Edgar Filing: HORTON D R INC /DE/

10-Q

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 December 31, 2015



¨	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 website, 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 ý	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 – 369,768,662 shares as of January 20, 2016

D.R. HORTON, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX




	Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets at December 31, 2015 (unaudited) and September 30, 2015 (unaudited)	3
Consolidated Statements of Operations and Comprehensive Income for the three months ended December 31, 2015 and 2014 (unaudited)	4
Consolidated Statements of Cash Flows for the three months ended December 31, 2015 and 2014 (unaudited)	5
Notes to Consolidated Financial Statements (unaudited)	6
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk	51
ITEM 4. Controls and Procedures	52
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings	52
ITEM 6. Exhibits	53
SIGNATURE	54

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

D.R. HORTON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



	December 31, 2015			September 30, 2015
	(In millions) (Unaudited)
ASSETS
Homebuilding:
Cash and cash equivalents	$	1,245.7		$	1,355.9
Restricted cash	9.7			9.7
Inventories:
Construction in progress and finished homes	3,792.6			3,501.2
Residential land and lots — developed and under development	4,072.6			4,065.3
Land held for development	185.4			202.3
Land held for sale	37.6			38.2
	8,088.2			7,807.0
Deferred income taxes, net of valuation allowance of $10.1 million at December 31, 2015 and September 30, 2015	542.2			558.1
Property and equipment, net	147.6			144.0
Other assets	434.3			456.2
Goodwill	87.2			87.2
	10,554.9			10,418.1
Financial Services:
Cash and cash equivalents	23.0			27.9
Mortgage loans held for sale	524.4			631.0
Other assets	77.2			74.0
	624.6			732.9
Total assets	$	11,179.5		$	11,151.0
LIABILITIES
Homebuilding:
Accounts payable	$	415.6		$	473.0
Accrued expenses and other liabilities	935.3			929.2
Notes payable	3,337.2			3,333.6
	4,688.1			4,735.8
Financial Services:
Accounts payable and other liabilities	33.8			41.9
Mortgage repurchase facility	397.1			477.9
	430.9			519.8
Total liabilities	5,119.0			5,255.6
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, 376,927,248 shares issued and 369,727,177 shares outstanding at December 31, 2015 and 375,847,442 shares issued and 368,647,371 shares outstanding at September 30, 2015	3.8			3.8
Additional paid-in capital	2,769.6			2,733.8
Retained earnings	3,417.7			3,289.6
Treasury stock, 7,200,071 shares at December 31, 2015 and September 30, 2015, at cost	(134.3		)	(134.3		)
Accumulated other comprehensive income	2.6			1.4
Stockholders’ equity	6,059.4			5,894.3
Noncontrolling interests	1.1			1.1
Total equity	6,060.5			5,895.4
Total liabilities and equity	$	11,179.5		$	11,151.0

See accompanying notes to consolidated financial statements.

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D.R. HORTON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME



	Three Months Ended December 31,
	2015			2014
	(In millions, except per share data) (Unaudited)
Homebuilding:
Revenues:
Home sales	$	2,340.9		$	2,240.7
Land/lot sales and other	20.2			12.3
	2,361.1			2,253.0
Cost of sales:
Home sales	1,874.3			1,798.1
Land/lot sales and other	15.9			10.3
Inventory and land option charges	2.0			6.0
	1,892.2			1,814.4
Gross profit:
Home sales	466.6			442.6
Land/lot sales and other	4.3			2.0
Inventory and land option charges	(2.0		)	(6.0		)
	468.9			438.6
Selling, general and administrative expense	243.3			238.0
Other (income)	(3.4		)	(5.5		)
Homebuilding pre-tax income	229.0			206.1
Financial Services:
Revenues	55.3			49.6
General and administrative expense	46.1			37.8
Interest and other (income)	(3.1		)	(2.8		)
Financial services pre-tax income	12.3			14.6
Income before income taxes	241.3			220.7
Income tax expense	83.6			78.2
Net income	$	157.7		$	142.5
Other comprehensive income, net of income tax:
Unrealized gain related to debt securities collateralized by residential real estate	1.2			—
Comprehensive income	$	158.9		$	142.5

Basic net income per common share	$	0.43		$	0.39
Net income per common share assuming dilution	$	0.42		$	0.39
Cash dividends declared per common share	$	0.08		$	0.0625

See accompanying notes to consolidated financial statements.

