Edgar Filing: HORTON D R INC /DE/

12.31.2012 10Q

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, 2012



¨	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 – 321,326,473 shares as of January 23, 2013

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, 2012 (unaudited) and September 30, 2012 (unaudited)		3
Consolidated Statements of Operations and Comprehensive Income for the three months ended December 31, 2012 and 2011 (unaudited)		4
Consolidated Statements of Cash Flows for the three months ended December 31, 2012 and 2011 (unaudited)		5
Notes to Consolidated Financial Statements (unaudited)		6
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		29
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk		49
ITEM 4. Controls and Procedures		50
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings		50
ITEM 6. Exhibits		51
SIGNATURE		52

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

D.R. HORTON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



	December 31, 2012			September 30, 2012
	(In millions) (Unaudited)
ASSETS
Homebuilding:
Cash and cash equivalents	$	546.4		$	1,030.4
Marketable securities, available-for-sale	96.7			298.0
Restricted cash	54.8			49.3
Inventories:
Construction in progress and finished homes	1,909.5			1,682.7
Residential land and lots — developed and under development	2,475.7			1,838.4
Land held for development	629.9			644.1
	5,015.1			4,165.2
Income taxes receivable	—			14.4
Deferred income taxes, net of valuation allowance of $41.9 million at December 31, 2012 and September 30, 2012	683.5			709.5
Property and equipment, net	81.9			72.6
Other assets	454.2			456.8
Goodwill	38.9			38.9
	6,971.5			6,835.1
Financial Services:
Cash and cash equivalents	20.5			17.3
Mortgage loans held for sale	307.9			345.3
Other assets	47.4			50.5
	375.8			413.1
Total assets	$	7,347.3		$	7,248.2
LIABILITIES
Homebuilding:
Accounts payable	$	241.8		$	216.2
Accrued expenses and other liabilities	856.6			893.8
Notes payable	2,424.3			2,305.3
	3,522.7			3,415.3
Financial Services:
Accounts payable and other liabilities	42.1			50.4
Mortgage repurchase facility	169.4			187.8
	211.5			238.2
Total liabilities	3,734.2			3,653.5
Commitments and contingencies (Note L)
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, 328,464,422 shares issued and 321,264,351 shares outstanding at December 31, 2012 and 328,092,047 shares issued and 320,891,976 shares outstanding at September 30, 2012	3.3			3.3
Additional paid-in capital	1,992.2			1,979.8
Retained earnings	1,749.2			1,743.1
Treasury stock, 7,200,071 shares at December 31, 2012 and September 30, 2012, at cost	(134.3		)	(134.3		)
Accumulated other comprehensive income	—			0.2
Total stockholders’ equity	3,610.4			3,592.1
Noncontrolling interests	2.7			2.6
Total equity	3,613.1			3,594.7
Total liabilities and equity	$	7,347.3		$	7,248.2

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,
	2012			2011
	(In millions, except per share data) (Unaudited)
Homebuilding:
Revenues:
Home sales	$	1,223.3		$	884.3
Land/lot sales and other	9.9			1.3
	1,233.2			885.6
Cost of sales:
Home sales	992.8			735.6
Land/lot sales and other	8.2			—
Inventory impairments and land option cost write-offs	1.3			1.4
	1,002.3			737.0
Gross profit:
Home sales	230.5			148.7
Land/lot sales and other	1.7			1.3
Inventory impairments and land option cost write-offs	(1.3		)	(1.4		)
	230.9			148.6
Selling, general and administrative expense	140.8			119.0
Interest expense	3.2			6.9
Gain on early retirement of debt, net	—			(0.1		)
Other (income)	(3.3		)	(2.2		)
	90.2			25.0
Financial Services:
Revenues, net of recourse and reinsurance expense	41.9			21.0
General and administrative expense	25.7			18.9
Interest expense	1.0			0.9
Interest and other (income)	(2.5		)	(3.0		)
	17.7			4.2
Income before income taxes	107.9			29.2
Income tax expense	41.6			1.5
Net income	$	66.3		$	27.7
Other comprehensive income (loss), net of income tax:
Unrealized (loss) gain related to available-for-sale securities	(0.1		)	0.1
Comprehensive income	$	66.2		$	27.8
Basic net income per common share	$	0.21		$	0.09
Net income per common share assuming dilution	$	0.20		$	0.09
Cash dividends declared per common share	$	0.1875		$	0.0375

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,
	2012			2011
	(In millions) (Unaudited)
OPERATING ACTIVITIES
Net income	$	66.3		$	27.7
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization	4.8			5.0
Amortization of discounts and fees	10.4			9.8
Stock based compensation expense	3.5			5.0
Deferred income taxes	35.2			—
Gain on early retirement of debt, net	—			(0.1		)
Gain on sale of marketable securities	(0.2		)	—
Inventory impairments and land option cost write-offs	1.3			1.4
Changes in operating assets and liabilities:
(Increase) decrease in construction in progress and finished homes	(226.8		)	9.7
Increase in residential land and lots – developed, under development, and held for development	(612.8		)	(40.1		)
Decrease in other assets	22.8			6.1
Decrease in income taxes receivable	14.4			—
Decrease in mortgage loans held for sale	37.4			18.2
Decrease in accounts payable, accrued expenses and other liabilities	(12.8		)	(44.4		)
Net cash used in operating activities	(656.5		)	(1.7		)
INVESTING ACTIVITIES
Purchases of property and equipment	(14.0		)	(2.4		)
Purchases of marketable securities	(26.8		)	(24.4		)
Proceeds from the sale or maturity of marketable securities	226.7			21.5
(Increase) decrease in restricted cash	(5.5		)	4.5
Net principal increase of other mortgage loans and real estate owned	(0.2		)	(1.6		)
Purchases of debt securities collateralized by residential real estate	(18.6		)	—
Payment related to acquisition of a business	(9.4		)	—
Net cash provided by (used in) investing activities	152.2			(2.4		)
FINANCING ACTIVITIES
Proceeds from notes payable	100.0			29.5
Repayment of notes payable	(18.4		)	(12.6		)
Proceeds from stock associated with certain employee benefit plans	2.1			4.6
Cash dividends paid	(60.2		)	(11.9		)
Net cash provided by financing activities	23.5			9.6
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	(480.8		)	5.5
Cash and cash equivalents at beginning of period	1,047.7			732.6
Cash and cash equivalents at end of period	$	566.9		$	738.1
Supplemental disclosures of non-cash activities:
Notes payable issued for inventory	$	11.4		$	—
Stock issued under employee incentive plans	$	3.9		$	3.1

