D.R. Horton, Inc.

Greetings and welcome to the first quarter 2019 earnings conference call for D.R. Horton, America's builder, the largest builder in the United States. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jessica Hansen, Vice President of Investor for D.R. Horton. Jessica, please go ahead.

Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the first quarter of fiscal 2019. Before we get started, today's call may include comments that constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K, which is filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at .dhrorton.com, and we plan to file our 10-Q early next week. After this call, we will post an investor presentation and supplementary data to our investor relations site on the presentation section under News and Events for your reference. The supplementary data relates to our home building return on inventory, home sales gross margin, changes in active selling communities, product mix, and our mortgage operations. Now I will turn the call over to David Auld, our President and CEO.

Thank you, Jessica, and good morning. In addition to Jessica, I'm pleased to be joined by Mike Murray, our Executive Vice President and Chief Operating Officer, and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D.R. Horton team delivered a solid first quarter of 2019. Our consolidated revenues increased 6% to $3.5 billion. Free tax income was $376 million, and our pre-tax profit margin was 10.7%. For the trailing 12 months, our home building return on inventory improved 230 basis points from a year ago to 19.3%. These results reflect the strength of our operational teams, our ability to leverage deal and scale across our broad geographic footprint, and our product positioning to offer affordable homes across multiple brands. As we discussed on our call in early November, sales prices for both new and existing homes have increased across most of our markets over the past several years, which coupled with rising interest rates has impacted affordability and resulted in some moderation of demand for homes over the last few months, particularly at higher price points. However, we continue to see good demand and as limited supply of homes at affordable prices across all of our markets, and economic fundamentals and financing availability remain solid. Our net sales orders during the first quarter increased 3% versus last year. As we indicated on our last call, our sales in October were down from the prior year. However, our sales comparisons improved in November and December was a good sales month. We are pleased with our positioning of affordable product offerings for the upcoming spring selling season, and we will adjust to future changes and market conditions as necessary. Our strategic focus is to continue consolidating market share while growing our revenues and profits, generating strong cash flows and returns, and maintaining a flexible financial position. With a conservative balance sheet that includes an ample supply of homes, lots, and land to support growth, we are well positioned for the remainder of 2019 and future years. Mike?

Net income attributable to D.R. Horton's for the first quarter increased 52% to $287 million or 76 cents per diluted share compared to $189 million or 49 cents per diluted share in the prior year quarter. Our prior year quarter includes the impact of a higher effective tax rate primarily due to the remeasurement of the company's deferred tax assets and liabilities as a result of the Tax Cuts and Jobs Act. Our consolidated pre-tax income for the quarter was $376 million versus $391 million a year ago, and home building pre-tax income was $354 million compared to $374 million. Our first quarter home sales revenues increased 7% to $3.4 billion on 11,500 homes closed, up from $3.2 billion on 10,788 homes closed in the prior year quarter. Our average closing price for the quarter was $296,600, essentially flat with the year ago quarter, while the average size of our homes closed was down 3%, reflecting our ongoing efforts to keep our homes affordable. Bill?

Net sales orders in the first quarter increased 3% to 11,042 homes, and the value of those orders was $3.2 billion, flat with the prior year quarter. Our average number of active selling communities increased 3% from both the prior year quarter and sequentially. Excluding the builders we acquired during the first quarter, our net sales orders increased 2%, and our average number of active selling communities was flat, both sequentially and year over year. Our average sales price on net sales orders in the first quarter was $292,100, down 3% from the prior year quarter. The cancellation rate for the first quarter was 24%, compared to 22% in the year ago quarter. Jessica?

Our gross profit margin on home sales revenue in the first quarter was 20%, down 80 basis points from the first quarter last year, and down 160 basis points sequentially from the September quarter. The majority of the sequential decrease in gross margin was due to cost increases, less pricing power, higher incentives, and to a lesser extent, purchase accounting from our recent acquisitions. We continue to focus on achieving our targeted absorptions to maximize returns in each of our communities, because we believe a consistent pace of starts, sales, and closings with the right product positioning drives both the highest returns and pre-tax profit margins. Our home sales gross margin for the full year of fiscal 2019 will be determined primarily by the strength of the spring selling season. Based on today's market conditions, we currently expect our gross margin in the second quarter to be in the range of 19 to .5% due primarily to less pricing power and higher incentives on our first quarter sales activity, as well as the impact of purchase accounting. Bill?

In the first quarter, home building SG&A expense as a percentage of our revenues was 9.5%, flat with the prior year quarter. We remain focused on managing our SG&A efficiently while ensuring that our infrastructure adequately supports our opportunities to consolidate market share and grow over the long term. Jessica?

Financial services pre-tax income in the first quarter increased 6% to $23.6 million from $22.2 million in the prior year quarter. Financial services pre-tax profit margin for the quarter was 27.7%, up slightly from .4% in the prior year. 98% of our mortgage company's loan originations during the quarter related to homes closed by our home building operations, and our mortgage company handled the financing for 54% of dear Horton home buyers. FHA and VA loans accounted for 44% of the mortgage company's volume. Borrowers' originating loans with DHI Mortgage this quarter had an average FICO score of 721 and an average loan to value ratio of 87%. First time home buyers represented 50% of the closings handled by our mortgage company, up from 43% in the prior year quarter, reflecting our continued focus on offering affordable homes for entry level buyers. Mike?