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D.R. HORTON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS



	Three Months Ended December 31,
	2015			2014
	(In millions) (Unaudited)
OPERATING ACTIVITIES
Net income	$	157.7		$	142.5
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization	13.6			12.3
Amortization of discounts and fees	1.4			1.3
Stock based compensation expense	10.4			11.4
Excess income tax benefit from employee stock awards	(2.2		)	(1.2		)
Deferred income taxes	13.4			12.3
Inventory and land option charges	2.0			6.0
Changes in operating assets and liabilities:
Increase in construction in progress and finished homes	(290.3		)	(179.5		)
Decrease (increase) in residential land and lots – developed, under development, held for development and held for sale	8.4			(110.8		)
Decrease (increase) in other assets	30.2			(2.9		)
Decrease in mortgage loans held for sale	106.6			23.1
Decrease in accounts payable, accrued expenses and other liabilities	(52.7		)	(43.5		)
Net cash used in operating activities	(1.5		)	(129.0		)
INVESTING ACTIVITIES
Purchases of property and equipment	(20.1		)	(11.3		)
Decrease in restricted cash	—			0.4
Net principal increase of other mortgage loans and real estate owned	(2.1		)	(3.0		)
Net cash used in investing activities	(22.2		)	(13.9		)
FINANCING ACTIVITIES
Proceeds from notes payable	—			490.0
Repayment of notes payable	(81.0		)	(450.9		)
Proceeds from stock associated with certain employee benefit plans	17.0			4.6
Excess income tax benefit from employee stock awards	2.2			1.2
Cash dividends paid	(29.6		)	(22.8		)
Net cash (used in) provided by financing activities	(91.4		)	22.1
DECREASE IN CASH AND CASH EQUIVALENTS	(115.1		)	(120.8		)
Cash and cash equivalents at beginning of period	1,383.8			661.8
Cash and cash equivalents at end of period	$	1,268.7		$	541.0
Supplemental disclosures of non-cash activities:
Notes payable issued for inventory	$	2.9		$	5.5
Stock issued under employee incentive plans	$	8.1		$	8.3

See accompanying notes to consolidated financial statements.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

December 31, 2015

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 collectively referred to as the Company, unless the context otherwise requires). All 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, these financial statements reflect all adjustments considered necessary to present fairly the results for the interim periods shown, including normal recurring accruals and other items. 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, 2015.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an initial maturity of three months or less when purchased to be cash equivalents. Proceeds from home closings held for the Company’s benefit at title companies are included in homebuilding cash and cash equivalents in the consolidated balance sheets.

Cash balances of the Company's captive insurance subsidiary, which are expected to be used to fund the subsidiary's operations and pay future anticipated legal claims, were $41.2 million and $40.5 million at December 31, 2015 and September 30, 2015, respectively, and are included in homebuilding cash and cash equivalents in the consolidated balance sheets.

Seasonality

Historically, the homebuilding industry has experienced seasonal fluctuations; therefore, the operating results for the three months ended December 31, 2015 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2016 or subsequent periods.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

Recent Accounting Pronouncements

In January 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-04, “Receivables - Troubled Debt Restructurings by Creditors,” which was revised in August 2014. ASU 2014-04 applies to all creditors who obtain physical possession of residential real estate property collateralizing a consumer mortgage loan in satisfaction of a receivable. The guidance clarifies when an in-substance repossession or foreclosure of the property has occurred and helps determine when a creditor should derecognize a loan receivable and recognize real estate property. ASU 2014-14 applies to creditors that hold government-guaranteed mortgage loans and requires that these loans, including those guaranteed by the Federal Housing Administration (FHA) and Veterans Affairs (VA), be derecognized and that a separate receivable be recognized upon foreclosure if certain conditions are met. Upon foreclosure, the separate receivable should be measured based on the amount of the loan balance expected to be recovered from the guarantor. The guidance was effective for the Company beginning October 1, 2015 and did not have an 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 that will replace most existing revenue recognition guidance. The core principle of this guidance is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. The guidance is effective for the Company beginning October 1, 2018 and allows for 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.

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements - Going Concern,” which provides guidance about management's responsibility to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and to provide related footnote disclosures. This guidance is intended to reduce the diversity in the timing and content of footnote disclosures. The guidance is effective for the Company in its fiscal year ending September 30, 2017 and is not expected to have any impact on its consolidated financial position, results of operations or cash flows.

In February 2015, the FASB issued ASU 2015-02, “Consolidation,” which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The guidance is effective for the Company beginning October 1, 2016 and is not expected to have a material impact on its consolidated financial position, results of operations or cash flows.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory,” which simplifies the subsequent measurement of inventory, excluding inventory measured using the last-in, first-out or retail inventory methods. The guidance specifies that inventory currently measured at the lower of cost or market, where market could be determined with different methods, should now be measured at the lower of cost or net realizable value. The guidance is effective for the Company beginning October 1, 2017 and is not expected to have a material impact on its consolidated financial position, results of operations or cash flows.

In September 2015, the FASB issued ASU 2015-16, “Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments,” which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The guidance is effective for the Company beginning October 1, 2016 and is not expected to have a material impact on its consolidated financial position, results of operations or cash flows.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE B – SEGMENT INFORMATION

The Company is a national homebuilder that is primarily engaged in the acquisition and development of land and the construction and sale of residential homes, 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 fully developed 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 or for other strategic reasons. 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’s financial services segment primarily provides mortgage financing and title agency services to homebuyers in many of the Company's homebuilding markets. The Company sells substantially all of the mortgages it originates and the related servicing rights to third-party purchasers. The financial services segment primarily generates its revenues from originating and selling mortgages and collecting fees for title insurance agency and closing services.