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, 2012

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 (consisting of normal, recurring accruals and the asset impairment charges, loss reserves and deferred tax asset valuation allowance discussed below) 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, 2012.

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.

Business

The Company is a national homebuilder that is engaged in the construction and sale of single-family housing in 26 states and 77 markets in the United States as of December 31, 2012. 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 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.

Reclassifications

The statement of cash flows for the three months ended December 31, 2011, including the cash flows for the Non-Guarantor Subsidiaries as reflected in Note O, has been corrected to reflect a $1.6 million use of cash previously reflected in operating activities to cash used in investing activities related to the net principal increase of other mortgage loans and real estate owned. The Company has determined that the impact to prior period financial statements is not material. As other prior period financial information is presented, the Company will similarly revise the statements of cash flows in its future filings.

Seasonality

Historically, the homebuilding industry has experienced seasonal fluctuations; therefore, the operating results for the three months ended December 31, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2013 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 the option purchase contracts, many of the option deposits are not refundable at the Company’s discretion.

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, 2012 and September 30, 2012 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 loss related to the Company’s variable interest entities is limited to the amounts of the

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D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

Company’s related option deposits. At December 31, 2012 and September 30, 2012, the amount of option deposits related to these contracts totaled $27.4 million and $32.0 million, respectively, and are included in homebuilding other assets on the consolidated balance sheets.

Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities,” which requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. The guidance is effective for the Company beginning October 1, 2013 and is to be applied retrospectively. The adoption of this guidance, which is related to disclosure only, is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In July 2012, the FASB issued ASU 2012-02, “Intangibles - Goodwill and Other,” which provides the option to perform a qualitative, rather than quantitative, assessment to determine whether it is more likely than not an indefinite-lived intangible asset is impaired. If the asset is considered impaired, an entity is required to perform the quantitative assessment under the existing guidance. The guidance was effective for the Company beginning in fiscal 2013. The adoption of this guidance did not impact the Company’s consolidated financial position, results of operations or cash flows.

NOTE B – SEGMENT INFORMATION

The Company’s 33 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 and Minnesota
	Southeast:		Alabama, Florida, Georgia and Mississippi
	South Central:		Louisiana, New Mexico (Las Cruces only), Oklahoma and Texas
	Southwest:		Arizona and New Mexico
	West:		California, Hawaii, Idaho, Nevada, Oregon, Utah and Washington

Homebuilding is the Company’s core business, generating 97% and 98% of consolidated revenues during the three months ended December 31, 2012 and 2011, respectively. The Company’s homebuilding segments are primarily engaged in the acquisition and development of land and the construction and sale of residential homes on the land, in 26 states and 77 markets in the United States. 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 provides mortgage financing and title agency services primarily to the Company’s homebuilding customers. The Company 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.

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D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

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, 2012.



	Three Months Ended December 31,
	2012			2011
	(In millions)
Revenues
Homebuilding revenues:
East	$	137.4		$	118.8
Midwest	89.4			57.7
Southeast	291.5			196.9
South Central	310.5			266.7
Southwest	76.0			54.0
West	328.4			191.5
Total homebuilding revenues	1,233.2			885.6
Financial services revenues	41.9			21.0
Consolidated revenues	$	1,275.1		$	906.6
Income (Loss) Before Income Taxes (1)
Homebuilding income (loss) before income taxes:
East	$	7.0		$	2.5
Midwest	(2.0		)	(7.1		)
Southeast	19.4			6.7
South Central	25.2			15.4
Southwest	9.8			2.1
West	30.8			5.4
Total homebuilding income before income taxes	90.2			25.0
Financial services income before income taxes	17.7			4.2
Consolidated income before income taxes	$	107.9		$	29.2

(1)

Expenses maintained at the corporate level consist primarily of interest and property taxes, which are capitalized and amortized to cost of sales or expensed directly, and the expenses related to operating 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 interest expense and those expenses associated with the corporate office are allocated to each segment based on the segment’s inventory balances.



	December 31, 2012		September 30, 2012
	(In millions)
Homebuilding Inventories (1)
East	$	636.8	$	572.7
Midwest	356.2		318.1
Southeast	1,103.8		905.0
South Central	1,216.7		935.2
Southwest	229.8		188.6
West	1,367.0		1,151.3
Corporate and unallocated (2)	104.8		94.3
Total homebuilding inventory	$	5,015.1	$	4,165.2


(1)	Homebuilding inventories are the only assets included in the measure of segment assets used by the Company’s chief operating decision maker, its CEO.