We ended the first quarter with 33,700 homes in inventory. 20,100 of our total homes were unsold, with 15,200 in various stages of construction and 4,900 completed. Our increased inventory of homes puts us in a great position for the spring selling season in fiscal 2019. We manage our home starts at a community level each week, and we will make adjustments to our starts as necessary throughout the spring to align our inventory levels with our sales pace in each community. Our home building investments in lots, land, and development during the first quarter totaled $1.1 billion, of which $440 million was for finished lots, $200 million was for land, and $450 million was for land development. Our underwriting criteria and operational expectations for new communities remain consistent at a minimum 20% annual pre-tax return on inventory and a return of our initial cash investment within 24 months. David?

We increased the option portion of our land and lot pipeline again this quarter. At December 31st, our home building lot position consisted of 309,400 lots, of which 128,500 or 42% were owned and 180,900 or 58% were controlled through option contracts. 37,000 of our total home lots are finished, and 89,000 of our option lots are or will be finished when we purchase them. We have increased our option lot position by 47,000 lots from a year ago, and we plan to increase our option lots further by expanding our relationship with lot developers across the country and continuing to support the expansion of 4 Star's national lot manufacturing platform. Our balanced and well-positioned lot portfolio is a strong competitive advantage. Mike?

4 Star, our majority-owned subsidiary, is a publicly traded residential lot development company now operating in 35 markets across 16 states. At December 31st, 4 Star owned and controlled approximately 25,600 lots, of which 2,400 are finished. 18,800 of 4 Star's lots are under contract with D.R. Horton or subject to a right of first offer under the master supply agreement between our two companies. 4 Star's revenues in the first quarter increased 25% to $38.5 million compared to the prior year quarter, and pre-tax income increased 23% to $4.9 million. During the first quarter, 4 Star delivered 518 lots and is on track to grow its annual deliveries to 4,000 lots, generating $300 to $350 million of revenue in fiscal 2019 and to approximately 10,000 lots, generating $700 to $800 million of revenue in fiscal 2020. We expect 4 Star to be consistently profitable with pre-tax profit margins of approximately 10% by fiscal 2020. These expectations are for 4 Star's standalone results. 4 Star is also making steady progress in building its operational platform and capital structure to support its significant growth plans. 4 Star's current liquidity, capital base, and lot position are sufficient to support its fiscal 2019 and 2020 planned growth in lot deliveries and revenues. 4 Star has current liquidity of $531 million and a debt to capital ratio of only 14%, subject to market conditions, 4 Star plans to access the capital markets in fiscal 2019 to provide additional capital for long-term growth. 4 Star will post an updated presentation to the events and presentation section of their investor website at .4star.com at the conclusion of this call. This presentation described 4 Star's unique business model and its significant growth and value creation opportunity. We encourage investors to review it. Bill? At

December 31st, our home building liquidity included $538 million of unrestricted home building cash and $901 million of available capacity on our revolving credit facility. Our home building leverage ratio improved 270 basis points from a year ago to 23.2%. The balance of our home building public notes outstanding at the end of the quarter was $2.4 billion and we have $500 million of senior notes maturing in March, which we plan to repay at maturity from liquidity and cash flow. During the quarter, we paid cash dividends of $56 million and we repurchased 4.1 million shares of our common stock for $140.6 million. Our remaining stock repurchase authorization at quarter end was $234.9 million. At December 31st, our stockholders' equity was $9.1 billion and book value per share was $24.45, up 17% from a year ago. David?

Our balanced capital approach focuses on being flexible, opportunistic, and disciplined. Our balance sheet strength, liquidity, earnings, and cash flow generation are increasing our flexibility and we plan to utilize our strong position to enhance the long-term value of the company. Our continued top cash flow priorities are to consolidate market share by investing in our home building business and strategic acquisitions, reduce home building leverage, and return capital to our shareholders through dividends and share repurchases. We have been actively pursuing select acquisitions across the country to expand and enhance our operational platform. During the first quarter, we purchased the home building operations of three private builders for approximately $321 million. In November, we acquired Westport Homes, a top five builder by volume in Indianapolis and Columbus, which are both top 50 U.S. housing markets. And in December, we entered Iowa by acquiring Classic Builders, the largest builder in Des Moines, and we enhanced our market position in Raleigh, North Carolina by acquiring Terra More Homes. We welcome the Westport Classic and Terra More teams to the D.R. Horton family. Jessica? Looking

forward, based on current market conditions, we expect our number of homes closed in the second quarter will be in the range of 12,800 to 13,300 homes. We expect our second quarter consolidated revenues to be in a range of $3.9 to $4.1 billion. And as we stated earlier, we expect our home sales gross margin in the second quarter to be in the range of 19 to 19.5%, resulting in a lower consolidated pre-tax profit margin in the second quarter compared to the first quarter. Our revenues and profit margins for the full year of fiscal 2019 will be determined primarily by the strength of the upcoming spring season, so we are not providing full year revenue or margin guidance at this time. We expect our quarterly income tax rate to be approximately 25% for the remainder of this year. We also continue to expect our home building segment to generate cash flows from operations of at least $1 billion in fiscal 2019. And we expect our outstanding share count to remain relatively flat with the current level for the remainder of the year. David?

