D.R. Horton - Q2 2024

Transcript

Operator (participant)

Good morning, and welcome to the second quarter 2024 earnings conference call for D.R. Horton, America's Builder, the largest builder in the United States. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If you wish to enter the queue, you may press star one on your phone at any time. Should you wish to remove yourself from queue, you may press star two. I will now turn the call over to Jessica Hanson, Senior Vice President of Communications for D.R. Horton.

Jessica Hansen (SVP of Communications)

Thank you, Tom, and good morning. Welcome to our call to discuss our financial results for the second quarter of fiscal 2024. Before we get started, today's call includes 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 statement. Additional information about factors that could lead to material changes in performance is contained in D.R. Horton's Annual Report on Form 10-K and its 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 updated investor and supplementary data presentations to our investor relations site on the Presentation section under News and Events for your reference. Now, I will turn the call over to Paul Romanowski, our President and CEO.

Paul Romanowski (President and CEO)

Thank you, Jessica, and good morning. I'm pleased to also be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer, and Bill Wheat, our Executive Vice President and Chief Financial Officer. For the second quarter, the D.R. Horton team delivered solid results, highlighted by earnings of $3.52 per diluted share. Our consolidated pretax income increased 23% to $1.5 billion on a 14% increase in revenues to $9.1 billion, with a pretax profit margin of 16.8%. Our homebuilding return on inventory for the trailing twelve months, ended March 31, was 29.9%, and our return on equity for the same period was 22.2%.

Although inflation and mortgage interest rates remain elevated, our net sales orders increased 46% for the first quarter and 14% from the prior year quarter, as the supply of both new and existing homes at affordable price points is still limited, and the demographics supporting housing demand remain favorable. Homebuyer demand during the spring selling season thus far has been good, despite continued affordability challenges. With 45,000 homes in inventory, we are well-positioned to continue consolidating market share. Our average construction cycle times are back to normal, and our housing inventory turns are improving. We continue to focus on capital efficiency to produce consistent, strong homebuilding operating cash flows and returns. Mike?

Mike Murray (EVP and COO)

Earnings for the second quarter of fiscal 2024 increased 29% to $3.52 per diluted share, compared to $2.73 per share in the prior year quarter. Net income for the quarter was $1.2 billion on consolidated revenues of $9.1 billion. Our second quarter home sales revenues increased 14% to $8.5 billion on 22,548 homes closed, compared to $7.4 billion on 19,664 homes closed in the prior year. Our average closing price for the quarter was $375,500, flat sequentially and down 1% from the prior year quarter. Bill?

Bill Wheat (CFO)

Our net sales orders in the second quarter increased 14% to 26,456 homes, and order value increased 17% from the prior year to $10.1 billion. Our cancellation rate for the quarter was 15%, down from 19% sequentially and 18% in the prior year quarter. Our average number of active selling communities was up 4% sequentially and up 15% year-over-year. The average price of net sales orders in the second quarter was $380,400, up 1% sequentially and up 2% from the prior year quarter. To address affordability for homebuyers, we are still using incentives such as mortgage rate buydowns, and we have reduced the prices and sizes of our homes where necessary.

Based on current market conditions and mortgage rates, we expect our incentives to remain at these elevated levels in the near term. Our sales continue to be primarily from homes under construction and completed homes, and we will continue to start homes and maintain sufficient inventory to meet sales demand and aggregate market share. Jessica?

Jessica Hansen (SVP of Communications)

Our gross profit margin on home sales revenues in the second quarter was 23.2%, up 30 basis points sequentially from the December quarter. On a per sq ft basis, home sales revenues and stick and brick costs were both essentially flat in the quarter, while lot costs increased 3%. Our home sales gross margin for the full-year fiscal 2024 will be dependent on the strength of demand during the rest of the spring selling season, in addition to changes in mortgage interest rates and other market conditions. For the third quarter, we expect our home sales gross margin to be similar to or slightly better than the second quarter. Bill?

Bill Wheat (CFO)

In the second quarter, our home building SG&A expenses increased by 13% from last year, and home building SG&A expense as a percentage of revenues was 7.2%, down 10 basis points from the same quarter in the prior year. Fiscal year-to-date, home building SG&A was 7.7% of revenues, up 20 basis points from the same period last year, due primarily to the expansion of our operations to support growth. We will continue to control our SG&A while ensuring that our platform adequately supports our business. Paul?

Paul Romanowski (President and CEO)

We started 24,900 homes in the March quarter and ended the quarter with 45,000 homes in inventory, up 3% from a year ago and up 6% sequentially. 27,600 of our homes at March 31 were unsold. 7,300 of our total unsold homes were completed, of which 790 had been completed for greater than 6 months. For homes we closed in the second quarter, our construction cycle time improved slightly from the first quarter, and we are back to our historical average of 4 months from start to complete. We will maintain a sufficient starts pace and homes and inventory to meet demand and continue consolidating market share. Mike?

Mike Murray (EVP and COO)

Our home building lot position at March 31st consisted of approximately 617,000 lots, of which 23% were owned and 77% were controlled through purchase contracts. We remain focused on our relationships with land developers across the country to maximize returns. These relationships allow us to build more homes on lots developed by others. Of the homes we closed this quarter, 62% were on a lot developed by Forestar or a third party. Our capital efficient and flexible lot portfolio is a key to our strong competitive position. Our second quarter home building investments in lots, land, and development totaled $2.4 billion. Our investments this quarter consisted of $1.4 billion for finished lots, $760 million for land development, and $230 million for land acquisition. Paul?

Paul Romanowski (President and CEO)

In the second quarter, our rental operations generated $33 million of pretax income on $371 million of revenues from the sale of 1,109 single-family rental homes and 424 multifamily rental units. Our rental property inventory at March 31 was $3.1 billion, which consisted of $1.3 billion of single-family rental properties and $1.8 billion of multifamily rental properties. We are not providing separate annual guidance for our rental segment due to the uncertainty regarding the timing of closings caused by interest rate volatility and capital market fluctuations. Based on our current pipeline of projects, we expect our rental revenues in the third quarter to be similar to the second quarter. Jessica?