(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)

December 31, 2012

NOTE C – MARKETABLE SECURITIES

The Company invests a portion of its cash on hand by purchasing marketable securities with maturities in excess of three months. These securities are held in the custody of a single financial institution. The Company considers its investment portfolio to be available-for-sale. Accordingly, these securities are recorded at fair value. The Company's investment portfolio consisted of the following marketable securities at December 31, 2012 and September 30, 2012:



	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In millions)
Type of security:
U.S. Treasury securities	$	12.1	$	—	$	—	$	12.1
Obligations of U.S. government agencies	20.1		—		—		20.1
Corporate debt securities	59.5		—		—		59.5
Total debt securities	91.7		—		—		91.7
Certificates of deposit	5.0		—		—		5.0
Total marketable securities, available-for-sale	$	96.7	$	—	$	—	$	96.7



	September 30, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In millions)
Type of security:
U.S. Treasury securities	$	75.7	$	—	$	—	$	75.7
Obligations of U.S. government agencies	58.1		—		—		58.1
Corporate debt securities issued under the FDIC Temporary Liquidity Guarantee Program	39.2		—		—		39.2
Corporate debt securities	114.8		0.2		—		115.0
Total debt securities	287.8		0.2		—		288.0
Certificates of deposit	10.0		—		—		10.0
Total marketable securities, available-for-sale	$	297.8	$	0.2	$	—	$	298.0

Of the $96.7 million in marketable securities at December 31, 2012, $55.1 million mature in the next twelve months and $41.6 million mature in one to two years. Gains and losses realized upon the sale of marketable securities are determined by specific identification and are included in homebuilding other income. Proceeds from the sale or maturity of securities during the three months ended December 31, 2012 and 2011 were $226.7 million and $21.5 million, respectively, and the realized gains related to these sales were $0.2 million and $0, respectively.

During January 2013, the Company sold all of its remaining marketable securities and recognized a minimal gain on the sales.

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D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

NOTE D – INVENTORY IMPAIRMENTS AND LAND OPTION COST WRITE-OFFS

At December 31, 2012, the Company reviewed the performance and outlook for all of its land inventory and communities under development for indicators of potential impairment and performed impairment evaluations and analyses when necessary. The Company performed impairment evaluations of communities with a combined carrying value of $200.5 million and determined that no communities were impaired. Accordingly, no impairment charges were recorded during the three months ended December 31, 2012. During the same period of 2011, the Company recorded impairment charges of $0.5 million to reduce the carrying value of impaired communities in its East and Southeast homebuilding reporting segments to their estimated fair value.

During the three months ended December 31, 2012 and 2011, the Company wrote off $1.3 million and $0.9 million, respectively, of earnest money deposits and land option costs related to land option contracts which are not expected to be acquired.

At December 31, 2012 and September 30, 2012, the Company had $33.5 million and $32.6 million, respectively, of land held for sale, consisting of land held for development and land under development that met the criteria of land held for sale.

NOTE E – NOTES PAYABLE

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



	December 31, 2012		September 30, 2012
	(In millions)
Homebuilding:
Unsecured:
Revolving credit facility, maturing 2017	$	100.0	$	—
6.875% senior notes due 2013	171.7		171.7
6.125% senior notes due 2014, net	145.6		145.5
2% convertible senior notes due 2014, net	454.6		447.0
5.625% senior notes due 2014, net	137.7		137.6
5.25% senior notes due 2015, net	157.4		157.4
5.625% senior notes due 2016, net	169.7		169.6
6.5% senior notes due 2016, net	372.4		372.4
4.75% senior notes due 2017	350.0		350.0
4.375% senior notes due 2022	350.0		350.0
Other secured	15.2		4.1
	$	2,424.3	$	2,305.3
Financial Services:
Mortgage repurchase facility, maturing 2013	$	169.4	$	187.8

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.

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D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

Homebuilding:

In September 2012, the Company entered into a five-year, $125 million senior unsecured revolving credit facility, which had a $375 million uncommitted accordion feature that could increase the size of the facility, subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit. On November 1, 2012, the Company increased the capacity of the credit facility to $600 million by obtaining additional lending commitments from banks. The Company also modified the uncommitted accordion feature to allow the size of the facility to increase to $1.0 billion, subject to certain conditions and availability of additional bank commitments. The amended sublimit for the issuance of letters of credit is $300 million. The interest rate on borrowings under the revolving credit facility may be based on either the Prime Rate or LIBOR plus an applicable margin, as defined in the credit agreement governing the facility. At December 31, 2012 the interest rate on borrowings under the revolving credit facility was 4.8% and the Company had borrowings of $100 million outstanding and letters of credit of $5.5 million outstanding under the revolving credit facility.

The revolving credit facility imposes restrictions on the Company's operations and activities, including requiring the maintenance of a minimum level of tangible net worth, a maximum allowable leverage ratio and a borrowing base restriction if the Company's leverage ratio exceeds a certain level. These covenants are measured as defined in the credit 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 facility and the indentures governing the senior notes impose restrictions on the creation of secured debt and liens. At December 31, 2012, the Company was in compliance with all of the covenants, limitations and restrictions of its revolving credit facility and public debt obligations.

In accordance with the indenture governing the 2% convertible senior notes due 2014, when cash dividends are paid in excess of $0.0375 per share in any fiscal quarter, the conversion rate related to these notes increases. As a result of the cash dividend of $0.15 per common share which was paid on December 21, 2012 (see Note J), the conversion rate of the 2% convertible senior notes increased from 76.5697 to 77.18004 shares of the Company's common stock per $1,000 principal amount of senior notes. The new conversion rate is equivalent to a conversion price of approximately $12.96 per share of common stock, compared to the initial conversion price of $13.06 per share. If all of the 2% convertible senior notes due 2014 were converted into the Company's common stock, the Company would issue 38.6 million shares of its common stock as a result of the conversion.

Effective August 1, 2012, the Board of Directors authorized the repurchase of up to $500 million of the Company's debt securities effective through July 31, 2013. All of the $500 million authorization was remaining at December 31, 2012.

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 $180 million; however, the capacity can be increased to $225 million as needed. Increases in borrowing capacity in excess of $180 million are provided on an uncommitted basis and at a higher borrowing cost than committed borrowings. The Company expects to renew and extend the term of the facility and increase its capacity prior to the facility's maturity date of March 3, 2013.

