霍頓房屋 (DHI) 2012 Q3 法說會逐字稿

Good morning, and welcome to DR Horton, America's Builder, the largest builder in the United States, third quarter 2012 earnings release conference call.

At this time all participants are in a listen-only mode.

A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Donald Tomnitz, President and CEO.

Thank you.

You may begin.

Thank you, and good morning.

Joining me this morning are Bill Wheat, Executive Vice President and CFO; Stacey Dwyer, Executive Vice President and Treasurer; and Mike Murray, Vice President and Controller.

Before we get started, Stacey?

Some comments made on this call may constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Although DR 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 DR Horton on the date of this conference call, and DR 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 DR Horton's annual report on Form 10-K and our most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

Don?

DR Horton posted its highest quarterly pre-tax income since the second quarter of fiscal 2007, the highest in the industry, earning $72 million this quarter and $144 million year-to-date.

Our pre-tax operating profit margin for the third quarter was 6.3%, the highest since the fourth quarter of fiscal 2006.

For the tenth consecutive year, we are the largest builder in the United States, based on homes closed.

Our net sales orders improved 25% from our third quarter last year and 3% sequentially from the March quarter.

Our average sales price increased during the quarter, driving a 32% increase in the value of net sales orders compared to the year-ago quarter.

We have seen solid, positive year-over-year sales comparisons continue into July.

Our sales this quarter resulted in a 31% increase in our backlog units, and a 40% increase in backlog value compared to the prior year, which puts us in a strong position for increased revenue and profitability in the fourth quarter of fiscal 2012.

In response to our sales growth, we are putting our liquidity to work by increasing our investments in homes under construction, finished lots, land, and lot development.

These investments are fueling our profitable growth, even though macroeconomic conditions remain soft and overall housing demand is at historically low levels.

We are finding opportunities to take market share in existing markets, while evaluating attractive new submarkets.

Our entry-level business remains strong, while we continue to expand our product offerings for move-up buyers.

Bill?

In the third quarter, our Homebuilding operations generated pre-tax income of $58.3 million, compared to $22.2 million in the year-ago quarter.

Our Financial Services operations generated pre-tax income of $13.9 million, compared to $6.7 million in the year-ago quarter.

Our net income for the quarter increased to $787.8 million, or $2.22 per diluted share, which included a non-cash tax benefit of $716.7 million from a reduction of the valuation allowance for our deferred tax asset.

We will discuss the valuation allowance reduction in more detail later in our prepared remarks.

Our diluted share count this quarter included 38.3 million shares related to our convertible senior notes.

When these shares are dilutive, they are added to the diluted EPS denominator, and the associated interest expense and amortized issuance costs are added back to net income to calculate diluted EPS.

For these shares and the related costs to be included in our diluted EPS in the fourth quarter, we estimate that our net income would need to be approximately $85 million.

Mike?

Our third-quarter Home Sales revenue increased 14% to $1.1 billion on 4,957 homes closed, up from $974.5 million on 4,555 homes closed in the year-ago quarter.

Our average closing price for the quarter was up 5% compared to the prior year, and up 2.5% sequentially to $225,000.

In the fourth quarter, we expect that our backlog conversion rate will be in the high 70%s to 85% range.

Don?

Net sales orders for the third quarter were up 25% from last year to 6,079 homes, and a 5% decrease in active selling communities.

Our average sales price on net sales orders of $232,300 was up 6% compared to the prior-year quarter, and up 4% sequentially.

The cancellation rate for the third quarter was 23%, which is very close to our pre-downturn cancellation rate range of 17% to 21%.

Our sales backlog at June 30, 2012 increased 31% in the prior year to 7,311 homes.

The value of the backlog increased 40% to $1.7 billion from $1.2 billion a year ago.

With 7,311 homes in backlog, and continued year-over-year improvement in sales through first part of July, we expect stronger closings and pre-tax profits in the fourth quarter, both sequentially and compared to the prior year.

Bill?

Our gross profit margin on home sales revenues in the third quarter was 18%, up 150 basis points from the year-ago period.

130 basis points of the increase was due to decreased incentives and discounts and increased average selling prices.

And 50 basis points of the increase was due to lower amortized interest and property taxes.

These increases were partially offset by a 30 basis-point decrease, due to higher estimated costs for warranty and construction defect claims as a percentage of home sales revenue.

Our expectation for fourth quarter home sales gross margin is around 18%, consistent with the third quarter.

Stacey?

Homebuilding SG&A expense for the quarter, which includes corporate overhead, was $136 million or 12.2% of Homebuilding revenues, compared to $114 million or 11.7% of Homebuilding revenues in the prior-year quarter.

The SG&A category that increased the most as a percentage of revenue was incentive compensation, reflecting our significantly higher revenues, profitability, and share price versus a year ago.

For the nine months ended June 30, 2012, Homebuilding SG&A expense was $383 million or 13% of Homebuilding revenues, compared to $356 million or 14.4% of Homebuilding revenues in the prior-year period.

In our fourth quarter, absolute SG&A expense will increase due to variable components.

However, we expect our SG&A, as a percentage of Homebuilding revenue, will improve both sequentially and year over year, as we close more homes and leverage our fixed cost structure.

Mike?

Homebuilding interest expense was down 39% from the year-ago quarter to $6.2 million.

Our third-quarter Homebuilding interest incurred improved slightly to $31.1 million from $31.4 million a year ago.

Even after issuing an additional $350 million of senior notes in May, our capitalized interest balance at June 30 totaled $81.2 million.

Financial Services pre-tax income for the quarter was $13.9 million.

84% of our mortgage company's loan originations during the quarter related to homes closed by our Homebuilding operations.

Our mortgage company handled the financing for 60% of our homebuyers this quarter, with virtually all loans meeting eligibility requirements for sale to Fannie Mae, Freddie Mac, or Ginnie Mae.

FHA and VA loans accounted for 55% of our mortgage company's volume this quarter, down from 62% in the year-ago quarter.

