霍頓房屋 (DHI) 2014 Q2 法說會逐字稿

Greetings and welcome to the D.R. Horton, America's Builder, the largest builder in the United States, second-quarter 2014 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Don Tomnitz, President and CEO of D.R. Horton.

Mr. Tomnitz, you may begin.

Thank you, Kevin, and good morning.

Joining me this morning are David Auld, Executive Vice President and Chief Operating Officer; Bill Wheat, Executive Vice President and Chief Financial Officer; Mike Murray, Senior Vice President of Business Development; and Jessica Hansen, Vice President of Communications.

Before we get started, Jessica?

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 10-K and our most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

Don?

Thank you, Jessica.

The spring selling season is well under way.

Our net sales orders in the March quarter were up 57% sequentially, in the December quarter, and up 9%, from the second quarter of last year.

Our average sales price increased by 10% year over year to $278,900, driving a 20% increase in the value of our net sales.

Our solid sales performance resulted in an 18% increase in our backlog value compared to the prior-year quarter, putting us in a strong position for increased revenue and profitability in the second half of FY14.

Our team of operators across the country also delivered outstanding profitability this quarter, with $201.9 million of pretax income on $1.7 billion of revenues, resulting in a pretax operating margin of 11.6%.

Housing market conditions remain favorable and continue to improve in a manner consistent with our long-stated expectations for the housing recovery.

As expected, we are seeing the pace and the strength of the recovery very significantly across our local operating markets.

Closely tied to improvement in each market's economy, as measured by growth in jobs, household incomes, household formations and increases in consumer confidence.

D.R. Horton is well known for offering homes for the first time and first time move-up buyer, with 56% of our homes closing at an average sales price of $250,000 or less this quarter.

We are experiencing solid demand and profitability in the heart of our business in our D.R. Horton communities.

Our high-end Emerald brand continues to grow and is currently being offered in 27 markets across 10 states.

This growth is evident as 6% of our homes closed this quarter were priced higher than $500,000, accounting for 16% of our home sales revenue, up from 3% of the homes close and 9% of revenues in the same quarter of the prior year.

We believe that the true entry level buyer is underserved in the current market especially after the significant increases of home prices the last two years.

Therefore, we recently introduced a new brand, Express Homes, targeted at the true entry level buyer, who is focused first and foremost on affordability.

A rollout of Express is in the very early stages, just getting off the ground in 13 markets and 4 states.

The price points of an Express Home will vary from market to market, but will consistently focus on providing an affordable entry level home.

We look forward to growing all three of our brands and product offerings to gain market share across all price points as the recovery continues.

We are positioned to grow revenues at a double-digit pace with strong operating margins while generating increasing returns.

Bill?

Our consolidated pretax income increased 42% to $201.9 million in the second quarter, from $142.1 million in the year-ago quarter.

Our pretax income as a percentage of consolidated revenue was 11.6%, an increase of 170 basis points from 9.9% in the year-ago quarter.

Home building pretax income increased 50% to $191.7 million from $127.4 million.

And financial services pretax income was $10.2 million compared to $14.7 million.

Net income for the second quarter increased 18% to $131 million, or $0.38 per diluted share, compared to $111 million, or $0.32 per diluted share in the year-ago quarter.

Mike?

Our second-quarter home sales revenues increased 23% to $1.7 billion on 6,194 homes closed, up from $1.4 billion on 5,643 homes closed in the year-ago quarter.

Our average closing price for the quarter was $271,200, up 12%, compared to the prior year, driven by pricing power and an increased mix of larger move-up homes.

David?

The value of our net sales orders in the second quarter increased 20% from the year-ago quarter to $2.4 billion.

Homes closed -- homes sold increased 9% to 8,569 homes on an 11% increase in active selling communities.

Our average sales price increased 10% to $278,900.

The cancellation rate for the second quarter was 19%, consistent with the year-ago quarter.

The value of our backlog increased 18% from a year ago to $2.8 billion, with an average sales price per home of $280,700.

And homes in backlog increased 5% to 10,059 homes.

Our backlog conversion rate for the quarter exceeded our expectations at 81%.

We expect our third-quarter backlog conversion rate to be around 75%, consistent with our long-term average rate.

Bill?

Our gross profit margin on home sales revenue in the second quarter was 22.5%, up 210 basis points from the year-ago quarter.

160 basis points of the margin increase was due to improved market conditions resulting in higher selling prices in excess of cost increases.

30 basis points was due to lower amortized interest and property taxes as a percentage of home sales revenue.

And the remaining 20 basis points was due to lower relative costs for warranty and construction defect claims.

Sequentially our gross margin improved 20 basis points from the first quarter, primarily due to lower relative costs for warranty and construction defect claims, with little impact for market conditions.

We expect that further improvements from this quarter's 22.5% gross margin will be challenging.

As long as market conditions remain stable, we expect to maintain strong gross margins, generally in the range of our last four quarters, with quarterly fluctuations due to product and geographic mix.

We are positioned to grow revenues at a double-digit pace, with strong operating margins while generating increasing returns.

We expect revenue growth to be a stronger driver of our earnings growth going forward rather than margin expansion.

David?

Home building SG&A for the quarter was 187,900 -- or $187.9 million, compared to $155.1 million in the prior-year quarter.

As a percentage of home building revenue, SG&A improved 10 basis points to 11.1% from 11.2%.

