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Edited Transcript of DHI earnings conference call or presentation 25-Apr-19 12:30pm GMT

Q2 2019 D.R. Horton Inc and Preliminary Q2 2019 Forestar Group Inc Earnings Call

FORT WORTH Apr 30, 2019 (Thomson StreetEvents) -- Edited Transcript of D.R. Horton Inc earnings conference call or presentation Thursday, April 25, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bill W. Wheat

D.R. Horton, Inc. - Executive VP & CFO

* David V. Auld

D.R. Horton, Inc. - President & CEO

* Jessica Hansen

D.R. Horton, Inc. - VP, IR

* Michael J. Murray

D.R. Horton, Inc. - Executive VP & COO

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* Buck Horne

Raymond James & Associates, Inc., Research Division - SVP of Equity Research

* Carl Edwin Reichardt

BTIG, LLC, Research Division - MD

* John Lovallo

BofA Merrill Lynch, Research Division - VP

* Kenneth Robinson Zener

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Matthew Adrien Bouley

Barclays Bank PLC, Research Division - VP

* Michael Jason Rehaut

JP Morgan Chase & Co, Research Division - Senior Analyst

* Nishu Sood

Deutsche Bank AG, Research Division - Director

* Soham Jairaj Bhonsle

Susquehanna Financial Group, LLLP, Research Division - Associate

* Stephen Kim

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team

* Stephen F. East

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Susan Marie Maklari

Crédit Suisse AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Second Quarter 2019 Earnings Conference Call for D.R. Horton, America’s Builder, the largest builder in the United States. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jessica Hansen, Vice President of Investor Relations for D.R. Horton. Please go ahead, Jessica.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [2]

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Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the second quarter of fiscal 2019.

Before we get started, today's call may include comments that constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Although D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements.

Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

This morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q early next week. After this call, we will post an investor presentation and supplementary data to our Investor Relations site on the Presentations section under News and Events for your reference. The supplementary data relates to our homebuilding return on inventory, home sales gross margin, changes in active selling communities, product mix and our mortgage operations.

Now, I will turn the call over to David Auld, our President and CEO.

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David V. Auld, D.R. Horton, Inc. - President & CEO [3]

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Thank you, Jessica, and good morning. In addition to Jessica, I am pleased to be joined by Mike Murray, our Executive Vice President and Chief Operating Officer; and Bill Wheat, our Executive Vice President and Chief Financial Officer.

The D.R. Horton team delivered a solid second quarter of 2019. Our consolidated revenues increased 9% to $4.1 billion. Pretax income was $463 million, and our pretax profit margin was 11.2%. The spring selling season is going well as our net sales orders increased 52% sequentially and 6% from the prior year quarter. These results reflect the strength of our operational teams, our ability to leverage D.R. Horton's scale across our broad geographic footprint and our product positioning to offer affordable homes across multiple brands.

As we have discussed on our last 2 calls, affordability concerns have caused some moderation in demand for homes since late 2018 particularly at higher price points. However, this spring, we have continued to see good demand and a limited supply of homes at affordable prices across our markets while economic fundamentals and financing availability remained solid.

We are pleased with our product positioning and our people sales trends to date. Our strategic focus is to continue consolidating market share while growing our revenues and profits, generating strong annual cash flows and returns and maintaining a flexible financial position.

With a conservative balance sheet that includes an ample supply of homes, lots and land to support growth, we are well positioned for the remainder of 2019 and future years. Mike?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [4]

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Net income attributable to D.R. Horton for the second quarter of both fiscal 2019 and fiscal 2018 was $351 million. Net income per diluted share in the second quarter of fiscal 2019 was $0.93, up from $0.91 last year due to our lower share count this year. Our consolidated pretax income for the quarter was $463 million, and our homebuilding pretax income was $400 million.

Our second quarter home sales revenues increased 8% to $4 billion on 13,480 homes closed, up from $3.7 billion on 12,281 homes closed in the prior year. Our average closing price for the quarter is $295,300, down 1% from the prior year due to product mix. And the average size of our homes closed was down 3%, both reflecting our ongoing efforts to keep our homes affordable. Bill?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [5]

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Net sales orders in the second quarter increased 6% to 16,805 homes, and the value of those orders was $4.9 billion, up from $4.7 billion in the prior year.

Our average number of active selling communities increased 8% from the prior year and 4% sequentially. Excluding the builders we acquired earlier this year, our second quarter net sales orders increased 3%, and our average number of active selling communities increased 2% year-over-year and 1% sequentially.

Our average sales price on net sales orders in the second quarter was $294,100, down 2% from the prior year. The cancellation rate for the second quarter was 19%, consistent with the same quarter last year. Jessica?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [6]

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Our gross profit margin on home sales revenue in the second quarter was 19.3%, down 150 basis points from the second quarter of last year and down 70 basis points sequentially from the December quarter. The sequential decrease in gross margin was in line with our expectations and was due to cost increases, less pricing power and higher incentives.

Based on today's market conditions and expected cost moderation, we currently expect our homes sales gross margin to be flat or increase slightly sequentially in the third quarter subject to possible fluctuations due to product and geographic mix as well as the relative impact of warranty, litigation and purchase accounting. Bill?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [7]

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In the second quarter, home building SG&A expense as a percentage of revenues was 9% compared to 8.8% in the prior year quarter. The increase in our homebuilding SG&A percentage from the prior year was mainly from higher employee costs due in part to compensation accruals related to increases in our stock price and the public equity markets this quarter. Year-to-date, homebuilding SG&A expense was 9.2% of revenues compared to 9.1% last year.