Our mortgage company's new borrowers during the quarter had an average FICO score of 708 and an average loan-to-value ratio of 91%.

First-time homebuyers represented 54% of the closings handled by our mortgage company this quarter.

Bill?

We reduced our deferred tax asset valuation allowance by $716.7 million this quarter.

This reduction was based on our evaluation of both positive and negative evidence, in which we determined that it is more likely than not that we will generate sufficient income in future periods to realize the substantial majority of our deferred tax assets.

The positive evidence included our five consecutive quarters of pre-tax income, the strong profitability and sales in both the current quarter and the fiscal year-to-date period, and an increased backlog, which positions us for increased income in our fourth quarter.

In addition, with our solid balance sheet, reduced debt and interest costs, ample liquidity, and growing inventory, we expect to be able to sustain and increase our pre-tax income in future years.

Even if our future pre-tax income remains flat with current-year levels, we estimate that we will utilize all of our federal net operating losses in less than five years.

The negative evidence included the losses we incurred during the housing downturn, the current weakness in the economy and historic low levels of activity in the housing market, the restrictive mortgage lending environment, and our lower than normal gross margins.

One of the most significant pieces of negative evidence that existed in prior periods, a three-year cumulative loss position, is not as significant now, as we are in a three-year cumulative income position at June 30.

We concluded that the positive evidence outweighed the negative evidence, and we reduced the DTA valuation allowance by $716.7 million.

Our remaining valuation allowance of $78.4 million relates to two factors.

First, certain state net operating loss carryforwards may not be realized due to shorter carryforward periods in those states.

Second, a portion of the valuation allowance reduction has been allocated to our expected fourth quarter income.

We expect to reduce this portion of the valuation allowance next quarter, resulting in minimal income tax on our fourth quarter income statement.

Beginning in the first quarter of fiscal 2013, we expect to report income tax expense at a tax rate of 38% to 38.5%.

Until we have utilized our NOLs, the majority of the tax expense recorded will not require cash but will reduce the carrying value of our DTA.

Stacey?

Since March, our total inventory increased by approximately $228 million, excluding non-cash items, reflecting a $133 million increase in homes and inventory and a $95 million increase in our investments in residential land and loss.

Our homes in inventory at the end of June totaled 12,200 homes, up 1,100 homes from March.

As of June 30, 1,100 of our homes were models, 5,600 were speculative homes, and 2,100 of the specs were completed.

During the quarter, we sold our spring inventory and grew our backlog, improving our spec percentage to 46%, from 50% at March 31.

Don?

In our third fiscal quarter, our investments in land, lots and development cost totaled $389 million, which reflects our ability to find new communities and replenish our finished lot supply.

During the first nine months of the fiscal year, we spent $938 million on land, lots and development cost, which is up from $582 million in the same period of the prior year.

We continue to purchase or option finished lots in many markets and are also selectively investing in land acquisition, and development opportunities to ensure we have adequate lot supplies in desirable markets.

At June 30, 2012, we control approximately 131,000 lots, of which 90,000 are owned and 41,000 are optioned.

Our owned lots include 23,000 finished lots and 24,000 lots to be developed within the next 12 to 18 months.

Our option lots consist of 25,000 finished lots and [16] lots that we expect to purchase and develop within the next 12 to 18 months, bringing our minimum pipeline of finished lots over the next two years to 88,000, which is up 13% from the second quarter and 24% from a year ago.

Mike?

We used $95 million of cash in operations in the June quarter, primarily due to increases in homes and inventory and residential land and lots, offset by pre-tax income and an increase in accounts payable.

We ended the quarter with $1.2 billion of Homebuilding unrestricted cash and marketable securities.

The balance of our public notes outstanding at June 30 was $1.9 billion.

Our next maturity of approximately $172 million is in May of 2013.

At June 30, our Homebuilding leverage ratio, net of cash and marketable securities, improved 160 basis points to 18.3%, compared to 19.9% a year ago.

Gross Homebuilding leverage at June 30 improved 470 basis points to 35.8%.

Don?

Thank you.

Fiscal year '12 has been a pivotal year for our Company, in which we reestablished our industry-leading profit levels and began to take advantage of the flexibility provided by our strong balance sheet.

We transitioned from defense to offense, raising new capital, investing our cash in the business, improving our operating margin and growing our profits.

We believe these are the initial stages of long-term growth for DR Horton.

DR and I would like to personally thank our employees for their hard work and accomplishments.

You have kept us in the number one builder slot for the past 10 years, and we are better positioned than we have ever been in my 29 years with DR Horton.

We are excited by the opportunities we see in fiscal 2013 and beyond.

And, as I always say as I travel around and meet all of our salespeople, kick tail.

This concludes our prepared remarks.

We will now host any questions.

We will now be conducting a question-and-answer session.

(Operator Instructions)

Daniel Oppenheim, Credit Suisse.

Sure, was wondering your last comment there about the directions to the employees in terms of kicking tails, interesting, in terms of that, how does that relate to thoughts on backlog conversion?

And, how much of that is a function in terms of specs versus just the construction?

Is there much that you can do in terms of working on that one for fiscal 2013?

If you can just provide a little more color on that?

Sure, Dan.

One of the things that we look at on our backlog conversion is really just going back pre-downturn.

And our expectation is we'll trend back to the backlog conversion rates we've traditionally seen.

And, those rates would typically be between about 55% and 65% in quarters one through three, and then quarter four could be up into the 70%, possibly into the low 70% range.

We've been in an accelerated backlog conversion rate because our spec levels have been higher.

As we went through the downturn, we had a higher level of completed specs than we currently have, and so those were available through very quick sale and quick close in the same quarter.

We would expect that to begin to slowdown a little bit as we have focused on reducing our completed specs.

The other thing we're seeing is more build-to-order sales come in.

And those typically stay in backlog a little bit longer because we actually work through the permitting process, people selecting their options before we begin construction on the home.

So, our expectation is for Q4 that the backlog will still remain in the high-70%s to the 85% range, but that going into next year, we actually see that continue to trend down a little bit.