The Company’s 39 homebuilding operating divisions and its financial services operations 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, Oklahoma and Texas
	Southwest:		Arizona and New Mexico
	West:		California, Hawaii, Nevada, Oregon, Utah and Washington

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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, 2015. Financial information relating to the Company's reporting segments is as follows:



	Three Months Ended December 31,
	2015		2014
	(In millions)
Revenues
Homebuilding revenues:
East	$	298.1	$	298.7
Midwest	123.3		130.0
Southeast	711.6		619.4
South Central	612.6		579.7
Southwest	73.9		75.4
West	541.6		549.8
Homebuilding revenues	2,361.1		2,253.0
Financial services revenues	55.3		49.6
Total revenues	$	2,416.4	$	2,302.6
Inventory Impairments
East	$	—	$	—
Midwest	—		—
Southeast	0.2		—
South Central	—		—
Southwest	—		—
West	0.3		3.8
Total inventory impairments	$	0.5	$	3.8
Income Before Income Taxes (1)
Homebuilding pre-tax income:
East	$	27.7	$	26.3
Midwest	7.0		4.8
Southeast	76.9		58.0
South Central	64.7		61.2
Southwest	2.7		1.9
West	50.0		53.9
Homebuilding pre-tax income	229.0		206.1
Financial services pre-tax income	12.3		14.6
Income before income taxes	$	241.3	$	220.7

________________

(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 cost of sales, while those expenses associated with the corporate office are allocated to each segment based on the segment’s inventory balances.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015



	December 31, 2015		September 30, 2015
	(In millions)
Homebuilding Inventories (1)
East	$	812.1	$	817.3
Midwest	486.9		474.5
Southeast	1,931.5		1,876.7
South Central	1,999.6		1,909.0
Southwest	334.1		312.4
West	2,261.0		2,165.3
Corporate and unallocated (2)	263.0		251.8
Total homebuilding inventories	$	8,088.2	$	7,807.0

________________


(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.

NOTE C – INVENTORY

At December 31, 2015, 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 and land inventories with a combined carrying value of $249.3 million and recorded impairment charges of $0.5 million during the three months ended December 31, 2015 to reduce the carrying value of impaired communities to their estimated fair value. There were $3.8 million of impairment charges recorded in the three months ended December 31, 2014.

During the three months ended December 31, 2015 and 2014, the Company wrote off $1.5 million and $2.2 million, respectively, of earnest money deposits and pre-acquisition costs related to land option contracts that the Company expects to terminate.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE D – NOTES PAYABLE

The Company’s notes payable at their principal amounts, net of any unamortized discounts and debt issuance costs, consist of the following:



	December 31, 2015		September 30, 2015
	(In millions)
Homebuilding:
Unsecured:
Revolving credit facility, maturing 2020	$	—	$	—
5.625% senior notes due 2016	170.2		170.1
6.5% senior notes due 2016	372.6		372.5
4.75% senior notes due 2017	348.9		348.7
3.625% senior notes due 2018	398.4		398.2
3.75% senior notes due 2019	497.4		497.3
4.0% senior notes due 2020	496.6		496.4
4.375% senior notes due 2022	347.5		347.4
4.75% senior notes due 2023	297.9		297.9
5.75% senior notes due 2023	397.1		397.0
Other secured notes	10.6		8.1
	$	3,337.2	$	3,333.6
Financial Services:
Mortgage repurchase facility, maturing 2016	$	397.1	$	477.9

Debt issuance costs that were deducted from the carrying amounts of the senior notes totaled $16.3 million and $17.3 million at December 31, 2015 and September 30, 2015, respectively.

Homebuilding:

The Company has a $975 million senior unsecured revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to $1.25 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 approximately 50% 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 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, 2020. At December 31, 2015, there were no borrowings outstanding and $103.9 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 December 31, 2015, the Company was in compliance with all of the covenants, limitations and restrictions of its revolving credit facility and public debt obligations.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

The Company has an automatically effective universal shelf registration statement filed with the Securities and Exchange Commission (SEC) in August 2015, registering debt and equity securities that the Company may issue from time to time in amounts to be determined.

On January 15, 2016, the Company repaid the remaining $170.2 million principal amount of its 5.625% senior notes which were due on that date.

Effective August 1, 2015, the Board of Directors authorized the repurchase of up to $500 million of the Company's debt securities effective through July 31, 2016. All of the $500 million authorization was remaining at December 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 60 days in accordance with the terms of the mortgage repurchase facility. The total capacity of the facility is $400 million; however, the capacity can be increased, without requiring additional commitments, to $450 million during the last five days of any fiscal quarter and the first twenty-five days of the following fiscal quarter. Additionally, the capacity of the facility can be increased to $550 million subject to the availability of additional commitments. The Company is currently in discussions with its lenders and expects to renew and extend the term of the facility on similar terms prior to its February 26, 2016 maturity date.