Jessica Hansen (SVP of Communications)

Forestar, our majority-owned residential lot development company, reported revenues of $334 million for the second quarter on 3,289 lots sold, with pretax income of $59 million. Forestar's owned and controlled lot position at March 31 was 96,100 lots. 60% of Forestar's owned lots are under contract with, or subject to a right of first offer to D.R. Horton. $310 million of the finished lots we purchased in the second quarter were from Forestar. Forestar had approximately $800 million of liquidity at quarter end, with a net debt to capital ratio of 16.4%.

Forestar remains uniquely positioned to capitalize on the shortage of finished lots in the home building industry and to aggregate significant market share over the next few years with its strong balance sheet, lot supply, and relationship with D.R. Horton. Mike?

Mike Murray (EVP and COO)

Financial Services earned $78 million of pretax income in the second quarter on $226 million of revenues, resulting in a pretax profit margin of 34.6%. During the second quarter, essentially all of our mortgage company's loan originations related to homes closed by our home building operations, and our mortgage company handled the financing for 80% of our buyers. FHA and VA loans accounted for 59% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 725 and an average loan-to-value ratio of 89%. First-time homebuyers represented 57% of the closings handled by our mortgage company this quarter. Bill?

Bill Wheat (CFO)

Our balanced capital approach focuses on being disciplined, flexible, and opportunistic to sustain an operating platform that produces consistent returns, growth, and cash flow. We continue to maintain a strong balance sheet with low leverage and significant liquidity, which provides us with the ability to adjust to changing market conditions. During the first six months of the year, our consolidated cash used in operations was $470 million, and our home building operations provided $408 million of cash. At March 31, we had $5.7 billion of consolidated liquidity, consisting of $3.1 billion of cash and $2.6 billion of available capacity on our credit facilities. Debt at the end of the quarter totaled $5.9 billion, with no senior note maturities in fiscal 2024.

Our consolidated leverage at March 31 was 20%, and consolidated leverage net of cash was 10.8%. At March 31, our stockholders' equity was $23.8 billion, and book value per share was $72.13, up 19% from a year ago. For the trailing twelve months ended March 31, our return on equity was 22.2%, and our consolidated return on assets was 15.1%. During the quarter, we paid cash dividends of $0.30 per share, totaling $99 million, and our board has declared a quarterly dividend at the same level to be paid in May. We repurchased 2.7 million shares of common stock for $402 million during the quarter, and our fiscal year-to-date stock repurchases were $801 million. Jessica?

Jessica Hansen (SVP of Communications)

For the third quarter, we currently expect to generate consolidated revenues of $9.5 billion-$9.7 billion, and homes closed by our home building operations to be in the range of 23,500-24,000 homes. We expect our home sales gross margin in the third quarter to be approximately 23%-23.5%, and home building SG&A as a percentage of revenues to be approximately 7%. We anticipate a financial services pretax profit margin of around 30%-35% in the third quarter, and we expect our quarterly income tax rate to be approximately 24%. Our full year fiscal 2024 revenue, pricing, and margins will be affected by market conditions and changes in mortgage rates, in addition to our efforts to meet demand by balancing sales pace and price to maximize returns.

For the full year of fiscal 2024, we now expect to generate consolidated revenues of approximately $36.7 billion-$37.7 billion, and expect homes closed by our home building operations to be in the range of 89,000-91,000 homes. We continue to expect to generate approximately $3 billion of cash flow from our home building operations. We now plan to purchase approximately $1.6 billion of our common stock for the full year, in addition to our annual dividend payments of around $400 million. Finally, we now expect an income tax rate for fiscal 2024 in the range of 23.5%-24%.

We are balancing our cash flow utilization priorities to grow our operations, pay an increased dividend and consistently repurchase shares, while maintaining strong liquidity and conservative leverage. Paul?

Paul Romanowski (President and CEO)

In closing, our results and position reflect our experienced teams, industry-leading market share, broad geographic footprint, and diverse product offerings. All of these are key components of our operating platform that sustain our ability to produce consistent returns, growth, and cash flow while continuing to aggregate market share. We will maintain our disciplined approach to investing capital to enhance the long-term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D.R. Horton family of employees, land developers, trade partners, vendors, and real estate agents for your continued focus and hard work. This concludes our prepared remarks. We will now host questions.

Operator (participant)

Thank you. The floor is now open for questions. If you wish to ask a question at this time, please press star one on your phone to join the queue. If you wish to remove yourself from queue, you may press star two. We do ask, if listening on speakerphone this morning, that you pick up your handset while asking your question to provide optimal sound quality, and we do also ask that you limit yourself to one question and one follow-up. Please hold a moment while we poll for questions. The first question this morning is coming from Carl Reichardt from BTIG. Carl, your line is live. Please go ahead.

Carl Reichardt (Managing Director)

Thanks. Morning, everybody. I wanted to talk about Florida. It's a pretty important market for you all, the long experience there. We've seen an increase in existing home inventory in some parts of that market, and we obviously know higher insurance costs are also coming to bear there. So could you talk a little bit in some detail about your performance there, maybe the various markets within Florida, and how it feels to you right now?

Paul Romanowski (President and CEO)

You know, Carl, Florida still feels good to us. There certainly has been a lot of news, you know, tied to the rise in insurance rates, and for most of where we sell our homes are off the coast, and building new construction allows for some stability in those insurance rates. So haven't seen as significant an increase for the homes in the communities where we sell as you may see reported along the coastal and high wind zones. Still seeing good in-migration and good job growth throughout the Florida market. So we feel pretty good about the Florida market and especially about our positioning at the more affordable price points across the Florida peninsula.

Carl Reichardt (Managing Director)

Thanks. And then follow-up, multifamily and single family for sale, that portfolio business, with some lumpiness there. I'm curious about the markets where you've got fairly good-sized operations in multifamily and single-family rental. One of the reasons for you entering and playing more significantly in that space, I think, is scale benefits for the overall home building operation. So if you think about the markets where you're big in those two businesses, are you seeing lower overall vertical costs for the home building operation, too, or better margins? And maybe sort of expand a little bit on that particular element of the business. Thanks.