Okay, great.

The second question is relating to that, you talked about bringing down specs more build-to-order.

I have had a lot of other builders talking about having a bit more pricing power.

As you think about the pure specs and more build-to-order and potentially pricing, depending on your focus there versus the orders, how are you thinking about margins as you're looking forward and the potential for some further improvement over the course of the year?

Well first of all, I would say to you we are not going to be decreasing our spec level from our historical levels.

Typically, we are running somewhere between 50% to 60% specs, dependent upon which quarter of the year it is.

And, we anticipate that we will increase our specs in the first calendar quarter of fiscal year 2012 in anticipation of the selling season, which historically starts in the second quarter.

Clearly, we moved a lot of older specs this quarter, which was a remarkable accomplishment, and it was even more a remarkable accomplishment that we increased our gross margin while we moved those older specs.

But, on a historical basis, our build-to-order business has been higher-margin business for us.

So, as we transition into fiscal year 2013, I anticipate we will have some upside in our margins just simply because of the mix change in build-to-order versus spec and also, combined with the fact that we have gotten rid of a lot of older specs and cleansed our spec backlog.

Great, thanks very much.

Michael Rehaut, JPMorgan.

First question, I want to go to the comments you made right at the beginning of the call, Don, in terms of increasing investment, trying to take share, looking at potential new submarkets, and I think you also said expanding the move-up buyer segment.

Looking at those statements as a whole, is that something that we should take to expect an acceleration in community count growth in 2013?

Absolutely.

We continue, even though we're closing more homes than anyone else in the industry, and we were able to add to our lot supply as we indicated in the most recent quarter.

We clearly are going to be buying land and developing lots where it makes economic sense for us.

Fortunately, in a lot of our markets, we're still able to execute option contracts.

Okay.

In terms of the comments just made around spec and going back earlier to comments around move up, it seems like historically, you guys have -- a healthy part of the business for you, and I think one of the core competencies for you as a Company, is your comfort level with spec as a part of the business.

Is this shift towards more build-to-order something that's just more temporary?

Maybe you could put into perspective how spec is going to be as a percent of the business in 2013 versus 2012, and maybe, historically?

Well clearly, our build-to-order business is being driven by our customers.

There are a number of people who are coming in who are either retirees, or they're buying their third home, and clearly they're desirous of having their home their way, and that's what we're accommodating.

On a go-forward basis though, as I said earlier, we are going to continue to maintain, as you said we are comfortable, we have always been a spec builder and we are comfortable with our specs.

And we will continue to maintain, depending upon which quarter of the year it is, a spec ratio somewhere of 50% to 60%.

How would that compare against 2012, then?

Well, in 2012, the percentages really haven't changed, frankly, even during the downturn because -- there are periods of time last year in 2012, certainly in 2011, where we were running 61%, 62% specs.

So, it just all depends upon what we see in the marketplace.

One of the things that has brought us to where we are today is we were willing, during the downturn, to put our specs out there and have homes available.

Especially, we saw that free tax credit and that was one of the things that led us to having such a successful 2011, or 2010, was having the homes on the market to take advantage of the tax credit when our competition really did not.

Okay, thank you.

David Goldberg, UBS.

My first question has to do with the Financial Services business, and specifically, the capture rate.

What I'm trying to get an idea about is, folks who don't use your mortgage product, do you have any visibility on why they do or don't use the mortgage product?

And, how that group -- maybe just some color on, from a statistics or metrics standpoint, what the credit quality of that group looks like?

Why they choose to go outside to a different mortgage vendor?

And, how the process actually works?

Well a number of our buyers come in pre-approved by some other mortgage company, and that's one of the major drivers of someone not using our mortgage company.

We also have an association with USAA, where basically they are also offering their mortgage company to our buyers.

And, all of their buyers are military or ex-military buyers, and they offer an incentive for their buyers to use their mortgage company.

Our mortgage company has always been in the business of absolutely competing with the competition.

They don't really have any upside.

They don't really have any downside.

They are just out there on a daily basis having to earn our business.

So, to the extent that someone wants to use an outside mortgage company, that's fine with us.

Just to make sure I understand this, is it fair to conclude you don't think the folks that are going through outside mortgage providers have a different credit profile than folks who are going through your internal mortgage provider?

Well, we don't necessarily have a clear visibility of that, David, but I would be surprised at this point.

Mortgage standards are pretty consistent across all of mortgage products right now, especially ones that are backed by the governmental entities, and that tends to be the majority of the market.

One other factor that impacts our capture rate is we don't have our mortgage company in every homebuilding market where we operate, so there's a certain segment of our business that we just won't capture.

And certainly, I don't think -- if you're inferring that, perhaps, the people who use our mortgage company have lesser credit qualification, that's not the case.

And, if you look at the solid results our mortgage company, very few millions of dollars they've had to reserve against billions of dollars of mortgages they have issued over the year, the quality of our buyer going to our mortgage company is extraordinarily high.

Thank you, and I wasn't trying to infer anything, I was just trying to understand, so --

Just double checking.

I wouldn't make any inferences, certainly not.

Usually you're straightforward.

My follow-up question, I wanted to delve a little bit more into this whole concept of looking into new markets.

And, I'm wondering if you go over the analysis that you guys perform when you think about new markets, what are the puts and takes on the decision making process?

What makes a market attractive; what makes it less attractive?

Just give us some overview on how you're thinking about it?

Well, largely, that's dependent on our regional presence because, obviously, they spend a lot more time in those specific markets than DR and I do.

Although, DR and I clearly bless every one of the new markets that we enter.

Clearly, what we're looking for is an opportunity to go, when we go into a new market, is to make a major -- take a major position in that market.

Typically the market is underserved by a production builder, or not served by a production builder at all, where we can go in and actually provide the homebuyers in that market with a more competitive house and a better-built house with a better margin.

