霍頓房屋 (DHI) 2013 Q2 法說會逐字稿

Good morning and welcome to the D.R. Horton, America's Builder, the largest builder in the United States, Second Quarter 2013 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, Donald Tomnitz, President and CEO for D.R. Horton.

Thank you, Mr. Tomnitz, 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, Senior Vice President.

As usual 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 D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different.

All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements.

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

Don?

Spring selling season is in full swing, especially for D.R. Horton.

Demand for homes has strengthened and the relative available housing supply has shrunk, which has created a favorable pricing environment.

Our first time buyer demand remains very strong and we continue to see improving demand for move up buyers.

We are well positioned to meet the increasing demand across our broad geographic footprint with our inventory of homes available for sale and with the land and lot position we have accumulated over the past three to four years.

Our team of operators across the country delivered an outstanding second quarter.

They generated significant sales and revenue growth along with substantial improvements in profit margins and returns, which resulted in our pre-tax income more than tripling last year's levels.

Overall, the first half of fiscal year 2013 was nothing short of phenomenal and we expect the second half to be even better.

Bill?

In the second quarter, our consolidated pre-tax income increased 236% to $142.1 million from $42.3 million in the year ago quarter.

Our pre-tax income as a percentage of consolidated revenue was 9.9%, an increase of 550 basis points from 4.4% in the prior year quarter, reflecting significant improvement in both our homebuilding and financial services operations.

Compared to the year ago quarter, homebuilding pre-tax income increased to $127.4 million from $34.6 million and financial services pre-tax income increased to $14.7 million from $7.7 million.

Net income for the second quarter increased 173% to $111 million or $0.32 per diluted share compared to $40.6 million or $0.13 per diluted share in the year ago quarter.

Our net income for the quarter included a non-cash tax benefit of $18.7 million from a reduction of the valuation allowance on our deferred tax asset.

Mike?

Our second quarter home sales revenues increased 47% to $1.4 billion on 5,643 homes closed, up from $930.6 million on 4,240 homes closed in the year ago quarter.

Our average closing price for the quarter was $242,500, up 10% compared to the prior year, driven primarily by pricing power and to a lesser extent by a larger average home size.

Don?

The value of our net sales orders increased 52% from last year due to increased volume and home prices.

Our net sales orders increased 34% to 7,879 homes on a 15% increase in active selling communities.

Our average sales price on net sales orders of $253,400 increased 14% compared to the year ago quarter.

The cancellation rate for the second quarter was 19% compared to the 22% in the year ago quarter.

The value of our backlog increased 76% from a year ago to $2.4 billion, with an average sales price per home of $249,800.

Homes in backlog increased 54% from the prior year to 9,553 homes.

Our backlog conversion rate for the quarter was 77% compared to 94% in the prior year quarter.

We expect this rate will continue to revert closer to historical seasonal norms.

For the third quarter, we expect our conversion rate to be in the low 70% range.

We have continued to see a solid sales pace through April.

Stacey?

Our gross profit margin on home sales revenue in the second quarter was 20.4%, up 280 basis points from the year ago period.

210 basis points of the margin increase was due to improving market conditions resulting in reduced incentives and higher average selling prices in excess of cost increases.

40 basis points of the margin was due to lower amortized interest and property taxes and 30 basis points was due to lower estimated cost for warranty and construction defect claims as a percentage of home sales revenue.

Sequentially, our gross margin on home sales revenue improved 160 basis points, of which 30 basis points was due to improving market conditions.

The additional 130 basis points of the increase was due to lower relative costs for warranty and construction defect claims as a percentage of home sales revenue, with approximately 40 basis points of the 130 due to a higher level of cash reimbursements of previously incurred litigation cost received during this quarter as compared to our Q1.

We expect to see continued improvement in our home sales gross margin from improving market conditions for the rest of the year.

For the third quarter, we expect a home sales gross margin of approximately 20%.

Mike?

Homebuilding SG&A expense for the quarter was $155.1 million compared to $127.5 million in the prior year quarter.

As a percentage of homebuilding revenues, SG&A improved 240 basis points to 11.2% from 13.6%.

We are leveraging our fixed cost structure, while at the same time building our sales and production capabilities where necessary to meet our increasing demand.

We expect our SG&A as a percentage of homebuilding revenues to be below 11% for the remainder of the fiscal year.

The improvements in our gross profit and SG&A percentages and a decrease in our direct interest expense expanded our homebuilding pre-tax margin to an industry leading 9.2% in the current quarter, an increase of 550 basis points from 3.7% in the year ago quarter.

Stacey?

Financial services pre-tax income for the quarter was $14.7 million compared to $7.7 million in the year ago quarter.

86% 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 58% of our home buyers this quarter, with virtually all loans meeting eligibility requirements for sale to Fannie Mae, Freddie Mac or Ginnie Mae.

F HA and VA loans accounted for 49% of our mortgage company's volume this quarter, down from 57% in the year ago quarter.

Our mortgage company's new borrowers during the quarter had an average FICO score of 723 and an average loan to value ratio of 90%.

First time home buyers represented 47% of the closing handled by our mortgage company this quarter compared to 49% in the year ago quarter.

Bill?

At March 31, after considering the impact of our improving profits, we concluded that it was more likely than not that we would realize more of our deferred tax assets from state net operating loss carry-forwards before they expire than we previously anticipated.