Mike Murray (EVP and COO)

I think there's two big factors that drive into our push into the rental business. One is we're a better buyer of land, a better user of land, and that we're able to convert more of the land to its ultimate final use. So we're a better counterparty to a lot of sellers, as we can deal with the build for rent, the multifamily component, as well as the residential for sale. That gives us some economies in the purchase of the land and efficiencies in the entitlement process. Certainly, within the vertical cost structure, we've probably seen more ability to influence, cost on the traditional multifamily side coming over from our home building operations, because we're much bigger buyers of parts and pieces that go into the structures than a traditional multifamily developer is.

Carl Reichardt (Managing Director)

Great. I appreciate it. Thanks, all.

Mike Murray (EVP and COO)

Thank you.

Operator (participant)

Thank you. Your next question is coming from John Lovallo from UBS. John, your line is live. Please go ahead.

John Lovallo (Managing Director and Senior Equity Analyst)

Good morning, guys, and thank you for taking my questions. You know, the first one, obviously, there's a lot of concern in the market, given, you know, the stickier than expected CPI,

... you know, although rates, you know, the long-term mortgage rates only moved up by about 35 basis points since pre-CPI. I mean, I guess the question is: have you seen or would you expect to see any impact to demand, or would there be any change in your incentive activity given the, you know, this 35 basis point move in rates?

Bill Wheat (CFO)

We, you know, we expect to, to continue to meet the market, and, you know, we, we continue to stay focused on, incentives that, that drive that activity, and interest rate buydowns has been a big portion of, what we have done. You know, we tend to move with the market, so as you've seen that increase, in market rates, we will move up the rate buydowns, to be about 1 point -1.5 points, below market. But we do expect, incentives to remain near their elevated levels today, you know, especially with the, the rate instability and, and stickiness, you know, up in that, 7% range today.

John Lovallo (Managing Director and Senior Equity Analyst)

Understood. Maybe splitting hairs slightly here, but you guys beat deliveries, you know, versus your outlook in the quarter by about 2,300 units at the midpoint, raised the outlook by about 1,500 units at the midpoint. I mean, was there some pull forward in the second quarter, or, you know, is there some conservatism in this outlook, or maybe the expectation that delivery pace could moderate to some extent? I mean, how should we think about that?

Jessica Hansen (SVP of Communications)

Yeah, great, great question, John. We did go into the quarter with a significant number of completed specs, so we actually sold and closed intra-quarter 54% of our houses. And so that is a very high percentage for us. A typical range would be about 35%-40% of our homes would be sold and closed within the same quarter. So we still have over 7,000 completed specs, so I do think you'll see that intra-quarter activity stay higher than our historical norms.

It may not be at the 54% we saw this quarter, but that did allow for probably a little bit of pull forward of demand, and it gave us the confidence to up the low end of our range by the full 2,000 units that we beat, and then the high end of our range by just 1,000. And we're now, you know, back to normal, if not better than our historical inventory terms in terms of what we're guiding to at the high end, it'd be a roughly 2.2X turn. So feel very good about the ability to take that range up, but don't think there's necessarily an opportunity for the same scale of beat next quarter.

John Lovallo (Managing Director and Senior Equity Analyst)

Yeah, makes a lot of sense. Thank you, guys.

Operator (participant)

Thank you. Your next question is coming from Stephen Kim from Evercore ISI. Stephen, your line is live. Please go ahead.

Stephen Kim (Senior Managing Director and Head)

Thanks very much, guys. A strong quarter. Appreciate all the guidance thus far. Was curious if you could shed a little bit more light regarding your cash flow guidance. You mentioned about $3 billion from home building specifically, but you do have other segments. You have the rental segment, you have Forestar in particular. And I was curious as to, you know, what kind of an offset should we expect from rental or Forestar this year relative to that $3 billion from home building? And then specifically with rental, you have about $3.1 billion in inventory value right now. Where do you think that's gonna go over the next, let's call it, 12 months or so?

Bill Wheat (CFO)

Sure, Steve. On our cash flow guide, we have been guiding to home building cash flow, because that has been the primary generator of cash for us over the last couple of years, and, and we have, you know, invested portions of that into the rental operation as well, which feeds to the consolidated cash flow from ops. So there is, some, some offset versus the home building cash flow this year. We're guiding to, around $3 billion of home building cash flow. Would expect, you know, in the, in the $800 million-$1 billion range, probably of offset to that for the full year this year, on consolidated. But we do expect that gap to start narrowing in, in future years, as the growth ramp of our rental platform starts to, starts to moderate.

And so, we would expect, going forward, our consolidated cash flow and our homebuilding cash flow to be much nearer to the same number, beyond fiscal 2024. And so with the rental platform, you know, asset growth moderating, we're at 3.1 today. We do still expect to see that grow a bit further, this year and will grow slightly next year, primarily from the multifamily platform. Our multifamily platform continues to grow, and we're building out a more elevated level of starts over the last couple of years. But that will, you know, probably late 2025, start to moderate as well.

We do see prospects for the cash flow on a consolidated basis to be increasing consistently, you know, from here, you know, into 2024 and into 2025.

Stephen Kim (Senior Managing Director and Head)

Okay, that's helpful. Appreciate that. And then, with respect to uses of cash, I think you know, as always, you talk about the opportunity for growth, and your market share for in and across the country is still leaves some room there. And so I wanted to ask about your community count. You were up 4% month-to-month, up 15% year-over-year. That's an area where a lot of other builders have struggled. And I'm curious if you could provide a little bit of granularity into how much you expect there's further opportunity for growth this year in your community count, and what you generally target for the next year or two in terms of community count growth.

Jessica Hansen (SVP of Communications)

Sure, Steve. We've been up a double-digit percentage on a year-over-year basis for community count now for several quarters. So we've probably got at least another quarter or so until we've cycled and anniversaried that and would expect the growth to moderate a bit. But as we look at our overall lot position and our positioning for the future to continue to drive growth, we have shifted to a lot of that coming from community count, rather than just continuing to have to drive more absorption out of each and every community. So I do think you'll continue to see our community count grow. It just probably won't continue to be at the double-digit percentage year-over-year increase here in a quarter or two.

Stephen Kim (Senior Managing Director and Head)

... Okay, gotcha. So like, more like kind of like a high single digit kind of rate is what you're talking about, right?

Jessica Hansen (SVP of Communications)

Yes, mid to high.