One of the things that we have focused on at Horton over the last couple of years is moving into, what I call, ancillary markets or tertiary markets and I have another name for them which I won't use on the conference call, but they are smaller markets.

And, I think with our low overhead, we can go in and take lot positions that are smaller than many other builders and be able to offer the buyers in that market an extremely competitive value.

And, I think you're seeing that in a number of markets where we have gone into in the Carolinas and in Florida, where we don't find competition from any other builders, certainly not production builders.

Thanks, that's great color.

Stephen Kim, Barclays.

I was wondering if you could comment on your community count change?

I know you don't give the actual community count number, but it was down 5%.

Obviously, that's a high-class problem because you've been selling a lot of houses, and I understand that.

At the same time, I was wondering if you had an internal goal, or a target, to significantly ramp up your communities as you head into next year.

If so, how you gauge that, or how we should be looking at that?

Is it in terms of just the gross number of communities that you expect to open, or is there a net year-over-year number that we can think about?

The way we look at new community count is, each one of our Division Presidents and each one of their markets are charged with how do they become the number one builder in their market, all the while focusing on our number one goal, which is profitability.

So, as I tell each one of our Division Presidents, the role they're taking is, how do we tie up in contract for any and all lot positions in that market that make sense for us to build that product and if it's a profitable transaction for us.

We are trying to expand our subdivisions, in each one of our markets, as aggressively as the business will support.

Clearly with our increase in investments and land, and our increases in our option lot positions, we are targeting increases in our overall community count.

You are correct, that with our increased sales this year, we have probably rolled out of more communities than we might have anticipated at the start of the year.

So the net count has not increased quite as much as we had, maybe, originally planned.

But, with the increased investments, we expect to be growing our community count, sequentially, as we move into 2013.

Some of the community counts are relative, Steve.

Basically, some markets are a lot easier to sign up contracts on finished lots, or option lots, or even land deals, which take less risk and less capital in other markets, like California, in particular.

That market seems to me, from a land perspective, is overheated right now and it takes big dollars and it's a higher risk given the state of California's economy.

So, we are trying to choose land and lot positions in low-risk areas that provide us the best return.

Okay, great.

Secondly, I was wondering if you could talk a little bit about the appraisal situation in the industry?

I think when I spoke with you last time, you had indicated that that was an ongoing annoyance, but it was still something that was weighing, it seemed, fairly heavily on your assessment of the overall market condition.

I was curious as to if you could give us a sense for whether that's still your view that the appraisal process is a meaningful impediment, or if you have seen some amelioration in that regard?

We wouldn't call that a meaningful impediment.

We do still continue to see challenges with evaluations on appraisals, more specifically with the VA loans than with other loan products.

There are a handful of markets that seem to have more ongoing challenges than some other markets, but generally, it's just an ongoing annoyance, but not a huge impediment.

Frankly, I think as you begin to see, and who knows whether the calcs are right or not, but as people begin to report some increase in average sales prices or median prices in various markets, that's going to solve the appraisal issue, substantially, for all builders.

You would think.

Thanks very much.

Ken Zener, KeyBanc Capital markets.

I think you mentioned a five-year recovery on your DTA, was that one of your assumptions?

If our income remains flat with fiscal 2012 levels, we expect to be able to recover our federal NOL carry-forwards.

That's a portion of our DTA.

Our federal NOL carry-forwards will capture that in less than five years.

Just for housekeeping, what portion of the $716 million is that?

It's between $200 million and $300 million (multiple speakers).

Okay.

So, it's a pretty small piece.

No, it's the second largest piece in the DTA.

Well, yes, but -- so, given the fact that you have relatively low net leverage today, your optioning, your land, finished and/or otherwise, when do you think you are going to be able to get back to a more -- and it sounds like you're more confident, obviously.

When do you think you are going to get back to a more effective rate of leverage, given that you're tying up the land through options?

And, if you're not going to be targeting at 40%, let's say net debt-to-cap, what are you going to be doing with that within capital?

I can tell you, right now, we are really comfortable with our net debt-to-cap, Ken.

Our focus is on how we continue to grow the business without increasing our leverage significantly.

We have a lot of flexibility, obviously, right now.

If the market's there and the demand is there, we have the ability to invest a lot with our balance sheet, both in our liquidity right now and the ability to add additional debt in the future.

But right now, we're increasing our investments significantly, and our leverage is still holding in there at a pretty low level.

Of course, going forward, we also plan on making a lot of money.

And to the extent we generate a lot of profits in the future, that adds to our equity, which helps keep our leverage in balance, as well.

Okay.

The second question I have, when you talked about sequentially, that your gross margins went up a bit; but, could you give us a bit, kind of the sequential -- I mean, if you were getting rid of your finished spec depletion, what was that drag, sequentially; given that, I think, broadly we are seeing incentives decline, sequentially, which has helped builders' gross margins move up?

You guided to 18% gross margin in 4Q, is that -- why wouldn't we see a little more lift, sequentially?

How much of the land is new?

The spread --?

Sure, on the sequential increase, it was about 40 bps from Q2 to Q3.

The entire amount of that increase is due to pure core margin improvements attributable to fewer discounts, some increases in average selling prices that we've been able to implement in some of our markets.

So, it's just a very simple improvement in core margin.

Specs are always a portion of that; but as Don mentioned earlier, we have reduced some of our aged completed specs, and we're starting to see improved margins on our specs this quarter, relative to some prior periods in the past.

A lot of that has, frankly, to do with the low new home inventory, basically.

Across the nation, we're down 4.7 months supply of new homes.

We have pricing power in a number of our markets, not as significant as what we had back in 2004 and 2005, but I'm not sure we need to get back to that point.

Nevertheless, we are having pricing power in most of our markets, which is improving our gross margins.

And obviously, we certainly sound more confident in our guidance on margins today because our trend has been positive here for a couple of quarters.

And the driver of the improved margin is truly based on our core operations.

So, that's what's driving our guidance to be able to hold the margins that we have today.

But clearly, our goals are to continue to improve margins over and above the 18% we reported this quarter.