As a result, we reduced our deferred tax asset valuation allowance by $18.7 million in the quarter, which reduced our income tax expense this quarter.

Mike?

Since December, our construction in progress and finished homes inventory increased by approximately $207 million.

We had 15,800 homes in inventory at the end of March, up 1,600 homes from last quarter and up 4,700 homes from a year ago.

As of March 31, 1,200 of our homes were models, 7,600 were speculative homes and 2,300 of the specs were completed.

We expect to continue to increase our homes in inventory to meet demand and we expect our average community count for the remainder of the fiscal year to remain 10% to 15% higher than last year.

Don?

In our second fiscal quarter, our investments in lots, land and development costs totaled $460 million, as we continue to find new communities and build our lot supply to meet increasing demand.

Of the $460 million, $217 million was used to purchase finished lots, $110 million was to purchase land and $133 million was for land development cost.

We expect our development spending will increase over the next few quarters.

At March 31, 2013 we control approximately 175,000 lots, of which 120,000 are owned and 55,000 are optioned.

30,000 of our owned lots and 28,000 of our optioned lots are finished.

The 58,000 total finished lots we control at quarter end are up 23% from a year ago.

Bill?

Our total available liquidity at March 31 was $1.7 billion, which included homebuilding unrestricted cash of $1.1 billion and available capacity on our revolving credit facility of $559 million.

The balance of our public notes outstanding at March 31 is $3 billion and we had no cash borrowings on our revolver.

$172 million of our notes mature in May 2013 and we have a total of $317 million of senior note maturities in the next 12 months.

At March 31, our homebuilding leverage ratio net of cash was 33.7% and our gross homebuilding leverage was 44.7%.

Don?

In closing, this quarter was D.R. Horton's most profitable second quarter since 2006, with $142 million of pre-tax income.

All of our operating metrics improved dramatically on a year-over-year basis this quarter.

The value of our sales, closings, and backlog increased by 52%, 47%, and 76% respectively.

Our pre-tax income increased 236%.

Our pre-tax income margin increased 550 basis points to 9.9%.

Our gross margin on home sales revenues increased 280 basis points.

Our SG&A as a percentage of homebuilding revenues improved 240 basis points and we are continuing to experience pricing power in many of our markets, as evidenced by a 14% increase in average sales price.

D.R. and I would like to personally thank all of our D.R. Horton teammates.

We have accomplished all of this with only a 29% increase in employees year-over-year.

Our team is consistently the most efficient in terms of closings per employee and I'm really pleased to share with you that this quarter we sold more homes, closed more homes, generated more revenue, earned more PTI, and had a higher PTI margin than any other builder.

We are in a great position as a Company.

We will clearly in 2013 be the homes closed, revenue, PTI, and PTI percentage leading builder for the year.

So, as my aunt used to say, stop for a moment and we should smell the roses for our major accomplishments, but get right back to work so we can continue to outperform our competition.

D.R. and I thank you for the great work.

This concludes our prepared remarks.

Now, we'll host any questions.

(Operator Instructions)

Dan Oppenheim from Credit Suisse.

You're talking about the land investment there, saying it's going to be more in terms of development.

There's so much in terms of the purchases during the fourth calendar quarter of last year as some tax related sales that benefited you on the purchasing side.

How much do you think about in terms of adding more land here versus just developing what you currently have?

Well, we're focused on clearly, Dan, developing what we have.

Obviously, our goal is to bring what we've purchased, especially in the last calendar year, into production; so, as we say, build, sell, close homes, and make money on those units.

We are continuing to add land deals, and anticipating, obviously, developing those in markets where the option lots are becoming shorter and shorter in supply.

Clearly, based upon the number of option lots that we added to our portfolio, we are able to still find option lots that are finished and finding also developed lots on an option basis, but there are markets where we're going to have to supplement the third party developers, as well as the finished option lots with land that we have to develop for ourselves.

And of course we've been very adept at that over the years.

Given the sales pace we're seeing, the demand we're seeing, the pricing dynamics we're seeing, we would expect to still be investing strongly in finished lots, land, and development in the coming quarters, as we have been so far this year.

Then in terms of just the margins, I think it talks about then pushing pricing with the average selling price up.

We've heard lots of different thoughts from over the course of actually this week here in terms of the earnings releases from different builders in terms of the thoughts on pushing price versus continuing to increase absorption at this point.

How are you balancing the two right now?

Well, clearly, you can see that we increased our sales and our closings this quarter dramatically, all the while, while dramatically improving our margins.

We think we're in a wonderful position.

There is a shortage of finished homes on the marketplace.

So, not only with our good inventory of specs that we consistently have maintained in this Company, we will continue to push price as well as volume.

Clearly, we've said before, our goal is improve the bottom line better than we improve the top line, but nevertheless we're in a position where we can do both.

Thanks.

Stephen East from ISI Group.

Great results, pretty impressive.

Great quote by the way this morning.

I think it's my favorite all-time quote.

Well, I think that was truly the case.

To follow on what Dan was talking about on the land side, maybe a little bit more.

What are you all seeing in the pricing of land?

And are there any markets that it's just very difficult to make land [pencil]?

And then if you look at your communities that you're opening right now and that you've got open, what percentage of that is previously mothballed or that either you're already in or will be opening?