We remain focused on managing our SG&A efficiently while ensuring that our infrastructure adequately supports our opportunities to increase market share over the long term. Mike?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [8]

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We ended the second quarter with 32,100 homes excluding malls. 17,800 of our homes were unsold with 12,500 in various stages of construction and 5,300 completed. Our current inventory homes puts us in a solid position to achieve the fiscal 2019 closing guidance we provided in our press release this morning. We manage our home starts at a community level, and we adjust our starts as necessary to align inventory levels with current sales pace in each community.

Our homebuilding investments in lots, land and development during the second quarter totaled $740 million, of which $340 million was for land and finished lots and $400 million was for land development.

Our underwriting criteria and operational expectations for new communities remain consistent at a minimum 20% annual pretax return on inventory and the return of our initial cash investment within 24 months. David?

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David V. Auld, D.R. Horton, Inc. - President & CEO [9]

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We increased the portion of our land and lot pipeline that we control through land purchase contracts again this quarter.

At March 31, our homebuilding lot position consisted of 316,400 lots of which 120,900 or 38% were owned and 195,500 or 62% were controlled.

35,000 of our total owned lots are finished and 103,000 of our controlled lots are or will be finished when we purchase them.

We plan to continue to increase our lot position being developed by third parties by supporting the expansion of Forestar's national lot manufacturing platform and continue to expand our relationship with lot developers across the country. Our lot portfolio with an ample supply of lots per homes at affordable price points is a strong competitive advantage. Jessica?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [10]

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Financial services pretax income in the second quarter increased 8% to $34 million from $31.4 million in the prior year. Financial services pretax profit margin for the quarter was 33.5%, up from 33.1% in the prior year.

98% of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operations and our mortgage company handled the financing for 56% of D.R. Horton homebuyers. FHA and VA loans accounted for 45% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 719 and an average loan-to-value ratio of 88%.

First-time homebuyers represented 53% of the closings handled by our mortgage company, up from 45% in the prior year, reflecting our continued focus on offering affordable homes for entry-level buyers. Mike?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [11]

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Forestar, our majority-owned subsidiary, is a publicly traded residential lot manufacturer now operating in 41 markets across 17 states. At March 31, Forestar owned and controlled approximately 31,400 lots of which 3,600 are finished. 21,700 of Forestar's lots are under contract with D.R. Horton or subject to a right of first offer under the master supply agreement between our 2 companies.

Forestar's revenues in the second quarter increased 189% to $65.4 million over the prior year quarter, and pretax income increased 257% to $16.4 million.

During the 6 months ended March 31, Forestar delivered 1,066 lots and is still on track to grow its fiscal 2019 deliveries to 4,000 lots, generating $300 million to $350 million of revenue and its fiscal 2020 deliveries to approximately 10,000 lots generating $700 million to $800 million of revenue.

Forestar is a profitable business today, and we expect Forestar to remain profitable throughout its significant growth period with expected pretax margins of approximately 10% by fiscal 2021. These expectations are Forestar's stand-alone results.

Forestar is making steady progress in building its operational platform and capital structure to support its significant growth plans. Forestar's liquidity, capital base and lot position at March 31, are sufficient to support its fiscal 2019 and 2020 planned growth in lot deliveries and revenues.

To support investments for revenue growth in 2021 and beyond, earlier this month Forestar issued $350 million of 8% senior notes due in 2024. Subject to market conditions, Forestar expects to opportunistically access the equity and debt capital markets as necessary to provide additional capital for long-term growth while managing their balance sheet at a net leverage ratio of 40% or less.

Forestar will post an updated presentation to the Events and Presentations section of their investor site at investor.forestar.com at the conclusion of this call. This presentation describes Forestar's unique lot manufacturing business model and its significant growth and value-creation opportunity. We encourage investors to review it. David?

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David V. Auld, D.R. Horton, Inc. - President & CEO [12]

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DHI Communities is our multifamily rental company focused on suburban garden-style apartments and currently operates primarily in Texas, Arizona and Florida. DHI Communities has 4 projects under active construction and 2 projects that were substantially complete at the end of the quarter.

During the quarter, DHI Communities sold its first apartment project of 432 units located in McKinney, Texas for $73.4 million and recognized a gain on sale of $29.3 million.

DHI Communities' total assets were $170 million at March 31, and it is reported as part of other business in our segment financials. Bill?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [13]

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At March 31, our $1 billion of homebuilding liquidity was comprised of $557 million of unrestricted homebuilding cash and $447 million of available capacity on our revolving credit facility. Our homebuilding leverage ratio improved 130 basis points from a year ago to 22.9%.

During the quarter, we repaid $500 million of senior notes at their maturity, and the balance of our homebuilding public notes outstanding at the end of the quarter was $1.9 billion. We have $500 million of senior note maturities due in the next 12 months.

During the quarter, we paid cash dividends of $56 million. We also repurchased 2 million shares of common stock for $75.6 million, bringing our total repurchases for the first half of the year to 6.1 million shares and $216.2 million.

Our remaining stock repurchase authorization at quarter end was $159.3 million. At March 31, our stockholders equity was $9.4 billion, and book value per share was $25.09, up 16% from a year ago. David?