In closing, our results reflect the strength of our long-tenured and well-established operating platforms across the country. We are striving to be the leading builder in America in each of our markets and to expand our industry-leading market share. We are focused on consolidating market share while growing our revenues and profits, generating strong cash flows and returns, and maintaining a flexible financial position. We are well positioned to do so with our conservative balance sheet, broad geographic footprint, affordable product offering across multiple brands, attractive finish lot and land position, and most importantly, our outstanding experienced team across the country. We thank the entire D.R. Horton team for their continued focus and hard work. We look forward to working together to continue growing and improving our operations throughout 2019. This concludes our prepared remarks. We will now host questions.

Thank you. We'll now be conducting a question and answer session. If you'd like to be placed in the question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that is star 1 to be placed into question queue. One moment please while we poll for questions. Our first question today is coming from John Lovallo from Bank of America Merrill Interline is now live.

Hey guys, thank you for taking my question. First question, David, your comments on the November sales pace improving in December being a pretty solid environment, clearly encouraging. Have you seen improving traffic and overall business trends continue into January, particularly given the rate pullback?

John, we have. We're feeling better and better as we progress into the spring selling season. Week to week we're seeing a little better sales, a little better traffic, and the last couple of weeks we've been happy.

Okay, that's exactly what I wanted to hear. It looks like you bought back more stock in the first quarter than you guys did in all of 2018. It seems like the blended price was around 34 change, which is obviously very well timed. Should we read this as expressing confidence not only in your business and in strategy but perhaps in the fact that the first quarter was kind of the market bottom here and things are looking potentially to improve?

Yeah, John, this is Bill. I think it's just a continuation of our strategy. We're remaining flexible, staying in a flexible position, and repurchases is part of our capital allocation strategy. I expect we want to be consistent over the long term in our program, but when opportunities exist, when our valuation is down in the stock, we're going to maintain flexibility to be opportunistic, and I would view the level this quarter as clearly an opportunistic buy, but we do expect to be a consistent buyer going forward, but the levels will fluctuate from quarter to quarter depending on what the valuation of the stock is.

John, just to build on that a little bit. We are very confident. The job growth numbers, the overall economy, it comes down to positioning and having the right house in front of the people that are out there trying to buy. So we're working very hard on that, and we do not believe that this is a great demise of housing, that we believe that it's going to be a good year.

Good stuff, guys. Thank you.

Thank you. Our next question today is coming from Stephen East from Wells Fargo. Your line is now live.

Thank you. Good morning, everybody. Maybe just following on that first question a little bit, David, as you look at what's happening, what's going on, getting a little bit better, a little bit better, how much of that is in your mind incremental incentives and you all or your peers meeting the market more versus the buyer behavior really stepping in and you all not needing to ramp incentives, say, in January or even December in January?

Steve, I feel like there was more pressure on the incentive side, trying to get the pace reestablished in November than there was in December and even less so in January. It really, to me, it comes down to taking advantage of the traffic that's coming in the door. And as more traffic comes in, you've got to be a little less aggressive to hit the targets because we've been playing it a long time, but we really do look at it subdivision by subdivision, market by market against a plan that incorporates sell starts and closings to maximize some kind of return.

We did guide to the lower gross margin, though, particularly related to the choppiness in Q1. So the 19 to 19.5 for Q2 is because of what we saw in the market in Q1, but we are optimistic that we'll find a good pace in the spring and begin to see some level of margin stability as we move forward throughout the year. I

can tell you, we haven't seen, I don't know if we've seen a month over month, a month year over year down number in a long time.

Ok, alright, gotcha.

October was a tough time.

And yeah, that was the only one.

Ok.

We've been hearing of layoffs at several of your public competitors. One, I guess, are you all seeing that out in the market and are you seeing them take a different stance on going to market than say you all are doing, you know, being aggressive with incentives and moving on pace? Are you seeing them, you know, try to go to market differently and are you seeing them back off land deals at all?

I would say that we've heard of the same, some of the same layoffs and we're looking to meet the market and the market's defined by our behavior and defined by their competitor behaviors as well. I don't think anybody is as well positioned as our teams have got us into, both in terms of product affordability, the communities we have that are now open and the inventory position we have coming in right now. So hard to generalize where we see it, but we empower our local teams to make market decisions every day and to drive their neighborhoods to the right pace to improve the returns on them. And the last part of your question I think was dealing with the land deals. You know, we probably have seen a couple, anecdotally you hear of a couple of land deals coming back around. Maybe it's a little more than normal. It's hard to exactly gauge that. It's not something that's measured very rigorously, but we do see some opportunities that come back around a bit.

Okay. Thank you.

Thank you. Our next question is coming from Stephen Kim from Evercore ISI. Your line is now live.