Actually, I was on the phone with one of our regional Presidents this morning, David Ald, and we were talking about how we're very fortunate that we were early mover in terms of finding land positions a year ago and two years ago; because our basis in that land, to answer your question directly, is very attractive relative to where pricing is on land today.

Specifically, land prices have escalated in most Markets rather dramatically over the last six to 12 months.

We're very conservative in terms of our approach, because we don't need to buy that much new land to support what we see over the next two years as our net sales and our net closings.

But clearly land prices have gone up.

As far as mothballed assets, Bill?

In terms of deliveries on mothballed assets, that's still a very small amount of our overall deliveries.

But we are, certainly with the improved pricing environment, improved demand, we are bringing -- starting to bring -- more mothballed communities into our production.

So, we will see some impact from that; and that's certainly a very good source of capital for us as we will not have to purchase the land; we'll just have to put the development costs in.

You will see that on our balance sheet.

Our land held for development balance declined this quarter down to $602 million, as compared to $630 million last quarter.

And we would expect to bring even more projects out of mothball in over the coming quarters as things continue to improve.

And then if we go back, you talked about the majority of your pricing was true pricing power, not mix shift.

Could you give us a little more color on that?

And just what you're seeing on the cost side so we can understand what type of magnitude you have on pricing power versus cost inflation?

Certainly there's cost inflation out there.

One of the things that we've been able to do clearly is raise prices faster than what our costs have been going up.

We control our costs both on a national, regional, and also on a division by division basis.

At this point, we are still clearly the largest builder in the clubhouse, and by virtue of that we have more purchasing power than most of our competitors.

And it's been a focus of this Company for years to focus on our sticks and brick, which is what we're doing.

In terms of specifics on the pricing power versus mix shift, our average selling price per square foot year over year for this quarter increased 7.6%.

The average square footage of the homes that we closed this quarter increased 3.7% from last year.

So, that's mixed between pricing and size of the home.

In terms of our cost increases -- those were up on a per square foot basis 3.8% year over year.

So we still have a very good gap between our selling price increases versus our cost increases.

Okay, thanks, very helpful.

Michael Roxland from Bank of America Merrill Lynch.

Thanks very much and congrats on a great quarter.

Thank you.

Just wanted to follow-up on a comment you made on the last call regarding California, and that you had some reservations about investing there due to the economy; and really the fact that there's not been a widespread housing recovery in that state as compared to some of the other states you're involved in.

Are you still witnessing those same type of issues that you witnessed in this past quarter?

What's occurred since then, because it certainly stands in contrast to what some of your peers have been indicating.

Obviously, we were more conservative last quarter in California, but the record speaks for itself this quarter and California for us is doing very well now.

We have made some major investments in land and lots over the course of this quarter and we're well positioned to capitalize on what is turning out to be a better than expected California housing recovery.

And do you happen to have a sense of what's driving the recovery in California?

And can you talk to us of some of the specific markets within the broader State of California that are doing well for you?

Well, I'm going to refrain from speaking about any specific markets.

Again, I promised myself that a couple years ago.

But I would say to you, I think what is driving in the Bay Area, clearly technology is still driving that market, as well as what I've understood is there are a lot more money managers in the Bay Area over the course of the past two years.

Actually employees managing the money of the technology industry in Northern California.

And in Southern California, I think it's just purely people buying homes because they are more affordable than they have been in a long period of time.

So, there are people who are able to sell their homes for the first time in a long time and then they're able to trade up and downsize and capitalize on the potential, having more appreciation in a new home versus the existing home that they are currently living in.

And then, just quickly, Don -- I know you mentioned briefly in your comments that trends that you've seen thus far in April have persisted.

So, it sounds like there's really been no change in momentum; so the sales pace had been relatively consistent thus far in the fiscal third quarter?

Absolutely.

Thank you very much.

Good luck for the balance of the year.

Thank you.

Michael Rehaut from JPMorgan.

Good morning and congrats on the quarter.

Thank you, Michael.

The first question I had was on the gross margins.

You mentioned that price continues to outpace cost and the breakout of that was very helpful, so thank you for that.

At the same time, you're looking at gross margins, flat sequentially going into the third quarter.

And certainly, I understand part of that perhaps is with timing of the warranty cost that helped you sequentially this quarter.

But at the same time would it be fair to say, as long as these trends continue that -- I don't know if 4Q is too premature to talk about, but as we look into next year that the 20% at least for the rest of this year is sustainable, and as long as trends hold, we could expect some further expansion into fiscal '14?

Yes, it all comes into what's in your crystal ball, Mike.

If trends continue, if we continue to see double-digit pricing increases we would expect that margins would continue to increase.

But when we're looking at a land deal, we don't factor in future price appreciation into our assumptions in order to justify a land deal; we take a similar approach in our overall expectations in the business.

Certainly, if things continue at this pace we'll see some further improvement, but based on what we see right now, what's in our backlog, we're comfortable with our guidance for next quarter.

Also, Don, you made an interesting comment at the beginning of the call, about first-time buyer demand remaining very strong, but move-up demand improving.

And maybe not to read too much into the exact word by word, but most other builders have talked about over the past year the move-up buyer being the strong element so far, and more waiting for the first time buyer to come back or demonstrate the same type of strength that the move-up has.

And it almost seems like your comments were in reverse, that the first-time was more the bedrock remaining very strong, and the move-up improving.

So, am I reading that right or interpreting that right?

And is the first-time better for you guys than maybe you feel some of your peers are?