As of December 31, 2015, $472.2 million of mortgage loans held for sale with a collateral value of $456.1 million were pledged under the mortgage repurchase facility. As a result of advance paydowns totaling $59.0 million, DHI Mortgage had an obligation of $397.1 million outstanding under the mortgage repurchase facility at December 31, 2015 at a 2.7% 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 to the lenders monthly. At December 31, 2015, DHI Mortgage was in compliance with all of the conditions and covenants of the mortgage repurchase facility.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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 periods in which the Company’s active inventory is lower than its debt level, a portion of the interest incurred is reflected as interest expense in the period incurred. During the first quarter of fiscal 2016 and in fiscal 2015, the Company's active inventory has exceeded its debt level, and all interest incurred has been capitalized to inventory.

The following table summarizes the Company’s interest costs incurred, capitalized and expensed during the three months ended December 31, 2015 and 2014:



	Three Months Ended December 31,
	2015			2014
	(In millions)
Capitalized interest, beginning of period	$	208.0		$	198.5
Interest incurred (1)	42.2			40.4
Interest expensed:
Charged to cost of sales	(35.2		)	(33.6		)
Written off with inventory impairments	—			(0.1		)
Capitalized interest, end of period	$	215.0		$	205.2

_______________


(1)	Interest incurred includes interest incurred on the Company's financial services mortgage repurchase facility of $1.6 million in both the three months ended December 31, 2015 and 2014.

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 December 31, 2015, mortgage loans held for sale had an aggregate fair value of $524.4 million and an aggregate outstanding principal balance of $511.6 million. At September 30, 2015, mortgage loans held for sale had an aggregate fair value of $631.0 million and an aggregate outstanding principal balance of $608.9 million. During the three months ended December 31, 2015 and 2014, mortgage loans originated totaled $1.1 billion and $1.0 billion, respectively, and mortgage loans sold totaled $1.2 billion and $1.1 billion, respectively. The Company had gains on sales of loans and servicing rights of $37.2 million during the three months ended December 31, 2015, compared to $32.7 million in the prior year period. Net gains on sales of loans and servicing rights are included in financial services revenues in the consolidated statements of operations. Approximately 72% of the mortgage loans sold by DHI Mortgage during the three months ended December 31, 2015 were sold to three major financial entities, one of which purchased 27% 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.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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 months ended December 31, 2015 and 2014 was not significant, is recognized in financial services revenues in the consolidated statements of operations. At December 31, 2015 and September 30, 2015, the Company's mortgage loans held for sale that were not committed to third-party purchasers totaled $373.5 million and $385.3 million, respectively, and the notional amounts of the hedging instruments related to those loans totaled $372.7 million and $383.8 million, respectively.

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. These representations and warranties primarily 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. The majority of other mortgage loans consists 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 December 31, 2015 and September 30, 2015, the Company’s total other mortgage loans and real estate owned, before loss reserves, were as follows:



	December 31, 2015		September 30, 2015
	(In millions)
Other mortgage loans	$	50.3	$	49.0
Real estate owned	0.3		0.6
	$	50.6	$	49.6

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 repurchase and settlement 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 December 31, 2015 and September 30, 2015 were as follows:



	December 31, 2015		September 30, 2015
	(In millions)
Loss reserves related to:
Other mortgage loans	$	1.9	$	1.5
Real estate owned	0.1		0.1
Loan repurchase and settlement obligations – known and expected	9.3		9.8
	$	11.3	$	11.4

Other mortgage loans and real estate owned net of 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.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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 December 31, 2015 and September 30, 2015, the notional amount of IRLCs, which are accounted for as derivative instruments recorded at fair value, totaled $372.9 million and $370.9 million, respectively.

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. At December 31, 2015 and September 30, 2015, the notional amount of best-efforts whole loan delivery commitments totaled $32.6 million and $37.7 million, respectively, and the notional amount of hedging instruments related to IRLCs not yet committed to purchasers totaled $301.3 million and $297.2 million, respectively.

NOTE G – INCOME TAXES

The Company’s income tax expense for the three months ended December 31, 2015 and 2014 was $83.6 million and $78.2 million, respectively. The effective tax rate was 34.6% for the three months ended December 31, 2015, compared to 35.4% in the prior year period. The effective tax rates for both periods include an expense for state income taxes that was reduced by a tax benefit for the domestic production activities deduction and a tax benefit related to the retroactive application of new tax legislation.

At December 31, 2015 and September 30, 2015, the Company had deferred tax assets, net of deferred tax liabilities, of $552.3 million and $568.2 million, respectively, partially offset by a valuation allowance of $10.1 million. 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.

