D.R. Horton, Inc.

Good morning and welcome to the fourth 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 a listen-only mode. An interactive 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. I would now like to turn the conference over to your host, Jessica Hanson, Vice President of Invest Relations for D.R. Horton. Thank you. You may begin.

Thank you, Melissa, and good morning. Welcome to our call to discuss our fourth quarter and fiscal 2019 financial results. 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 and our subsequent quarterly reports on Form 10-Q, all of which are filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at .droghorton.com, and we plan to file our 10-K next week. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentations section under News and Events for your reference. Now I will turn the call over to David Alde, our President and CEO.

Thank you, Jessica, and good morning. In addition to Jessica, I am pleased to be joined on the call by Mike Murray, our Executive Vice President and Chief Operating Officer, and Bill Leet, our Executive Vice President and Chief Financial Officer. Our D.R. Horton team finished the year strong. Pre-tax income for the fourth quarter increased 9% to $660 million on $5 billion of revenue, and our pre-tax operating margin was 13.1%. For the year, EPS increased 13% to $4.29 per diluted share, and consolidated pre-tax income increased to $2.1 billion on $17.6 billion of revenues. Our consolidated pre-tax margin for the year was 12.1%. We closed 56,975 homes this year, an increase of over 5,000 homes, or 10% from last year. Our home building return on inventory was 18.1%, and our return on equity was 17.2%. These results reflect the strength of our operational teams, our ability to leverage D.R. Horton's scale across our broad geographic footprint, and our product positioning to offer homes at affordable price points across multiple brands. Our home building cash flow from operations in 2019 was $1.4 billion. Over the past five years, we have generated approximately $4 billion of cash flow from home building operations, while growing our home building revenues by more than $9 billion, or 117%, and our earnings per share by 186%. During these five years, in addition to organically growing the business, we have invested approximately $1 billion in acquisitions and returned over $1.4 billion to shareholders through dividends and share repurchases, while reducing home building debt by $1.3 billion. As a result, our return on equity increased by 540 basis points, while our home building debt to capital ratio decreased by less than half of its level five years ago. Our strategic focus is to continue consolidating market share, while growing both our revenues and pre-tax 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, and a good October sales pace, we are well positioned as we began 2020. Mike? Deluded

earnings per share for the fourth quarter of fiscal 2019 increased 11% to $1.35 per share, compared to $1.22 per share in the prior year quarter. Net income for the quarter increased 8% to $505 million, compared to $466 million. Our consolidated pre-tax income increased 9% to $660 million in the fourth quarter, from $608 million, and home building pre-tax income increased 3% to $594 million, from $578 million. Our fourth quarter home sales revenues increased 10% to $4.8 billion on 16,024 homes closed, up from $4.4 billion on 14,674 homes closed in the year-ago quarter. Our average closing price for the quarter was $299,500, flat with the prior year. Bill?

Net sales orders in the fourth quarter increased 14% to 13,130 homes, and the value of those orders was $4 billion, up 16% from $3.4 billion in the prior year. Our average number of active selling communities increased 9% from the prior year, and was flat sequentially. Excluding the builders we acquired earlier this year, our fourth quarter net sales orders were up 11%, and our average number of active selling communities increased 2%. Our average sales price on net sales orders in the fourth quarter was $302,300, up 1% from the prior year. The cancellation rate for the fourth quarter was 23%, down from 26% in the same quarter last year. Jessica? Our

gross profit margin on home sales revenue in the fourth quarter was 21%, up 70 basis points sequentially from the June quarter. The sequential increase in our gross margin from June to September exceeded our expectations and was primarily due to lower sales incentives. Based on today's market conditions, we currently expect our home sales gross margin in the first quarter to be consistent with the fourth quarter, subject to possible fluctuations due to product and geographic mix, as well as the relative impact of warranty, litigation, and purchase accounting.

Bill? In the fourth quarter, SG&A expense as a percentage of home building revenues was .5% compared to .4% in the prior year quarter. The increase in our fourth quarter SG&A year over year was primarily due to compensation accruals related to increases in our stock price. For the full year, home building SG&A was .7% compared to .6% in 2018. We did not achieve SG&A leverage this year after we lowered our revenue growth expectations in our fiscal first quarter and worked to align our inventory levels and operations with our revised expectations throughout the year. We remain focused on controlling our SG&A while ensuring our infrastructure adequately supports our growth and we expect to improve our SG&A rate in 2020. Jessica?