Stephen Kim (Senior Managing Director and Head)

Okay, gotcha. Appreciate it. Thanks very much, guys.

Mike Murray (EVP and COO)

Thank you.

Jessica Hansen (SVP of Communications)

Thanks, Steven.

Operator (participant)

Thank you. Your next question is coming from Matthew Bouley from Barclays. Matthew, your line is live. Please go ahead.

Matthew Bouley (Senior Equity Research Analyst)

Morning, everyone. Thank you for taking the questions. Wanted to ask around start pace going forward. Perhaps, assuming we live in this kind of, you know, mid- to high-sevens mortgage rate environment, is there a scenario where you would dial back production at all to the extent it supports price or margin? Or, you know, maybe said another way, is there a mortgage rate at which you would consider pulling back a little bit on starts? Thank you.

Mike Murray (EVP and COO)

I think we're going to manage the starts pace at a community by community level based upon what we're seeing with buyers in the market and how they're responding to the current interest rate environment and mix of incentives that, that we're offering. You know, traditionally, we've had a limiter for the past several periods on lot supply in terms of what we could actually start. So as we're seeing our lots get developed and get brought online, we're able to bring good production starts into the market. I think we started just under 25,000 homes in the quarter, and, you know, we probably expect that to continue into the June quarter, you know, as if we see continued absorptions and sales.

Jessica Hansen (SVP of Communications)

And so with our gross margin currently over 23% and very solid, it would take a pretty big disruption in the market for you to see us have a broad-based across the board pullback in starts. As Mike alluded to, it's going to be just driven on a community by community basis like it always is, based on our finished lot position and what makes the most sense to maximize returns at that individual community level. So as we see right now, you know, without another big shock or any sort of big shock to the system or a more significant move in rates, I think we would expect our starts to be pretty consistent through the remainder of the year.

Matthew Bouley (Senior Equity Research Analyst)

Got it. Very helpful. Secondly, I wanted to ask around credit and DTI metrics, particularly for your first-time buyers. Are you seeing any sort of incremental signs of stress in your mortgage applications, just given this affordability backdrop? Thank you.

Bill Wheat (CFO)

No, we've seen a pretty solid level of qualified buyer. You know, our average FICO score this last quarter was still at 725. And, you know, with the low level of inventory and available homes to purchase out there, you know, we still see a strong buyer demographic and demand, and, you know, we've remained pretty consistent. You know, we have seen fluctuation in rates, but they've really not been significant enough to have any meaningful impact on our backlog and people's ability to qualify.

Matthew Bouley (Senior Equity Research Analyst)

Great. Thanks, everyone.

Jessica Hansen (SVP of Communications)

Thanks, Matt.

Operator (participant)

Thank you. Your next question is coming from Michael Rehaut from JPMorgan. Michael, your line is live. Please go ahead.

Michael Rehaut (Head of U.S. Homebuilding and Building Products Research)

Thanks. Good morning, everyone. Just wanted to drill down, if possible, a little bit on, you know, the demand trends over the last, you know, couple of months. I know you don't typically go too far down the rabbit hole in terms of month-to-month, but, you know, obviously with the change in rates, with, with some of the concerns in the market, any, you know, kind of, you know, January, February, March, April type of progression, we've heard that, you know, for example, March... I'm sorry, March and April maybe are a little bit more moderate than what we saw in February.

I'd love your take on just, you know, how the demand trends, how the sales pace has come in through the door, you know, maybe versus your expectations, and, you know, if incentives in the marketplace have changed at all around that.

Bill Wheat (CFO)

Sure, Mike. You know, we did see at the end of our first fiscal quarter in December, we saw, you know, I'd say, better than normal seasonality in terms of sales demand, and that continued on into January. When we had our call in January, we were still seeing, I'd say, probably a little bit better than normal seasonality into January. And then, as we've talked many times, anytime you see a lot of volatility in rates, there's always an adjustment period for buyers. And so we saw more volatility in rates in February and March, and so we saw some intermittent periods where buyers were having to adjust, which does affect, you know, weekly sales pace.

But then, you know, as we look out, like over the last 6 weeks or so, we've seen that stabilize and are seeing a very good sales pace in line with our overall plans and very pleased that that's positioned us to increase our guide for the year. Going forward, as Jessica has said a couple of times already, going forward, it's going to be subject to the rates, you know, what happens in the market with rates, and in the last week, we've seen another period of volatility. So I think we'll continue to see that the market adjust, and we'll adjust to it as the rate environment changes.

Michael Rehaut (Head of U.S. Homebuilding and Building Products Research)

Great. Thanks, Bill. Appreciate that. I guess just maybe along those lines, in terms of the impact of higher rates at points, you know, it seems like if you go back to your guidance last quarter, there was a little bit of surprise that, you know, maybe the outlook for the quarter for gross margins was a little less than people were looking for, and it kind of went back to the higher level of rates and incentives seen in the calendar third quarter.

Wondering, you know, obviously, you haven't given guidance for the fourth quarter, but all else equal, you know, if, if perhaps you're having some of the, delayed impact of perhaps higher incentives, perhaps more costly incentives, and I know there's some, you know, warehouse buying and, delaying of an impact on the incentive front from the mortgage rate buydowns. You know, if we were to stay at these levels, just from the standpoint, basically, of the, buydowns being maybe a little more expensive, all else equal, would that impact be more on your fiscal fourth quarter than your third quarter?

Jessica Hansen (SVP of Communications)

I think right now, Mike, you know, with the number of homes that we're selling and closing intra-quarter, you're seeing a pretty good real-time average gross margin. And so, unlike a lot of other builders, I think you'll see more real-time market conditions show up in our results faster. Hard to say, you know, splitting hairs between Q3 and Q4, but we, you know, we're really pleased with where our gross margin came in this quarter. And we actually did see an increase in the number of buyers sequentially that were able to utilize the mortgage rate buydown, and in spite of that, we had, you know, a slight tick-up in our gross margin.

So without giving specific guidance for the remainder of the year, because it is gonna be dependent on the interest rate environment, you know, it feels pretty good to us right now. Our, our costs outside of incentives have generally flattened out, on the stick and brick side. You know, we're still having some categories go up where we have pressure, but we've had some success getting categories to go down. We obviously do still have some lot cost, inflation we would expect to continue to need to be able to offset. So when we think about really predominantly the next two quarters, it is gonna be incentives as, as the wild card, and it's gonna be dependent solely on market conditions.