Our Company goal has always been 20% gross margins.

We're working toward that, but we're not going to tell you we are going to be there next quarter, but we're working on it.

Thank you.

Will Randow, Citigroup.

I just had a question on your SG&A.

When we talked in the past, you talked that -- mentioned you want to run it around 10% as your goal as a percentage of housing sales.

However, you are running low teens because you've cut quite a bit.

Is there potential to get below 10% in the next couple years, if we continue to see this recovery?

That would be a stretch.

We would expect we'll be in the -- it will be in the 12%s this year, which is going to be a good improvement versus last year.

As we continue to add volume, we clearly have more room to leverage our SG&A infrastructure on the fixed cost side.

So, we would expect to continue driving that down, but our Company goal remains at around 10%.

We have had some short periods in the past when we've been below 10%, but those have typically been periods when we've seen significant selling price increases that have driven that.

But, to the extent we're able to drive it towards 10%, that will be in line with our targets.

Thanks for that.

Then, on the first-time homebuyer segment, as well as the lending environment -- given your lower average ASP, you might be targeting, call it a slightly less affluent buyer, for lack of a better term.

So, really, how do you open up that segment of the market?

And, do you plan to get heavier into the first-time homebuyer?

Right now, we are very concentrated with the first-time homebuyer.

We've typically been running between about 50% and 55% of our business to the first-time homebuyer.

In terms of opening it up, that's been, actually, the most consistent part of the homebuyer population.

And, one of the things we're looking to do is not necessarily to decrease the number of homes and the number of first-time homebuying customers that we have, but rather to increase, incrementally, the product that we have available and the number of people who are buying more of a move-up product.

Our goal is, actually, for that percentage to work its way back down closer to the 35% to 40% historical range, as we see the higher end of the market recovering.

Okay, thank you.

I was curious because, obviously, some of the harder-hit markets on the lower income side have been hit the most.

But, appreciate the color.

Adam Rudiger, Wells Fargo Securities.

In one of the answers to a previous question, you mentioned getting some pricing power in some of your markets.

For our call from last quarter, I feel like the tone was a little bit different.

So, I was wondering if I was interpreting that correctly, if you think that, sequentially, the market's changed, and you've gained power since you reported last quarter's earnings?

Yes we do, clearly.

Secondly, I just wanted to clarify some of the comments you made in the opening statements about the SG&A.

You mentioned that the fourth quarter should be higher on an absolute basis.

I was wondering if that was sequentially higher, or year-over-year higher?

I was also wondering if you could just clarify that if most of the year-over-year increase this year, was that solely incentive-based comp that you mentioned?

We will see an increase, both sequentially and year-over-year, as we'll have a higher activity level, more homes closing, more revenue, and that results in more sales commission and more activities around the home construction.

But, we'll also see a bigger piece of that increase being incentive compensation, both to increased revenues profitability as well as share price adjusting some accruals.

To be clear, the main driver of the year-over-year increase this year, would you -- is incentive-based comp, or were there any other factors you should call out?

That was, by far, the largest portion of it, and it's simply a matter of the significant profitability we have year-to-date this year.

Last year at this point, we were not profitable on a year-to-date basis, so that's a huge swing.

Okay, great.

Thank you.

Joshua Pollard, Goldman Sachs.

Typical seasonality in your orders and deliveries, you guys have the September year-end, so things can be a little bit funky for you.

I'm ultimately trying to understand, your net absorption rate in the quarter were about 2.2 per month.

How much should we see that go down Q-on-Q, as we move into your fourth quarter?

Then again, into your first quarter for '13, based on typical seasonality?

Yes, Josh, we can pull that up, and I can get back with you, and see what we've done historically.

You're absolutely right though, our seasonal trend is that the March quarter and the June quarter are usually pretty similar, within a few basis points.

Then, we see our sales trend down into the September quarter, down a little bit more into December, and then start back up in the spring selling season into the March quarter.

I'll follow-up with you in terms of historically what percentage we've seen.

Okay.

In replacement of that question, can I ask what's your year-on-year growth through July is, you talked about it being still robust, but I'd love to get a little bit more clarity and understand whether or not you guys expect your year-on-year order growth to begin to slow in the back-half of the year.

Well, in terms of the year-on-year order growth, we haven't actually seen the end of July yet, so we would prefer not to comment.

While we would expect the absolute orders to go down, we'll see what happens with the year-over-year order growth because even with the decline in orders, it could still hang in there very strongly.

Okay, great.

Then, if I could ask one additional one.

The orders in the north were up only 2%.

Can you just dig into each of the states in that market and give us a view of what's going on?

It seems like the housing market is improving a lot, but this north and northeast seems to not be doing as well.

Well clearly, our position in the north is small.

And frankly, if you take a look at the markets in our the north region, they're small and they continue to be weak.

So, as a result, it's an insignificant number really.

But, those markets have been hit a lot harder, and they are slow to recover.

And largely, if you take a look at some of them, they just have high unemployment still and their state economies are weak.

Jade Rahmani, KBW.

I wanted to ask, also, about the mortgage environment.

You indicated about 84% of the mortgage originations were from DR Horton homebuyers.

What percent, historically, have you originated from non-DR Horton homebuyers?

There has been a pretty good range on that, Jade, and a lot of it has to do with the amount of refinance that's going on in any individual quarter.

We've probably ranged between, maybe, 5% to 20% would be outside business.

One of the things that we do like to focus on, though, is increasing that non-captive business, even beyond the refi business because that helps us leverage the overhead structure in those markets.

So, that is one of the focus points for the mortgage company is continue to look at outside business.

Okay, and then a follow-up on that.

The gain on sale margins are pretty elevated right now, given the refi boom we're seeing as well as the HARP 2.0 program.

Are you seeing -- presumably, you're seeing a benefit from that.

Can you just comment on the sustainability of the margins you showed this quarter?

Yes, clearly, the improved gain on sale is part of the increase in margins this quarter in Financial Services with a 40% operating margin.