Financial services pre-tax income in the fourth quarter was $61 million and the pre-tax operating margin was 44.8%. For the year, financial services pre-tax income was $166 million on $442 million of revenues, representing a .6% pre-tax operating margin. 97% of our mortgage companies loan originations during the quarter related to homes closed via home building operations and our mortgage company handled the financing for 63% of our home buyers. FHA and VA loans accounted for 48% of the mortgage companies volume. Borrowers originating loans with DHI mortgage this quarter had an average FICO score of 720 and an average loan to value ratio of 89%. First time home buyers represented 50% of the closings handled by our mortgage company, up from 49% in the prior year quarter, reflecting our continued focus on offering homes at affordable price points for entry level buyers. Mike?

We ended the year with 27,700 homes in inventory, essentially flat with last year. 16,000 of our total homes were unsold, of which 5,200 were completed. Our fourth quarter home building investments in lots, land and development totaled $990 million, of which $610 million was to replenish finished lots and land and $380 million was for land development. For the year, we invested $3.7 billion in lots, land and development. David?

As September 30th, our home building lot position consisted of approximately 307,000 lots, of which 40% were owned and 60% were controlled. 30% of our total owned lots are finished and at least 54% of our controlled lots are or will be finished when we purchase them. We continue working to increase our lot position being developed by third parties by supporting the growth of 4 Star's national lot manufacturing platform and expanding our relationships with lot developers across the country. Our current lot portfolio includes an ample supply of homes at affordable price points and continues to provide a strong competitive advantage. Mike?

4 Star, our majority owned subsidiary, is a publicly traded residential lot manufacturer now operating in 51 markets across 20 states. At September 30th, 4 Star's lot position consisted of 38,300 lots, of which 29,700 are owned and 8,600 are controlled through purchase contracts. 79% of 4 Star's owned lots are already under contract with D.R. Horton or subject to a right of first offer under the master supply agreement. 4 Star exceeded its guidance for the year by delivering 4,132 lots and generating $428 million of revenue for its fiscal year and its September 30th. 4 Star expects to deliver 10,000 lots and generate $750 million to $850 million of revenue in fiscal 2020 and to deliver 12,000 lots and generate $900 million to $1 billion of revenue in fiscal 2021. These expectations are for 4 Star's standalone results. 4 Star is making steady progress in building its operational platform and capital structure to support its significant growth plans. During the quarter, 4 Star issued approximately 6 million shares of its common stock in a public offering. Net proceeds from this offering were approximately $100 million, which will help support 4 Star's future growth. After the issuance, D.R. Horton's ownership percentage of 4 Star decreased from 35% to approximately 66%. 4 Star plans to opportunistically access the capital markets as necessary to provide additional capital for long-term growth. 4 Star is separately capitalized from D.R. Horton and is targeting a long-term -to-capital ratio of 40% or less. We are excited about 4 Star's growing operating platform and the value this relationship will create over the long term for both D.R. Horton and 4 Star shareholders.

David? The HII Communities is our multifamily rental company focused on suburban, garden-style apartments with operations primarily in Texas, Arizona, and Florida. The HII Communities currently has four projects under active construction and two projects that were substantially complete at the end of the quarter, one of which was under contract to sell at September 30th. During 2019, the HII Communities sold two multifamily rental properties for ,400,000 and recorded a gain on sale of $51.9 million. The HII Communities' total assets were $204 million at the end of the year. We expect the HII Community assets to increase significantly in 2020 as its pipeline of multifamily rental projects grows. We also expect to sell two rental properties in 2020. Bill?