While we continued to build our sales and production capabilities where necessary, we expect to see modest improvement in our annual SG&A percentage as we continue to work to our target of 10%.

For our third and fourth quarters this year, we expect our SG&A as a percentage of home building revenues to decrease sequentially on higher expected revenues.

The improvement in our gross profit and SG&A percentages expanded our home building pretax margin to 11.3% in the current quarter, an increase of 210 basis points from 9.2% in the year-ago quarter.

Jessica?

Financial services pre-tax income for the quarter was $10.2 million, compared to $14.7 million in the year-ago quarter.

This quarter continued to reflect a more competitive pricing environment where as the year-ago quarter benefited from unusually favorable market conditions, which produced higher than normal gains on sale of mortgages.

90% of our mortgage companies loan originations during the quarter related to homes closed by our home building operations.

FHA and VA loans accounted for 43% of our mortgage company's volume this quarter, down from 49% in the year-ago quarter.

Borrowers originating loans with our mortgage company during the quarter had an average FICO score of 716 and an average loan to value ratio of 89%.

First time home buyers represented 42% of the closings handled by our mortgage company this quarter compared to 50% in the year-ago quarter.

Mike?

Our construction in progress and finished homes inventory increased by approximately $142 million since December.

We had 17,600 homes in inventory at the end of March, of which 1,400 were models, 8,600 were speculative homes, and 3,000 of the specs were completed.

In our second fiscal quarter, our investments in lots, land and development totaled $560 million, of which $376 million was to purchase finished lots and land and $184 million was for land development.

At March 31, 2014, we owned 125,000 lots and controlled another 47,000 lots through option contracts.

60,000 of our lots are finished, of which 33,000 are owned and 27,000 are optioned.

We are well positioned to meet demand with our 172,000 total lots owned and controlled.

Bill?

Our unrestricted home building cash totaled $930.8 million at quarter end.

At March 31, we had available capacity on our revolving credit facility of $654.5 million and no cash borrowings outstanding.

Our home building leverage ratio net of cash was 38.4%, and our gross home building leverage was 45.5%.

The balance of our public notes outstanding at March 31 was $3.6 billion.

Our $500 million principal amount of convertible notes mature on May 15.

Holders of these notes may convert all or any portion of their notes at their option at any time prior to the close of business on May 13.

For the notes that convert, we intend to settle them with common stock.

Don?

In closing, this quarter our pretax income increased 42% to $201.9 million.

The majority of our operating metrics continue to improve on a year-over-year basis this quarter highlighted by the value of our sales, closings and backlog, increased by 20%, 23% and 18% respectively.

Our net sales orders increased 57% sequentially on a 3% increase in average active selling communities.

And our pretax operating margin increased 170 basis points to 11.6%.

We are well positioned to improve our profit and return metrics with our broad geographic footprint, diversified product offerings across our three brands, and attractive finished lot position and a solid balance sheet.

We continue to focus on our core D.R. Horton brand as well as striving to become the leading luxury builder with our Emerald brand.

We believe the next leg of this recovery will be driven by the true entry level buyer and we are prepared to capture that demand with our recently introduced Express brand.

We'd like to personally thank all of our D.R. Horton team for another great quarter.

D.R. and I request that you keep up the good work and finish out the spring selling season strong.

This concludes our prepared remarks, we'll now host any questions that you may have.

Thank you, at this time we will conducting a question-and-answer session.

(Operator Instructions)

David Goldberg, UBS.

Good morning, everybody and great quarter, great results.

Good morning.

Thank you.

I wanted to ask, it feels like in addition to the increased absorption pace, the better tone, it feels like you guys are differentiating your performance a little bit from some of your peers.

And I was wondering if you could talk about, do you think that's sales effort, do you think that's product, do you think it's geography?

It is a little bit of both?

Maybe how you rank order what you think is causing some differentiation in terms of performance?

Well, I think it's a combination of all, but I think if you remember, we had and we still have the broadest geographic footprint in the industry.

And during the downturn, we kept our footprint, we consolidated our divisions within our footprint, in anticipation of the housing recovery.

And we're now prepared to continue to expand those markets where we kept our footprint.

So clearly, we're not dependent on any one market, and there are weak markets across the country, but we're able to supplement those weak markets with stronger markets and our footprint.

So clearly I think our geographic footprint is the key to our great performance.

And as you know, David, we're always very focused on our execution and our operation of the business, controlling our costs and we're always focused on sales.

So I think that's been a hallmark, a consistent aspect to our approach to the business.

Definitely.

And then I had a follow-up question on the Express brand and the rollout.

Is that going to be done on a market-by-market basis?

Because it feels like the entry level coming back, I agree that it's the next leg of the recovery but it's been a little bit sporadic in terms of where we've seen it.

Do you see it rolling out nationally or do you see it on a market-by-market basis, a slow rollout?

Well as you know at Horton, we like to dip our toe in the water before we jump completely in.

So clearly we're going to roll out the Express brand on a market-by-market basis focusing perhaps more on the affordable markets than the higher end markets.

And we'll roll it out on a national basis, but we're going to focus first and foremost on where we feel like we have the best chance of affordability.

Thanks so much.

Adam Rudiger, Wells Fargo Securities.

Previously, you talked a bit about having some plans put in place in case the spring didn't materialize the way you wanted it to.