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 valuation allowance for both periods relates to the Company’s state deferred tax assets for net operating loss (NOL) carryforwards and tax credit carryforwards. The Company believes it is more likely than not that a portion of its state NOL carryforwards and state tax credit carryforwards will not be realized because some state NOL and tax credit carryforward periods are too brief to realize the related deferred tax assets. The Company will continue to evaluate both the positive and negative evidence in determining the need for a valuation allowance with respect to its remaining state NOL carryforwards and state tax credit carryforwards.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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 8.9 million shares of common stock were excluded from the computation of diluted earnings per share for the 2014 period because their effect would have been antidilutive.



	Three Months Ended December 31,
	2015		2014
	(In millions)
Numerator:
Net income	$	157.7	$	142.5
Denominator:
Denominator for basic earnings per share — weighted average common shares	369.3		364.9
Effect of dilutive securities:
Employee stock awards	4.2		3.2
Denominator for diluted earnings per share — adjusted weighted average common shares	373.5		368.1

Basic net income per common share	$	0.43	$	0.39
Net income per common share assuming dilution	$	0.42	$	0.39

NOTE I – STOCKHOLDERS’ EQUITY

The Company has an automatically effective universal shelf registration statement, filed with the SEC in August 2015, registering debt and equity securities that it may issue from time to time in amounts to be determined.

Effective August 1, 2015, the Board of Directors authorized the repurchase of up to $100 million of the Company’s common stock effective through July 31, 2016. All of the $100 million authorization was remaining at December 31, 2015, and no common stock has been repurchased subsequent to December 31, 2015.

During the three months ended December 31, 2015, the Board of Directors approved a quarterly cash dividend of $0.08 per common share, which was paid on December 14, 2015 to stockholders of record on November 30, 2015. In January 2016, the Board of Directors approved a quarterly cash dividend of $0.08 per common share, payable on February 17, 2016 to stockholders of record on February 5, 2016. Quarterly cash dividends of $0.0625 per common share were approved and paid in the comparable quarters of fiscal 2015.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE J – EMPLOYEE BENEFIT PLANS

Restricted Stock Units (RSUs)

The Company’s Stock Incentive Plan provides for the granting of stock options and restricted stock units by the Compensation Committee of the Board of Directors to executive officers, other key employees and non-management directors. Restricted stock unit awards may be based on performance (performance-based) or on service over a requisite time period (time-based).

In November 2015, a total of 330,000 performance-based RSU equity awards were granted to the Company's Chairman, its Chief Executive Officer and its Chief Operating Officer. These awards vest at the end of a three-year performance period ending September 30, 2018. 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 total shareholder return; return on investment; selling, general and administrative expense containment; and gross profit. The performance-based RSUs have no dividend or voting rights during the performance period. Each performance-based RSU represents the contingent right to receive one share of the Company's common stock if the vesting conditions are satisfied. The fair value of these equity awards on the date of grant was $30.81 per unit. Compensation expense related to these grants was $1.1 million for the three months ended December 31, 2015 based on the Company's performance against the peer group, the elapsed portion of the performance period and the grant date fair value of the award.

In November 2015, 30,000 time-based RSUs were granted to the Company's Chief Financial Officer. These time-based RSUs vest annually in equal installments over a three-year period ending in November 2018 and have no dividend or voting rights during the vesting period. Each time-based RSU represents the contingent right to receive one share of the Company's common stock if the vesting conditions are satisfied. The fair value of this equity award on the date of grant was $28.98 per unit.

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 months ended December 31, 2015 and 2014 were as follows:



	Three Months Ended December 31,
	2015			2014
	(In millions)
Warranty liability, beginning of period	$	82.0		$	65.7
Warranties issued	10.6			10.0
Changes in liability for pre-existing warranties	1.2			(2.2		)
Settlements made	(9.7		)	(7.6		)
Warranty liability, end of period	$	84.1		$	65.9

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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 $458.9 million and $451.0 million at December 31, 2015 and September 30, 2015, respectively, and are included in homebuilding accrued expenses and other liabilities in the consolidated balance sheets. At both December 31, 2015 and September 30, 2015, approximately 99% of these reserves related to construction defect matters. Expenses related to the Company’s legal contingencies were $17.3 million and $11.3 million in the three months ended December 31, 2015 and 2014, respectively.

The Company’s reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. As of December 31, 2015, 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 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 over the past ten years. If the ultimate resolution of construction defect claims resulting from the Company's home closings in prior 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 increased from $451.0 million at September 30, 2015 to $458.9 million at December 31, 2015 due to an increase in the number of closed homes that are subject to possible future construction defect claims, partially offset by payments made for legal claims during the period, net of reimbursements received from subcontractors. Changes in the Company’s legal claims reserves during the three months ended December 31, 2015 and 2014 were as follows:



	Three Months Ended December 31,
	2015			2014
	(In millions)
Reserves for legal claims, beginning of period	$	451.0		$	456.9
Increase in reserves	21.8			12.9
Payments	(13.9		)	(12.2		)
Reserves for legal claims, end of period	$	458.9		$	457.6

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

The Company estimates and records receivables under its 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 for pending legal claims and anticipated future claims related to previously closed homes totaled $127.8 million, $126.5 million and $137.7 million at December 31, 2015, September 30, 2015 and December 31, 2014, respectively, and are included in homebuilding other assets in the consolidated balance sheets.