Our balanced capital approach focuses on being flexible, opportunistic, and disciplined. Our balance sheet strength and operating results have increased our flexibility and we are utilizing our strong position to enhance the long-term value of the company. During fiscal 2019, cash generated by home building operations was $1.4 billion, bringing our cumulative cash generated from home building operations for the past five years to approximately $4 billion. At September 30th, we had $2.2 billion of home building liquidity consisting of $1 billion of unrestricted home building cash and $1.2 billion of available capacity on our revolving credit facility. Our consolidated leverage improved 100 basis points from a year ago to 25.3 percent, and home building leverage improved 440 basis points to 17 percent. The balance of our home building public notes outstanding at fiscal year end was $1.9 billion and we have $500 million of senior note maturities due in the next 12 months. Subsequent to year end, we issued $500 million of 2.5 percent senior notes due in 2024. We also extended the maturity date of our revolving credit facility by just over a year and increased its capacity to $1.59 billion. At September 30th, our stockholders' equity was $10 billion and book value per share was $27.20, up 14 percent from a year ago. During the quarter, we paid cash dividends of $55.5 million and repurchased 2.1 million shares of common stock for $104.3 million. For the year, we paid cash dividends of $223.4 million and repurchased 11.9 million shares of common stock for $479.8 million. As a result of our share repurchases this year, we reduced our outstanding share count by 2 percent compared to a year ago. The company's remaining stock repurchase authorization at September 30th was $895.7 million with no expiration date. Based on our financial position and outlook for fiscal 2020, our board of directors increased our quarterly cash dividend by 17 percent to 17.5 cents per share. We currently expect to pay cash dividends of approximately $250 million in fiscal 2020. Jessica?

Looking forward to the first quarter of fiscal 2020, we expect to generate consolidated revenues of $3.7 billion to $3.8 billion and our homes close to being arranged between 12,100 and 12,400 homes. We expect our home sales gross margin in the first quarter to be approximately 21 percent and home building revenues to be around 9.5 percent of home building revenues. Based on today's market conditions, our expected gross for fiscal 2020 is still in the mid to high single digit percentage range for both consolidated revenues and homes closed. We currently expect to generate consolidated revenues for the full year of $18.5 billion to $19 billion and to close between 60,000 and 61,000 homes. We forecast an income tax rate for fiscal 2020 of approximately 25 percent and we expect to reduce our outstanding share count by approximately 2 percent at the end of fiscal 2020 compared to the end of fiscal 2019. We also expect to generate home building cash flow from operations in excess of $1 billion again during fiscal 2020. David?

In closing, our results reflect the strength of our well-established operating platform across the country. We are focused on consolidating market share while growing our revenues and profits and generating strong annual cash flows and returns while maintaining a flexible financial position. We are well positioned to do so with our conservative balance of money, broad geographic footprint, affordable product offerings across multiple brands, attractive finish lot and land position and most importantly, our outstanding experienced team across the country. We congratulate the entire G.R. Horton team on closing the most homes in a year in company history and we thank you for your hard work and accomplishments. We are incredibly well positioned to continue growing and improving our operations in 2020. This concludes our conference. We will now host questions.

Thank you. At this time we'll be conducting a question and answer session. If you'd like to ask a question, 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 key. In the interest of time, we ask that you limit yourself to one question and one follow-up each. Our first question comes from the line of John Lovala with Bank of America. Please proceed with your question.

Hey guys, thank you for taking my question. I guess first of all, the cash flow from operations target of greater than a billion could be interpreted as being somewhat conservative given the 2019 performance of 1.4 billion and what appears to be a set up here for improved profitability in fiscal year 20. What do you see as the biggest variables here and is there any reason that you can point to why cash flow would be lower on a -over-year basis?

John, we expect to generate consistently strong cash flow in excess of a billion. -to-year, that number can move around a little bit just depending on timing of investments in home building and given that we're early in the year and we want to see how demand goes through the year, that could impact our investment levels in the business. So greater than a billion dollars is certainly a solid range and that gives us flexibility then as we move through the year and we'll update that estimate as we need to. Okay, that makes sense.

And then last year, I think you guys outlined a potential acquisition target range of $400-600 million. How are you guys thinking about that heading into 2020 and what does the pipeline look like?

We're still actively looking at some opportunities, Jalen, but we're very selective and wanting to be very targeted in what we're doing there. So while we're looking at some, they're very hard to predict when they're actually going to happen. This year, we don't have that same level of clarity to a number that we had at this time last year. Okay, thanks, guys.

Thank you. Our next question comes from the line of Alan Ratner with Zellman & Associates. Please proceed with your question.

Hey, guys. Good morning. Congrats on a strong close to the year. So my first question, you know, I've always kind of thought about the homes and inventory data point that you guys provide as a little bit of a leading indicator in terms of how you see the business growing over the next few quarters. And I think this is the first quarter in a while where you've actually been down a bit on a -over-year basis. And I'm just curious, you know, as you think about that mid to high single digit growth target in 2020, should we start to see that number move higher? Or is there any kind of change in the way you're thinking about, you know, having specs on the ground and homes and inventory and maybe any shifts in demand for -be-built homes versus specs that that would be potentially driving that number lower than I would have suspected?