Michael Rehaut (Head of U.S. Homebuilding and Building Products Research)

But if just to make sure we understand then, to the extent that rates have risen and the cost of those mortgage rate buydowns become more expensive, do you feel like a lot of that is already reflected in 2Q and 3Q?

Paul Romanowski (President and CEO)

I, I think, again, based on the fact that we are selling, you know, more than 50% of our homes inter-quarter, we'll see how that plays out as we look at the next, you know, in the third quarter and the fourth. But, you know, we move our rates along with the market, and so really it becomes a question of absorption and pace. You know, we're gonna continue to manage, pace and margin to the returns that we want, and if we need to, you know, to press a little more on the incentives to keep that pace consistent, we'll do so. But, you know, we move our, rates along with the market, so it doesn't necessarily mean we're seeing significant cost in the level of those buydowns.

It really just starts to stress the buyer when they climb up, you know, into the 7%, and if they go to the 8% range, then we'll see a little more challenge in getting buyers qualified. And if it goes that high, I would expect to see our incentives increase to keep our pace.

Michael Rehaut (Head of U.S. Homebuilding and Building Products Research)

Great. Thanks so much. Appreciate it.

Jessica Hansen (SVP of Communications)

Thanks, Mike.

Operator (participant)

Thank you. Your next question is coming from Eric Bosshard, from CRC. Eric, your line is live. Please go ahead.

Eric Bosshard (CEO and Consumer Industry Analyst)

Good morning. Two things, if I could. First of all, the gross margin in the quarter was a little bit better. What was different that created that?

Jessica Hansen (SVP of Communications)

I'm assuming you're talking on a sequential basis?

Eric Bosshard (CEO and Consumer Industry Analyst)

Cor- Correct.

Jessica Hansen (SVP of Communications)

Yeah, so a little bit of it was just core, inclusive of just a very modest pickup on the incentive front in terms of the forward commitments and the interest rate buydown, because you'll see when we put out our supplemental guidance that kind of core margin's up about 20 basis points. And then we also had a little bit less of an impact on warranty and litigation this quarter. Those are the two kind of biggest pieces of why there was a sequential increase.

Eric Bosshard (CEO and Consumer Industry Analyst)

Okay. And then, and then secondly, you talked about it a little bit, but, I'm just curious the, the effectiveness of the incentives as you've moved through the quarter and in the, March and April, I suppose. But just trying to figure out the effectiveness and the, the last comment that was made, of as rates move higher, what do you have to do differently with buydowns? I'm just curious how you're seeing, conversion or closing customers behave relative to incentives, relative to buydowns, and if you're you indeed are having to do anything different.

Paul Romanowski (President and CEO)

Currently, we're not doing anything significantly different. We're responding to the rates and the customers that are in front of us at the time, and they are reacting very positively to the incentive offerings that our teams have crafted for the various neighborhoods we have out there. So no, we're not seeing anything with the current range, range of rates we've been dealing with right now. We feel, you know, like it's sort of, I wanna say business as usual in this crazy, volatile world we're in, but right now, we feel pretty steady, pretty good about, about where things are.

Eric Bosshard (CEO and Consumer Industry Analyst)

Thank you.

Operator (participant)

Thank you. Your next question is coming from Sam Reid from Wells Fargo. Sam, your line is live. Please go ahead.

Sam Reid (Executive Director of Equity Research)

Awesome. Thanks so much, guys, for taking my question. You made a lot of progress here in getting back to your historic levels on cycle times. That said, I mean, one thing that I'm thinking here is, you're also building a more value-engineered house today than perhaps what might have been the case pre-pandemic. So the question really is: is there an opportunity to bring cycle times lower versus that historical trend, or do you really think kind of four months is the steady state we should be thinking about longer term?

Paul Romanowski (President and CEO)

Yeah, Sam, we're pleased to be back at what we deem our historical norm, and you bring up a good point. We are building a more efficient house, and it's been an extreme focus of us to try and pull labor and man-hours out of the home to reach and maintain affordability. We're always gonna believe there's upside for improvement in our business. And so we continue to stay focused on our inventory turns and the opportunity to reduce cycle times and be more efficient in the construction process where we can. We're gonna continue to strive for that. We're not counting on significant reductions from here. We got back, you know, to this place, and we'll continue to focus on doing everything we can to drive it down further.

Sam Reid (Executive Director of Equity Research)

Gotcha. And then maybe to touch on order ASP a little bit. It looks like there was a little bit of a sequential lift between Q1 and Q2. I just would like to hear maybe a bit more context on that number. Was there a function of perhaps, you know, a little bit of a dial back in incentives in early spring, or were there any kind of geographic or other mix dynamics that might have also driven that sequential improvement? Thanks.

Jessica Hansen (SVP of Communications)

Yeah, it continues to be primarily geographic. When you look at our price points, the South Central and the Southeast, which are two of our lower price point markets in terms of average sales price, have been a slightly lower percentage of our mix for a couple of quarters now, and that that's continued this quarter.

Sam Reid (Executive Director of Equity Research)

Awesome. Thank you so much. I'll pass it on.

Operator (participant)

Thank you. Your next question is coming from Alan Ratner from Zelman & Associates. Alan, your line is live. Please go ahead.

Alan Ratner (Managing Director)

Hey, guys. Good morning. Nice quarter, and thanks for the taking my questions. First, on the resale market, I'm curious, you know, some of your thoughts there. We're starting to see inventories ticking up a little bit, and in some of your markets, you know, more meaningfully than others. And, you know, when I think about the spec entry-level model, I think you guys have really benefited from the tight resale market over the last few years. And I'm just curious, are there any markets now where you're starting to see increased competition from resale, you know, maybe more contingent buyers on your move-up product, and just more broadly, how you're viewing kind of the uptick in resale inventory right now?

Mike Murray (EVP and COO)

I still think it's a very limited amount of inventory that's available in the marketplace, especially at our price point, at an affordable price point. That coupled with some of the interest rate incentives that we're able to offer, that for the most part, existing home offerings don't provide, we're able to solve the affordability problem a little better than some of the existing home sales would be able to do. But we haven't seen a significant impact on our sales pace to date.