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. 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 deposits are included in homebuilding other assets in the consolidated balance sheets.

At December 31, 2015, the Company had total deposits of $88.7 million, consisting of cash deposits of $84.0 million and promissory notes and letters of credit of $4.7 million, to purchase land and lots with a total remaining purchase price of approximately $2.5 billion. A limited number of the land and lot option purchase contracts at December 31, 2015, representing $37.0 million of remaining purchase price, were subject to specific performance provisions 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.

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 December 31, 2015 and September 30, 2015 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 December 31, 2015 and September 30, 2015, the option deposits related to these contracts totaled $83.2 million and $74.4 million, respectively.

Other Commitments

At December 31, 2015, the Company had outstanding surety bonds of $1.0 billion and letters of credit of $107.1 million to secure performance under various contracts. Of the total letters of credit, $103.9 million were issued under the Company's revolving credit facility and were cash collateralized to receive better pricing. This unrestricted cash can be withdrawn by the Company at its discretion. The remaining $3.2 million of letters of credit were issued under a secured letter of credit agreement requiring the Company to deposit cash as collateral with the issuing bank, and the cash restricted for this purpose is included in homebuilding restricted cash in the consolidated balance sheets.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE L – OTHER ASSETS AND ACCRUED EXPENSES AND OTHER LIABILITIES

The Company’s homebuilding other assets at December 31, 2015 and September 30, 2015 were as follows:



	December 31, 2015		September 30, 2015
	(In millions)
Insurance receivables	$	127.8	$	126.5
Earnest money and refundable deposits	143.3		137.2
Accounts and notes receivable	29.9		49.2
Prepaid assets	31.8		40.9
Rental properties	45.9		47.1
Debt securities collateralized by residential real estate	35.5		33.9
Other assets	20.1		21.4
	$	434.3	$	456.2

The Company’s homebuilding accrued expenses and other liabilities at December 31, 2015 and September 30, 2015 were as follows:



	December 31, 2015		September 30, 2015
	(In millions)
Reserves for legal claims	$	458.9	$	451.0
Employee compensation and related liabilities	142.2		172.7
Warranty liability	84.1		82.0
Accrued interest	49.4		30.7
Federal and state income tax liabilities	65.1		36.1
Inventory related accruals	25.4		30.0
Homebuyer deposits	56.8		58.9
Accrued property taxes	23.7		32.0
Other liabilities	29.7		35.8
	$	935.3	$	929.2

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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, rental properties 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 other mortgage loans; and


▪	rental properties and real estate owned.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

The following tables summarize the Company’s assets and liabilities measured at fair value on a recurring basis at December 31, 2015 and September 30, 2015, and the changes in the fair value of the Level 3 assets during the three months ended December 31, 2015 and 2014.



		Fair Value at December 31, 2015
	Balance Sheet Location	Level 1		Level 2			Level 3		Total
		(In millions)
Homebuilding:
Debt securities collateralized by residential real estate (a)	Other assets	$	—	$	—		$	35.5	$	35.5
Financial Services:
Mortgage loans held for sale (b)	Mortgage loans held for sale	—		507.0			17.4		524.4
Derivatives not designated as hedging instruments (c):
Interest rate lock commitments	Other assets	—		5.5			—		5.5
Forward sales of MBS	Other liabilities	—		(0.5		)	—		(0.5		)
Best-efforts and mandatory commitments	Other assets	—		0.1			—		0.1



		Fair Value at September 30, 2015
	Balance Sheet Location	Level 1		Level 2			Level 3		Total
		(In millions)
Homebuilding:
Debt securities collateralized by residential real estate (a)	Other assets	$	—	$	—		$	33.9	$	33.9
Financial Services:
Mortgage loans held for sale (b)	Mortgage loans held for sale	—		617.1			13.9		631.0
Derivatives not designated as hedging instruments (c):
Interest rate lock commitments	Other assets	—		3.6			—		3.6
Forward sales of MBS	Other liabilities	—		(6.0		)	—		(6.0		)
Best-efforts and mandatory commitments	Other liabilities	—		(1.1		)	—		(1.1		)



	Level 3 Assets at Fair Value for the Three Months Ended December 31, 2015
	Balance at September 30, 2015		Net realized and unrealized gains (losses)			Purchases		Sales and Settlements			Principal Reductions			Net transfers in (out) of Level 3		Balance at December 31, 2015
	(In millions)
Debt securities collateralized by residential real estate (a)	$	33.9	$	1.9		$	—	$	—		$	(0.3	)	$	—	$	35.5
Mortgage loans held for sale (b)	13.9		(0.1		)	—		(0.3		)	—			3.9		17.4
	Level 3 Assets at Fair Value for the Three Months Ended December 31, 2014
	Balance at September 30, 2014		Net realized and unrealized gains (losses)			Purchases		Sales and Settlements			Principal Reductions			Net transfers in (out) of Level 3		Balance at December 31, 2014
	(In millions)
Debt securities collateralized by residential real estate (a)	$	20.8	$	—		$	—	$	—		$	—		$	—	$	20.8
Mortgage loans held for sale (b)	12.0		0.2			—		(0.3		)	—			0.7		12.6