Yeah, thanks very much, guys. Appreciate it. Again, because I know this is what everybody is really focused on, I wanted to delve a little bit, if I could, into the tone of the market and your stance towards that strategically and also the impact on margins. So to frame it a little bit, David, when we met up a month or so ago, I think maybe a little over a month ago, you had indicated that you weren't as a firm looking to get particularly aggressive on incentives until you had had January sort of under your belt. January is not quite under your belt, but your commentary suggests that things have improved to the point where perhaps the level of incentives that you had contemplated you might need to do in the fourth quarter or, sorry, your first quarter, the fourth calendar quarter, is not what you're expecting you're going to need to be able to do. So I just want to make sure, first of all, that you have sort of held back in terms of some of the incentives that you were thinking you might have had to do relative to what you had previously thought. And then also if you could remind us where various incentives show up on the income statement, so like some of the actions you do, like whether it be rate buy-downs or whether it be closing costs or things like that, landscaping, you know, just which ones show up in the gross margin and which ones may show up elsewhere?

To start with the latter, and then I'm sure David will chime in on incentives and margins and his commentary on that, Steve, but any incentive we offer essentially shows up in our home sales gross margin. So whether it be a price reduction which would impact revenue or any of the myriad of things you just listed, those would all flow through cost of sales. Excellent. Okay.

Thank you,

Todd. And I can tell you, Steve, the market is performing, I would say pretty much as we expected, maybe a little better given the first quarter. So it is, you know, you've got to get on budget, you've got to keep the community on plan. When you get on budget, you have it, it's easier to maintain it than it is to create it. It's always more difficult than maintaining it. So it's my expectation that it's going to be a little easier to get people on contract through the spring if it continues. Now, that's, you know, that's the big debate is, you know, a lot of things happened in the market as far as politically, as far as internationally. You know, it's, we think the rates rising in conjunction with the cost rising, you know, created affordability issues and coming out of higher fiscal 2018 and, you know, there's kind of the combination of two people paused or became choppy or whatever term you want to call it. They weren't buying houses. So we've seen, you know, the market come back. Really, you know, you can, if you talk to Don Horton, he'd tell you it's better than he thought it was going to be. I can tell you, I think it's pretty much what I expected. So, but I've always been more optimistic than Don Horton. I don't know if that helps or

not. So the very short answer, the very early signs, because it is still early, the very early signs for spring are good.

Sounds great. Thank you. And then the second question I had relates to the political environment to some degree. The shutdown, obviously, has been lingering on for a while now. There's been some thought that some delayed paychecks might have caused some folks who, on the margin, would have been looking to get into their first home, might make it difficult for them to do that and that maybe once this thing is resolved and you get some back pay hitting and maybe also with some tax refunds hitting as well, that, you know, a little bit later in the spring where spring starts to take shape, you might actually have a little bit of boost. I was wondering if you could comment a little bit on what you see is from a cash flow perspective, you know, hitting some of these affected people as well as the tax refunds, whether or not you think it's reasonable to think that it might be a little bit of a boost a little later on in the year.

I think that might be a reasonable take, but it's not something we're counting on or really have expectations for as it relates to the current government shutdown. Fortunately, that's been relatively minimal on our business and we're keeping a close eye on the guidelines day to day, but really it's impacted USDA, which for us is a very low single digit percentage of our business. It's less than 2% generally of what we've been running, including this quarter. So our mortgage company is doing a great job of managing our backlog accordingly, but other than USDA and as you mentioned, government employees who aren't getting a paycheck today, there's still ways to work around that from an income verification and the different types of things you have to do. Could it be, you know, a modest help down the road? Maybe, but not something we're real worried about right now or relying on being a big uptick.

I will say, Stephen, government is a huge part of the economy now and the shutdown is going to have ripple effects throughout all the industries. And, you know, you just look at consumer confidence and when you have the lack of ability to work together at that level, you see confidence coming down, which is a big part of our, you know, that's a big part of our business. People got to be confident by all. So, again, it just adds to the kind of the uncertainty about, you know, putting a committing to a number out there in the future today. But if it gets out, you know, I think it will be a very positive impact or when it gets out.

All right, great. Thanks very much,

guys. Thank you. Our next question is coming from Carl Reichart from BTIG. Your line is now live.

Good morning, guys. I wonder, David, if you guys are in 80 plus markets now, I think. Could you talk a little bit maybe about the two or three markets that produce the most positive surprise or strength this last quarter from an orders perspective and maybe two or three that were softer than what you thought? And then I'd also just be curious as to whether or not you feel like across your product mix the trends are effectively the same through the quarter in terms of the improvement?

You know, Carl, as far as markets go, we're still very, very happy we have the concentration assets in Texas, Florida, and the Carolinas. Those have been solid markets. They continue to be solid markets and don't see any change in the future, really. Upside, surprise markets that seem to be, you know, performing better from our standpoint. I think the Utah market has been somewhat of a pleasant surprise. We've spent a lot of time positioning there. We've got a long-term, with the company, very focused operator running that market. He has positioned us incredibly well, so very happy with that. Probably going to be record years for us in Utah this year. And what was the?

Soft markets.

Soft market. California continues to be soft. Chicago continues to be soft. I do think we are very well positioned in both California and in Chicago for the markets we got. And our operators there, I think, are doing a better job than at any time I've ever seen in this company. So, you know, again, it's people, product, and price, and you get them aligned. You can have good markets, you can have bad markets. You know, our goal is to outperform any market. So that's what we focus on. That's what we get up every day trying to do.