I was wondering if you could talk about the quarter and what parts of those plans you actually implemented, if any, and how the quarter progressed relative to your expectations when you last spoke to us?

Well our sales improved on a month-to-month basis sequentially, each month of the quarter.

And as we mentioned in the last quarter's conference call, we expected to meet a challenge -- if there was challenging demand in any of our markets, we indicated that we were more than well prepared with our low cost basis and our low construction cost to be able to increase incentives as necessary.

We did increase incentives some within the second quarter, primarily toward the end of the quarter, but not significantly.

And we'll continue to do that because one thing that we're focused on is inventory turn and hitting our absorptions in each one of our respective markets.

Okay, thank you.

And then moving to your specs, previously I think there's been discussion about specs getting higher margins than dirt sales, I was wondering if that was still the case?

And if -- how you're, back to David's question, about potential differentiation, how you thought your differentiated spec strategy relative to some peers might have been impacting your quarter?

Yes, our spec strategy is still clearly a very important part of our business.

We're getting closer back to a more normal environment as pricing power is still there in some markets but is not across the board as much as it was.

And so today, our spec margins are more in line with our dirt margins.

And over time, we would expect that our build jobs will have slightly higher margins than our specs.

And really we've managed our specs very, very well over the years, as you know.

We look (inaudible) account for over 60% of our sales.

And they have one thing in common, they like to put a buyer on a home as quickly as possible and also collect a commission as quickly as possible.

So we're well prepared to meet that realtor support and demand that we have across the country.

But typically if you look on our spec percentage, it went down from 55% to 49%.

Our completed specs declined.

And our sales -- our specs greater than six months were pretty much stable.

So we're in a very strong position spec wise.

Okay, thank you for taking my questions.

Mike Roxland, Bank of America.

Thanks for taking my questions and congrats on a very good quarter.

Thank you.

First question I had was on the incentives and Don, I think you mentioned that you increased in incentives and that was more oriented toward I guess the back half of your fiscal second quarter, so wanted to get a sense of how much incentives increased and what your approach is with respect to incentives on a go-forward basis?

Mike, we take a very targeted approach to incentives, it's community by community.

Each community has their sales absorption plans and they make sure that they are meeting the market, meeting the competition to hit those plans so if they need to add some incentives, they do.

In general we saw a very slight increase in our incentives over the quarter, but we really expected to see that.

Some markets increased incentives, some did not.

We're still seeing many markets where we're increasing price and incentives are still very low.

So it really is in line with our overall assessment of the market, is that the market is improving very differently from market to market, and some markets we'll see incentives and some we will not.

So suffice to say it was at the margin in terms of the amount of incentives that you increased in aggregate?

For the quarter, it was a slight increase on the margin.

And now of course, that's coming off of very low incentive levels a year ago, abnormally low incentive levels a year ago.

So really we just view that we're coming back to a more normal level, community-by-community basis.

Some have incentives, some do not.

And take into consideration the increase in ASPs and the pricing power we've got over the last couple of years, I think it's only natural that incentives begin to kick in some.

Got it, appreciate that.

And my last question, can you provide some color around further operating leverage and the additional opportunities you have to drive that lower?

Is that more of a function at this point of the double-digit increase in revenue that you're expecting or are there actually additional cost takeouts that you could pursue that would help drive that -- drive further operating leverage?

So the primary driver would be increased volumes.

As you well know, our long-term target on SG&A is 10%.

We're working our way there, but we're not there yet.

But as volumes increase, we would expect to get there.

There's always places that we can continue to get more efficient throughout our Company and we continue to focus on that.

But we would believe that the larger driver of those efficiencies going forward would be volume increases.

Thanks.

Good luck in the quarter.

Thank you.

Ken Zener, KeyBanc Capital Markets.

As you guys are bringing this new product line on for the first-time buyer, other builders have talked about their new product targeting this the new buyer being a lower margin but higher turning product.

Do you think it's set to come out at the margins, the gross margins that you're now delivering?

We think that obviously on that first-time mover, first-time buyer market, the margins are more challenging.

We're budgeting as close as we can to our current margins but probably slightly lower.

But don't forget we're planning on turning that product line as much as three times per year.

So basically our return on that segment of the business will be just as good if not better than our normal business, in fact it will be better.

Yes, we would expect much higher absorptions in those communities.

And so certainly in a much higher absorption you can take a slightly higher margin and you'll see as good or better returns in an entry level community.

Slightly lower margin.

Yes, slightly lower margins more returns.

Correct.

I got the ratio.

We'd like to have the higher margin and the higher turns and that would be a beautiful thing.

Right.

So for your orders sequentially, you came in a little bit above I think your long-term seasonal rate of just a little above 50%.

Flattens out generally in the third quarter.

Is that what you're seeing now, is one question?

And second, you referred to community count being up 3% sequentially, could you refer to it year over year, please?

Thank you.

Our community count was up about 11% year over year and I think we'd expect to see that community count continue to grow year over year, albeit it at the slower pace than 11%, probably single digits to high-single digits for the balance of the year.

Thank you.

And about the seasonality of orders you're seeing so far?

So in terms of what we're seeing today, we're only three weeks into April, so we really don't have a whole lot to share.

But we would expect our strongest sales quarters to be our fiscal second and third quarters of the year.