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David V. Auld, D.R. Horton, Inc. - President & CEO [14]

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Our balanced capital approach focuses on being flexible, opportunistic and disciplined. Our balance sheet strength, earnings and annual cash flow generation are increasing our flexibility, and we plan to utilize our strong position to enhance the long-term value of the company.

Our continued top cash flow priorities are to consolidate market share by investing in our homebuilding business and strategic acquisitions, reduce homebuilding leverage and return capital to our shareholders through the dividends and share repurchases. Jessica?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [15]

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Looking forward and as outlined in our press release this morning, we are providing our current expectations for the full year of fiscal 2019 based on today's market conditions and our results for the first half of the year. We currently expect to generate consolidated revenues of between $16.7 billion and $17 billion and to close approximately 55,000 to 56,000 homes.

We are forecasting a full year fiscal 2019 income tax rate of approximately 24.5%. We continue to expect to generate homebuilding cash flow from operations of at least $1 billion for the full fiscal year, and we expect our outstanding share count to be down slightly at the end of the year compared to the end of fiscal 2018.

For the third quarter of fiscal 2019, we expect to generate consolidated revenues in the range of $4.4 billion to $4.6 billion and to close approximately 14,500 to 15,000 homes during the quarter. We expect our homes sales gross margin in the third quarter to be in the range of 19.3% to 19.8%, and our homebuilding SG&A in the third quarter to be approximately 8.2% to 8.3%. David?

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David V. Auld, D.R. Horton, Inc. - President & CEO [16]

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In closing, our results reflect the strength of our long tenured and well-established operating platform across the country.

We are striving to be the leading builder in each of our markets and to expand our industry-leading market share.

We are focused on consolidated market share while growing our revenues and profits, generating strong annual cash flows and returns and maintaining a flexible financial position.

We are well positioned to do so with our conservative balance sheet, broad geographic footprint, affordable product offerings across multiple brands, attractive finished lot and land position and, most importantly, our outstanding experienced team across the country.

We thank the entire D.R. Horton team for their continued focus and hard work. We look forward to working together to continue growing and improving our operations.

This concludes our prepared remarks. We will now host questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today is coming from Stephen East from Wells Fargo.

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Stephen F. East, Wells Fargo Securities, LLC, Research Division - Senior Analyst [2]

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David, maybe I'll start with the progression through the quarter. What you all were seeing with traffic trends, with order progression and probably maybe most importantly, the incentive progression through the quarter and if you can give -- shed any light on what you're seeing in April with those?

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David V. Auld, D.R. Horton, Inc. - President & CEO [3]

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Stephen, I'd say it was kind of a traditional seasonality that's got a little better in January, a little better in February, a little better in March. The market is -- it seems pretty solid out there. It's -- and April is pretty much as we expected. So I will tell you it's kind of a pleasant surprise, given our first quarter. So we're happy with what we're seeing out there right now.

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Stephen F. East, Wells Fargo Securities, LLC, Research Division - Senior Analyst [4]

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Okay. If you look at the incentives progression either with what you all were doing or what you think you were seeing in the market, is that also unwinding as you move through the months?

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David V. Auld, D.R. Horton, Inc. - President & CEO [5]

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We have seen it unwinding, yes, incentives are certainly lower today than they were first quarter. And progressively we've been able to hit our sales targets with a little less incentive each month.

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Stephen F. East, Wells Fargo Securities, LLC, Research Division - Senior Analyst [6]

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Okay. All right. Fair enough and then the other thing -- go ahead.

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David V. Auld, D.R. Horton, Inc. - President & CEO [7]

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I said pretty much as we expected.

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Stephen F. East, Wells Fargo Securities, LLC, Research Division - Senior Analyst [8]

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Okay. And then the other thing, just looking at your capital allocation moving forward, you know your option lots, up to 62%. I know you don't like to -- 60% was your target that you stood by, but we're already past that. So maybe a compound question here. One, if you can talk about how you expect that to progress. And then looking at your capital allocation moving forward, you do have some debt coming due. Your net debt to total cap's probably a little bit or a whole lot higher than D.R. wants it, et cetera. And how do you look at allocating your capital?

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David V. Auld, D.R. Horton, Inc. - President & CEO [9]

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I got to tell you, Stephen, we're kind of maintaining as much flexibility as we possibly can and in Don Horton's world, any debt's bad debt. I can tell you this from a return base and capital priorities. Some debt's not a terrible thing. Bill?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [10]

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And, Stephen, with respect to the option percentage, certainly, we're pleased with the progress we're making. We expect to continue to progress from here, and we're not going to put out a set target necessarily, but we do expect to continue to increase the percentage of our lots that are controlled through purchase contracts. And that's giving us more flexibility. What that sets up is the potential to increase our cash flow from operations over the next few years. And with that increased cash flow, that gives us more flexibility for our capital allocation. We've been able to fold in share repurchases into our allocation over the last 1.5 years or so and pleased with the progress we've made there and expect to continue to keep that as an important part of our allocation.

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Operator [11]

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Our next question is coming from Carl Reichardt from BTIG.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD [12]

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I wanted to ask about Texas. So it's been sort of a quarter of your business, 20%, 25% I think for a bit, and your orders were slightly down flattish there. We've seen some of your peers report better numbers out of Texas. Some of them have talked about it being effectively the best market they've got in terms of turnover. So it looks like you lost some share there this quarter if you just go on orders. So can you talk a little bit, David, about what's happened in that particular market, for you particularly, over the last quarter given your strength there historically?