I think, Alan, as we're seeing a similar breakdown between our -be-built and our available homes that we have in inventory, but, you know, we're excited looking at going into this year with a good demand environment and an opportunity to continue improving our returns. And part of the way we talked about last quarter of improving returns is to focus on improving our home inventory turnover. And so that's something we're excited about the opportunity to deliver on in fiscal 2020.

Great. And then I guess just a follow-up on that. But, you know, implied there, I guess, is you're still confident that you can maintain the very high backlog conversion rates that you've delivered in the past and while keeping a lower inventory level in total. Is that the way to interpret that?

I think you will see our inventory level increase from where we are at this point in the year, but we're looking to be more efficient with the capital, so we'd love to see a higher overall turnover rate.

Okay. Now that's helpful. And if I could just ask one more. You know, investors obviously have been very focused on the 10-year treasury yield, which has been climbing off of recent lows of late and still at incredibly low levels from an absolute standpoint. Right. But, you know, you mentioned the strong sales environment in October, which obviously coincides with that move up we've seen in recent weeks. How do you see the rate environment today? I mean, is there any what you see maybe pulled forward from buyers that are trying to jump in before rates continue to move higher? Is it not a concern at all of yours in the marketplace? Any commentary you can give just in terms of what you're thinking about or seeing on the ground from the rate environment would be helpful.

You know, I think anything that impacts affordability is always going to be a concern. I will say when you look at what drives home building, which is job growth and overall economy, we feel very, very good about what's happening there. And homes, you know, they're affordable as they're going to get. So I do think, yes, there may be a little bit of pull forward demand, but right now the market feels really, really good.

And Alan, if one positive came out of last year at this time and what we experienced, it was a renewed focus in the field for us to stay and make sure we have those affordable product offerings kind of regardless of what interest rates are doing. So we continue to see our average square footage come down slightly. It was down about 3% on a year over year basis again. And we've proactively gotten the houses out there that we believe are affordable in today's market. And we'll continue to adjust as necessary to whatever rate environment we find ourselves in. But clearly today is a little bit better rate environment than it was last year at this time.

Appreciate that, guys. Thanks a lot.

Thank you. Our next question comes from the line of Carl Reikart with BTIG. Please proceed with your question.

Thanks. Morning, all. I wanted to ask David a little bit about competition, especially for entry level lots in particular. You know, a number of your peers are making a move in a direction that you made some time ago. And you've had a couple of smaller peers talk about how it's been harder to find assets where they'd like to build smaller homes. Can you talk a little bit about what you're seeing competitively? Obviously, a lot of supply is what it is and it's strong, but you'll be looking for more. I think there'll be more looking than the same area as you are. So I just curious to your thoughts there.

You know, Carl, we compete every day. And yes, I do think that you're seeing more people attempt to get lower in price point and drive better affordability. But again, you know, like we've talked about in the past, our positions are very long, very deep. And we don't intend to give up market share in that service in that bar. I will say demand is still very, very deep. And I think from my travels that, you know, supplies feel tight, especially as you achieve true affordability. So, but, you know, we take a lot of comfort in the fact that we've got a long runway and very affordable positions, deep and long.

So thanks, David. And then, Bill, I just I'm going to follow up on Alan's question about inventories. I think you made a few reclassifications to what's in the unsold versus we move models, I think. But I'm thinking back to, I think, three years ago or so where you entered the year feeling like you were short a little bit of inventory and it hurt you from a delivery perspective. I just want to make sure you're not feeling that way now. You feel comfortable. The inventory that you got in the ground as you head into this first quarter is there and you're not feeling the same way that you did three years ago.

Carlos is Mike. And I would say it's different from three years ago that not just, you know, we feel really good about the focus we've had on housing turns and how to improve that, as well as having the lots on the ground to support the starts that we'll need to be making over this quarter to support what we hope to be a really robust spring selling season. So three years ago we were struggling not just with the inventory levels of housing, but also with our finished lot positions behind that.