So with our positioning, we would expect to have a strong Q3.

Especially after having overcome the tough comp that we had in the second quarter.

Nishu Sood, Deutsche Bank.

First question I wanted to ask about Emerald and Express and how to think about those longer term in the context of your strategy.

This recovery and downturn have been choppy, first it was a first-time buyer and then it's been the entry level, I'm sorry, then it's been the move-up buyer, so should we think about Emerald and Express as medium term plays to -- that you might put more capital into depending where we are in the cycle or is this a longer term shift to a more multi-brand strategy?

It's a longer term shift to a multi-brand strategy.

We believe, from our perspective, that we have underserved that luxury buyer, and that was the reason we started focusing on the Emerald brand.

It also helps us gain entry to some of the master plan communities, where there are no or very few custom builders because of a lack of financing for those.

And so we're able to backfill the space left by them, because banks are still not lending to that small custom builder, and provides us a great entry with a great capital position and a great balance sheet to become a major player in that higher end market, especially a master plan community.

So we're focused on truly becoming the leading luxury builder with that brand over the next three to four years.

The Express side, there's no question that with the price increases that we've experienced in our industry over the last couple three years, with all the pricing power we've had, we've really depleted that pool of affordable buyers.

And so as a result by going down into the price range where we think we'll be in a typical market, somewhere between [$120,000] and [$150,000] on the price point, that that truly is going to create for us a whole new pool of affordable buyers that lets us expand our footprint and our revenues.

Got it.

That makes a lot of sense at the lower end of the market, especially as that comes back.

But in a rising interest rate environment, affordability will be stretched and the amount that a dollar mortgage payment buys will be stretched across all price segments, so will there be, or are you planning to, or are you in the stages of implementing reactions to that across your D.R. Horton brand as well?

Or is that something where you're going to think about, as interest rates rise?

Clearly as interest rates rise, I think that the Express brand is even going to put us in a stronger position, because as buyers have more difficulty qualifying, just as we saw six, nine months ago is the 30-year mortgage moved up than we had a higher cancellation rate during that time period and it was primarily because of a fact that -- lack of affordability.

So key I think to expanding our business on a go-forward basis in a rising interest rate environment is to be able to offer a lower priced but competitive well-built house.

Got it.

Thank you.

Dan Oppenheim, Credit Suisse.

I was wondering if you can talk a little bit about Express in terms of how different it's going to be from what you're doing currently in some markets.

And if we look at Mobile and some other places you're currently building at that price point, is it going to be -- so is some of it based on the success you've had there in terms of selling homes at that price point?

Is it going to be continuing in terms of the -- what -- something along those lines?

How should we think about it overall in terms of doing something different in terms of construction at a lower price point and such?

Certainly on the Express side, we believe we're going to be able to turn that inventory a lot faster because the cycle time on the construction side of the business is going to be significantly less and we're focusing on that, those cycle times on Express, but also across the other price points.

But if you take a look at Express in general, we are going to be offering essentially a product that's not going to require options, not going to require upgrades, it's going to be basically a turnkey operation.

When those people show up, they basically are going to be able to not have to go to the design center and purchase a lot of upgrades and options because they have difficulty qualifying.

So basically it's going to be pretty much a turnkey product.

Great.

Okay, sounds like it will definitely meet a segment in the market that will work well there.

Second question, wondering, you talked about slight increase incentives at the end of the quarter.

And how have you seen that in terms of as it's gone into April, and how are you thinking about the environment here?

We're continuing to do what we would do on a day-to-day basis, which is meet the market on a community-by-community basis and do what we need to do to hit our targeted absorptions.

Now we're in a -- Dan, we're in an extraordinarily strong position because as we've talked about on other conference calls, we've accumulated a very attractive land and lot position over the last couple years.

We're glad we're not in the market having to be aggressive on the land side today because we've got built in gross margin in our existing land supply.

So as a result, we assign a certain absorption level for each community and we're going to move forward with our low cost structure on our land side and our construction side in order to meet our target.

Great.

Thank you.

Michael Rehaut, JPMorgan.

Good morning and nice quarter.

Thank you.

First question was on the Express brands and I think it's a great idea, and I do believe that the first-time buyer, it is definitely -- there are different reasons why I believe that buyer hasn't come back to the market.

Certainly affordability is at the top of the list.

But I also think there is a lack of product out there as well.

So I think it's a great idea.

On that rollout, you said you typically initially dip your toe in the water and go from there.

Is -- how should we think about that in terms of timing?

Would 2014 be more of the initial stages and would we expect to see a more aggressive rollout in 2015, if the expectations are met?

And also from the land side, you mentioned a faster turn business.

Is that going to be all finished lot option take downs, are there going to be any land banking perhaps or would any of this be developed through your own development machine?

Well clearly on the Express side, we have our targets, and 2015, it will be a much greater growth rate than what it is in 2014.

I can tell you that D.R. has given us guidance in terms of where he wants to be with Express in 2015 and our goal is to hit his aggressive targets.

On the land side, we're focusing right now on finished lot deals.

And in terms of having to develop land for Express, we may very well have to do that.

But I want to remind you of our strict underwriting guidelines and we're adhering to those as we move forward even into Express.

And that is our goal is when we buy a piece of land that we get our initial land expense back within 24 months and Express will adhere to those guidelines.

Great.