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David V. Auld, D.R. Horton, Inc. - President & CEO [13]

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Carl, I can tell you Texas is a great market. We're seeing solid performance across all of our divisions. We're coming off very tough comp of the second quarter last year and we are dominant market share in the 4 major cities. So it's -- we've very happy with Texas. We like what our operators are doing out there, and the truth is our targeted growth in Texas is probably low single digits to mid-single digits for the year, and we think we're well positioned to hit that.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [14]

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We've got a lot of markets across the rest of the country, Carl, where we don't have that kind of dominant position, and that's where a lot of our growth's coming from this year while we maintain or continue to gradually improve our share in Texas.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD [15]

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Right. Okay. I appreciate that, Jessica. And then in terms of community count, you had an increase this quarter, and you're starting to grow those again. Can you give us sort of a sense as you look maybe over the next year or so how you're thinking about the expansion of outlet count, ex acquisitions? Is that something we can expect to accelerate beyond just acquisitions?

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David V. Auld, D.R. Horton, Inc. - President & CEO [16]

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I wouldn't say accelerate. We have markets where we are not dominant, and our focus is to be in a significant, if not dominant, market position in every market. So a lot of growth opportunities, a flag in Texas typically absorbs at a much higher pace than flags in other markets. So it's balanced. It's disciplined, and it's something we're focused on continuing.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [17]

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We have a great lot position that will continue to replenish our communities. So we wouldn't probably anticipate anything more than flat to slightly up organically going forward.

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Operator [18]

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Our next question is coming from John Lovallo from Bank of America Merrill Lynch.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [19]

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First question is your outlook for a flat sequential gross margin at the low end of the range at least would seem to imply a fairly meaningful year-over-year step down in core margin versus what you saw in the first quarter despite -- if there I guess, should be a lumber benefit for one and an improving market? Could you just help us understand some of the moving pieces there?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [20]

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I think you see, John, that we are expecting some benefit from the lumber softening that we saw last year as those closings come through and we start to deliver those. We have started and we'll continue to deliver those. But the market did take a step backwards in our first quarter, and the pricing and incentive levels that we're pushing off of right now are going to allow us to be a little stronger in the margin but it's difficult to gauge the full extent of how much and when any of those concessions we gave up in the fall are going to be back and showing up in closing margins. Trying to take a measured pace to looking at margin.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [21]

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Got you. And then I guess just more broadly speaking in terms of just the overall environment, I mean, are you guys fairly confident that things are reaccelerating at this point? I mean would you expect growth to kind of trend higher as the year progresses here for D.R. Horton and for the industry itself?

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David V. Auld, D.R. Horton, Inc. - President & CEO [22]

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Reaccelerating, that's a tough question to answer today. A lot depends on interest rates. I can tell you we're very happy with the spring market so far. We're going to know a lot more as it rolls along. If it continues through May and early June, it's going to be a great year.

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [23]

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And we would look and see that some of the demand that was displaced in the fall will probably elongate a selling season this year in the spring and into early summer as those buyers have returned and more continue to come into the market seeing it's still a great time to buy a home.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [24]

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Our annual guide for closings and for the 6% to 8% increase in closings and a 4% to 6% increase in our consolidated revenues. So we are -- a little less pricing power this year, but we've got a great housing position to go drive outsized growth as compared to the industry.

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Operator [25]

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Our next question is coming from Alan Ratner from Zelman & Associates.

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Alan S. Ratner, Zelman & Associates LLC - MD [26]

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Just on that last question on the last point, I guess. I think if you take a step back 6% to 8% growth given how you started the year, certainly very impressive especially compared to what we've seen in the market. I know you guys have talked historically about 10% to 15% kind of where you hope to be annually. So I'm just curious as you kind of think about the way the spring's unfolding, you kind of put some of the softer demand in the rearview mirror. Is that still kind of the hope and the intention and kind of the thought based on what you're seeing right now in the market that you could eventually get back to that 10% to 15% annualized growth? Or have those plans changed for some reason?

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David V. Auld, D.R. Horton, Inc. - President & CEO [27]

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It's always possible, Alan. We try to be conservative, disciplined in what we say and then do what we say we're going to do. So it depends on the market. As we get through the spring, we'll take a look at it. And then how this year ends up, we'll take a look at next year. I can tell you our operators all have the Horton DNA in them and they want to drive growth, so.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [28]

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We're continuing to focus on returns, though. And so if you look at what we did experience in the late fall and as we're moving into the spring, there's a balance between price and pace, and we're striking that on an individual community level to drive the best possible return. And in today's market, that may mean that's a 6% to 8% growth rate rather than a 10% to 15% rate to continue to maintain or improve upon our overall returns.

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Alan S. Ratner, Zelman & Associates LLC - MD [29]

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Got it. That's helpful, Jessica. And then second, you gave some stats on the mortgage business and the profitability this quarter was actually quite impressive given some of the challenges in the mortgage space today. I was hoping you could just comment quickly on what you're seeing regarding the changes out of FHA? I know your average metrics are very favorable, but there's a piece of your business that goes outside of the mortgage business. So has there been any fallout or any impact at all from the adjustments FHA made in March?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [30]

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We have not seen material impact in the business of all. At the margin, there are certainly individual customers that may have to wait and work on a different loan program or are getting delayed in their process, but we have not seen any significant impact whatsoever.