As of December 31, 2012, $248.6 million of mortgage loans held for sale with a collateral value of $235.3 million were pledged under the mortgage repurchase facility. As a result of advance paydowns totaling $65.9 million, DHI Mortgage had an obligation of $169.4 million outstanding under the mortgage repurchase facility at December 31, 2012 at a 2.8% 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

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D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

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 December 31, 2012, DHI Mortgage was in compliance with all of the conditions and covenants of the mortgage repurchase facility.

NOTE F – CAPITALIZED INTEREST

The Company capitalizes interest costs incurred to inventory during active development and construction. Capitalized interest is charged to cost of sales as the related inventory is delivered to the buyer. The Company’s inventory under active development and construction was lower than its debt level during the quarter; therefore, a portion of the interest incurred was reflected as interest expense.

The following table summarizes the Company’s interest costs incurred, capitalized, expensed as interest expense and charged to cost of sales during the three months ended December 31, 2012 and 2011:



	Three Months Ended December 31,
	2012			2011
	(In millions)
Capitalized interest, beginning of period	$	82.3		$	79.2
Interest incurred	38.1			28.8
Interest expensed:
Directly to interest expense	(4.2		)	(7.8		)
Amortized to cost of sales	(24.9		)	(20.4		)
Capitalized interest, end of period	$	91.3		$	79.8

NOTE G – MORTGAGE LOANS

To manage the interest rate risk inherent in its mortgage operations, the Company hedges its risk using various derivative instruments, which include forward sales of mortgage-backed securities (MBS), Eurodollar Futures Contracts (EDFC) and put options on both MBS and EDFC. Use of the term “hedging instruments” in the following discussion refers to these securities collectively, or in any combination. The Company does not enter into or hold derivatives for trading or speculative purposes.

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, 2012, mortgage loans held for sale had an aggregate fair value of $307.9 million and an aggregate outstanding principal balance of $298.6 million. At September 30, 2012, mortgage loans held for sale had an aggregate fair value of $345.3 million and an aggregate outstanding principal balance of $332.9 million. During the three months ended December 31, 2012 and 2011, the Company had net gains on sales of loans and servicing rights of $27.5 million and $10.1 million, respectively, which includes the effect of recording recourse expense of $0.5 million and $1.7 million, respectively, as discussed below in “Other Mortgage Loans and Loss Reserves.” Net gains on sales of loans and servicing rights are included in financial services revenues on the consolidated statements of operations. Approximately 65% of the mortgage loans sold by DHI Mortgage during the three months ended December 31, 2012 were sold to one major financial institution.

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, which for the three months ended December 31, 2012 and 2011 was not significant, and is recognized in current earnings. As of December 31, 2012, the Company had a notional amount of $133.7 million in mortgage

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December 31, 2012

loans held for sale not committed to third-party purchasers and the notional amounts of the hedging instruments related to those loans totaled $134.0 million.

Other Mortgage Loans and Loss Reserves

Mortgage loans are sold with limited recourse provisions which include industry-standard representations and warranties, primarily involving the absence of misrepresentations by the borrower or other parties, insurability if applicable and, depending on the agreement, may include requiring a 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 often become real estate owned through the foreclosure process. At December 31, 2012 and September 30, 2012, the Company’s total other mortgage loans and real estate owned, before loss reserves were as follows:



	December 31, 2012		September 30, 2012
	(In millions)
Other mortgage loans	$	37.1	$	38.1
Real estate owned	1.5		1.3
	$	38.6	$	39.4

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 December 31, 2012 and September 30, 2012 were as follows:



	December 31, 2012		September 30, 2012
	(In millions)
Loss reserves related to:
Other mortgage loans	$	5.1	$	5.0
Real estate owned	0.5		0.4
Loan repurchase and settlement obligations – known and expected	25.0		25.5
	$	30.6	$	30.9

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 December 31, 2012, the notional amount of IRLCs, which are accounted for as derivative instruments recorded at fair value, totaled $255.0 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 current earnings. As of December 31, 2012, the Company had a notional amount of approximately $16.8 million of best-efforts whole loan delivery commitments and a notional amount of $208.5 million of hedging instruments related to IRLCs not yet committed to purchasers.

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

December 31, 2012

NOTE H – INCOME TAXES

The Company’s income tax expense for the three months ended December 31, 2012 was $41.6 million, which reflects an effective income tax rate of 38.5% of pre-tax income for the period. The Company’s income tax expense for the three months ended December 31, 2011 was $1.5 million. The Company did not have a meaningful effective tax rate for the first quarter of fiscal 2012 because its net deferred tax assets were fully offset by a valuation allowance for the period.

At September 30, 2012, the Company had income taxes receivable of $14.4 million, which related to an expected federal tax refund associated with the Company's 2006 and 2007 tax returns. This refund was received in October 2012.

A reduction of $9.9 million in the amount of unrecognized tax benefits and $3.1 million of accrued interest is reasonably possible within the current fiscal year, of which $11.0 million would be reflected as an income tax benefit in the consolidated statement of operations and $2.0 million would result in an adjustment to deferred income taxes.

The American Taxpayer Relief Act of 2012 (Act) was signed into law on January 2, 2013. The Act is not expected to have a material effect on the Company's consolidated financial position, results of operations or cash flows.

At December 31, 2012 and September 30, 2012, the Company had deferred tax assets, net of deferred tax liabilities, of $725.4 million and $751.4 million, respectively, offset by valuation allowances of $41.9 million for both periods. At September 30, 2012, the Company needed to generate approximately $1.3 billion of pre-tax income in fiscal 2013 and in future periods before its federal net operating loss (NOL) carryforwards expire to realize its federal deferred tax assets. At September 30, 2012, the Company had federal NOL carryforwards of $310.5 million that expire in fiscal 2030 and 2031.