We feel very comfortable with the 60 to 61,000 annual target. But the reason we right now wouldn't say we're comfortable moving higher than that for this next fiscal year is because of where we're starting from from a home's perspective. So 60 to 61 we feel very comfortable with. All right. Great. Thanks, Jessica. Thanks,

all. Thank you. Our next question comes in line. As Truman Patterson with Wells Fargo, please proceed with your question.

Hi. Good morning, everybody. And nice results. First, I wanted to touch on the SG&A. You know, it came in a little bit above your guidance. Could you just walk us through the drivers of this and, you know, how we should think about incremental SG&A going forward? You know, I'm really thinking about 2020. You mentioned some leverage, but you guys are guiding the mid to high single-digit revenue growth, which is pretty much what you all did in 2019. And your SG&A was kind of flattish. Could you just kind of break it out why, you know, 2020 would improve while 2019 didn't necessarily take down?

Sure. Sure, Truman. This is Bill. Specifically in the fourth quarter when we missed our guidance, that was specifically due to some of our compensation accruals are tied to changes in our share price. And as our stock price increased pretty sharply in the fourth quarter, we had to increase a number of those accruals. And that entirely accounts for the miss versus our guidance for the Q4 SG&A rate. As you look back over the full year of 2019 and as we look forward to 2020, though, it's a little bit of a broader discussion. As you recall, in fiscal 2019, at the start of the year, you know, we had expectations to grow more at a double-digit pace. But then very early in the year, as we saw a softer market in the first quarter, we lowered our revenue expectations. And we had our infrastructure in place and homes in place, homes and inventory, obviously, to support a higher revenue number. So really throughout this year, we've been working to adjust our inventory levels and our operations to kind of fit that lower revenue expectation. And we've been running, you know, typically about 10 basis points higher than the prior year all year long. As we go into fiscal 2020, while we have the same revenue expectations that we ultimately achieved in 2019, we feel like our positioning is appropriate for that revenue. And with mid to high single-digit revenue growth, we should see SG&A leverage. And so we do expect to improve on our SG&A rate versus 2019 as we go into fiscal 2020.

Okay. Thanks for that. And then on the financial services side, you know, I think it's the best result you guys have had in history. Could you just walk us through the drivers of this and possibly how sustainable it is going forward?

Sure. Sherman, it was mainly due to favorable market conditions just because of the low interest rate environment. So that was by far the strongest driver. Our mortgage company, though, has also done a fantastic job working on becoming more efficient. They've improved their capture rate. I think 63% this quarter was one of the highest we've seen in quite some time. But a normal historical operating margin is more in the 30% range, the low 30s. And we do anticipate that's what they're ultimately going to return to. But no question this year was a very strong performance for that business.

Okay. Thank you all.

Thank you. Our next question comes from Lyon. Derek Bosshard with Cleveland Research. Please proceed with your question.

Good morning. Question on gross margin. As you look at price and incentives and gross margin, I'm curious how you would compare your thinking for the coming year relative to the year you just completed.

I think we're going to see, frankly, more of the same. We see lower levels of incentives than where we've been sequentially through the year. You know, margins have come up nicely as we've walked from the second quarter low that we've had. We've been very intentional about trying to manage that to drive the best returns. And looking, you know, into fiscal 20, as clear as our cladding ball shows us, we'd be expecting margins to be about flat, you know, kind of where we've been in the fourth quarter.

And then secondly, in terms of four-star and option, can you talk about the progress you've made and where that number is going and how it's going, how you would characterize how it's going?

Overall, we feel really, really well about the progress we've made to get to 60%. I know that's a little bit bouncy quarter to quarter. And we've talked about it's a dynamic number that measured at any quarter end. It's going to move a little bit directionally. You know, I hope to get a little more progress on that this year. And the trend continues. Four-star continues to add to their operating platform, add to their team, which is a great first source for us, for a third-party developer. And at the same time, you know, we work really hard developing relationships with other third-party developers as well and continuing to expand those relationships that we have in various markets and getting people in markets we have not historically been able to get developers to step in and complete log for us. It's an ongoing long-term process. And the destination, ultimately, the 60%, where would you like that number to get to and over what time frame? Hard to say. An ultimate number, higher than where it is today. But it's something we'll probably be working at very hard for, you know, our entire careers here at DOE.

Thank

you.

Thank you. Our next question comes from the line of Stephen Kim with Evercore RSI. Please proceed with your question.