That's at the high end of our historical range, and clearly higher than where we have been more recently.

I would say a more typical operating margin, over the long term, would be more in the 30% range, 30% to 35% perhaps.

So, 40% was a bit higher than usual.

Great, thanks very much.

Nishu Sood, Deutsche Bank.

Wanted to ask about your debt offering.

You folks have been reluctant to add expenses -- interest expenses in the past, so I was a little bit surprised to see the debt deal, especially considering the amount of cash you guys have on hand.

You got, obviously, plenty of cash, solid cash position.

So, I just wanted to get your thoughts on that?

Your -- overcoming your reluctance to add this interest expense, does that tell us you are going to be stepping on the accelerator in terms of growth?

Do you expect that to put to work sooner rather than later?

Is that -- what was behind the thinking of that deal?

I think it was clearly an opportunistic approach to the debt market at the time.

Certainly, the coupon was extraordinarily low.

Are we going to step on the accelerator?

We are moderating the accelerator.

One of our focuses still at this Company, is to underwrite land and lot deals, specifically, the ones we have to cash out.

And, our underwriting guidelines are pretty specific.

We desire, right now, to get our capital back within 24 months.

We do have some deals we're approving that are greater than 24 months, but we are very focused on not overextending our land and lot position to an excessive number of years to get our capital back.

We are, just to be clear, we are optimistic about the housing market today, but we're also realizing that the US economy is still weak.

So, I wouldn't say we're stepping on any accelerator.

We're just adjusting to each market and trying to take profitable market share from our competitors.

Then, you are right, that we had been reluctant to add interest expense to the Company.

And I think this reflects that we have more confidence in our ability to generate profits and cover that incremental interest expense than we may have had the last couple of years.

Got it, great.

Second question on your orders.

Your year-over-year order performance, relative to the group, has lagged the past, say four quarters or so, by about 10 or 15 percentage points.

I just wanted to get your thoughts on that.

Would we expect to see some closing of that gap, going forward?

Well, as one of my favorite Division Presidents, Todd Horton, always says, no good deed shall go unpunished.

Clearly, we outperformed everyone during the downturn.

So obviously, we have a much higher comp as we go through each quarter, relative to our peers who performed much more poorly than we during the downturn.

So as a result, we are continuing to focus on growing the Company.

But again, we're focusing on growing the Company in a profitable manner.

We began growing our sales sooner, which got us to profitability sooner.

Now we have much more substantial profits, and we plan on growing on that.

We expect substantial sales increases in the future.

We're focused on our sales.

All right, thanks.

Alex Barron, Housing Research Center.

Well, great job, guys, over the last few quarters and this quarter.

I wanted to understand, I guess now that, obviously, the recovery seems more evident, how you guys are thinking about your land opportunities?

I know you were one of the first to be out there buying finished lots three years ago, and it seems like you guys were picking up even a lot of, what I would consider, pretty small positions.

So, I'm trying to figure out -- are you still focused on that, even though prices are going up?

Are you just paying more, or are you finding undeveloped or partially developed land deals within those better markets?

Or, are you moving further out to find finished lot deals, maybe in the so-called B and C markets?

Clearly, our balance sheet is extraordinarily strong, so we're in a position to capitalize on any opportunities that we see on the land and lot side.

Clearly, land prices in certain markets have moved up more dramatically than we think they should have; and as a result, we're being more conservative in those particular markets.

But, we are putting our balance sheet to work on good deals in good markets with good returns.

The great thing about this Company is we pretty much have maintained our original footprint during this downturn.

And as opposed like a number of our competitors having to focus on just a handful of markets to generate their growth, we have got a huge footprint, so we can selectively invest in each one of those markets, our selected markets such that we don't have to take the risk that our other competitors do.

And, we can focus on growth and risk in the markets that we think are the best for us at that particular time, without pushing the window too hard in any one market.

We, clearly, are focused on one thing.

We are not going to take the hook at this early stage in the housing recovery with the weak macroeconomic scenario that we see, and bet the balance sheet of this Company, that we've cleaned up so nicely and it's the strongest it has ever been, just because of the fact there are a lot of people out there thinking that land prices need to be a lot higher than what they deserve to be.

Are you able to also pushback on labor and materials, or are you finding that the labor is, it is what it is and you're having to pay out more for that?

Well, first of all, we have a lot of partners who we have been doing business with for a number of years.

We just completed our every two year Purchasing Managers meeting in Las Vegas with our vendors and our manufactures, so as a result we set the expectations for them of where our volume is going.

Clearly, we're a big portion of a lot of their business; and as a result, we continue to work together to keep our prices and our costs moderated.

And, we expect them to cover their overhead with DR Horton business and make their profit off of our competitors.

Got it.

Okay, thanks.

Stephen East, ISI Group.

Don, if I hear you as you talk, it sounds like you're focusing more on volume as we move through, call it the next four or five quarters, versus pricing.

How would you characterize how you prefer to grow between now and the end of 2013?

Well clearly, we've been the number one builder, unit wise, for 10 consecutive years.

All the while, I think, clearly, out earning most of our competitors.

A few, a handful, have done slightly better than we, but not significantly.

And, our goal on a go-forward basis is to continue to be the largest builder in the US; but most importantly, to continue to focus on profitability.

As Horton has said many times, it's easy to make money in this business; it's harder to keep it.

And as a result, what we're trying to focus on, and we are focused very hard on, is profitability.

But, we're going to blend profitability with volume, but we're -- clearly, our Division Presidents know one thing -- they are not to take a back seat to any builder in any market because we have the best cost and the best pricing and the best balance sheet of anybody in the industry.

So, you can add all that up, and divide it up, and see what I really said.

That's going to be a chore on that one.

Okay.

Then, just two other distinct questions.

One, your split between fixed and variable on your G&A expense, and then you've talked a lot about some areas land's just too expensive and that type of thing.

If you look region by region, where are you primarily trying to put your money to work?