And are you just therefore -- but on the move-up side, more aggressively addressing that market, given that the strength there as well?

Yes, to answer your question.

As you know, we've focused on the first-time buyer for years at this Company.

And we still believe that's the largest component of the new home market.

And we are priced very competitively in the marketplace and can compete.

And we're able to offer buyers who are moving out of apartments a more attractively-priced home due to our low cost and our volume.

So, it's natural for us, given our size, to be able to offer a more competitively priced first-time home buyer opportunity for those people moving out of the apartments.

And as we mentioned to you probably 1.5 years ago, we began a significant focus on the move-up buyer, and we are penetrating that market very well and we expect that part of our business to continue to grow as it has.

One last quick one, if I could.

The financial services profit ticked down about $3 million sequentially, despite homebuilding revenue up and land financial services revenue flat.

Anything going on there?

And how should we think about that in terms of the profitability going forward?

Our financial services segment has slightly different timing than the homebuilder, because a lot of their revenue is recognized when they sell the loans.

So, at the end of the fourth quarter -- our calendar fourth quarter -- they had a very large mortgage loans held for sale balance, which then they sell during our first quarter and recognize that gain on sale.

Their mortgage loans held for sale at the end of the December quarter are lower and so the amount of gain that they recognize this quarter is a little bit lower.

It's just a timing difference.

So, it could drift up a little bit throughout the rest of the year?

Yes.

As their mortgage loans held for sale, it could drift up if the market conditions and the margins hold.

Great.

Thank you.

Ken Zener from KeyBanc Capital Markets.

Good morning.

Can you talk about the mix in gross margins?

Your ability to build and sell spec homes has obviously helped you absorb a lot of fixed SG&A costs through the bottom.

But I think there's still a misconception among investors that spec homes have to be at a lower margin than the homes in backlog.

We think it actually could be an area that's giving you upside on gross margins, as homes that you built in January are locked in backlog at a certain price, but actually go up as the market goes up.

So, could you talk about the spread in spec?

First, backlog -- how much that impacted your second quarter results.

And if your 20% number is just focused on your backlog margin expectations as opposed to what might flow through on spec homes?

Thank you.

I'll let Bill handle the second part of that question.

Frankly, where we are today, we see a shortage of finished new homes in the marketplace.

So, by virtue of having the specs that we have out there, we have tremendous pricing power on our specs.

We have a number of people who are listing their homes, and as one of our people in the legal, who runs our environmental force, he listed a home and had four offers in three days.

So, people are listing their homes and selling them a lot more quickly than what they've anticipated.

And to the extent that we have a spec inventory that we have out there, which has been a tradition of this Company, then in essence we have had significant pricing power in our specs.

Our specs used to be slightly less in terms of margins than our build jobs, and that has semi-reversed itself.

Recently we have seen some trends where some spec margins have been higher than pre-sales.

We don't expect that will be the long term trend, but in an environment where we're seeing rising pricing, that certainly can happen, And obviously with our spec inventory, then that's certainly a benefit to our margins right now.

Matter of fact, currently, with our sales demand, we're having our spec level is slightly lower than what we'd prefer to have it, because as we release (inaudible - technical difficulties), they're selling more rapidly than we anticipated.

Could you maybe give us a little context then to, not necessarily the peak in '05, but what it was doing in '03, '04?

Was it common for a spec to be in line with your backlog homes?

Or was your backlog tied to some optionality, always a bit higher?

If you could give us a context that would be appreciated.

Thank you.

Ken, we don't have the specific data on that from that period, but I would suspect back in a period when there was significant pricing increase, we're probably seeing a similar trend to what we're seeing right now.

Matter of fact, back then we were hoping that people would can and we could resell the home for more.

We're not in that current situation, but currently, we have adequate number of specs out there that meet the demand.

We're trying to increase our specs because we anticipate increasing demand.

And to the extent, as I said, that we have a home ready for a buyer who sells their home more quickly than anticipated, it's a great position.

And please don't forget, realtors are a large percentage of our sales and realtors like one thing.

They love to collect their commission more quickly.

So, when you have a spec home, they can typically collect their commission within 30 to 45 days, as opposed to if they sell a build job they are having to wait three to four months to collect their commission.

And as we have long said, the key to being successful with specs is to manage them very carefully.

And obviously it's been part of our business model for a long time.

So, even though we're in a period right now where we're seeing rising prices, we are still going to stay disciplined and we are going to manage our specs effectively.

Thank you.

Adam Rudiger from Wells Fargo Securities.

Don, I have a big picture question; and you've kind of alluded to some of the answers a little bit, but I wanted to ask it more concisely.

Despite the likelihood, I think, that we're probably in the early innings of a multi-year recovery, it looks like now you and some of your peers are already starting to generate what you, I think, you would consider normalized margins.

And, so, to me there's somewhat of a disconnect there.

So, I was wondering what you thought about what that means for the next few years in terms of already achieving what might be a normal margin well ahead of mid-cycle or normal production levels.

Well, we aren't going to argue with having achieved it earlier than we anticipated, because it's a beautiful thing after the last five years in our industry.

And I've thought about what your question is.

And, not to be negative, but to be realistic, our margin increases have been dramatic to the extent that we're able to improve our margins as much in the future as what we certainly have done in this past quarter.

You'd have to probably question as to whether we could improve them that much on a go-forward basis quarter after quarter after quarter.

