value at September 30, 2013
 
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
(In millions)
Homebuilding:
 
 
 
 
 
 
 
 
 
 
Debt securities collateralized by residential real estate (a)
 
Other assets
 
$

 
$

 
$
20.3

 
$
20.3

Financial Services:
 
 
 
 
 
 
 
 
 
 
Mortgage loans held for sale (b)
 
Mortgage loans held for sale
 

 
389.4

 
5.7

 
395.1

Derivatives not designated as hedging instruments (c):
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments
 
Other assets
 

 
7.0

 

 
7.0

Forward sales of MBS
 
Other liabilities
 

 
(8.8
)
 

 
(8.8
)
Best-efforts and mandatory commitments
 
Other liabilities
 

 
(3.1
)
 

 
(3.1
)


 
Level 3 Assets at Fair Value for the
 
Nine Months Ended June 30, 2014
 
Balance at September 30, 2013
 
Net realized and unrealized gains/(losses)
 
Purchases
 
Sales and Settlements
 
Principal Reductions
 
Net transfers in/(out)
of Level 3
 
Balance at June 30, 2014
 
(In millions)
Debt securities collateralized by residential real estate (a)
$
20.3

 
$
0.5

 
$

 
$

 
$

 
$

 
$
20.8

Mortgage loans held for sale (b)
5.7

 
0.7

 

 
(0.5
)
 

 
3.4

 
9.3

(a)
In October 2012, the Company purchased defaulted debt securities which are secured by residential real estate. These securities, which are included in other assets in the consolidated balance sheets, are classified as available for sale and are reflected at fair value. At June 30, 2014, the fair value of these securities was based on a recent agreement with an outside third party to sell the securities. Unrealized gains or losses on these securities, net of tax, are recorded in accumulated other comprehensive income (loss) in the consolidated balance sheets.
(b)
Mortgage loans held for sale are reflected at fair value. Interest income earned on mortgage loans held for sale is based on contractual interest rates and included in financial services interest and other income. Mortgage loans held for sale at June 30, 2014 includes $9.3 million of originated loans for which the Company elected the fair value option upon origination and which the Company has not sold into the secondary market, but plans to sell as market conditions permit. The fair value of these mortgage loans held for sale is generally calculated considering the secondary market and adjusted for the value of the underlying collateral, including interest rate risk, liquidity risk and prepayment risk.
(c)
Fair value measurements of these derivatives represent changes in fair value and are reflected in the balance sheet. Changes in these fair values during the periods presented are included in financial services revenues in the consolidated statements of operations.

22

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D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014


The following table summarizes the Company’s assets measured at fair value on a nonrecurring basis at June 30, 2014 and September 30, 2013:
 
 
 
 
Fair Value at
 
Fair Value at
 
 
 
 
June 30, 2014
 
September 30, 2013
 
 
Balance Sheet Location
 
Level 3
 
Level 3
 
 
 
 
(In millions)
Homebuilding:
 
 
 
 
 
 
Inventory held and used (a) (b)
 
Inventories
 
$
46.6

 
$
0.5

Inventory available for sale (a) (c)
 
Inventories
 
8.7

 
10.8

Financial Services:
 
 
 
 
 
 
Other mortgage loans (a) (d)
 
Other assets
 
18.8

 
22.6

Real estate owned (a) (d)
 
Other assets
 
0.8

 
0.7

_______________________________________
(a)
The fair values included in the table above represent only those assets whose carrying values were adjusted to fair value in the respective quarter.
(b)
In performing its impairment analysis of communities, discount rates ranging from 12% to 18% were used in the periods presented.
(c)
The fair value of inventory available for sale was determined based on recent offers received from outside third parties, comparable sales or actual contracts.
(d)
The fair values of other mortgage loans and real estate owned are determined based on the value of the underlying collateral.