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Alan S. Ratner, Zelman & Associates LLC - MD [31]

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Got it. One final one if I could sneak it in, Jessica. I might have missed it, but was there a pretext margin guidance for the full year? I think you typically give that.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [32]

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No, there was not. We just gave gross margin and SG&A guidance for the third quarter.

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [33]

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We need to see the rest of the year to really guide beyond Q3 or the rest of this spring to guide beyond Q3.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [34]

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We're continuing to sell and close 30% to 40% of our homes. It was actually even higher than 40% this quarter. And so to get a feel for gross margin much further out than a quarter is pretty difficult.

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Operator [35]

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Our next question is coming from Stephen Kim from Evercore ISI.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [36]

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And just a follow-on there with Alan's question on the full year profitability projection. In the past, you've talked a lot about how you kind of run your business with a 20%, 22% kind of gross margin range. I'm gathering from your commentary that much like the top line historical range of 10% to 15% growth, isn't necessarily the dominating factor in the way you're running your business right now but rather returns, that similarly on the gross margin side, we could see this year be a little bit below your 20% to 22% historical range, and that wouldn't be inconsistent with how you're positioning yourself for the longer term in a difficult market. I just wanted to make sure that I'm hearing you correctly. And then could you, with respect to margins, talk about the degree to which mix may be impacting your margin? Is it, in other words, is Express still generating gross margins comparable to the company average or maybe a little better? Or just give us some sense about mix in terms of your margin makeup right now.

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [37]

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Yes. In terms of the gross margin, yes, we're balancing pace and price margin and volume to generate the best returns we have. So yes, those are levers that may move up and down within our range. I would say our longer-term range on margin has been 19% to 21% or a little bit broader, 18% to 22%. And so margin in the 19s is certainly not unusual for us. And in the current market coming off the incentive levels that we had to put in place to regain momentum back in Q1, we feel good about the level that we're at and the ability to potentially start to carve some margin back going forward.

In terms of the gross margin profile across our brands, we're seeing pretty tight range in terms of margin and still seeing very good margins within our Express brand. That's still the heart of the market where we're seeing the strongest demand and the lowest supply of inventory in the marketplace. So still seeing very solid margins in Express.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [38]

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Great. That's very helpful. And then with respect to M&A, I think you talked about maintaining a balanced and disciplined approach. Recently, we've seen a couple of what I would basically call asset purchases in local markets, Pulte just announced the American West -- and then Lennar, we understand, bought Level Homes out in Raleigh. And so I guess I'm wondering, do you see the competition for local deals, midsize sort of private names in local markets, do you see that competition intensifying in the current environment? And if not -- or I should say, in a situation where that is actually happening, can you talk about how D.R. Horton is positioned or prepared to approach those kinds of opportunities? Do you think that this is something that you would, for instance, at this point favor share repurchases just because of an intensifying competitive environment for M&A?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [39]

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I would say, Stephen, say that we look at the M&A as opportunities to add to the long-term profitability and capabilities of the D.R. Horton Company overall. So where we can expand with great teams into new markets or deepening share in existing markets with great teams and people. That's our primary focus. And we're frankly very selective on where we're going to get aggressive in any kind of an acquisition opportunity.

Having said that, we continue to look at lots of opportunities and acquisitions, and we certainly think that DHI is an attractive acquisition opportunity as well for us in terms of our share buyback. You can see that as we have allocated more capital to that this fiscal year than in prior. So it's a balanced approach.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [40]

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So you're kind of drawing a distinction between the way you would approach M&A. In other words, being basically you're personnel-oriented and talent-oriented as opposed to what we've seen from, let's say, Pulte and Lennar most recently in terms of primarily being asset acquisitions, right?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [41]

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Yes. It certainly is a component of the overall acquisition, but the determining factor for us is generally going to be the people and the talent rather than simply the lot position, the lot portfolio. That is what justifies for us, the effort, expense and potential risk you have with an acquisition is the long-term payback of adding to your platform.

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Operator [42]

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Our next question is coming from Michael Rehaut from JPMorgan.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [43]

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First question I had was just kind of the pace that you've seen over the last 2 or 3 months perhaps relative to your expectations. So far as some of the other builders have reported, they've pointed to not just seasonal improvement but a little bit of improved year-over-year trends, in other words, the year-over-year growth improving as well from January into February into March. Maybe not every month but certainly towards the end of the quarter and perhaps even into April. So I was curious if you could give us a sense if that year-over-year growth accelerated as well particularly on a sales-pace basis. And when you talk to similarly incentives improving sequentially, obviously they're still up year-over-year. I was wondering if that year-over-year delta on incentives perhaps has moderated as well.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [44]

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Mike, we generally don't comment on individual months within a quarter in terms of a year-over-year improvement. As David said, we're very pleased with our sales pace. We did see normal seasonality as we moved throughout the quarter from month to month to month. And incentives for us are always on a community-by-community basis. So we've got communities where we have been able to roll those back fully from what we had to do in the fall. And we've got some that still have some elevated incentives out there. But as we continue to move throughout the spring, we're hopeful that we can continue to dial those back in communities where maybe we haven't been able to fully yet.

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [45]

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And I would say we're not seeing anything outside of normal seasonality, it's been a good spring. It's been a solid spring. But we would say it's consistent with what we would expect to see a normal seasonality thus far.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [46]

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Okay. So unless I'm interpreting that differently, it seems like perhaps again on a year-over-year trend basis, again, I know you kind of punted on the month-to-month but it does -- it sounds like normal seasonality means that, I guess -- unless I'm reading the tea leaves of your answer a little too finely, that perhaps it was more steady, it sounds like, rather than improvement.