(a)

In October 2012, the Company purchased defaulted debt securities, which were secured by residential real estate, for $18.6 million in cash. In fiscal 2015, the Company purchased the residential real estate parcel and all additional defaulted debt securities associated with the parcel for $19.9 million in cash, of which $5.1 million was allocated to the land and $14.8 million was allocated to the debt securities. The Company is developing the property to build and sell homes and sold the debt securities to a third party in January 2016. 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. The fair value of the securities was determined based on the proceeds received from their sale in January 2016. 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 December 31, 2015 includes $17.4 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, as calculated by reference to quoted prices for similar assets, 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.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

The following table summarizes the Company’s assets measured at fair value on a nonrecurring basis at December 31, 2015 and September 30, 2015:



		Fair Value at December 31, 2015		Fair Value at September 30, 2015
		Fair Value at December 31, 2015		Fair Value at September 30, 2015
	Balance Sheet Location	Level 3		Level 3
		(In millions)
Homebuilding:
Inventory held and used (a) (b)	Inventories	$	3.8	$	10.1
Inventory available for sale (a) (c)	Inventories	0.7		2.8
Financial Services:
Other mortgage loans (a) (d)	Other assets	40.0		15.2
Real estate owned (a) (d)	Other assets	0.2		0.5

_______________________________________


(a)	The fair values included in the table above represent only those assets whose carrying values were adjusted to fair value in the respective period.


(b)	In performing its impairment analysis of communities, discount rates ranging from 12% to 14% 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 December 31, 2015 and September 30, 2015:



	Carrying Value		Fair Value at December 31, 2015
	Carrying Value		Level 1		Level 2		Level 3		Total
	(In millions)
Homebuilding:
Cash and cash equivalents (a)	$	1,245.7	$	1,245.7	$	—	$	—	$	1,245.7
Restricted cash (a)	9.7		9.7		—		—		9.7
Senior notes (b)	3,326.6		—		3,394.3		—		3,394.3
Other secured notes (a)	10.6		—		—		10.6		10.6
Financial Services:
Cash and cash equivalents (a)	23.0		23.0		—		—		23.0
Mortgage repurchase facility (a)	397.1		—		—		397.1		397.1



	Carrying Value		Fair Value at September 30, 2015
	Carrying Value		Level 1		Level 2		Level 3		Total
	(In millions)
Homebuilding:
Cash and cash equivalents (a)	$	1,355.9	$	1,355.9	$	—	$	—	$	1,355.9
Restricted cash (a)	9.7		9.7		—		—		9.7
Senior notes (b)	3,325.5		—		3,405.9		—		3,405.9
Other secured notes (a)	8.1		—		—		8.1		8.1
Financial Services:
Cash and cash equivalents (a)	27.9		27.9		—		—		27.9
Mortgage repurchase facility (a)	477.9		—		—		477.9		477.9

_______________________________________


(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.

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D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

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.

Consolidating Balance Sheet

December 31, 2015



	D.R. Horton, Inc.		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Total
	(In millions)
ASSETS
Cash and cash equivalents	$	1,166.1	$	34.2	$	68.4	$	—		$	1,268.7
Restricted cash	7.2		2.5		—		—			9.7
Investments in subsidiaries	3,569.1		—		—		(3,569.1		)	—
Inventories	2,679.2		5,383.7		25.3		—			8,088.2
Deferred income taxes	174.4		362.6		5.2		—			542.2
Property and equipment, net	58.4		52.5		36.7		—			147.6
Other assets	174.8		244.3		94.9		(2.5		)	511.5
Mortgage loans held for sale	—		—		524.4		—			524.4
Goodwill	—		87.2		—		—			87.2
Intercompany receivables	1,996.9		5.4		—		(2,002.3		)	—
Total Assets	$	9,826.1	$	6,172.4	$	754.9	$	(5,573.9	)	$	11,179.5
LIABILITIES & EQUITY
Accounts payable and other liabilities	$	438.8	$	828.1	$	117.8	$	—		$	1,384.7
Intercompany payables	—		1,913.4		91.4		(2,004.8		)	—
Notes payable	3,327.9		9.3		397.1		—			3,734.3
Total Liabilities	3,766.7		2,750.8		606.3		(2,004.8		)	5,119.0
Stockholders’ equity	6,059.4		3,421.6		147.5		(3,569.1		)	6,059.4
Noncontrolling interests	—		—		1.1		—			1.1
Total Equity	6,059.4		3,421.6		148.6		(3,569.1		)	6,060.5
Total Liabilities & Equity	$	9,826.1	$	6,172.4	$	754.9	$	(5,573.9	)	$	11,179.5