Clearly, as we continue to do the volume that we're doing -- and I'm so proud of our people because we clearly will be the leader in the clubhouse both on units as well as revenue this year -- we are definitely experiencing more purchasing power than our peers.

And that's really our goal.

Our goal has always been to keep our SG&A as low as possible in this Company, but also to be very proactive in controlling our stick and brick cost; and our volume helps us do that dramatically.

If you look back over history through cycles, even though we talk about a normalized margin of wanting to be a 20% gross, 10% SG&A, 10% on the bottom line, what we have seen during the up part of the cycle in the past when pricing has been going up, is we have seen margins above that level.

Over the long-term average it kind of averages out to the 20%, but we've certainly seen periods where its been above the 20%; and we're hopeful that if trends continue that we'll see some of that.

I guess, Bill, it's an interesting point you talk about that above 20%.

It looks like without having perfectly checking my model, it looks like those years were really just the exceptions for 2004, '05 & '06.

So, what I'm wondering is, if we think that's going to repeat itself in terms of the margin potential?

Or is the goal to be big, and the goal to be scaling your markets, and the goal to take market share going to erase a little bit of that margin potentially or cap it?

The goal is always to strike the best balance.

Scale and volume helps drive some efficiencies and helps drive some bottom-line profitability in margins and returns, but we'll always want to balance that.

So, I don't think one supersedes the other.

I would say after being in the industry for 33 years and I'll celebrate my 30th anniversary at Horton in August, 20 and 10 and 10 is pretty much -- A -- it's a good return; and to the extent that our gross margins are higher than that and our SG&A is lower, I think to a certain extent that's largely an anomaly in this business.

And you are going to have years where you're going to do that and you better pack away the earnings and stick them away for the days when you're going to be back to 16% and 17% margins.

So, clearly think where we see the business year after year after year, if we can maintain a 20% gross margin, a 10% SG&A and a 10% at the pre-tax line, that's a beautiful scenario.

You take it when it's better, but you don't get too caught up in it.

And we do think this is a period of when it's better, because there's a shortage of supply compared to the current levels of demand on housing.

And we alluded earlier, we are seeing land prices increase because there's a shortage of finished lots available to construct the houses.

So, we've got that inventory.

So we think we can take advantage of the current environment, increase our margins then going forward.

We don't have to go out and buy land at today's prices to hit any sort of growth targets.

We will still reinvest, but we're in a very good position on land we already own, houses that we can build and put in inventory to deliver.

Strong growth and strong margins.

Great.

Thanks for taking my questions.

Thank you.

Susan Maklari from UBS.

I want to go back and I have a land question, but I want to ask it in a slightly different way.

In the sense that as you buy more land that needs to be developed, how does that inhibit your ability to adjust your community count growth?

And given that -- maybe not for this year so much, but in terms of thinking about maybe for 2014 and going forward -- how you balance the need to have lots that can be delivered more quickly to be more flexible to community count relative to needing to develop land?

Well, I think as the market recovers, there will be another party that enters into the fray and that will be the third party developer.

And, so, as a result, in the past we've always had a good group of third party developers who have helped us provide lots for our lot inventory.

Obviously, with the banks over the last five years -- and they're beginning to slightly increase their lending -- but we are seeing third party developers qualifying for development loans.

So, as a result, our existing land development will be augmented by third party developers and that will continue to increase as the housing market continues to improve, because as the housing market continues to improve there's no doubt in my mind that the banks will begin lending once again.

There is certainly a longer lead time to opening a community when you buy land and have to develop it yourself, versus buying finished lots.

But it's a very local decision and each one of our operators in the local markets understands where their positions are, where their communities need to be replaced and where their counts make sense to add.

And they account for that lead time in planning to buy land and bring it into production at open communities.

So, it is definitely a difference in timing, but as Don said before, we expect there will be other opportunities that may not exist today for some finished lot developers to be in place to help support our growth as well.

That's one of the reasons we give you our finished lot count and not just our total lot count.

Because with 58,000 finished lots we should be able to have some time to adjust to the demand levels that we're seeing and react without running out of lots.

I assure you one thing we won't do.

We will not run out of lots.

(laughter)

No, I'm sure.

In terms of the third party coming back in, are there any specific markets where you're seeing that maybe take hold more than in other areas?

Susan, I've made myself a promise I'm just not going to get market-specific, because over the past years I think its benefited our competitors more than it has our analysts.

So, as a result if you want to follow-up with that question with Stacey or Jessica later, they will try to help you with that.

Okay, great.

Thank you.

Jade Rahmani from KBW.

On the land spend, what percentage are option exercises on deals that you tied up in the past?

Well, in any deal where we bought finished lots, it would have been tied up under an option contract.

We don't have the aging of when the contracts were signed, though, in terms of the buys or anything like that.

But clearly, it's still a substantial portion of our spend was on finished lots.

And are you seeing developers increasingly look to build participation into the option deals that they're structuring?

I've seen that decrease.

Personally reviewing every land deal in the Company along with Bill and Stacey, we'll tell you that two years ago and even a year ago we saw more profit participation from developers than we are today.

And I don't know why that is, but we're not seeing very much of it today.

And every time we have a chance, we push back on that, because we deserve the upside.

But not as much today as what it was a year, 1.5 year ago.

Just wanted to ask -- on SG&A, a simple question is, how do you look at the growth in SG&A on a year-over-year basis?