And on the gross margins, I appreciate the color there, and I believe what was stated earlier in the call is that further improvement will be more difficult and that you'd expect gross margins to be in the range in the last four quarters.

And so that would seem to imply that the number that you did in this most recent quarter, being at the high end of that range, are you saying in a way that there's a little bit of expectations for the back half of the year to be lower than the first half of the year, albeit it modestly?

No, I don't -- Go ahead.

No, we're not really saying that we expect margins to go down.

What we're saying is we expect any further significant increases to be challenging.

We really don't expect significant increases or really any significant decreases in margins, but we feel like they'll operate in a range similar to where we've been the last few quarter, including this quarter.

Obviously, there's a number of -- there are a number of factors that could push margins up or compress margins in an individual quarter.

We expect some fluctuation from quarter to quarter, but in general we expect to stay in the same range we are right now.

Mike, and we've had tremendous, as you know, pricing power over the last couple of years, and that's one of the things I think that's depleting the pool of buyers out there.

So clearly with our Express brand we're going to try to increase that pool, but yet at the same time, we don't see major pricing power opportunities in as many markets as what we've had in the last two years.

We are focused first and foremost on returns.

We've achieved a lot of pricing power, a lot of operating margin improvement over the last couple of years, now we're focusing on maintaining that, improving our volumes to drive stronger returns.

So continuing to increase and strengthen our returns versus where we've been.

All right.

And then one last quick one.

SG&A down 10 bips year over year, I think in the first quarter it was down 30, should we expect a similar type of modest year-over-year improvement?

I know longer term you're still trying to go for the 10%, but in terms of the back half, should we expect a similar type of 10, 20 bip improvement?

Clearly, with most of -- with approximately 60% of our annual closings coming in the second half of the year, we are anticipating stronger SG&A performance in terms of decreasing our SG&A as a percentage of revenues in the second half of the year.

So we would not be happy with a 20 bip decrease.

I'm referring to year over year.

So I certainly would expect it to be materially lower back half versus first half, but as you look at -- on a year-over-year basis.

With our expectation that it would decrease by even more in the second half than you would infer, than for the year, it would also decrease by even more than the 20 basis points we've been showing.

Thank you.

Bob Wetenhall, RBC Capital Markets.

Hey, good morning and great quarter.

I wanted to ask about DT's comments regarding the first-time home buyer potentially returning.

We've heard from a lot of people, Texas is strong and benefiting from sustained investment in oil and gas.

What's your expectation for other geographies that don't have that tailwind?

And what do you think the timing is for something like that, where we see this category open up?

Well clearly, I think as we gain job growth in this country, which I think ultimately we're going to experience and I think clearly that is where a lot of those first-time home buyers are going to come from.

But I also believe strongly that as we move into this recovery, the first time home buyer is not participating at the level that a lot of our political leaders would like for them to be participating.

And I think that we'll see some encouragement from the Government in terms of trying to get more and more people into entry level homes.

So my focus is really the affordable buyer, job creation as well as a little help from the politics.

Got it.

So you need some things to come together for that to work out in the relative near term.

Thank you.

I think that was a take-away close there.

I'm supposed to do the take-away close.

(laughter)

Go ahead, tell me.

I'm supposed do the take-away close.

We wouldn't be getting into the Express brand if we didn't feel like that was the next segment of the business to recover, and clearly I do see more favorable job growth and I think a lot of that job growth is more on entry level jobs and that's going to translate into entry level buyers.

So the improved job growth in the country, as well as I think that as we start looking at the underwriting guidelines and moving forwards and try to get more people qualified, I think that we're going to get some help on the qualification side.

And I think you're seeing that with several lenders today.

Got it, very helpful.

Switching gears a little bit, average order price on new homes in the quarter was up 10% against a very tough comp from last year.

Do you think you can sustain that kind of price appreciation during the balance of the year?

How should we think about that?

Should it tail off in the second half or do you think a mid single-digit full-year price increase is achievable?

Thanks again.

It's hard to make a call quarter to quarter, but in a specific discrete time because of mix changes and things like that.

But we said consistency that we do expect -- we still expect further price increases but we expect it to moderate down into the single digits.

Whether that will occur in Q3 or Q4 or sometime in FY15 we can't tell you.

But we do expect it to moderate back to the single digits.

Got it.

Thanks very much.

Stephen East, ISI Group.

Thank you and congratulations on a nice quarter, guys.

Thank you, Stephen.

I know you haven't talked about Express at all this call, but I will ask you a couple of questions on the first-time buyer.

I mean in our field research, we're definitely seeing a comeback and we're seeing some of that credit availability that you just mentioned.

Are you seeing a meaningful change?

Your sales to first-time buyers were down year over year, but are you -- have you already reached the inflection point?

And is that turning as far as you all are seeing in traffic and demand, et cetera, and are you starting to see that drive to qualify type of activity going on?

I think the biggest thing that we're seeing is the lack of affordable buyers out there.

And as we increased our prices, through pricing power over the last couple of years, as I say, we've depleted that pool of the first-time home buyer.

And our goal is to have a more competitively priced product with Express.

And as I said, we are focusing on, in a typical affordable market somewhere between [$120,000] and [$150,000] as an average sales price.

So we have not had product offerings in that price point.

So I think it's more of us trying to bring those people into the market as opposed to those people being out there and being underserved and driving to qualify.