I guess second question maybe just to zone in on a region here, I appreciate the color commentary on Texas. Another big focal point has been California with -- and in particular some of the real improvement month-to-month over the last 2, 3 months, the 4Q was pretty rough. Just wanted to get a sense again if there's been anything outside of normal seasonality or would you say that your -- or by contrast, anything a little bit more from an acceleration standpoint.

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [47]

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I spent the last 4 to 6 weeks traveling our California market, driving communities. Very impressed with the effort and execution of our teams out there. I don't think our -- the California market is on fire by any stretch of the imagination. But I will say in my world, effort and execution is what separates us from our competitors, and I was very happy with what I saw from our people.

The overall market in California appears to be getting a little better. It was not good in the first quarter, and there are some portions of it that have -- gives you a sense that it is coming back fairly well. We're focused on the -- as affordable as you can be in California, and it's -- Yes, I was very happy with what I saw, I'll say that.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [48]

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And, Mike, when we post our supplemental data after the call, you'll see we've been talking a lot about that in the west, part of our issue had just been getting the communities online. And this is the first quarter in several quarters our west region community count on average is up 5% year-over-year and it's even up 4% sequentially. So we're getting those new communities online, and we're very excited about the product that we're bringing to market.

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [49]

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And I think you'll see those communities -- new communities contribute more meaningful in Q3 and Q4 to sales than in the first month -- the first quarter of their opening.

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Operator [50]

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Our next question is coming from Ken Zener from KeyBanc Capital Markets.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [51]

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So could you just start with your spec completed number?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [52]

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That's 5,300.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [53]

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Okay. And that -- I apologize, I was just kind of going through calls this morning, but you gave guidance for 14,500 to 15,000. Is that correct for 3Q?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [54]

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That's correct.

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [55]

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That's correct.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [56]

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So let me ask you this question. If you look at your units and your units of inventory. It appears that your conversion rate of closings is decelerating versus kind of the past, which would imply -- and that's been happening in recent quarters. So it's 1 of 2 things. Obviously, there's slower demand or your inventory on average is just a little bit younger. Is it because your -- why is that? Is it because you're building specs so you just tend to have more younger inventory versus something that is more backlog-ish? And what exactly was the intra-quarter order of closings, please?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [57]

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Intra-quarter closings would be those that we sold and closed in the same quarter. I believe it was over 40%.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [58]

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Yes.

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [59]

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In the second quarter. Looking at the age of our inventory, the number of unsold homes that we have in inventory completed over 6 months was the same at March 31, '19, as it was at March 31, '18. So the inventory is still young, to use your word. And looking at that, we did have some -- I don't want to use the W word, but we did have some events this quarter that affected some production. So we do have some of those completions coming a little bit later -- out of the winter and into the early spring.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [60]

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Yes. And how -- okay, then let me look at this another way. I mean, obviously you guys are issuing guidance because for the last -- next 6 months are pretty much already going vertical. How do you think about your spec position as it relates to backlog? So obviously you want to achieve even flow which you do by not reducing your December quarter units and inventory as much as you did historically and others do, which helps you with market share. But how do you think about how you're running spec versus what you're seeing in terms of orders? I mean are you always going to keep basically your units under construction as a 2:1 ratio to backlog? Is that your approach in general? Or how should we think about how that spec will turn relative to the lower industry growth rate that we're seeing?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [61]

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Generally, we look at a snapshot of inventory position of around 50% of sold to unsold homes in total inventory. That will vary higher and lower at different points in the year, but -- and that's sort of the sum result of every one of our operating divisions, evaluating their communities 1 by 1, looking at a trailing sales pace along with an expected forward sales pace based upon where they are in the year and what they're seeing in those submarkets and then they're adjusting their spec inventory kind of relative to the construction cycle of that community and managing it week to week to week based on sales, closings and production completions and their varying starts on that basis. So that's -- the sum result of it comes up to about a 50% ratio plus/minus throughout the year. 2:1, yes, is a good ratio.

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Operator [62]

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Our next question is coming from Matthew Bouley from Barclays.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [63]

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I wanted to ask about the closings guidance. I think 3% to 6% in the third quarter, and it seems that the full year guide suggests some acceleration of that growth in the fourth quarter. So I mean, is that third quarter guide, I guess the 3% to 6%, is that a fair reflection for how you're seeing the, I guess, the sales environment today? Obviously, as you just mentioned, 40% orders and closings in the same quarter. And then what kind of gives you confidence in that acceleration in the fourth quarter? Is it really just the timing of your spec completions? Or I guess what else can you say there?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [64]

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I think, yes, [so we test them] for spec completions as well as maybe elongated demand cycle this spring because of what got displaced on the market in the fall. That's still the same people that want to live in a home from the fall, still want to live in a home. They still have a housing need, and we're positioned to supply that need this summer.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [65]

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Okay. And then just on the purchase accounting, can you -- do you have the numbers for what that was in the second quarter and then how that will trend into the third and fourth quarters?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [66]

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Sure. So, Matthew, we saw actually 20 basis points impact in our March quarter. Honestly, probably a little bit lighter than we would have expected. We did -- not that we like to talk about weather, but some of our acquisitions are in markets that do experience a little bit more extreme weather than a lot of the markets we already operated in. So a little bit of that purchase accounting impact has been delayed really until this quarter, Q3 and into Q4. So I wouldn't be surprised if that 20 basis points of impact in March ticks up in June.