For the financial assets and liabilities that the Company does not reflect at fair value, the following tables present both their respective carrying value and fair value at June 30, 2014 and September 30, 2013:
 
Carrying Value
 
Fair Value at June 30, 2014
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In millions)
Homebuilding:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (a)
$
538.5

 
$
538.5

 
$

 
$

 
$
538.5

Restricted cash (a)
20.1

 
20.1

 

 

 
20.1

Senior notes (b)
3,138.0

 

 
3,244.4

 

 
3,244.4

Financial Services:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (a)
36.5

 
36.5

 

 

 
36.5

Mortgage repurchase facility (a)
302.9

 

 

 
302.9

 
302.9


 
Carrying Value
 
Fair Value at September 30, 2013
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In millions)
Homebuilding:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (a)
$
913.3

 
$
913.3

 
$

 
$

 
$
913.3

Restricted cash (a)
77.8

 
77.8

 

 

 
77.8

Senior notes (b)
2,783.3

 

 
2,811.5

 

 
2,811.5

Convertible senior notes (b)
478.7

 

 
762.4

 

 
762.4

Financial Services:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (a)
23.2

 
23.2

 

 

 
23.2

Mortgage repurchase facility (a)
238.6

 

 

 
238.6

 
238.6

_______________________________________
(a)
The fair value approximates carrying value due to its short-term nature, short maturity or floating interest rate terms, as applicable.
(b)
The fair value is determined based on quoted market prices of recent transactions of the notes, which is classified as Level 2 within the fair value hierarchy.

23

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D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION

All of the Company's senior notes and the unsecured revolving credit facility are fully and unconditionally guaranteed, on a joint and several basis, by substantially all of the Company's homebuilding subsidiaries (collectively, Guarantor Subsidiaries). Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly, by the Company. The Company's subsidiaries engaged in the financial services segment and certain other subsidiaries do not guarantee the Company's senior notes and the unsecured revolving credit facility (collectively, Non-Guarantor Subsidiaries). In lieu of providing separate financial statements for the Guarantor Subsidiaries, consolidating condensed financial statements are presented below. Separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented because management has determined that they are not material to investors.

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 the Company; (2) the sale or other disposition of all or substantially all of its assets (other than to the Company or another Guarantor); (3) its merger or consolidation with an entity other than the Company or another Guarantor; or (4) depending on the provisions of the applicable indenture, either (a) its proper designation as an unrestricted subsidiary, (b) its ceasing to guarantee any of the Company's publicly traded debt securities, or (c) its ceasing to guarantee any of the Company's obligations under the revolving credit facility.

The Company revised its condensed consolidating statement of cash flows for the nine months ended June 30, 2013 to reflect the change in intercompany advances in the D.R. Horton, Inc. column as an investing activity. Such amount was previously labeled net change in intercompany receivables/payables and classified as a financing activity. The revision resulted in an increase in cash provided by financing activities and an increase in cash used in investing activities in the D.R. Horton, Inc. column in the amount of $714.3 million. This revision had no impact on any financial statements or notes, except for the D.R. Horton, Inc. and Eliminations columns of the condensed consolidating statement of cash flows in this Supplemental Guarantor Information note, and the Company determined the revision was not material. As other prior period financial information is presented, the Company will similarly revise the condensed consolidating statements of cash flows in its future filings.

During the quarter ended March 31, 2014, the Company identified an error with respect to its condensed consolidating statement of cash flows for the three months ended December 31, 2013. The Company will revise the condensed consolidating statement of cash flows when it is presented as comparative information in the Company’s December 31, 2014 quarterly report. The revision will increase net cash used in operating activities in the D.R. Horton, Inc. column by $32.0 million and decrease intercompany advances and net cash used in investing activities in the D.R. Horton, Inc. column by $32.0 million. The revision will also decrease net cash used in operating activities in the Guarantor Subsidiaries column by $32.0 million and decrease intercompany advances and cash provided by financing activities in the Guarantor Subsidiaries column by $32.0 million. The revision described above corrects the classification of the cash flows related to the purchase of the homebuilding operations of Regent Homes. The error, which the Company determined is not material, had no impact on any financial statements or notes, except for the D.R. Horton, Inc., Guarantor Subsidiaries and Eliminations columns of the condensed consolidating statement of cash flows in the Supplemental Guarantor Information note for the quarter ended December 31, 2013. Such amounts have been appropriately reflected in the condensed consolidating statement of cash flows for the nine months ended June 30, 2014.