Just think it's a function of -- there's just not the product out there for those people to qualify.

And if we can get that product price point down, then I believe there are people out there who truly will buy just simply because they have been priced out of the market.

Okay.

And are you having to -- for the Express product, are you able to utilize some of that land that you've already got on your books or is that primarily going to be new purchase type of land base?

It'll be both, Stephen.

There are some properties we have that we can bring out, and it will be a good fit for Express.

But then there's also finished lots out there in areas that have been underserved, that because there hasn't been anybody out there building this kind of product that are available to us as well.

So we'll look at all sources, but yes, it will help us a little bit on our land held piece, too.

Okay.

And quickly one last question, following on what Bob was asking about other regions, this definitely -- your performance this quarter turned from Texas to a lot of other regions, at least from the order perspective, and we haven't necessarily seen that from all of the other builders.

What do you all think is going on in your markets that's allowed you to start to see that meaningful improvement?

Well I think clearly, if you take a look at our west, our west had better sales and better closings.

And that's a function of us over the last year and two years, taking good land positions in California and just now bringing those to fruition with our model grand openings, so I think that clearly helped a lot.

We look at the east, the east performed well for us, and that's because David Auld was the previous Regional President for the east and one of the reasons he's sitting across on this conference call table is because of his performance in the east.

But we entered into a lot of rolling options and a lot of good land deals in the east during his tenure, and they were penetrating those markets deeper and we expect to continue to do that.

The south on the other hand, it's been strong all during the downturn, and it continues to be strong.

But it's being, to our credit, the south is being out paced and we always said by the east and the west and we said that will be a great position for this Company to be in because the south region held us up and supported us during the downturn.

And as Rick Horton said, the best thing that could ever happen to him is for the east and west to take the pressure off of him.

So they're doing that today and we're in a great position.

All right.

Thanks a lot.

Stephen Kim, Barclays.

I just wanted to mention that I totally agree with your strategy to go after the entry level.

As I wrote last month, I think this is really where the pucks going and I really congratulate you guys on really being unique and skating to where the pucks going, so good job with that.

And I'm looking forward to learning a little bit more about the timing of how you roll out Express.

I know there was already a question asked on it.

I wanted to roll something -- run something by you though.

When we look at the job growth figures that have been coming across, generally speaking, the numbers in raw units or raw numbers of jobs have actually been pretty good for a while and yet household formation has been very depressed.

We have our view on why you haven't seen that translate into household formation.

I'm curious as to what you are seeing in your markets.

Are you hearing that your entry, that the entry level buyers who are coming out are saying, gee, it's been really tough to get to this point where we can actually buy a home because we haven't been able to -- it took us a while to get jobs or are you hearing that it's the type of jobs that they have been having that have required them to take longer to accrue the savings to buy the homes?

Well, I think most of the jobs being created in this country, Steve, are entry level jobs.

And as a result, just by definition, I think they're having to save a lot longer.

I think the other thing that I was talking about earlier, getting help from the political side is with the high student loan debt that these people are -- these college kids are graduating, young adults are graduating with.

And there's work on the political side to help relieve them of some of that burden with the college debt.

So as a result, even though they're graduating from college, many of them have had difficulty finding higher paying jobs.

And secondly they're burdened with typically $26,000 worth of student debt.

So by function of getting them in that entry level job, which is pretty much a lot of them having to go into, at perhaps a lower salary than what they expected, and some relief on their student loan debt, I think that pool begins to grow.

We've looked into the students loan issue, and what we've seen mostly has been an initiative in Washington to prevent predatory servicing, I guess you could say, but not necessarily in terms of forbearance or forgiveness so much.

Have you been hearing something more specific to forbearance or forgiveness of current outstanding student loan balances?

As I like to say, I watch too much Fox News, but on Fox Business News yesterday, there was a discussion on that.

And I caught the headline as I was walking by the conference room, so I don't know specifically about that, but there was a discussion yesterday on that in terms of how they could work with the people who have the college debt.

I don't know whether that's forgiveness, forbearance or whatever, but I think you're going to have some relief.

I think the fact that there's recognition that it's an issue and it is holding back economic growth, I think there's a general sentiment that there will be some improvement or help along the way.

We're helping everyone else, we might as well help the college students.

Well that's actually -- that actually would obviously be very encouraging.

So thanks for that.

Your land spend figures that you gave this quarter suggested you spend about 22% of your revs on land spend, it's about the lowest we've seen since the downturn.

I was curious as to whether you anticipate maintaining this very strict control on land spend for the rest of the year?

And in particular, whether it is -- you would expect to spend maybe a little more on land suitable for your Express, or if you think you really got enough there, just like you do in the rest of your business?

I think we made a lot of early investments in the cycle that have allowed us to be very selective at this point and focus as Bill said before on the returns.

So I think we're seeing some -- a lot of replacement of lot costs that is coming through.

Bringing some of our land held back into production, will help support some further growth.

But I don't see a huge expansion, Stephen, in the push on land at this point.

I think we're going to stay pretty focused and disciplined at this point moving forward.

The Express model, we're going to prefer the finished lot deals as DT said.

But where necessary, make disciplined investments on projects that meet our return hurdles.

And at owned and controlled position of 170,000 lots, that will support much higher revenues than what we're generating today.

So we believe that we can increase our revenues on the lot supply we have and then if we need to augment it at some point down the line we will.