Alan Ratner (Managing Director)

Great, appreciate that. And then second, on the NAR settlement with brokers, you know, I know it's still very early, but you guys have been one of the heavier users that were friends to the brokerage community, if you will, over the years. I think you view them as an important tool to bring buyers to your communities. And I'm just curious if you've given any thought to how this settlement might change the economics there, the relationships you have with brokers, any commentary you can give would be helpful.

Paul Romanowski (President and CEO)

Yeah, Alan, I mean, we think this is going to take some time to play out. You know, we work very closely with the brokerage community, and we'll continue to do so, regardless of what direction this takes. You know, I think you are going to see some restructuring, certainly in terms of commissions, and it'll have some impact, I believe, on the number of Realtors that stay active through the market. But, you know, we are going to continue to stay close to the Realtor community, communicate with them. This is still an emotional buy for people. And we're also going to stay focused on our digital presence and ability to make sure that we are ahead of the curve in terms of reaching customers, through whatever form it takes over the next couple of years.

Alan Ratner (Managing Director)

Appreciate the thoughts. Thank you.

Operator (participant)

Thank you. Your next question is coming from Collin Verron from Jefferies. Collin, your line is live. Please go ahead.

Collin Verron (SVP)

Good morning. Thank you for taking my questions. I guess I just want to start on the lot in cost inflation you're seeing. Any thoughts on the magnitude of that through the remainder of the year? I think you said it was tracking in the low single digits in the most recent quarter.

Mike Murray (EVP and COO)

Yeah, I think our expectation is we'll continue to see moderate increases. I think that low single-digit percentage continuing is in our current what we can see in our current pipeline.

Collin Verron (SVP)

That's helpful. And then, just on the lots controlled, it's moved up again as you concentrate on that land light model. I guess, how much more runway do you think that there is, and any update on the timeline of getting there, and just thoughts on the right number of the years of land or lots owned?

Mike Murray (EVP and COO)

So I, I think we continue to look for ways to be more efficient, and more capital efficient in our lot portfolio. Seventy-seven percent is a very controlled number position right now, and we're looking at 62% of our deliveries were on lots that were actually developed by third parties or Forestar. So we're continuing to expand those relationships and seek opportunities to buy more lots from third parties. I'm not going to put a ceiling on to how, how far we can take that, but we've made a lot of progress, and, and when you've had a lot of success, incremental success takes a lot more work, but that's what we do every day.

Collin Verron (SVP)

Great. Thank you for taking my questions.

Mike Murray (EVP and COO)

Thank you.

Operator (participant)

Thank you. Your next question is coming from Jade Rahmani from KBW. Jade, your line is live. Please go ahead.

Jade Rahmani (Managing Director and Equity Research Analyst)

Thank you. Are you seeing any changes in terms of investor appetite for single-family rentals and multifamily, leaving aside the issue of interest rates? You know, we've seen Blackstone, for example, make a couple of quite large acquisitions. Wondering what the tone is from the investors you sell to.

Paul Romanowski (President and CEO)

Yeah, I would, I would say we've seen a little bit of a tick up in terms of interest and the number of investors out there in the market. You know, they're still being cautious and, you know, rates are where they are and cap rates acting in kind. But I would say that just across the board, we've seen a bit of a tick up and have more interested parties in those assets that we have out for sale today.

Jade Rahmani (Managing Director and Equity Research Analyst)

A follow-up would be, a lot of these investors are looking for scale in their capital deployment. You've already done, you know, some large deals. Are you seeing, on average, the size of deals you're looking at increase?

Mike Murray (EVP and COO)

Size per community, not necessarily, but there are large appetites to place dollars at scale into this space.

Jade Rahmani (Managing Director and Equity Research Analyst)

Thank you.

Mike Murray (EVP and COO)

For multiple communities, yes.

Operator (participant)

Thank you. Your next question is coming from Mike Dahl from RBC Capital Markets. Mike, your line is live. Please go ahead.

Mike Dahl (Managing Director of Equity Research)

Morning. Thanks for taking my questions. Just to follow up on Jay's question, on the rental side, you know, revenue is flat sequentially expected in 3Q. You do have more units completed on, I think, both single family and multi-families. Is that a function of, if you have to characterize why it's not better, is it more the investor hesitancy at this point, or is it the conversations you're having around price don't meet your objectives for margin and return on those projects?

Bill Wheat (CFO)

You know, it's really a matter of communities, community size, and timing of those closings. And, you know, we're gonna be selective through the process, but we have projects that are done, and we're gonna go ahead and monetize those and put them into the market. You know, not seeing the margins where we would like to see them, but that's relative. That's just tied to cap rates and interest rates. But, you know, no real significant shift that we're gonna see in terms of up or down, and it's gonna be a little lumpy as we look through the quarters because we're selling whole communities at a time. It's not one at a time.

Mike Dahl (Managing Director of Equity Research)

Got it. Okay, and then shifting gears back to the, the home building margins. Last fall, when there was a period of significant rate volatility and ultimately rates came, came down, you had a negative mark-to-market. Jessica, I think you mentioned that lower, lower forward contracts played a role in, or lower costs or, or mark-to-market there played a role in sequential gross margin improvement in fiscal quarter. Can you be more specific around what impact or quantification, your forward hedges are having on both the 2Q gross margin? And is that actually a continued sequential benefit in your 3Q guide?

Jessica Hansen (SVP of Communications)

No, I mean, we really think about it, Mike, as last quarter was somewhat of an anomaly. We're not gonna say one time. I mean, it could happen again, but, but it was highly unusual in terms of the rate move going up and down so quickly and the timing in which that happened, and then, you know, a move close to quarter end. So this quarter, when we say minimal impact, I mean, we've talked about outside of Q1, it's been no more than a ±10 basis point move from a gross margin perspective. And so, you know, hopefully, that'll be the case going forward as well, and, and you won't see a repeat of what happened in Q1.

Mike Dahl (Managing Director of Equity Research)

Okay, great. Thanks.