24

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D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)


Consolidating Balance Sheet
June 30, 2014

 
 
D.R.
Horton, Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Total
 
 
(In millions)
ASSETS
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
467.5


$
65.1


$
42.4


$

 
$
575.0

Restricted cash
 
18.3

 
1.8

 

 

 
20.1

Investments in subsidiaries
 
2,742.6

 

 

 
(2,742.6
)
 

Inventories
 
2,624.0

 
4,740.5

 
11.1

 

 
7,375.6

Deferred income taxes
 
201.6

 
381.0

 

 

 
582.6

Property and equipment, net
 
47.8

 
49.2

 
35.9

 

 
132.9

Other assets
 
147.9

 
252.7

 
115.8

 

 
516.4

Mortgage loans held for sale
 

 

 
419.2

 

 
419.2

Goodwill
 

 
94.8

 

 

 
94.8

Intercompany receivables
 
2,248.6

 

 

 
(2,248.6
)
 

Total Assets
 
$
8,498.3

 
$
5,585.1

 
$
624.4

 
$
(4,991.2
)
 
$
9,716.6

LIABILITIES & EQUITY
 
 
 
 
 
 
 
 
 
 
Accounts payable and other liabilities
 
$
392.6

 
$
776.0

 
$
132.8

 
$

 
$
1,301.4

Intercompany payables
 

 
2,219.5

 
29.1

 
(2,248.6
)
 

Notes payable
 
3,139.5

 
2.9

 
302.9

 

 
3,445.3

Total Liabilities
 
3,532.1

 
2,998.4

 
464.8

 
(2,248.6
)
 
4,746.7

Total stockholders’ equity
 
4,966.2

 
2,586.7

 
155.9

 
(2,742.6
)
 
4,966.2

Noncontrolling interests
 

 

 
3.7

 

 
3.7

Total Equity
 
4,966.2

 
2,586.7

 
159.6

 
(2,742.6
)
 
4,969.9

Total Liabilities & Equity
 
$
8,498.3

 
$
5,585.1

 
$
624.4

 
$
(4,991.2
)
 
$
9,716.6


25

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)


Consolidating Balance Sheet
September 30, 2013
 
 
 
D.R.
Horton, Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Total
 
 
(In millions)
ASSETS
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
871.4

 
$
38.4

 
$
26.7

 
$

 
$
936.5

Restricted cash
 
76.5

 
1.2

 
0.1

 

 
77.8

Investments in subsidiaries
 
2,477.7

 

 

 
(2,477.7
)
 

Inventories
 
2,177.4

 
4,002.9

 
17.1

 

 
6,197.4

Deferred income taxes
 
201.7

 
384.9

 

 

 
586.6

Property and equipment, net
 
41.0

 
34.5

 
31.2

 

 
106.7

Other assets
 
167.0

 
233.4

 
117.0

 

 
517.4

Mortgage loans held for sale
 

 

 
395.1

 

 
395.1

Goodwill
 

 
38.9

 

 

 
38.9

Intercompany receivables
 
1,697.0

 

 

 
(1,697.0
)
 

Total Assets
 
$
7,709.7

 
$
4,734.2

 
$
587.2

 
$
(4,174.7
)
 
$
8,856.4

LIABILITIES & EQUITY
 
 
 
 
 
 
 
 
 
 
Accounts payable and other liabilities
 
$
383.8

 
$
766.5

 
$
135.7

 
$

 
$
1,286.0

Intercompany payables
 

 
1,664.2

 
32.8

 
(1,697.0
)
 

Notes payable
 
3,267.4

 
3.0

 
238.6

 

 
3,509.0

Total Liabilities
 
3,651.2

 
2,433.7

 
407.1

 
(1,697.0
)
 
4,795.0

Total stockholders’ equity
 
4,058.5

 
2,300.5

 
177.2

 
(2,477.7
)
 
4,058.5

Noncontrolling interests
 

 

 
2.9

 

 
2.9

Total Equity
 
4,058.5

 
2,300.5

 
180.1

 
(2,477.7
)
 
4,061.4

Total Liabilities & Equity
 
$
7,709.7

 
$
4,734.2

 
$
587.2

 
$
(4,174.7
)
 
$
8,856.4


 

26

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D.R. HORTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)
June 30, 2014



NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)


Consolidating Statement of Operations
Three Months Ended June 30, 2014
 
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