But today we feel like we're in good position.

We're clearly focused on one thing on the land side I assure you, and that's how do we get our initial investment on our land back within a 24-month period and that's going to apply to all three brands.

But even just to replenish our lot supply, there's still a significant spend.

There's still on pace of a $2 billion year in terms of land acq and land development just to replenish and keep our lot supply where it is.

So this is not like we're not investing, we're just not necessarily growing our investment from the current level right now.

Yes, well I remember about a year ago, you made this comment, DT that you wanted to limit your land spend to things that you could get your money back in in 24 months and I hand it to you, that was good timing because that was at a time when the market was feeling really (inaudible).

So anyway, good job, guys, and thanks very much.

Jack Micenko, SIG.

Most of my questions have been answered, but I wanted to get your take on Texas specifically.

Obviously your home market, knocking on almost 40 years there.

It seemed like a lot of the competition has been carving out Texas commentary this quarter, job growth, taxation what it may be, reading a lot about population addition numbers pretty encouraging.

Are you seeing more builders come in, is it more competitive than it was a year or two ago?

Are there more builders, is your lot supply adequate there?

Is land pricing disproportionately rising in Texas versus other markets?

Some color you can give on the state overall, thanks.

Obviously D.R. started in Texas in 1978 and I will tell you, you can go to almost any community and turn the corner and there are multiple builder signs on every corner, 20 or 30.

So Texas is one of the most competitive markets but it also has few barriers to entry.

And that's one of the things that makes it so attractive and that is that land prices are still competitively priced, so we can deliver a competitive lot.

And there is ease of entry in terms of not having to go through, as we do in a number of markets, a two or three-year entitlement period.

Most of our land we can get entitled and platted within a period of six months or less.

And there are adequate general contractors to develop lots down there.

So in general we think Texas has been a strong market.

It's a very competitive market.

We continue to lead every market in Texas.

One of the things we're most proud of recently is that we're on our way to being number one in the Houston market.

We've been in the Dallas/Fort Worth market number one.

And we're focusing on San Antonio and Austin and I will tell that you all of those markets are very, very strong for us and we're very competitive in those markets.

So it sounds like it's always sort of a status quo, always been a good housing market and it doesn't -- maybe others are putting success there.

I think it's a good housing market because of the strong economy, and as well as it is a great place to live with people coming in and being able to buy a nice house that is affordable, and land prices are competitive.

So there's no income tax in the state of Texas.

So there are a lot of attractive reasons and the weather is great here.

So I don't know why -- there aren't as many states that are centrally located with as many attributes as the State of Texas has and we've been a leader in Texas and we'll continue to be a leader in Texas as we move forward.

Okay and then how do you think about Emerald, in terms of size and mix?

I know it's a tough answer -- tough thing to answer with numerator, denominator mix and that sort of thing moving around.

But how big can Emerald be, I know you rattled off some numbers early on I missed some of those, I think you said 6% on deliveries.

How do you think that number can play out over time?

Well I think we said it all when we said we are focusing on being the leading luxury builder in the US and we anticipate that that's a good growth segment for us and a very profitable growth segment for us.

But we're expanding it where it makes sense.

And just like we said on the Express side, we started slow, dipping our toe in the water and we found great success in that market, great demand for our product out there.

And the product line that we're offering is extraordinary in terms of finish out and quality of homes.

So we expect Emerald to continue to be a bigger and bigger portion of our business, and as I said, our focus is how do we become the leading luxury builder in the US.

Okay, that's clear.

Thanks.

Jade Rahmani, KBW.

I wanted to ask if you could clarify your comments on backlog conversion and how you'd expect that to trend in the balance of the year?

Do you think 4Q levels could reach what was achieved this quarter?

And longer term do you think normal backlog conversion should be below 70% or something in the 70% to 75% range normal?

Yes, there definitely is seasonality, Jade, to our backlog conversion rate.

As we said earlier, we'd expect it to be around 75% in our third quarter, which really is our historical average at this point, if you look over the last 10 years.

And then traditionally, our fourth quarter would be a higher backlog conversion rate than our third quarter.

With as many homes that we sell and close in the same quarter, it's hard for us to give you guidance much further out than the next quarter.

But yes, I think we'd expect our backlog conversion rate to increase somewhat in the fourth quarter from whatever we end up doing in the third quarter.

Okay.

And as far as the normal conversion rate, you think something in the 70% to 75% range is a normalized level?

I think in the back half of the year, yes.

In the first half of the year, seasonally it's usually a little bit lighter.

We thought it was abnormal that we had an 80% backlog conversion in the second quarter because usually the second quarter is slower, or lower backlog conversion than the first quarter.

So I guess our builders out there just decided to close a lot more homes in the second quarter than we anticipated.

Great, thanks for that.

On financial service, the operating margin increased sequentially, which is counter to some of the mortgage banking trends we have been seeing.

Do you expect the margin to moderate in coming quarters or do you think the current level has absorbed most of the competitive pressures?

We think we've absorbed most of it thus far.

Obviously we don't -- can't tell what the future holds but we certainly are encouraged when our volume is going up.

And typically in the quarters when we have higher volume in our financial services segment, we'll see a better operating margin.

And so Q3 and Q4 typically will show a better margin than we do in Q1 and Q2.

Great.

Thanks so much.