Operator (participant)

Thank you. Your next question is coming from Susan Maklari from Goldman Sachs. Susan, your line is live. Please go ahead.

Susan Maklari (Senior Equity Research Analyst)

Thank you. Good morning, everyone. My first question is on the material costs. I think, Jessica, you'd mentioned that you're seeing some success on seeing some of those, move lower. Can you give more detail on what is coming down and how you're thinking about that relative to some of the other areas where there may be some inflation that's coming through? Any thoughts on lumber as well within that?

Jessica Hansen (SVP of Communications)

I'll start with lumber, and then I'll leave the up and down on other categories to Paul and Mike. They're probably better versed than I am. Lumber is still less than half what it was at its peak back in March of 2022, but it has started to increase since December, which would be, you know, kind of a typical seasonal trend. So hopefully, we're not going to be talking about lumber in terms of big swings in our closings. Most of our year-over-year stick and brick decline is still from lumber, but in terms of sequential moves going forward, we expect it to be relatively modest.

Mike Murray (EVP and COO)

Very fair. I think in terms of the other categories, it's a market-by-market, category-by-category, I don't wanna say struggle or battle-

Jessica Hansen (SVP of Communications)

Mm-hmm.

Mike Murray (EVP and COO)

But it's an ongoing effort to be as efficient as we can be with that. And, you know, we make some progress on some categories, and then we might have to give back some on others. So it's a constant battle, Susan. And, you know, we've seen right now, I think, some moderation and seeing increases, which has been very helpful in margin right now.

Susan Maklari (Senior Equity Research Analyst)

Okay, all right. That's helpful. And then you guided your SG&A to be about 7% for the third quarter, which is, you know, still really low in there, even as you're making those investments. Can you just talk about the puts and takes into the SG&A as we think about not just the third quarter, but even looking out? Any thoughts there?

Bill Wheat (CFO)

Yeah, sure. So we're continually trying to position ourselves across our footprint to be in position to grow. And as we've gotten larger and have more scale in individual markets, that has involved you know, realigning certain divisions, breaking up certain markets into multiple divisions to put ourselves in position to more deeply penetrate you know, market share in those markets, and the same has applied across our infrastructure you know, across the country as well. So we're making some of those investments right now, and then we do see pretty quick payback on that. And so that's why our SG&A percentage has remained as low as it has, but we are making those investments that you know, sometimes do have to come a little bit ahead of the growth.

But it's primarily in, primarily in people, and in making sure we've got the depth on our teams and we've got the land personnel in various markets in order to be able to tie up the land positions and develop those relationships with third-party third-party developers and trades to continue to position our platform to support growth.

Susan Maklari (Senior Equity Research Analyst)

... Okay, that's great. Thank you. Good luck.

Bill Wheat (CFO)

Thank you.

Operator (participant)

Thank you. Your next question is coming from Kenneth Zener from Seaport Research Partners. Kenneth, your line is live. Please go ahead.

Kenneth Zener (Senior Analyst of Housing Sector)

Morning, everybody.

Paul Romanowski (President and CEO)

Morning.

Bill Wheat (CFO)

Morning, Ken.

Kenneth Zener (Senior Analyst of Housing Sector)

All right. Margin stability to up 52% of closings, intra-quarter orders. Why was it higher specifically? It looks to me, again, I could make my own narrative, but I want to hear it specifically. And then what was the margin spread between those 52% intra-Q versus the ones that were naturally coming out of backlog?

Jessica Hansen (SVP of Communications)

I frankly don't think any of us looked at that before the call, but we can take a look and get back to you. It was 54% versus the 52%, just to clarify. And the driver on that was just a function of we went into the quarter with over 9,000 completed specs, and our cycle times are back to normal.

Kenneth Zener (Senior Analyst of Housing Sector)

Okay. So you're getting, we'll follow up on the margin, backlog versus intra-Q. Is that correct?

Jessica Hansen (SVP of Communications)

Yes.

Kenneth Zener (Senior Analyst of Housing Sector)

Okay. And then, Paul, I think you kind of talked about your markets in Florida not being affected by the rise in inventory we're seeing in coastal markets and/or, you know, higher costs of ownership related to insurance. Could we maybe isolate that comment to a place like Central Texas, think Austin? I know you're building in Buda, not, you know, Austin per se. But we are seeing inventory go up in Central Texas. You don't have, right, the coastal issues. Is it still that you have homes that are affordable, and in demand, so you're seeing the same dynamics you talked about there, where we're kind of excluding, you know, coastal conditions? Thank you.

Paul Romanowski (President and CEO)

Well, well, the question and the comment back on Florida was mostly as it relates to insurance and increased costs around that. You know, inventories, you know, we have certainly seen more inventory in the market today on the resale side than we have in the past. Months of supply has crept up, you know, slowly across most of our markets, but majority of what we see coming to the market, you know, is still maybe either overpriced or has significant need and work and very minimal in the affordable price points, you know, where we tend to compete. So, you know, we expect it's going to take significantly more homes to come on before we see, you know, to be a lot of impact on our ability to sell. But, you know, we've competed in that market forever.

You know, we have been a spec builder. We do that to compete, you know, in the new home market as much as we do against the resale market. Feel very good about our product and positioning against the homes that come to market, as resale available when they do. And we think we have a great package of incentives, warranty, and closing cost basis, to compete against that inventory when it does come on, and it will at some point in the future.

Kenneth Zener (Senior Analyst of Housing Sector)

Right. Appreciate it. I guess, Jessica, you said 3% on land. Could you split that between land you developed and land you're buying finished?

Jessica Hansen (SVP of Communications)

I don't think we've quantified that, and I definitely don't have that in front of me.

Kenneth Zener (Senior Analyst of Housing Sector)

Talk to you guys later. Thank you.

Jessica Hansen (SVP of Communications)

All right.

Operator (participant)

Thank you. Your next question is coming from Rafe Jadrosich from Bank of America. Rafe, your line is live. Please go ahead.

Rafe Jadrosich (Director of Senior Equity Analyst)

Hi. Good morning, and thanks for taking my questions. Just first on the fiscal third quarter gross margin outlook for flat to slightly up, just how do we think about the assumptions for the stick and brick per square foot, net pricing and land inflation that's baked into that guidance? And then specifically on land inflation, just the lot cost is flat quarter-over-quarter. What are you seeing in terms of land inflation for land that's contracted today?