Okay, thanks, David. And then since I asked two and one, I'll just repeat the second one, which is I'm just curious when you're looking across your mix set and you have Express, you've got the other brands, the traditional Horton, and then maybe especially Emerald brand. Is the traffic performance in orders as you work through the quarter, you call that weakness at the higher end? And I'd just be curious if you could expand on that, if the strength that you've seen is really coming out of the most affordable stuff, which is certainly what we'd expect.

We did see, you know, good traffic. I think some of the rate spike that we saw in our first quarter did affect some of the entry-level buyers. Still have 50% of our deliveries were to entry-level buyers, but I think there was a bit of an adjustment period for those buyers with that rate change, and then certainly the moderation was helpful there. I think a lot of our, over the past few years, we've been focused on even our Horton brand positioning that product to make it very affordable relative to the alternatives in the marketplace and provide efficiencies to the buyer with that. And so we saw probably a good performance in the Horton brand relative to Express. Great. Thanks a lot, guys. Thank you, Carl.

Thank you. Our next question is coming from Alan Ratner from Zellman & Associates. Your line is now live.

Hey, guys. Good morning. Nice job taking share in the choppy demand environment. I guess a question on the margin. I think last quarter, Jessica, you kind of implied that for margins to get down to this 20% level would be a pretty dramatic move, I think is the word you used, based on where you were running previously. And you got there, and now it sounds like the next quarter might be a bit below that. So I guess, you know, you sound very positive on January, which I think is encouraging. But if you wanted to take the flip side to that way, or maybe this is a bit of a temporary bump from the rate pullback, as you think about that price versus pace dynamic, how low are you willing to take that margin in order to hit the desired absorption pace that you target in your communities?

Well, we continue to focus first on returns. So we're going to continue to make adjustments community by community to drive the best possible return. And the margin really is just what that drives based on hitting the best return on a community by community level. So we do still think that maintaining our consistent production and sales base is going to drive not only the best return, but the best margins and particularly pre-tax margins.

So

we did end up at the low end of our range. I would tell you that October, November, and December, even though November and December got better, still were weaker than we expected. And so we did give up some margin to find that sales pace again, as David indicated. But typically, once you can get back to a consistent sales pace, that's the best way to find stability in your gross margin.

And I'd also like to point out that, you know, typically, roughly a third to better of our closings in any one quarter were sales in that quarter. So we're very quickly reacting with pricing to the marketplace to maintain our pace and our returns focus at every community level. In our first calendar quarter, we probably had a large percentage of the homes closed were started late spring, early summer when lumber was at some of the highest prices we've ever seen. So those costs, pressures were cycling through against a time when we were kind of, you know, marking our homes to real time market to maintain a pace. And, you know, those two things were a fair bit of headwind to margins. And so we did see a rather dramatic move. But because so much of our deliveries in any one quarter are reflective of market conditions in that quarter, sales market conditions, we will see, as we talked about in the past, volatility and margins that can

move

rather quickly. So, you know, we expect, you know, going forward, we're going to see some of that cost headwind fall away. We'll have more of our closings being delivered from starts at a time when lumber was less expensive. So that coupled with the sales trends and the pacing that we're looking at in every community now week to week, you know, we're cautiously optimistic we should see some stabilization in the margins.

Understood. I appreciate that. I think it definitely is the benefit of the sales strategy and the model. Second question, you know, when I look at your land portfolio and obviously the mix shift towards more options has benefits on the balance sheet, but also, you know, in a softer demand environment, I guess at some point, it does give you the ability to go back to the landowners and attempt to renegotiate some of those contracts. So are you at that level in any markets or any communities at this point? And if so, how have those conversations been going?

I would say, you know, we are at that level every quarter of every year, irrespective of whatever the market is. Our goal is to enhance the value of our shares for our shareholders. And we do that by making money and being very conscious of the fact that capital is a precious commodity.

So from that standpoint, then, David, I guess the question is, are you seeing land sellers, I don't know if capitulate is the right word, but are you seeing them a bit more receptive given the, you know, it seemed like a softer fourth quarter for sure or calendar fourth quarter to renegotiate or are you seeing that? Or are they still pretty, pretty set in their pricing?

You know, the guys that probably are most vulnerable to that are the people that put contract or contracted land to our competitors and our competitors are not in a position to take advantage to close it. You know, we are, you know, I'm not going to say we're punitive to somebody coming back with a deal they didn't sell us the first time, but we are punitive to sellers coming back with a deal they didn't sell us first time. Got it. I can tell you, it's a choppy, you know, this is not a market where you're going to see huge revaluations. It's choppy. You know, I think the way we positioned our focus on operations over the last, well, since the downturn, starting coming out of the downturn, has put us in a position to, you know, operate pretty well, outperform the industry in pretty much any market. And, you know, I'm not going to tell you we're excited about a market that could be correcting, but we're certainly not scared of it. So we're going to continue to build, sell, close houses and drive returns across the country.

All right. Good luck, guys. Thank

you. Thank you. Our next question today is coming from Eric Boshard from Cleveland Research Company. Your line is now live.