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Operator [67]

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Our next question is coming from Nishu Sood from Deutsche Bank.

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Nishu Sood, Deutsche Bank AG, Research Division - Director [68]

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I just wanted to ask about the DHI Communities. Appreciate the incremental details on that. Now that part of your business seems to be maturing, just wondering if you can give us some kind of broad brushstrokes on how you expect that to grow, how big a part of the business it can become, what regions of the country you might ultimately expect it to be in and whether it would kind of stick to the garden-style apartments or whether it might broaden in terms of product lines? Just wanted to kind of get whatever longer-term visions you can provide right now.

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David V. Auld, D.R. Horton, Inc. - President & CEO [69]

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We are, I think, very happy with the progress to date building out a team, identifying sites. The whole key for us is sustainable and scalable. So it's going to tie very closely in with our homebuilding operations. The sites that we're building on right now are pieces of property that were a part of our larger communities where we're building houses. It seems very synergistic to what we're trying to accomplish. It allows us to reach affordability buyers -- or not buyers, but homeowners, future homeowners, that gives them a -- we start the relationship with them. So we're very excited about it. I think right now we have 4 projects under construction to pretty much completed and in lease-up and a pipeline of deals across the country of more than 20. So over time, it's going to be a pretty significant business for us.

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [70]

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There's some -- from some very early stage projects to more robust further down the line.

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [71]

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We'd still expect the next couple of years, we're not going to see a sale every quarter, but there will be occasional sales as we deliver the first set of projects that have been in the pipeline the last couple of years. But then over the longer term, certainly expect some growth there.

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Nishu Sood, Deutsche Bank AG, Research Division - Director [72]

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Got it. Got it. So coming back to the annual guidance, I know there's been a lot of questions about it, and it's been a very difficult environment over the past 6 to 9 months to even think about what '19 might have looked like. Investors generally looking at the market, rates have fallen. The outlook for the year, obviously from what builders have been saying, has improved. And so I just wanted to dig into how are you reflecting that in your guidance that you've given? I mean if you look at the volume guidance, for example, acquisitions are a big part of it, and the gross margins, you're expecting some modest improvement.

So and of course, we appreciate your more kind of level approach to giving guidance through these periods of volatility, but how should we think about how your guidance is reflecting the improvement in demand that the market has seen in recent months? Should we think about there potentially being more upside against your guidance so that it's a derisk, the guidance? Or, how should we think about that?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [73]

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I would say the first thing I would take away is we feel good enough to give guidance again. So that to me is the biggest takeaway, is that the spring has been good enough we felt comfortable to sit here today and provide that level of guidance. We'll continue to update quarterly as we can, but with 6 months left in the year and the houses we have under construction, the spring sales we've seen to date, you know us, we don't want to put guidance out there we don't feel comfortable that we can hit. But I'd tell you that we think the 55,000 to 56,000 annual homes is a very realistic range and what we would expect to deliver for this year.

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Operator [74]

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Our next question is coming from Buck Horne from Raymond James.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [75]

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I just want to follow up on issues -- a comment about or just a question about the DHI Communities. Just wondering I guess, would you -- I guess, are you considering a build-to-hold strategy? Are these all going to be built for sale at some point? And also would you consider JV partners or some other capital structure to scale that up more quickly?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [76]

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Currently, we're in a kind of a build-for-sale operation. We would evaluate alternative capital structures. David mentioned before, we're looking for something that's scalable and sustainable, and that would certainly be more accretive to returns in that business.

First thing for us was simplistically wanting to figure out and kind of understand the business and looking at how we can build that business as sort of a combination with our homebuilding platform across the country. So a lot of the initial pipeline that we have been working with in current projects have largely been on land parcels that are part of the larger master plans we've been developing and building homes in. And rather than in the past typically selling off those corners of land to other developers, look to develop the capabilities to monetize that land and add that value ourselves.

So as we look to roll it out forward and accelerate it, we would certainly be looking at the capitalization of that business with a lot of options open in front of us.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [77]

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Okay. That's great. That's helpful. And on the debt that you have coming due in the next 12 months, I think you mentioned another $500 million, is there a plan to possibly pay that off sooner? Or would you wait until the maturity on that? And also just related to Forestar's capital plans, how are you think about the market timing for their debt or equity?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [78]

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In terms of the Horton capital plan, no plans to pay off the next maturity early. We'll be then evaluating our cash flow, our investment plans for fiscal 2020. And as we put those plans together, we'll determine whether we simply pay that debt off or whether we refinance all or a portion of that. In terms of Forestar capital, very pleased with the progress that has been made with respect to building the capital stack at Forestar, them issuing their first issuance of senior notes here in April was an important step to getting the capital, start making investments for fiscal '21 revenues for Forestar.

Certainly equity is in the plans as well, and we want to be prepared and in position for Forestar to issue equity when the opportunity presents itself. We've been very pleased that Forestar now has 3 equity analysts covering them. And the management team at Forestar, really alongside the Horton team here as well, is starting to hold more meetings with investors. We'll begin attending some investor conferences and basically getting the story out there.

I would encourage investors to look at the investor deck that's on the Forestar website. It's very helpful in describing the lot manufacturing business model at Forestar and certainly look forward to them being able to expand their float in the future.