This quarter's growth was less than half of the revenue growth, and do you expect that kind of relationship to continue?

Thanks a lot.

That's pretty good.

(laughter) Our long-term target on SG&A is 10% and we're certainly rapidly moving that direction.

We would expect if things continue we will get there, maybe not quite this year, but we will get there.

And as we grow, we certainly have to add infrastructure.

We have to add people and as we add new communities we add expenses.

But there have been periods where we've been below 10% when we've seen a lot of pricing increases.

So, we could see a period below 10%.

But again, 10% is a long-term average.

We're still striving to get there.

We started to see very good SG&A leverage toward the back half of last year.

So, continuing to see the same level of year-over-year improvement or that same ratio you mentioned between incremental revenue and SG&A would probably be a little bit aggressive, but we do feel that we are working our way back down toward the 10%.

And as we said, we expect to be under 11% for the balance of the year.

Please don't recall, we are the most efficient in the industry.

We still close and sell more homes per employee than anyone else and I'm astounded when I looked at the number for the quarter when we year-over-year increased our employee count by 29%, but yet our sales, closings, and backlog values increased 52%, 47% and 76% respectively.

We leveraged our overhead extraordinarily well.

Joel Locker from FBN Securities.

Nice quarter.

Thank you, Joel.

Just wanted to, I guess, get behind you mentioned brokers before, and wanted to see what the participation rate from outside brokers were in the second quarter closings?

What that was a year ago?

We typically run somewhere between about 60% and 70% participation from brokers.

And has that changed at all?

Not significantly.

And just on community count, did you guys mention what it was up sequentially?

And up year over year?

Year over year was, on active selling communities, was up 15%.

I don't believe we gave the sequential number.

That was up 5% sequentially.

And just a follow-up on that -- how many communities do you plan to open in the last two quarters of 2013?

And what are slated to open in 2014, if you have some kind of ballpark?

We're planning on opening every community that meets our current underwriting guidelines, which is a combination of gross margin and return on capital.

And I don't mean to not answer your question, but we are aggressively pursuing land and lot positions in most every one of our markets; and to the extent that our conservative underwriting guidelines are met, we're on the deal.

We do expect our selling communities to continue to be up 10% to15% year over year for the remainder of this fiscal year.

Past that it's hard to have perfect visibility on timing of openings and closings.

But just to clarify, we are approaching this up cycle in a totally different manner than we have in my 30 years with this Company.

And that is, we are adhering very closely to our return of initial investment on any land deal that we get our capital back, our original investment back within 24 months.

Some slight exceptions, but our goal is to maintain that hard and fast rule.

We're not having a hard time finding deals that meet those criteria today.

And in the Southwest, that was down 9% year over year on orders.

Was that a function of just community count declining?

Yes, in the Southwest, as I think we mentioned on last quarter's call, with the vast improvement in the Phoenix market last year our lot supply is a little lower than we would like.

So, we're working to build that back up.

So, our sales are reflecting that, but we're also seeing very strong pricing in that region as we rebuild our inventory.

And that's really -- in terms of markets, that's Arizona and New Mexico for us.

Right.

All right, thanks a lot guys.

Thank you.

Jack Micenko with SIG.

Stacey, going back to the mortgage question, I know you talked about timing and those closings rolling -- the revenue recognition of the mortgage.

Can you talk about sequential trends in the gain on sale margins in mortgage?

And where you think those margins maybe go in the next two quarters or so?

We've been in a very robust gain on sale environment.

The demand side for the mortgages that we're originating has increased.

A large portion of our loans have been sold to one buyer for a long period of time.

We're now seeing more buyers come into the market and that is helping with the pricing.

We don't know exactly where the margins will go, but it might be a little aggressive to assume that they continue to stay exactly where they are, because this is above any historical margins we've ever run in terms of gain on sale.

But you didn't see a big decline quarter to quarter?

No.

And then, Don?

Right now, if you were investing in a mortgage, I can't imagine a better time with the FICO scores, the underwriting guidelines and with low interest rates where they are today, very few prepayment, early prepayment.

So, if you're an investor in mortgages, it's a great time to be in the business.

Not enough banks are doing it.

Don, you'd talked about continuing to say and reiterate that you aren't changing standards on the land purchase side.

We've heard some competitors talk about maybe moving in some inflation into their underwriting.

And I guess the mix of almost half your land activity this quarter was finished.

Is that a sustainable percentage?

Going back to the '03, '04 time frame, is that a consistent mix, finished versus raw, into more building demand scenarios?

I think that is a more normalized balance for us -- about half developed.

We internally develop half; we might buy finished from someone else.

Over the past few years it had swung more to us buying finished lots as they were available through distressed and other situations.

As we're getting back to more normalized times we're developing more of our own lots, but it's not swinging the pendulum past what we believe to be a historical balance.

I think that's reflective of our geographic mix.

We have a very strong presence in Texas, where there are third party developers, where there are finished lot opportunities, and really throughout the South, there's a lot more opportunities there.

So, we typically have seen substantial amount of finished lot purchases in those markets.

I'll tell you -- and with our volume in each one of our markets, we're assisting third party developers in terms of them obtaining their loans from banks, because simply the fact that, one, we have a strong balance sheet; and secondly, we're a strong performer.

We start a number of specs in each one of our communities.