Thank you. We'd

love

to hear you expand a little bit more on the moving parts and gross margin, specifically the optimism about what you've seen recently and the 2Q gross margin, your rear contraction, I think, is worse than in this current quarter. I know there's obviously some timing of what's going on in the business, but could you just expand within the moving parts in gross margin and how we should think about that in the 2Q and then in the second half of the year?

Sure, Eric. And some of this information will be in our supplementary data that we'll post as well. But if you look at the first line of that margin analysis that you see there that is kind of what we would call our core gross margin, sequentially from the September quarter to the December quarter, that was down 140 basis points, so that was the lion's share of the change in the quarter. On a -over-year basis, that was down 90 basis points. And then as you kind of move through the pieces, your interest in property taxes sequentially was actually improvement of 10 basis points. -over-year was 20. Warranty and litigation sequentially was flat. -over-year was an improvement of 10 basis points. And then purchase accounting is the final piece of that. And then the acquisition was a 30 basis point negative impact on our margin with the acquisitions we did during the quarter. -over-year, that was a 20 basis point negative impact. So it's still mainly in the core business related to the sales activity in Q1 as we work to meet the market and get our sales pace back on track. And then that's really what's the Q1 sales activity and our current backlog that's a result of that is really what's driving our guide for Q2 to be down a bit further from Q1. But then our recent sales activity, I'd say in December and then what we've seen thus far in January would indicate that we're much better back on track. And if we can continue that momentum, we do see signs that we should be able to see some stabilization in our margins. And then we potentially have certainly have some cost tailwinds that will start to kick in as well late in our fiscal Q2 and into Q3 that gives us some cautious optimism that we'll see stability and hopefully some opportunity to start regaining some of the margin that we've given away here in the last quarter or two.

And then secondly, I know that you're continuing to defer a bit on full year guidance, but is it up 10 year of delivery still in the making here?

We wouldn't rule it out. You know, we're not providing guidance yet because it's too early until we get into the spring. Sales in February, March, April will be a big driver of it. But we're guiding to, you know, 4 to 8 percent, you know, closing growth in Q2. And so if we can if we see good momentum in sales and and we certainly have the inventory to go deliver as well, we wouldn't rule that out.

Eric, we're positioned to accomplish that.

Correct. Thank you.

Thank you. Our next question today is coming from Nishu Sit from Deutsche Bank. Your line is now live.

Thank you. I wanted to come back to the share buybacks. Obviously, there was a nice pickup, you know, an opportunistic pickup in your, you know, your December quarter. But, you know, thinking back on how you'd been framing your share buyback strategy, you'd said earlier that, you know, your plan is to just offset dilution. And, you know, if I look at the activity in the fourth quarter, I could look at it as just offsetting dilution, even though it was a pickup. But from your comments earlier, it sounds like you're willing to go beyond just offsetting dilution. So I just wanted to, you know, to kind of come back to that. Are you are you now saying that you will be willing to, you know, on a continual basis here go past just offsetting dilution or is that still your kind of main main way you're going to approach it?

Well, this year, I would say our base plan for the longer term is to continue to offset dilution. However, we are keeping the flexibility to remain opportunistic. And so with the buy in the first quarter, that certainly brought our share count down slightly as we will see further dilution in future quarters. And we want to continue to be consistent in our repurchases to offset that. But, you know, Tommy, we made around remaining flat with the with the December share count level would keep us flat from this point going forward.

Gotcha, gotcha. Okay. And on on four star, obviously, you know, continued nice pickup in the, you know, the spread of operations out of out of four star number of, you know, states and markets that you're you're operating in there. How does this choppiness in demand affect your approach there? Does it give you the opportunity to, you know, since you still feel good about the market for 19 to maybe be a little bit more aggressive, there are probably more opportunities out there? Or does it give you some pause in what kind of portfolio build out of there? And also on the capital raising side, how does it affect your plans there?

I think from the market perspective, we're not seeing any any of the sales choppiness we experienced earlier in our fourth quarter and our first quarter, the calendar fourth quarter impacting any of the sort of the operating decisions that at four star. I mean, our underwriting guidelines for each of our communities and each of our investments, whether it's on the four star side or the Horton side, are reflective of current market conditions. And so to the extent that that's impacting valuation or terms discussions, that's just going to be incorporated in as normal force of business. So but it's but it, you know, if there is extended choppiness and it creates other folks pulling back in their opportunities, then then it may create some ability for four star to participate more broadly in more deals. But we're not we're not seeing that broadly yet. Nor are we counting on that in the growth. We still feel really good about four stars ability to create its its growth, obtain its growth objectives in the current market conditions. What we're seeing out there every day with regard to the capital raise at somewhat market condition dependent. You know, we feel good about the capital position four stars in today. It has adequate capital to support its its growth plans for 19 and 20. And the market conditions will dictate largely when we when we access the markets for longer term growth capital.

OK, great. Thank you.

Thank you. Next question is coming from Ken Zinner from KeyBank Capital Markets. Your line is now live.

Good morning, everybody.

Well, good morning, Ken.