Bill Wheat (CFO)

Yeah, Rafe, in our forward guide, we've got relative stability right now in materials and labor, so but we are still seeing some components go up slightly. So I think a very low single-digit percentage increase is generally the expectation there, and our lot cost a little bit higher than that. Still low single digits, but you know, probably more in that 3%-4% range. And in terms of just new land, that's deal-by-deal specific, market-by-market specific. I think in general, we've seen, you know, land prices kind of settle out here over the last little while, not as much inflation, but the long-term trend is still up over time.

This industry still has a shortage of lot availability, and so I think that's going to continue to be a constrained situation. And so in that situation, we would not expect to see land prices come down.

Rafe Jadrosich (Director of Senior Equity Analyst)

Thank you. That's very helpful. And then on the—for the rate buy downs, the forward commitments that you all have, how long do those go out? Are those months? Are those weeks? So the recent move in rates, it hasn't impacted the rates that you are offering yet. When will that start to be kind of offered to the home buyer? Like, how long of a forward commitment do you have?

Mike Murray (EVP and COO)

We generally don't go out too terribly far in terms of the volume of forward commitments that we go with. We have various levels based upon anticipated demand of how much we'll buy for a given expiration date, which can vary from 60-90 days out. But we're not going to look to fulfill all of our existing sales expectations with any one given

... a hedge or any one given builder forward, and we'll continually sort of reprice to market so that we're offering incentives that are within, as Paul said before, I think 1 point-1.5 points of market when that is the incentive that we feel is the most effective at driving appropriate pace and margin for the returns at a given community.

Rafe Jadrosich (Director of Senior Equity Analyst)

Thank you. That's helpful.

Operator (participant)

Thank you. Your next question is coming from Alex Barron from Housing Research Center. Alex, your line is live. Please go ahead.

Alex Barron (President & Founder)

Yeah, thanks, guys, and great job on the quarter. Yeah, I was just curious around land development costs. I mean, you guys are developing, I mean, using more, a lot more land options and stuff, but are land development costs expected to, you know, impact margin for you guys in the near term, or do you feel that's gonna be more absorbed by whoever's developing the land for you?

Paul Romanowski (President and CEO)

Hey, Alex, we haven't seen much reduction in land development costs, either from materials or labor. You know, we still have significant demand out there for the labor, and those that are putting lots on the ground, not just in what we're doing and other builders are doing, but you have, you know, infrastructure improvements throughout the country that are keeping demand up for materials and labor. So, you know, that's kind of baked into what we look at in terms of our increase in lot price over time. So we don't-- We'd love to see some reduction, but we don't expect to see it in the near term.

Alex Barron (President & Founder)

Got it. And, I guess, you know, you already touched a bit on the, on the rental business, but I was just curious if the margins we saw this quarter, do you expect that's gonna be sort of more what they're gonna look like in the future, or, or not necessarily?

Mike Murray (EVP and COO)

It's gonna be largely rate dependent in the capital markets as to the execution on those. You know, I think at this point, our expectation is that it's gonna be somewhat consistent with where we are today, but there is opportunity for some volatility around that, too, especially within quarters, you know, within one quarter to the next, because these are some chunky transactions. They are large individual transactions, and our multifamily platform is not yet to the scale where they're producing a significant number of multifamily communities delivering every quarter to the marketplace. So there's a relatively small number, they can be chunky, and there's an opportunity for volatility. But our expectation is, you know, somewhere in the range we're in today.

Alex Barron (President & Founder)

Got it. Okay. Well, good luck. Thanks.

Mike Murray (EVP and COO)

Thank you. Thank you.

Operator (participant)

Thank you. The final question this morning is coming from Jay McCanless from Wedbush. Jay, your line is live. Please go ahead.

Jay McCanless (Equity Research Analyst)

Thanks. Good morning, everyone. So on that rental guidance you talked about for 3Q, is that guidance based on projects that already have financing in place, or is that just the schedule of what you think might close during the quarter?

Mike Murray (EVP and COO)

It's a mix of both.

Jay McCanless (Equity Research Analyst)

Okay. And then the other question I had is, I don't wanna make too much of this if it's not a big deal, but it does seem like you're going from maybe an aggressive selling pace during the COVID years now to trying to gain market share leadership through more communities. I guess, how far along do you think you are in that, in that transition? And, I think kind of to Sue's question also, what, what is that ultimately gonna mean for SG&A going forward if you are starting to staff up and, and bring more people on to support a larger organization?

Jessica Hansen (SVP of Communications)

Yes. I wouldn't say, Jay, that it has anything to do with us trying to push more pace during COVID. It's all tied to our lot position. And so we've been building our lot position up, but not all of those lots were ready to go, and so we knew the communities were coming. And, you know, obviously, the market was extremely hot for a period of time, so we were able to drive additional absorption where we had the lots available. We don't have that same kind of strong demand, you know, less affordability-challenged environment today, and at the same time, our lots are getting finished, and the communities are ready to go.

So we're bringing them online, and it happens to be good timing that we have the communities ready to go when we're not able to drive incremental absorption, you know, further in our existing communities.

Jay McCanless (Equity Research Analyst)

Okay. And I guess, how far along do you think you are maybe in the process of trying to get bigger from a community count standpoint?

Jessica Hansen (SVP of Communications)

That's gonna be an ongoing, you know, plan and, and goal and positioning. And I'd say, just watch our lot position, and ultimately, you know, the communities are gonna come online over time. Now, from year to year, what exactly is that community count growth gonna look like? It's impossible for us to predict.

Jay McCanless (Equity Research Analyst)

Okay, great. Thanks for fitting me in.

Jessica Hansen (SVP of Communications)

Sure. Thanks.

Operator (participant)

Thank you. I would now like to turn the floor back to Paul Romanowski for closing remarks.

Paul Romanowski (President and CEO)

Thank you, Tom. We appreciate everyone's time on the call today and look forward to speaking with you again to share our third quarter results in July. Congratulations to the entire D.R. Horton family on producing a solid second quarter. We are proud to represent you on this call and appreciate all that you do.

Operator (participant)

Thank you. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.