So, there are a lot of third party developers who are seeking loans that look at Horton as a great catalyst to them securing their loan from a bank.

Thank you.

Stephen Kim from Barclays.

Congratulations on a good quarter.

Congratulations on a good call, timing-wise.

Wanted to ask you a question about M&A.

In the 1990 cycle, you all were really among the most successful M&A story in the industry.

And recently we've seen a little bit of activity from some of your peers on the M&A side getting into some markets here or there.

And I guess I was curious whether or not you felt that it was reasonable to think that D.R. Horton would be able to have M&A be a meaningful part of your growth opportunities over the next, let's say, two to three years.

Well, clearly -- and I'll speak for him because he's sitting to my left -- but Mike Murray has moved up to 38.

He was our controller and he was promoted to Senior Vice President and he's in charge of our acquisitions for us.

And clearly, if you'll recall, what was -- it four months ago, five months ago -- we closed on Breland, which was a builder in Mobile and Gulfport, Mississippi, area, as well as Huntsville, Alabama.

So, he's working deals.

We're working deals.

And it's our goal to be a participant in the M&A gain, just as we were in the past upcycle.

Maybe just as a follow-up to that, can you give us a sense for what may be different about the way you're pursuing those deals, either in terms of the kinds of constraints you'll put from your end or in terms of what embedded expectations are on the part of the folks on the other side of the table, relative to what you saw in the last cycle?

You've indicated a lot of changes in the operations of your business; you just said you're doing things very differently in many ways in this upcycle operationally.

Are there other differences on the M&A side as you look at things that are also relevant?

Before Mike gets into the facts, all of the other relations, let me just say that our acquisition gain, one of the things is, our preeminent plan has always been that we are looking for people who will fit within our Company and make sure that they blend well with us.

And if you look at the people that we inherited from the Breland acquisition, there wasn't much Hortonization that was necessary; they fit within our organization very well and are performing very well.

So, that's our first plan.

Our second plan is, is to make sure that they fill a hole where we currently need some help.

And, so, I'll let Mike go on with the rest of it.

In looking at our footprint, perhaps, today versus where it was when we went through the last round of M&A that concluded in really in '02, our footprint is much more robust today and so there's perhaps less geographies that we would be looking to fill in.

Doesn't mean there's not places that we're existing today that might be attractive opportunities for us.

Situations, sometimes seller-motivated, that they may have survived the last cycle very well, but they're looking for a way to take some of their capital out of play and a different lifestyle, perhaps, from where they are today.

But as Don said, it's the people part that's got to be the first fit.

And we are going to be focused on what we believe to be top drawer people and really good long-term fits for us.

We can grow lot and land positions in our markets, but to add some key talent and key teams and selectively new markets -- there's opportunities.

Great.

Thank you very much, guys.

Alex Barron from Housing Research Center.

Yes, good morning, guys, and great job.

Thank you, good to hear from you, Alex.

Likewise, Don.

I, as you know, have been following you guys for a long time and I am kind of surprised by your conservatism in your guidance, because it seems to me that everything is going on all cylinders.

And so I'm just trying to understand if that is all that's behind your SG&A, your backlog conversion, and your gross margin guidance.

Are you saying that our gross margin guidance is light and our SG&A decreases are light?

Well, it seems to me that the-- I mean, based on what you have in backlog going for you, and I know that you're not going to grow the SG&A.

You've always watched it.

It would seem to me you're going to get below, way below 11% in the back half.

But anyway --

Let me clearly say--

We didn't say how far below.

We talked clearly, Alex, about the fact that we still see gross margin expansion opportunities in the quarters ahead, especially in the next two quarters.

And as, obviously, we get more of our closings in second half of the year than the first half of the year, we see some declines in our SG&A as a percentage of revenue moving forward.

And that clearly, I think, our SG&A percentage in the second half of the year will clearly be under 11% and may approach 10% for the third and fourth quarter.

But on an average for the year based upon where we are today, it's not going to be -- probably going to be closer to 11% than it's going to be closer to 10%.

But it could be somewhere in between there.

And on backlog conversion, 70% compared to what we have historically done in our third quarter is probably about 10% higher.

We have seen our spec percentage come down a little bit as our percentage of inventory.

So, that's one of the things we're weighing.

But quite honestly, we haven't been the perfect predictors of what our backlog conversion will be.

We've known that it would start reverting back to historical norms, but predicting how quickly and how much has been a little difficult.

But we have seen a slower backlog conversion this year than last year.

We expect that to continue to revert.

That's what's in the guidance.

Could we do better than 70%?

Sure, but historically would say that we could do a little worse than that too.

And please remember what I said in my prepared remarks.

The second half of the year will be substantially better than the first half of the year for us.

Absolutely.

Right, so I guess that leads me to ask why -- I know you gave historical averages of the 20% gross margin and the 10% SG&A, but why would SG&A stay at 10%?

Why couldn't it go below that in the future years, since you guys are obviously getting a lot of scale advantages, and, as you pointed out, you don't need to hire that many incremental people to manage the growth in the units.

With all due respect, Alex, we aren't focused on where our SG&A is going to be so much in year in '14 and '15 as where we are in the next two quarters.

So, we're just focusing right now on delivering what we can very effectively deliver in the third and fourth quarters.

And obviously, you know this organization, you know Don Horton very well.

If we get to 10%, Horton will want 9% and we'll be working on trying to get to 9%.