At June 30, 2012, the Company determined it was more likely than not that the substantial majority of the Company's deferred tax assets would be realized, which resulted in a $753.2 million reversal of the valuation allowance on its deferred tax assets during the third and fourth quarters of fiscal 2012. The Company evaluated both positive and negative evidence to determine its ability to realize its deferred tax assets. In its evaluation, the Company gave more significant weight to evidence that was objective in nature as compared to subjective evidence. Also, more significant weight was given to evidence that directly relates to the Company's current financial performance as compared to indirect or less current evidence.

The Company gave the most significant weight in its evaluation to the objective, direct positive evidence related to its recent strong financial results, especially its positive and growing levels of pre-tax income and its significant growth in net sales orders and sales order backlog during fiscal 2012. The Company estimated that if its annual pre-tax income remains at the fiscal 2012 level in future years, it would realize all of its federal net operating losses in less than five years, well in advance of the expiration of the Company's NOL carryforwards in fiscal 2030 and 2031, and it would also absorb all federal deductible temporary differences as they reverse in future years. Additionally, the Company considered, at a lower weighting, the subjective, direct positive evidence that it expects to increase its pre-tax income in future years by utilizing its strong balance sheet and liquidity position to invest in opportunities to sustain and grow its operations. If industry conditions weaken, the Company expects to be able to adjust its operations to maintain long-term profitability and still realize its deferred tax assets.

Prior to the quarter ended June 30, 2012, the Company had given significant weight to the negative, direct evidence of its three-year cumulative pre-tax loss position as a result of losses incurred in prior years during the housing downturn. As of June 30, 2012, the Company had generated positive cumulative pre-tax income for the past three years and therefore, the prior year losses were weighted less than the recent positive financial results in the Company's evaluation at June 30, 2012. Other negative, indirect evidence, such as the current overall weakness in the U.S. economy and the housing market and the restrictive mortgage lending environment, was considered at a lower weighting because the Company's recent financial performance has been achieved in this environment. Also, the negative, direct evidence of the Company's gross profit margins, which were lower than historical levels before the housing downturn, were considered at a lower weight than the direct, positive evidence of its growing pre-tax income levels.

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December 31, 2012

The most significant changes in the Company's evaluation of the realizability of its deferred tax assets at June 30, 2012 were the development of significant positive evidence related to the Company's accelerating growth in pre-tax income, net sales orders and backlog as fiscal 2012 progressed; the Company's expectation to realize all of its federal net operating losses in less than five years and to absorb all federal deductible temporary differences as they reverse in future years based on fiscal 2012 pre-tax income levels; the Company's expectation of sustained and increasing profitability in future years; and the lessening of the significance of the negative evidence considered in prior periods related to the Company's pre-tax losses incurred in prior years, because the Company had generated positive cumulative pre-tax income for the past three years as of June 30, 2012. These significant changes in the evidence at June 30, 2012 led the Company to determine that it was appropriate to reverse all of the valuation allowance related to its federal deferred tax assets and a portion of the valuation allowance related to its state deferred tax assets.

Based on its evaluation of the positive and negative evidence described above at June 30, 2012, the Company concluded that the positive evidence outweighed the negative evidence and that it was more likely than not that all of the Company's federal deferred tax assets would be realized. Therefore, there is no remaining valuation allowance related to the Company's federal deferred tax assets at December 31, 2012 and September 30, 2012.

At September 30, 2012, the Company had tax benefits for state net operating loss carryforwards of $85.2 million that expire at various times depending on the tax jurisdiction from fiscal 2013 to fiscal 2031. The Company had a valuation allowance of $41.9 million related to its state deferred tax assets at both December 31, 2012 and September 30, 2012 because the Company believes it is more likely than not that a portion of its state net operating losses will not be realized due to the more limited carryforward periods that exist in certain states. The Company estimated the amount of this valuation allowance based on an analysis of the amount of its net operating loss carryforwards associated with each state in which it conducts business, as compared to its expected level of taxable income under existing apportionment or recognition rules in each state and the carryforward periods allowed in each state's tax code.

The Company continues to evaluate both the positive and negative evidence in determining the need for a valuation allowance with respect to its tax benefits for state net operating loss carryforwards. Changes in the positive and negative evidence, including differences in the Company's future operating results as compared to the estimates utilized in the determination of the valuation allowance, could result in changes in the Company's estimate of the valuation allowance related to its tax benefits for state net operating loss carryforwards. If the Company produces operating results similar to or better than the results it achieved during the three months ended December 31, 2012 in future periods, there could be sufficient positive evidence to support a conclusion that the Company will realize more of its state NOL carryforwards than previously anticipated which could result in a reduction of a portion of the remaining valuation allowance at some point during fiscal 2013.

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)

December 31, 2012

NOTE I – 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 4.0 million and 9.0 million shares of common stock were excluded from the computation of diluted earnings per share for the three months ended December 31, 2012 and 2011, 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. Additionally, the convertible senior notes were excluded from the computation of diluted earnings per share for the 2011 period because their effect would have been antidilutive.



	Three Months Ended December 31,
	2012		2011
	(In millions)
Numerator:
Net income	$	66.3	$	27.7
Effect of dilutive securities:
Interest expense and amortization of issuance costs associated with convertible senior notes, net of tax	5.7		—
Numerator for diluted earnings per share after assumed conversions	$	72.0	$	27.7
Denominator:
Denominator for basic earnings per share — weighted average common shares	321.1		316.3
Effect of dilutive securities:
Employee stock awards	4.4		0.2
Convertible senior notes	38.6		—
Denominator for diluted earnings per share — adjusted weighted average common shares	364.1		316.5

NOTE J – 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.

Effective August 1, 2012, the Board of Directors authorized the repurchase of up to $100 million of the Company’s common stock effective through July 31, 2013. All of the $100 million authorization was remaining at December 31, 2012, and no common stock has been repurchased subsequent to December 31, 2012.