Well, I don't mean to be rude, Steve, but I just stopped giving the Bobby Toll market grade by markets because, frankly, we have some preeminent positions in a lot of our markets.

And I just don't want to be telling our competition where we're doing better --.

I appreciate that.

Can you do it in a more generalized area, not Dallas or Houston, but southwest versus east, or something like that?

Steven, if you look at our land position in the regions that are improving most, in terms of the lots they have under control, the two stand outs for us still continue to be the southeast and the south central regions.

Those are where we're finding more opportunities, and those have been consistently where we have found more opportunities.

Okay.

Then, on the SG&A?

Yes, in terms of the variable portion of our SG&A, when we are looking at revenue increasing sequentially, typically, our variable SG&A will equate to between 3% and 5% of the increase in revenues.

So, if revenues increased by $100 million, then we would expect SG&A to, the variable portion, to increase between $3 million and $5 million.

This quarter, the sequential increase from Q2 to Q3 was 5% of our sequential revenue increase.

Okay, thanks.

Michael Rehaut, JPMorgan.

Just wanted to get better clarity around the question I had before in terms of spec; but particularly, as it relates to your comments around gross margins.

You said that you expect gross margins, I believe, to improve in 2013 and, in part, due to more build-to-order versus spec.

But, I thought DT said that you expect spec next year to be roughly similar to -- next year to be roughly similar to this year.

Was I mishearing, or misunderstanding, those comments?

No, you're not.

And frankly, our spec level, as I said earlier, has run pretty consistently year after year after year, and we run somewhere between 50% and 60%.

We may get into the 62% or 63% level at the right time of the year, and we drop down to the mid-40%s at other times of the year, when we get closer to our third and fourth quarter.

So as a result, our game plan has always been -- in this Company, we know how to build specs, we know how to make money off specs and we believe it's a, really, a key stone of our business.

So as a result, on a go-forward basis, notwithstanding the fact that we have more and more build jobs, we are also continuing to offer the same level of specs at the specific quarters in the year where it makes sense.

We increase them and decrease them dependent upon the quarter of the year.

I think the other thing that may be a little bit confusing is, when we were talking about the ability to turn the backlog more quickly and some of the drag on the margin, we were talking about completed specs.

Completed specs have come down, year-over-year, from about 2,500, I believe, last year, to about 2,100 this year.

And, as a percentage of our inventory, that's even a greater drop because our overall inventory has been growing.

That's another factor that we look at just in addition to our overall spec percentage.

Okay.

Then, the completed specs is really one of the factors to drive gross margin improvement next year.

Would another factor also be -- you had mentioned, over time you're trying to migrate back from a 54% first-time buyer exposure more to typically 35% to 40%.

And, given comments around expanding the move-up product offering, would that also -- to the extent that you have a higher exposure in move-up next year, would that also benefit the gross margins?

Well clearly, the bigger percentage of our backlog that's move-up should have a higher margin than the spec margin.

And, we should be rewarded for that simply because of the fact that we are building a home for a particular person, as opposed to have building a production home, which takes slightly longer.

So, we should get a higher return on a build job.

Right now we are seeing margin improvement in every component of our business.

We think we have a good trend going.

We're going to work on continuing to improve that in every component of our business.

Maybe just to tie it all together, in terms of gross margins for next year, what would be the biggest drivers of expansion, if you were to think across, let's say three categories of less incentives, better pricing, mix shift towards move-up, and the third being less completed specs?

Can you give us a sense of the order of the drivers there?

Well clearly, I think that the more build jobs we have, that's going to drive our margins the best of those three categories.

The completed specs, basically what we're talking about is, we have fewer aged completed specs, specs that have been completed for a period of six months or less.

So, to the extent that that makes up a smaller percent of our backlog, that would be really the number two driver.

We have focused for years on making sure our specs that have been completed for a period of greater than six months are moved and sold as quickly as possible.

Okay, thank you.

Joel Locker, FBN Securities.

On your ASP, do you still expect that to -- I mean, it's been trending, the closing has been trending higher than the backlog, do you think that will continue?

The trend has been up.

We hope it continues.

But, that's a week to week, month to month thing, but clearly the trend has been up pretty consistently the last several quarters.

I'd say that two factors are driving that.

One is how many build jobs we have, build-to-order houses we have, move-up homes we have.

And also, frankly, our pricing power.

Right now, the pricing power is small, but it's there.

So, I think that's one of the things clearly contributing to our increase in our ASP.

Right.

You mentioned your compensation expense in third quarter being higher than a year ago.

Can you quantify that on what it was in the third quarter 2012 and third quarter 2011?

We would have to get back to you on the specific numbers on that, but that is the -- on the year-over-year change, that is the largest component of the year-over-year increase and directly related to the profitability of the Company and the change in share price.

Just to be clear, that's sales commissions.

It's bonuses for the superintendents.

It's division-level comp.

It's region comp.

And, it's corporate comp.

All of those have some component that's either tied to volume, revenue, or profitability, and stock price.

Right.

All right, thanks a lot, guys.

Mike Rybak, Ivory Capital.

First question, can you comment on the order growth progression for the quarter?

Yes, Mike, we typically don't comment about the inter-quarter trend.

But, the results that we posted where June was a little bit higher than our March quarter -- typically, March and June are pretty close together; but usually, only about a third of the situations is June higher than March.

So, we would view this as a very positive sales trend.

And, we're continuing that into July, as we said.

Okay.

Don, I think a couple quarters ago, I think on the Q1 call, you mentioned your personal goal was, five years out coming close to 50,000 units.

Is that still a realistic goal?

And, is there -- what sort of environment do we need to see for you to reach that before the five year mark?

Well, I think when we went back and did the math that's probably -- that's assuming about a 20% to 25% growth each year for four or five years.

To answer your question directly, I would be disappointed in five years if we weren't closing over 50,000 units.

Okay, got it.

Thank you so much for your time.

Mike Widner, Stifel Nicolaus.

Congrats on another solid quarter.