But let's get to 10% first before you try to get us committed to where we're going to be in '14, '15, sir.

If I could just ask -- on your land strategy, I go out and visit a lot of communities around the country and it seems to me like you guys are the only ones moving out to a lot of the first-time -- where the first-time buyers are and your peers seem to be hesitating.

Are you finding that the opportunities and returns and the cost of land there are more attractive than fighting for the A locations?

Well, actually, as we come through -- as I said earlier in the conference call, Bill, Stacey and I see every deal that comes through the Company and one of us approves it and I hear and see every deal.

I would say to you that we are clearly still seeing a number of great opportunities in A locations and most of the deals we're approving right now are A locations based upon our gross margin hurdles, as well as our return of initial capital.

So, I don't believe we're seeing -- I know one thing, we aren't doing any C deals.

So, clearly we're augmenting our A deals, which the majority of our deals are As, with some B deals, but we've got a high level of A deals coming through the Corporation right now.

If there's strong buyer demand in a submarket at margins that meet our hurdle, that's an A deal for us.

Got it.

Thanks.

Yes, sir.

Megan McGrath from MKM Partners.

Just wanted to ask a little bit about pricing and affordability.

You've got pricing going up a couple percentage points, but, at least according to the data this morning, we've got real incomes down about 5%.

So, obviously, all about mortgage rates here.

How much wiggle room do you think that you still have on the pricing, especially with your first-time buyer.

What are you hearing from your sales folks in terms of how much they can push it in terms of affordability here?

Well, as we look across the country, frankly, we're selling more and more larger plans, as our sales price indicates and square footage indicates.

And, frankly, in a number of our markets we're deleting the smallest two plans simply because of the fact that we have much better margins in the third largest small plan and going up the scale.

So, I don't see any issues with that currently.

And I know that, that's an issue, because obviously, with the increased taxes that everyone is having to pay this year, there is less disposable income.

But we still have people largely coming into our models, especially in the first-time home buyer market, with the affordability rates where they are today, even though they may not be as great as they once were but they are still very good -- they are still trying to buy all the house they possibly can.

That's something we always have to watch, always watch the affordability; but today it's still very good.

And then especially with where mortgage standards are today -- for those buyers that are able to qualify for a mortgage, they have very good credit quality.

So, they are typically able to probably to afford a little bit more house than buyers several years ago when credit standards were a little different.

When we're dropping our one or two smallest plans in a number of our communities, there's good demand out there.

So, to the extent that we're dropping those, to the extent that we had to come back and add those, because of less disposable income or qualifying problems, we can easily do that.

And then, just to follow-up on your comment around financing -- we actually heard in a couple of instances that now that prices are going up that appraisers are falling behind a little bit and having a hard time catching up.

Has that been any pushback for you in the quarter in terms of appraisers catching up with your price increases?

Actually, we work very closely, to the extent that we can, with our appraisers; and we try to help them by having a focal person in each division deliver the appraisal packet and to the extent that they can use any of our help, we're trying to help them.

But clearly I think the appraisers are doing a good job in most of our markets.

There are a handful of markets where we feel like that the appraisers are not giving the value that we should be getting for our homes, but we're working through that.

Great, thank you.

Buck Horne from Raymond James.

Can you quantify any external commissions that were in the gross margin line?

And also, are there any markets where you're actively trying to slow absorption, given the lending constraints out there?

And how do you balance the equation between price and pace right now?

I'll take the second half of that.

We're not trying to slow our sales in any particular market by lack of lot supply.

If we are doing anything and our sales are slowing in a particular area, it's because we're very proactive on our price increases and we're trying to take price increases wherever we can and as actively as we can.

But not any restriction on our sales relative to land and lot supply.

And commissions over the long-term are typically around 3% of revenue for us.

And this quarter was in line with that long-term range.

One last one in the call here -- but can you talk a little bit about the margin differential between internally-developed communities versus communities you buy from third parties?

What's the margin differential between those, typically?

And on the finished lots you do buy today, what's the implied margin relative to your current 20%?

It's really a risk assessment, and basically if we are buying lots all cash from a third party developer, or if we have bought the land and are developing the lots, we have a higher gross margin underwriting hurdle than our standard on a rolling option basis.

That could be anywhere from 200 to 300 to 400 basis points differential, because we believe that as we have to cash something out or -- in terms of finished lots -- or if we develop the subdivision ourself, we should be paying ourselves a risk-adjusted return.

And if we're not, then we're making a mistake.

So, that's where we focus.

And sometimes it's 500 basis points, but I'd say it's typically somewhere between 300 and 400 basis points if we have to cash something out.

That's very helpful.

Thanks guys, great quarter.

Thank you.

Thank you.

We have reached the end of our question and answer session.

I'd like to turn the floor back over to Management for any further or closing comments.

Thank you and thank our employees for a wonderful quarter.

We've come through a tough five years in the Company.

We've rebuilt the Company from the ground up.

Our employees have done a phenomenal job out there helping us get to where we are.

Without a doubt, we're clearly the leader in the industry and with where we are today and where we are positioned over the course of the next two years, we should clearly be the leader in the industry both on units, revenues, profit, gross margins, SG&A.

We have absolutely had a phenomenal quarter, but there's more great things to come with this Company and I appreciate it and D.R. and I thank each one of our employees.

Goodbye.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.

We thank you for your participation today.