So I get why you're trying to build steadily. It helps for a variety of reasons. Your total units in inventory, which I'm really glad you're highlighting that, is up about 19 percent year over year, obviously above order. So that's what I want to focus on. Now, you guys do a lot of spec. If you look at your two queue closing range, it does imply a lower percentage of your unit center construction closing. And related to that, I want to ask you some of that's obviously coming out of backlog. Some of that is obviously spec, which I think you're being judicious around. So what is the margin differential? So I think last year, historically, in the two queue, you have about 40 plus percent orders are actually closing. So what are we seeing right now in terms of the margin spread from backlog and spec?

From backlog and spec. So from a build job preorder versus the spec.

Right. So the homes a year, for instance, usually close about 40 percent plus in two queue from spec. What is, you know, that's not a backlog by definition. So what is that kind of spread that you're seeing right now? Because I think it sounds like, you know, when you say meet the market, you're talking about both backlog, but more importantly, homes that you're closing into a quarter. Could you highlight if that's a 200 basis point spread, 400, because it has to do with how many units you have under construction. Thank you.

It's typically about a 200 basis point differential between call it a pre-seller, a build job versus a standing spec. Now, then it also depends on the age of the spec. So the way you could see even more of a gross margin differential is if we had a completed spec that had been sitting and then sold. But the vast majority for a period of time, the vast majority of what we're selling and closing in the same quarter is very timely. And so it's only about that 200 basis point differential.

And I would like to comment about the closings in Q2 or our projected closings in Q2 being a lower percentage of inventory. I would say our positioning going into the spring is much stronger this year. The last several years, we had really been trying to catch up with community openings, getting our starts out. And I'd say our positioning with our community openings and our starts and our homes and inventory is better this year than we've seen in several years. And so we're in great position to really be able to drive sales, drive growth in the spring with our inventory position today.

So I guess,

you know, because

you guys don't give community count, when you're saying you're better positioned, if you could maybe clarify. So I see you're, you know, adjusted for your acquisitions. Your total units are up about 19% year over year. But you're saying you're happy with that despite community count. You're saying flat year over year, you know, sequentially. So you've actually intentionally increased your units, your spec, you know, spec per community. And that's actually where you want to be right now. You were trying to play catch up is what you're saying. So it's not excessive in your view.

For the last couple of years, going into the spring selling season, we had planned on having more houses coming out of the ground and more lots available to start houses on. This year, we are better positioned to hit the plan than we have been at any point in the last four, five, six years. So I do think when Bill talks about positioning, we are very happy with the way we're positioned and believe that we will be able to drive absorptions and generate very high returns.

And that's analysis of community by community homes and finish lots that can still deliver a home on this year. Better positions than we've had in each of the last few years.

If you look at our ESP, there is still a tremendous amount of demand at the price points we're delivering homes into. And there is some competition, but it is significantly less in competition that, you know, $150,000 higher.

Right. And I guess if I could make my one last question, not as complicated, but if the pricing is fine at the low end, which everybody says, I get it. How much do you think pricing is off at the high end? I mean, does that have to go down? Is it like 3% or is it like 10%? I mean, considering you're giving us this relative demand, I mean, how much is priced off at that high end? Thank you.

Well, let me take this. We're all kind of looking at each other with the, what did Tom just used to call it?

Blank empty look. I think, Kim, let me, to look at what pricing needs to adjust for us to give a number that it needs to be X, Y or Z percent, we just don't know. What we see is what our sales demand is, what our net sales, our teams are able to go out to the market and meet the market with the sales to hit pace. And they're working with customers, working with buyers and writing contracts and then delivering those homes. And we're watching the margin that's coming in on those sales contracts and the margin that's coming in on the closings. And they're meeting it. And we're not necessarily trying to globally measure from an index price or any other price for the community. It's what is that price house by house? What is that margin house by house? And we focus on this business, one home, one lot, one family at a time. And it kind of rolls up to what it is. And it can be a fairly dynamic number because a large percentage of our deliveries in any quarter reflect the market conditions of that quarter. So we saw that in our first fiscal quarter. We saw a change in the base level, lot level house margin. Thank you. I'll have a number for you, Kim. Thank you.

Next question today is coming from Michael Rijo from JP Morgan. Your line is now live.

Hi. Good morning. Thanks for taking my question. You bet, Mike. Good morning, Dave. You know, first I just wanted to get a little bit more insight, I guess, into the November, December, January trends and appreciate the detail there so far. You know, I think what everyone's trying to triangulate is, you know, your performance versus the underlying market because clearly if you go back to the last downturn, you know, Jordan was kind of a first mover. Oftentimes as the market softened, you were typically a little bit more aggressive off the bat. And, you know, it's consistent with your approach today just in terms of, you know, volume and returns and meeting the market. So I just wanted to get a sense, number one, you know, what are you seeing there in terms of your performance versus the market, you know, -a-vis share gains? Do you feel like the underlying market is a little bit softer than what you've been able to put together in terms of results? And secondly, you know, when you talk about December being good and January being better, particularly, you know, in the comments of January, is that more of just the typical sequential improvement for the spring? Or are you talking about sales pace actually, you know, growing or accelerating on a -over-year basis?