You had mentioned not really paying too much attention to what your peers do and mostly focusing on running the business for yourselves, which you've done very well.

But, I did want to ask you about what you're seeing out there, particularly amongst some of the private builders?

And really, I guess the question is that, there has been a widespread perception that those guys have been paralyzed; and to some degree, a lot of them are gone forever and not coming back.

And as you indicated, you guys took a lot of market share over the past couple years, as you were in a better position and reacted more quickly.

With that said, the last couple quarters really have been exceptionally strong for the public builders, and there's a lot of market share stealing going on by other folks.

I'm wondering if you're seeing response in any of the private guys yet, in terms of land competition for new deals, or new communities opening up, or anything along those lines?

And, how you'd expect that to play out, going forward, especially given that you've been around this business a few years, and you've probably seen a cycle or two in your day?

I have seen a couple cycles in my day, yes.

To your point about peers, we do focus on our competitors out there because, frankly, that's a daily focus of ours.

I would say to you, as DR and I travel around the markets, one of the things we don't see a lot of is activity in the small and medium-sized builders.

And, that's directly a function of the unwillingness of the banks to lend to them.

I think as the market continues to improve, obviously, the banks will begin to lend to them.

But clearly, most of that lending will be done for the vertical construction and not the land and lots.

So, as long as the banks continue not to lend to the small and medium-sized builder on land and lots, or independent developers to sell to individual builders, small and medium-sized builders, I think the production homebuilders, in particular DR Horton, will be in a preeminent position.

A lot of the developers over the last four or five years, who did concentrate on developing lots and selling them to the small and medium-sized builders, have learned a valuable lesson.

And that is, they need to deal with well-capitalized builders.

So, we're finding a number of the developers who focused on that portion of the market, as they try to get back in the market, and some of them are getting back in the market, they are definitely focused on dealing with well-capitalized production builders like Horton.

How does this differ from some of the prior cycles in that sense?

Obviously, this has been a much deeper cycle; but certainly, if we look back to the last one and coming out of this S&L crisis, most of the private guys did come back.

And, it's very mixed, I think, by geography as we look around and talk to small builders.

But, there's definitely been a tick up in activity, at least in some of the local areas that we look at, and just wondering on your sense of, does it vary by area, does it vary by local relationships that the guys have with local banks and sitting on the local PTA and all that sort of stuff?

How did it play out last time?

How did it play out back in the '80s?

And again, any parallels or differences you're seeing today?

I think the key today is the banks have obviously have gone through a very difficult time period themselves; and as I read, they are still not willing to lend to very many people, including well-capitalized and strong balance sheet companies like DR Horton.

So clearly, they are not in the game to lend to the small and medium-sized builders.

I think where the builders, small and medium-sized builders, clearly have an advantage is in the less capital-intensive markets.

Clearly, Texas is a less capital-intensive market, places like Louisiana, even New Mexico and Arizona, but you get into places like California and Florida and particularly in the northeast, the average lot price is extraordinarily high.

So, as a result, it costs -- it's a high risk and a high loan amount for a builder to get a loan from a bank, and it takes a lot of equity, on many occasions, for those small and medium-size builders in those capital-intensive markets to even be in the market.

And, to answer your question from a slightly different angle, I think if you look back to the early '80s, even the public builders were dependent on a significant level of bank debt.

So we were still talking to the same sources of capital for growth during that time period.

Now, when you look at the balance sheets, we're using capital markets paper.

So, it's a different source of lending for us that comes with fewer covenants and a defined time frame that can't be taken back.

So, one last point on that.

The early '90s did have some parallels in that we were coming out of the S&L crisis.

So certainly, particularly, with regard to mortgage lending or anything residential, it's a pretty horrific experience for most banks, and there is certainly -- there was a lot more bank failures, actually, last time around than this time around.

Again, just drawing the parallel back to, in your experience from the last cycle, does it feel different, worse this time for the banks?

Or, do you think you have the same amount of running room to, again, take advantage of their being paralyzed?

Or, again, any historical comparison would just be helpful?

Just from a personal standpoint, I think the banks today are in a preeminent position.

They have the US tax payers backing them, so as a result, they're stronger than they have ever been.

That's different from the last time because the '80s and the '90s, clearly, the bank failure rate and savings and loan rate was extraordinarily high.

So, there were very few players in the market to even lend.

But today, all of our banks are, I think, extraordinarily well capitalized.

I think what they are waiting for is, clearly, some indication that when they make a loan that they are not going to be underwater on the loan three months later, or six months later, because asset values have depreciated.

So, from their perspective and being an ex-commercial banker, I think it's tough to make a loan today, just simply from the perspective of your loan-to-value ratio could change overnight.

So, I think there needs to be, as it relates to the housing industry, I think there needs to be some small, but rather consistent increasing in valuations on houses and land and lots, such that the banks feel comfortable they are not going to be taking a writedown, after having made the loan, three months later.

Yes, certainly makes sense.

Well, for your sake, let's hope that you walk the fine line of those guys not getting capital, but housing continuing to recover, and keep them sidelined for a long time.

Oh, it will be another adaptation for us, I assure you.

Thanks, guys, and congrats on a solid quarter.

There are no further questions at this time.

I'd like to hand the floor back over to Mr. Tomnitz for closing comments.

Thank you.

And, thank you for joining us on our Q3 conference call.

Obviously, we're very proud of what our Company has accomplished; and most importantly, we're very proud of what our people have accomplished.

Seems like that people key in our on conference calls to try to determine the level of confidence that we have in the homebuilding industry, going forward; and clearly, you should have concluded from this conference call that we feel very good about the US housing market.

We feel very strong about our position in the US housing market, and that's all in the face of a rather weak macroeconomic environment.

We're confident about our future.

We're confident about our abilities to continue to capture market share.

We're confident about continuing to be able to expand our market share and our profits and our profit margins.

Thank you, and we'll see you after the fourth quarter.

Ladies and gentlemen, this concludes today's teleconference.

You may disconnect your lines at this time, and thank you for your participation.