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Balance Sheet

September 30, 2015



	D.R. Horton, Inc.		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Total
	(In millions)
ASSETS
Cash and cash equivalents	$	1,217.7	$	94.6	$	71.5	$	—		$	1,383.8
Restricted cash	7.4		2.3		—		—			9.7
Investments in subsidiaries	3,479.7		—		—		(3,479.7		)	—
Inventories	2,597.3		5,184.3		25.4		—			7,807.0
Deferred income taxes	179.9		373.0		5.2		—			558.1
Property and equipment, net	54.6		52.7		36.7		—			144.0
Other assets	199.5		240.4		90.3		—			530.2
Mortgage loans held for sale	—		—		631.0		—			631.0
Goodwill	—		87.2		—		—			87.2
Intercompany receivables	1,932.2		—		—		(1,932.2		)	—
Total Assets	$	9,668.3	$	6,034.5	$	860.1	$	(5,411.9	)	$	11,151.0
LIABILITIES & EQUITY
Accounts payable and other liabilities	$	447.2	$	872.8	$	124.1	$	—		$	1,444.1
Intercompany payables	—		1,856.7		75.5		(1,932.2		)	—
Notes payable	3,326.8		6.8		477.9		—			3,811.5
Total Liabilities	3,774.0		2,736.3		677.5		(1,932.2		)	5,255.6
Stockholders’ equity	5,894.3		3,298.2		181.5		(3,479.7		)	5,894.3
Noncontrolling interests	—		—		1.1		—			1.1
Total Equity	5,894.3		3,298.2		182.6		(3,479.7		)	5,895.4
Total Liabilities & Equity	$	9,668.3	$	6,034.5	$	860.1	$	(5,411.9	)	$	11,151.0

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Statement of Operations

Three Months Ended December 31, 2015



	D.R. Horton, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
	(In millions)
Homebuilding:
Revenues	$	795.6		$	1,570.9		$	—		$	(5.4	)	$	2,361.1
Cost of sales	638.9			1,253.8			2.4			(2.9		)	1,892.2
Gross profit (loss)	156.7			317.1			(2.4		)	(2.5		)	468.9
Selling, general and administrative expense	111.9			129.2			2.2			—			243.3
Equity in (income) of subsidiaries	(195.7		)	—			—			195.7			—
Other (income)	(0.8		)	(0.7		)	(1.9		)	—			(3.4		)
Homebuilding pre-tax income (loss)	241.3			188.6			(2.7		)	(198.2		)	229.0
Financial Services:
Revenues	—			—			55.3			—			55.3
General and administrative expense	—			—			46.1			—			46.1
Interest and other (income)	—			—			(3.1		)	—			(3.1		)
Financial services pre-tax income	—			—			12.3			—			12.3
Income before income taxes	241.3			188.6			9.6			(198.2		)	241.3
Income tax expense	83.6			65.1			3.7			(68.8		)	83.6
Net income	$	157.7		$	123.5		$	5.9		$	(129.4	)	$	157.7
Comprehensive income	$	158.9		$	123.5		$	5.9		$	(129.4	)	$	158.9

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Statement of Operations

Three Months Ended December 31, 2014



	D.R. Horton, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
	(In millions)
Homebuilding:
Revenues	$	696.8		$	1,556.2		$	—		$	—		$	2,253.0
Cost of sales	554.0			1,257.0			3.4			—			1,814.4
Gross profit (loss)	142.8			299.2			(3.4		)	—			438.6
Selling, general and administrative expense	110.2			121.2			6.6			—			238.0
Equity in (income) of subsidiaries	(187.8		)	—			—			187.8			—
Other (income)	(0.3		)	(1.3		)	(3.9		)	—			(5.5		)
Homebuilding pre-tax income (loss)	220.7			179.3			(6.1		)	(187.8		)	206.1
Financial Services:
Revenues	—			—			49.6			—			49.6
General and administrative expense	—			—			37.8			—			37.8
Interest and other (income)	—			—			(2.8		)	—			(2.8		)
Financial services pre-tax income	—			—			14.6			—			14.6
Income before income taxes	220.7			179.3			8.5			(187.8		)	220.7
Income tax expense	78.2			63.2			3.4			(66.6		)	78.2
Net income	$	142.5		$	116.1		$	5.1		$	(121.2	)	$	142.5
Comprehensive income	$	142.5		$	116.1		$	5.1		$	(121.2	)	$	142.5

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) – (Continued)

December 31, 2015

NOTE N – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Statement of Cash Flows

Three Months Ended December 31, 2015

D.R.

Horton, Inc.

Guarantor

Subsidiaries

Non-Guarantor

Subsidiaries

Eliminations

Total

(In millions)

OPERATING ACTIVITIES

Net cash provided by (used in) operating activities

35.7