Jay McCanless, Sterne, Agee.

First question on Express.

Is the initial crop of neighborhoods there going to be repurposed D.R. Horton neighborhoods or is that something you might be pulling out of moth ball?

If you could talk about that?

I think it's a combination of both, but a lot of them are new option lot deals that we've entered into.

And typically it's in a market clearly where we've already been building the D.R. Horton brand.

And we're trying to increase our affordable buyer pool in that market because we've seen people coming into our model homes and the D.R. Horton brand who can't qualify because of the pricing power that we had over the last couple of years.

So primarily, it's expanding and supplementing our existing markets.

Okay.

And then I was going to ask you if you can dig into the financing questions, because while I would guess you're waiting on Washington to decide it wants to get back into the entry level housing market, have you been hearing from bankers that they're willing to buy higher FICO paper, excuse me, lower FICO paper, a little bit riskier paper on the average Express buyer even with mortgage rates sitting where they are now?

Actually we've heard the same thing you've heard in the media over the course of the last 60 to 90 days.

We, from our mortgage company perspective, don't see a lot of institutions willing to buy that kind of paper.

So as a result, it's limited from that perspective.

Okay.

And then if I can sneak one more in, where you were talking about the luxury builders, private luxury builders not getting a lot of financing from the banks, could you -- what are you seeing on the land development side?

Are the banks willing to do development lending now or is that still a very small closed business?

Very, very limited.

And thank goodness for our strong balance sheet because frankly, as we have worked through that supply of finished lots that were generated in 2007, 2008 and 2009, we've had to begin developing obviously and it takes a strong balance sheet to be able to do that.

Clearly, that small builder, small developer, not back in the business because of lack of capital.

Okay.

Thank you.

Jim Krapfel, Morningstar.

To what extent did weather push out closings negatively, impact orders or lead to incremental costs in the quarter?

It appears that there wasn't much effect on the closing side.

Well, we have a policy at D.R. Horton, and it's a sincere policy and that is we don't want our division Presidents to give us a weather report and so we're not really -- we work with our broad geographic footprint to the extent that we did have weather related issues, it was really a non event at D.R. Horton.

Okay.

And what were the costs and ASPs per square foot in your closings this quarter?

On a year-over-year basis, our revenues per square foot were up 9%.

We usually talk about our vertical costs.

Our verticals stick and brick costs during the quarter on a per square foot basis were up 10%.

So essentially our costs and our revenues increased at about the same rate on a per square foot basis.

Now in aggregate per unit, revenues still exceeded our cost increases.

Okay.

And then on the cost side, where do you see that trending going forward?

Do you expect to see some moderation in that inflation?

I think costs are going to continue to increase.

We are fortunate in that we have a lot of volume in most of our markets so that we can be more competitive with our subcontractors on the cost side.

But clearly, labor is one of the cost components that's going up.

And lumber, I don't think is going to come down nearly as much as what it did last year.

It seems like it's going to hang high from where it is currently right now.

But it's a day to day process for our purchasing managers to work with our vendors, and our suppliers, and our trades out there to get the benefit of the volume that we can offer our vendors and our trades.

All right.

Thanks for taking the questions.

Alex Barron, Housing Research Center.

Good morning, guys, and great job and --

Thanks.

D.R. was asking where you were.

I also wanted to congratulate you on this move towards the three brands.

I wanted to ask on the Express homes, are you guys going about your marketing strategy in a different way, meaning are you trying to target those entry level, those renters more directly?

Or are you going the traditional way of waiting for them to show up at the communities?

Well, I think it's a different type of marketing.

I know that as you clearly are trying to attract the entry level buyer, a lot of them living in apartments.

And so we try to do special marketing with the apartment complexes are near us.

And another potential pool are of the people living with their -- the college graduates and others who are living with their parents, and I think we do that primarily through realtors.

I also believe with our Express brand, that it's going to be easier for perhaps parents to help their children get into homes because they could help them a lot easier with a lower price point as we have with the Express brand than we can with the standard price that's with D.R. Horton.

So I look at both those avenues as trying to get with the realtors to make sure that the parents where the kids are living at home, we can attract them with a lower price point as well as focusing on those apartments.

And also wondering if you guys have considered doing a stock buyback given how cheap your stock is here?

Well we don't -- I don't really want to comment on the stock buyback.

I do know one thing in our business, that's pretty general, and that is that our focus is how do we get to a free cash flow position.

And I think Alex, if we adhere to our business plan that David's helping us implement, I think that we'll clearly get to a free cash flow position.

And when we get to a free cash flow position, we're going to be in a position to do a lot of things.

And one of them will be perhaps buying back our stock.

But the key is how do we get to that free cash flow.

Okay, thanks, Don.

Thank you.

We've reached the end of our question-and-answer session.

I'd like to turn the floor back over to Management at this time.

Thank you and thank you for joining this call.

D.R. and I and David want to thank everybody in the field because we had one heck of a quarter, as you know.

And you turned in a sterling performance in the month of March and we appreciate that.

The key is how do we go forward, execute the business plan in Q3 and Q4 and deliver a very, very outstanding year for us in 2014.

We're welcome to have David on board, he's a great addition to the 38th floor up here and we've got a great team of people here as well as in the field.

So thank you very much, and as I say, execute the competition and don't take any prisoners.

Thank you.

That 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.