During the three months ended December 31, 2012, the Board of Directors approved a quarterly cash dividend of $0.0375 per common share, which was paid on December 17, 2012 to stockholders of record on December 3, 2012. Additionally, in December 2012, the Board of Directors approved a cash dividend of $0.15 per common share, which was paid on December 21, 2012 to stockholders of record on December 17, 2012. This dividend was in lieu of and accelerated the payment of all quarterly dividends that the Company would have otherwise paid in calendar year 2013. Cash dividends of $0.0375 per common share were declared and paid in each quarter of fiscal 2012. In accordance with the indenture governing the 2% convertible senior notes due 2014, when cash dividends are paid in excess of $0.0375 per share in any fiscal quarter, the conversion rate related to these notes increases. As a result of the cash dividend of $0.15 per common share which was paid on December 21, 2012, the conversion rate of the 2% convertible senior notes increased from 76.5697 to 77.18004 shares of the Company's common stock per $1,000 principal amount of senior notes. The new conversion rate is equivalent to a conversion price of approximately $12.96 per share of common stock, compared to the initial conversion price of $13.06 per share. If all of the 2% convertible senior notes due 2014 were converted into the Company's common stock, the Company would issue 38.6 million shares of its common stock as a result of the conversion.

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

December 31, 2012

NOTE K – EMPLOYEE BENEFIT PLANS

Restricted Stock Unit Agreement

In November 2012, the Compensation Committee of the Company's Board of Directors approved and granted awards of 350,000 performance based units (Performance Units) that will vest at the end of a three-year performance period ending September 30, 2015. 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. The liability for these awards of $0.8 million at December 31, 2012 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 the end of the period. Compensation expense related to this grant was $0.8 million for the three months ended December 31, 2012.

NOTE L – 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, 2012 and 2011 were as follows:



	Three Months Ended December 31,
	2012			2011
	(In millions)
Warranty liability, beginning of period	$	56.8		$	46.2
Warranties issued	5.5			4.1
Changes in liability for pre-existing warranties	3.6			1.9
Settlements made	(9.3		)	(6.2		)
Warranty liability, end of period	$	56.6		$	46.0

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 $529.8 million and $544.9 million at December 31, 2012 and September 30, 2012, respectively, and are included in homebuilding accrued expenses and other liabilities in the consolidated balance sheets. At both December 31, 2012 and September 30, 2012, approximately 99% of these reserves related to construction defect matters. Expenses related to the Company’s legal contingencies were $14.2 million and $12.5 million in the three months ended December 31, 2012 and 2011, respectively.

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December 31, 2012

The Company’s reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. As of December 31, 2012, 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 $544.9 million at September 30, 2012 to $529.8 million at December 31, 2012 primarily due to payments made for legal claims during the period and a decrease in the estimated cost to resolve future claims. This decrease was partially offset by an increase in the number of closed homes that are subject to possible future construction defect claims and an increase in the estimated frequency of claims incurred. Following is a rollforward of the balance of the reserves for the three months ended December 31, 2012:



	Three Months Ended
	December 31, 2012
	(In millions)
Reserves for legal claims, beginning of period	$	544.9
Payments	(8.2		)
Decrease in reserves	(6.9		)
Reserves for legal claims, end of period	$	529.8

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 $202.0 million and $225.0 million at December 31, 2012 and September 30, 2012, 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.

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December 31, 2012

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 December 31, 2012, the Company had total deposits of $31.2 million, consisting of cash deposits of $27.8 million and promissory notes and surety bonds of $3.4 million, to purchase land and lots with a total remaining purchase price of approximately $1.7 billion. Within the land and lot option purchase contracts at December 31, 2012, there were a limited number of contracts, representing $25.6 million of remaining purchase price, subject to specific performance clauses which may require the Company to purchase the land or lots upon the land sellers meeting their obligations. The majority of land and lots under contract are currently expected to be purchased within three years.

Other Commitments

To secure performance under various contracts, the Company had outstanding letters of credit of $51.4 million and surety bonds of $657.4 million at December 31, 2012. The Company has secured letter of credit agreements for $45.9 million of its outstanding letters of credit that require it to deposit cash, in an amount approximating the balance of letters of credit outstanding, as collateral with the issuing banks. At December 31, 2012 and September 30, 2012, the amount of cash restricted for this purpose totaled $45.9 million and $46.2 million, respectively, and is included in homebuilding restricted cash on the Company’s consolidated balance sheets. Additionally, the Company has $5.5 million of outstanding letters of credit under its revolving credit facility at December 31, 2012 which were also cash collateralized to receive better pricing.

NOTE M – OTHER ASSETS AND ACCRUED EXPENSES AND OTHER LIABILITIES

The Company’s homebuilding other assets were as follows:



	December 31, 2012		September 30, 2012
	(In millions)
Insurance receivables	$	202.0	$	225.0
Earnest money and refundable deposits	80.4		80.0
Accounts and notes receivable	19.5		21.9
Prepaid assets	31.7		29.4
Debt securities collateralized by residential real estate	18.6		—
Other assets	102.0		100.5
	$	454.2	$	456.8

The Company’s homebuilding accrued expenses and other liabilities were as follows:



	December 31, 2012		September 30, 2012
	(In millions)
Reserves for legal claims	$	529.8	$	544.9
Employee compensation and related liabilities	100.3		106.4
Warranty liability	56.6		56.8
Accrued interest	28.6		32.6
Federal and state income tax liabilities	25.8		21.6
Other liabilities	115.5		131.5
	$	856.6	$	893.8

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

December 31, 2012

NOTE N – FAIR VALUE MEASUREMENTS

Fair value measurements are used for the Company’s marketable securities, 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. The Company’s U.S. Treasury securities are measured at fair value using Level 1 inputs.