So, Mike, it is a sequential improvement, particularly in January, which is what we would normally see with traditional seasonality. But to be specific about November and December, our October sales were down on a -over-year basis. Our November and December sales were both up on a -over-year basis. Then as we move into January, what we've referred to is really just traditional seasonality in terms of -to-week improvement in sales. So it's too early still. I mean, we've got a lot of January left to give a full read on what January looks like.

Okay. And in terms of the, you know, share gain question, as you kind of see it over the last two or three months, any sense for, you know, how you performed versus the underlying market?

Mike, we would expect that we perform better than the underlying market. That's our goal every day. And that's been kind of our performance over the past several years is to continue to grow market share. And for our teams, they're very competitive and they like to win. But we don't have any empirical data to that today.

We'll see as everyone reports just like you do over the coming weeks.

Right. Right. And just lastly on the gross margin front, you know, you talked about, you know, hoping to see some stabilization there, you know, with a potential tailwind in perhaps the back half of the year from lower lumber. You know, at the same time, you know, obviously, you've been buying land over the last two, three years. You know, I would suspect that there's still somewhat of a rising cost basis from a land perspective in your inventory books. So, you know, we talk about stabilization. Are we are we to think of, you know, the upcoming second quarter low 19 range as something where all else equal given that sales cases come a little bit back in response to the incentives. That's kind of the new base. And, you know, even with I mean, I guess the real question is stabilization at those levels and, you know, what would a lower lumber kind of just offset higher land costs in the back half?

You know, Mike, as we sit here today and based on the recent sales trends we've seen, we're hopeful, we're cautiously optimistic that we are going to see some stability in our margin and, you know, the cost relief we'll get on the lumber rolling through our closings in the latter half of the year should be a part of that. In terms of the land costs, we've actually seen our finished lot cost as a percentage of overall revenues stay relatively consistent over the last year or two. So I would not say to think we have any headwinds coming in terms of our lot count or lot cost as a percentage of revenues. I think part of that reflects the fact that we're buying more and more of our lots on a finished lot basis in the current market. And so that's adjusting community by community based on market conditions.

Okay. But just to be clear, the stabilization we're talking about is coming off of two Q levels. Is that fair?

Yes, yes. I think that's where we would start. And in terms of some cost relief coming and stability in sales pace should provide stability in margins. It starts with stability. And if we see good momentum, hopefully we would have the opportunity to improve on it.

You know, Mike, as we've gone through all these numbers and I keep going back and looking at the first quarter that our people put on the books, first quarter, SG&A at nine and a half percent and operating margin at 10.7 percent. I mean, those are historically incredibly strong numbers. And so I got to tell you, I'm pretty proud of our people.

We are focused first on returns and returns don't happen without selling and closing houses. And so that's what we're going to do. We're going to meet the market and margin is what we solve for. But then obviously, you know, improving margins improves returns as well. So it's always a balanced community by community to drive the volume, hit the sales pace, generate the best returns we can get at the best margins we can get.

I appreciate it. Like I said, you're definitely at the vanguard in the last downturn and it looks like you continue to be here. So congrats. Thanks, Mike.

Thank you. Our next question today is coming from Susan McClarry from Credit Suisse. Your line is now live.

Thank you. Good morning. Good morning. My first question is, you know, with the chappiness that we have seen in the market, has that changed the appetite of some of the M&A opportunities that you see out there? Are sellers maybe a bit more willing to sort of, you know, get out before things perhaps get a little softer?

I think we'll probably see a fair bit of that. People engaging where they are in their markets and where they are on their horizons and think, you know, it may not get a whole lot better going forward potentially. And so they might want to take a little off the table. And, you know, it may affect bringing some of the bid-ask spreads a little bit.

Okay. And then my second question is just in terms of some of the raw materials, you know, the inputs, the labor. Have you seen any changes there? How should we think certainly about the lumber prices coming down as we move through the year and anything else that's in there?

You know, nothing real noticeable other than the lumber costs that we have already talked about that will still be headwind in Q2 but then should be more of a tailwind going forward. You typically hear us talk about our stick and brick costs on a per square footage basis. So on a -over-year basis, our stick and brick costs were up just a little over 4%. And our revenues were just slightly behind that, which was some of our margin issue. Sequentially, our revenues per square foot were essentially flat and our stick and brick costs were up about 2%.

Okay.

Thank you.

Thank you. Our final question today is coming from Jay Ramani from KBW. Your line is now live.

Thanks very much. Any change in investor purchases of homes in your communities? Any, you know, opportunistic purchases as a result of the moderation in sales?

No. We track that very closely as it's something that did cause a big impact last cycle that we're very cognizant of. So we have limited sales to investors that are, you know, essentially one-off in individual communities. We don't do any big bulk sales transactions to investors. We really want to focus on the for-sale, -the-house part of the business to keep our communities in good shape.

And can you give the percentage of closings that came from spec? It

was almost 80% this quarter, I believe. It traditionally runs right in the 70 to 80% range very tightly. There's some seasonality to it.

Thanks very much.

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

Thank you, Kevin. We appreciate everyone's time on the call today and look forward to speaking to you again in April to share our second quarter results. And to the D.R. Horton team, thank you for a solid first quarter and a strong start to 2019. It's your focus and hard work that has put us where we are. We appreciate it. We thank you for it and expect it to continue. Thank you.

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