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [79]

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And Forestar will start having a stand-alone conference call beginning in the June quarter.

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Operator [80]

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Our next question is coming from Jack Micenko for SIG.

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Soham Jairaj Bhonsle, Susquehanna Financial Group, LLLP, Research Division - Associate [81]

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This is actually Soham Bhonsle for Jack this morning. Just on your gross margin guide for third quarter. I know you guys are on the lower end, it's 19.3%, which is flat. But how do we sort of get to the higher end of 19.8%? Can you just maybe talk through some of the moving parts of how we could get there?

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Michael J. Murray, D.R. Horton, Inc. - Executive VP & COO [82]

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Sure. We do have some cost tailwinds that we do expect to start coming through our closings in Q3 primarily from lumber pricings having dropped in the latter part of '18. And as we've talked about a bit, as we've been able to pull back our incentives gradually through the spring, that should result in some improved margins versus the closings we've seen in Q2. So those are our primary factors that we would expect to see some sequential or a potential for margin improvement.

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Soham Jairaj Bhonsle, Susquehanna Financial Group, LLLP, Research Division - Associate [83]

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Okay. Great. And then on sales pace, it looks like core sales pace was -- ex the acquisitions, was up 1% but down 2% if you were to include the acquisitions. Can you just confirm that? And then in going forward, should we expect order increases to be more a function of pace improvement at this point or more of community count year-over-year?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [84]

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So on your first question, our absorption kind of on the same-store basis is up 1% year-over-year and it was up 49% sequentially. So that's kind of right in line with traditional seasonality, even ex acquisitions. And then the second question?

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Soham Jairaj Bhonsle, Susquehanna Financial Group, LLLP, Research Division - Associate [85]

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Just in terms of how we should think about order improvement year-over-year, is it pace-driven or community count?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [86]

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Well, our community count did tick up organically this quarter and then even further because of the acquisitions. So I'd anticipate the community count remaining up through the remainder of the year. We'll see what comes from absorptions versus communities but we haven't given a specific guide to sales.

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Operator [87]

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Our next question is coming from Susan Maklari from Crédit Suisse.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [88]

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My first question is just, can you talk a little bit to what you've seen across your various brands? You've got such a range in there with Freedom, Express, Emerald. Can you just talk to maybe some of the differences that you've seen and especially maybe if things have improved as we've moved through the quarter?

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David V. Auld, D.R. Horton, Inc. - President & CEO [89]

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We're very happy with the performance of all the brands. I mean we are growing Freedom. I think that's going to be a very important part of our future offerings. Emerald has stayed fairly steady at about 3% of our deliveries. The Horton brand maintains dominance. And Express, it's pretty much fully rolled out. So I think that 30%, 35% may go up a little bit. Percent of leverage will remain constant.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [90]

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Okay. And then can you just talk to any updated expectations as it relates to input costs? You've talked in the past about lumber coming off and how that could provide some offset within the gross margins to some of the pressures that are there. Has anything changed in there or anything that we should sort of be thinking about in the back half?

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Jessica Hansen, D.R. Horton, Inc. - VP, IR [91]

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No. Sue, I mean, we do expect that cost moderation to primarily come from lumber as it pertains to other material inputs. We've always got some costs there rising but we generally find ways to offset those. So we would expect lumber to be a tailwind to gross margin in the back half of the year.

Labor costs haven't come down even with some of the softness. But in terms of trade availability that's helped a little bit as some builders have slowed their starts this spring as compared to maybe what was anticipated. I don't think we've given our revenue in stick-and-brick per square foot yet that we typically provide on the call. So on a year-over-year basis our revenues per square foot were up about 2% versus our stick-and-brick costs, which were up 4%. So that goes right in line with the year-over-year decline in gross margin we saw. Sequentially, that was a much tighter range. Our revenue per square foot was essentially flat and our stick-and-brick costs per square foot was just very, very slightly up.

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Operator [92]

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Our final question today is coming from Alex Barrón from Housing Research Center.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [93]

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I wanted to ask along the lines of the multifamily rental business, whether you guys have given any thought or have started any plans to build out single-family rental communities for sale?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [94]

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Something we're always looking at opportunities, Alex, and as we get further into that, if we get further into that, we will certainly let you know.

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David V. Auld, D.R. Horton, Inc. - President & CEO [95]

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If the question is, have we given it any thought? Absolutely. We watch everything going on in the industry.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [96]

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One last one if I can ask. On the other one, the multifamily, I don't know if you guys -- if I missed it or did you guys give any specific guidance, can we expect another of those communities to be sort of [report another gain] next quarter or not necessarily?

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Bill W. Wheat, D.R. Horton, Inc. - Executive VP & CFO [97]

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We've not given specific guidance, Alex. We're still on the early stages. This was the first project sale in the multifamily division. We do have 4 projects under construction and 2 projects that are substantially complete and in the lease-up phase. So we certainly expect we would have 2 projects in the coming quarters. But we don't expect to see a sale every quarter, so we're not in a position yet to provide more specific guidance than that.

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Operator [98]

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Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

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David V. Auld, D.R. Horton, Inc. - President & CEO [99]

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Thank you, Kevin. We appreciate everyone's time on the call today and look forward to speaking to you again in July to share the third quarter results.

And to the D.R. Horton team, incredibly proud of what you guys have accomplished out there over the last 6 months. I just want to thank you.

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Operator [100]

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Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.