•	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/liabilities measured at fair value using Level 2 inputs are as follows:


▪	government agency securities, corporate debt securities, foreign government securities and certificates of deposit;


▪	mortgage loans held for sale;


▪	over-the-counter derivatives such as forward sales of MBS, put options on MBS and best-efforts and mandatory commitments; and


▪	IRLCs.

•

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 debt securities collateralized by residential real estate are measured using Level 3 inputs and are measured at fair value on a recurring basis. The assets shown below are measured using Level 3 inputs and are typically reported at the lower of carrying value or fair value on a nonrecurring basis:


▪	inventory held and used;


▪	certain mortgage loans; and


▪	real estate owned.

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December 31, 2012

The following tables summarize the Company’s assets and liabilities at December 31, 2012 and September 30, 2012, measured at fair value on a recurring basis.



		Fair Value at December 31, 2012
	Balance Sheet Location	Level 1		Level 2			Level 3		Total
		(In millions)
Homebuilding:
Marketable securities, available-for-sale:
U.S. Treasury securities	Marketable securities	$	12.1	$	—		$	—	$	12.1
Government agency and corporate debt securities	Marketable securities	—		79.6			—		79.6
Certificates of deposit	Marketable securities	—		5.0			—		5.0
Debt securities collateralized by residential real estate (a)	Other assets	—		—			18.6		18.6

Financial Services:
Mortgage loans held for sale (b)	Mortgage loans held for sale	—		300.2			7.7		307.9
Derivatives not designated as hedging instruments (c):
Interest rate lock commitments	Other assets	—		2.3			—		2.3
Forward sales of MBS	Other liabilities	—		(0.5		)	—		(0.5		)
Best-efforts and mandatory commitments	Other liabilities	—		(0.2		)	—		(0.2		)



		Fair Value at September 30, 2012
	Balance Sheet Location	Level 1		Level 2			Level 3		Total
		(In millions)
Homebuilding:
Marketable securities, available-for-sale:
U.S. Treasury securities	Marketable securities	$	75.7	$	—		$	—	$	75.7
Government agency and corporate debt securities	Marketable securities	—		212.3			—		212.3
Certificates of deposit	Marketable securities	—		10.0			—		10.0

Financial Services:
Mortgage loans held for sale (b)	Mortgage loans held for sale	—		345.3			—		345.3
Derivatives not designated as hedging instruments (c):
Interest rate lock commitments	Other assets	—		6.1			—		6.1
Forward sales of MBS	Other liabilities	—		(6.9		)	—		(6.9		)
Best-efforts and mandatory commitments	Other liabilities	—		(0.8		)	—		(0.8		)

The following table summarizes the changes in the fair value of the Company's Level 3 assets during the three months ended December 31, 2012:



	Level 3 Assets at Fair Value for the Three Months Ended December 31, 2012
	Balance at September 30, 2012		Purchases		Net transfers in and/or (out) of Level 3		Balance at December 31, 2012
	(In millions)
Debt securities collateralized by residential real estate (a)	$	—	$	18.6	$	—	$	18.6
Mortgage loans held for sale (b)	—		—		7.7		7.7

(a)

In October 2012, the Company purchased $18.6 million of defaulted debt securities which are secured by residential real estate. The Company intends to foreclose and take possession of the residential real estate in order to develop the property and ultimately build and sell homes. These securities are classified as available for sale and are included in other assets in the Company's consolidated balance sheets. At December 31, 2012, the Company valued these securities at the recent October 2012 transaction price, which is considered to be the best initial estimate of fair value.

(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 includes $7.7 million of loans originated under the fair value option 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; therefore, they were transferred from a Level 2 valuation to a Level 3 valuation during the three months ended December 31, 2012.


(c)	Fair value measurements of these derivatives represent changes in fair value since inception. These changes are reflected in the balance sheet and included in financial services revenues on the consolidated statement of operations.

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

The following table summarizes the Company’s assets at December 31, 2012 and September 30, 2012 measured at fair value on a nonrecurring basis:



		Fair Value at		Fair Value at
		December 31, 2012		September 30, 2012
	Balance Sheet Location	Level 3		Level 3
		(In millions)
Homebuilding:
Inventory held and used (a) (b)	Inventories	$	—	$	1.2
Financial Services:
Other mortgage loans (a) (c)	Other assets	25.5		25.8
Real estate owned (a) (c)	Other assets	0.9		0.9


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


(b)	In performing its impairment analysis, the Company used discount rates ranging from 12% to 20% during the three months ended December 31, 2012 and during fiscal 2012.


(c)	The fair values for other mortgage loans and real estate owned are determined based on the value of the underlying collateral.

For the financial assets and liabilities for which the Company has not elected the fair value option, the following tables present both their respective carrying value and fair value at December 31, 2012 and September 30, 2012:



	Carrying Value		Fair Value at December 31, 2012
	Carrying Value		Level 1		Level 2		Level 3		Total
	(In millions)
Homebuilding:
Cash and cash equivalents (a)	$	546.4	$	546.4	$	—	$	—	$	546.4
Restricted cash (a)	54.8		54.8		—		—		54.8
Revolving credit facility (a)	100.0		—		—		100.0		100.0
Senior notes (b)	1,854.5		—		1,961.3		—		1,961.3
Convertible senior notes (b)	454.6		—		791.6		—		791.6
Financial Services:
Cash and cash equivalents (a)	20.5		20.5		—		—		20.5
Mortgage repurchase facility (a)	169.4		—		—		169.4		169.4



	Carrying Value		Fair Value at September 30, 2012
	Carrying Value		Level 1		Level 2		Level 3		Total
	(In millions)
Homebuilding:
Cash and cash equivalents (a)	$	1,030.4	$	1,030.4	$	—	$	—	$	1,030.4
Restricted cash (a)	49.3		49.3		—		—		49.3
Senior notes (b)	1,854.2		—		1,973.9		—		1,973.9
Convertible senior notes (b)	447.0		—		821.2		—		821.2
Financial Services:
Cash and cash equivalents (a)	17.3		17.3		—		—		17.3
Mortgage repurchase facility (a)	187.8		—		—		187.8		187.8


(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, which is classified as Level 2 within the fair value hierarchy.

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

NOTE O – SUPPLEMENTAL GUARANTOR INFORMATION

All of the Company's senior and convertible 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. The Company's subsidiaries engaged in the financial services segment and certain other subsidiaries do not guarantee the Company's senior and convertible 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, 2012



	D.R. Horton, Inc.		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Total
	(In millions)
ASSETS
Cash and cash equivalents	$	526.6	$	18.9	$	21.4	$	—		$	566.9
Marketable securities, available-for-sale	96.7		—		—		—			96.7
Restricted cash	54.0		0.7		0.1		—			54.8
Investments in subsidiaries	2,157.4		—		—		(2,157.4		)	—
Inventories	1,651.4		3,345.7		18.0		—			5,015.1
Deferred income taxes	220.1		463.4		—		—			683.5
Property and equipment, net	25.4		27.5		29.0		—			81.9
Other assets	126.8		270.1		104.7		—			501.6
Mortgage loans held for sale	—		—		307.9		—			307.9
Goodwill	—		38.9		—		—			38.9
Intercompany receivables	1,480.7		—		—		(1,480.7		)	—
Total Assets	$	6,339.1	$	4,165.2	$	481.1	$	(3,638.1	)	$	7,347.3
LIABILITIES & EQUITY
Accounts payable and other liabilities	$	306.8	$	705.2	$	128.5	$	—		$	1,140.5
Intercompany payables	—		1,450.3		30.4		(1,480.7		)	—
Notes payable	2,421.9		2.4		169.4		—			2,593.7
Total Liabilities	2,728.7		2,157.9		328.3		(1,480.7		)	3,734.2
Total stockholders’ equity	3,610.4		2,007.3		150.1		(2,157.4		)	3,610.4
Noncontrolling interests	—		—		2.7		—			2.7
Total Equity	3,610.4		2,007.3		152.8		(2,157.4		)	3,613.1
Total Liabilities & Equity	$	6,339.1	$	4,165.2	$	481.1	$	(3,638.1	)	$	7,347.3

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

NOTE O – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Balance Sheet

September 30, 2012



	D.R. Horton, Inc.		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Total
	(In millions)
ASSETS
Cash and cash equivalents	$	968.9	$	56.3	$	22.5	$	—		$	1,047.7
Marketable securities, available-for-sale	298.0		—		—		—			298.0
Restricted cash	48.7		0.5		0.1		—			49.3
Investments in subsidiaries	2,120.8		—		—		(2,120.8		)	—
Inventories	1,375.1		2,770.6		19.5		—			4,165.2
Income taxes receivable	14.4		—		—		—			14.4
Deferred income taxes	227.6		481.9		—		—			709.5
Property and equipment, net	20.7		20.7		31.2		—			72.6
Other assets	127.8		271.1		108.4		—			507.3
Mortgage loans held for sale	—		—		345.3		—			345.3
Goodwill	—		38.9		—		—			38.9
Intercompany receivables	1,022.6		—		—		(1,022.6		)	—
Total Assets	$	6,224.6	$	3,640.0	$	527.0	$	(3,143.4	)	$	7,248.2
LIABILITIES & EQUITY
Accounts payable and other liabilities	$	329.8	$	700.0	$	130.6	$	—		$	1,160.4
Intercompany payables	—		986.8		35.8		(1,022.6		)	—
Notes payable	2,302.7		2.6		187.8		—			2,493.1
Total Liabilities	2,632.5		1,689.4		354.2		(1,022.6		)	3,653.5
Total stockholders’ equity	3,592.1		1,950.6		170.2		(2,120.8		)	3,592.1
Noncontrolling interests	—		—		2.6		—			2.6
Total Equity	3,592.1		1,950.6		172.8		(2,120.8		)	3,594.7
Total Liabilities & Equity	$	6,224.6	$	3,640.0	$	527.0	$	(3,143.4	)	$	7,248.2

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

NOTE O – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Statement of Operations

Three Months Ended December 31, 2012



	D.R. Horton, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
	(In millions)
Homebuilding:
Revenues	$	406.2		$	823.6		$	3.4		$	—		$	1,233.2
Cost of sales	327.0			665.7			9.6			—			1,002.3
Gross profit (loss)	79.2			157.9			(6.2		)	—			230.9
Selling, general and administrative expense	64.0			75.1			1.7			—			140.8
Equity in (income) of subsidiaries	(94.9		)	—			—			94.9			—
Interest expense	3.2			—			—			—			3.2
Other (income)	(1.0		)	(1.1		)	(1.2		)	—			(3.3		)
	107.9			83.9			(6.7		)	(94.9		)	90.2
Financial Services:
Revenues, net of recourse and reinsurance expense	—			—			41.9			—			41.9
General and administrative expense	—			—			25.7			—			25.7
Interest expense	—			—			1.0			—			1.0
Interest and other (income)	—			—			(2.5		)	—			(2.5		)
	—			—			17.7			—			17.7
Income before income taxes	107.9			83.9			11.0			(94.9		)	107.9
Income tax expense	41.6			26.8			1.5			(28.3		)	41.6
Net income	$	66.3		$	57.1		$	9.5		$	(66.6	)	$	66.3
Comprehensive income	$	66.2		$	57.1		$	9.5		$	(66.6	)	$	66.2

Table of Contents

D.R. HORTON, INC. AND SUBSIDIARIES

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

December 31, 2012

NOTE O – SUPPLEMENTAL GUARANTOR INFORMATION - (Continued)

Consolidating Statement of Operations

Three Months Ended December 31, 2011

D.R.

Horton, Inc.

Guarantor

Subsidiaries