Yeah, thanks very much, guys. Mike, just wanted to clarify one thing. You just said, I think, with respect to margins in 2020 that you're thinking you could probably be flat with where you were in 4Q19. So, in other words, kind of around that 21% gross margin in 2020 is kind of what you're thinking, right? Yes, sir. Okay, great. Just wanted to clarify that. That's great. The second question relates to SG&A. So, I believe, Bill, you were talking about the impact of the stock-based compensation in 4Q, your September quarter, you made adjustments to your accruals for the higher stock price. I was wondering if there shouldn't be any lingering impact from that. Let's say if your stock price were to remain flat into next year, should there...the reason I'm asking is because your 1Q guide on SG&A is for flat, even though your closings are up about 7%, you know, which is kind of like what you're thinking for the year. So, just trying to figure out why we wouldn't see a little more leverage in 1Q like you were expecting to see for the full year.

Right. Yeah, the change in the accrual should not have any lingering effect. You're correct in that assumption. As we look at our absolute level of SG&A spend going into the first quarter along with our revenue guide, we believe that the .5% is the level that we feel like we will be at. If you do go back a year ago though, if you're comparing year over year, in the first quarter, we had some, you know, I hate to say benefit, but we did have some benefit from a reduction in our stock price last year. So, some of those accruals were pulled down a year ago in the first quarter. So, it's simply timing on that basis, but it does move the needle a bit. You know, it can move a 10 to 20 basis points. Got

it.

Yep, that's

very clear. And then lastly, I think in your opening remarks, you talked about October off to a strong start. I was just wondering if you could give us a little bit more color. Are we seeing in any way an acceleration into October in any way, either in terms of being able to reduce incentives at a more aggressive pace or any other kind of color you can provide around the demand? And what is the current economic environment in October?

Well, this October feels so much better than last October. Sure. It's hard not to be a little bit excited about what the year brings. I can tell you the, you know, we're not thinking that we're going to see a margin expansion because I do believe there's going to be more competition. But where we see the business right now today is very, very solid and feel comfortable, at least today, with sharing that, you know, we're looking for pretty flat margins going forward, which as you know, we're not typically the most optimistic group out there.

Right. But just the hardest working. Appreciate it, guys.

Yes,

sir.

Thank you. Our next question comes from line of Matthew Boulay with Barclays. Please associate with your question.

Hi. Good morning. Thank you for taking my questions and asking the results. I wanted to start with a question of a Q1 gross margin guide, consistent with Q4. Can you just kind of go through some of the sequential puts and takes on that? So I guess what are you guys assuming around incentives and direct costs and, you know, perhaps if there was any purchase accounting that's still rolling off? Thank you.

It's really just looking at kind of our core lot level gross margin and assuming all else remains equal. So really no impact one way or another from warranty and litigation or interest or property taxes. Now those can move the needle quarter to quarter, but they're really hard to project. So right now they're approximately 21% would assume those are relatively in the same range as they were in Q4. And then we're able to maintain, you know, a flat pricing environment or a pricing environment that is increased at the same level as our costs. So that's what we saw this quarter sequentially. Well, actually sequentially we saw an improvement because of the continued pullback on incentives, which we think we're through the most of. But our revenues per square foot were up about 2% and our stick and brick costs were up about 1%.

Okay. Thank you for that color, Jessica. And then I want to ask about some of the regional sense as well because it looked like the south central really accelerated. So any elaboration if you guys are still leaning into Texas again? These guys have continually pulled back a bit there the past couple quarters and then I guess any color on the west in California as well?

So I think, you know, looking at the second part of your question first, you know, California in the west, we're seeing, you know, good sales trends out there. We've kind of refocused ourselves on maintaining affordability and at the price points we're offering our teams out there doing a great job executing for those buyers and we're seeing the buyers respond. You know, in Texas, you know, it's home. We've been dominating here for a long time and we'll continue to do so. And those communities are performing exceptionally well, great teams on those projects and the economy is strong here and, you know, the interest rate adjustments, as David mentioned before, helps affordability. But we have always been focused on meeting that affordable need in the state of Texas and we're seeing great response.

You know, I'll just add that a lot of it's positioning and I think coming into this year we feel very good about the way we're positioned. And both really California with the price that we've been able to drag down to and in Texas with lots out in front of our building operation.

All right, appreciate the call. Thank you.

Thank you. Our next question comes from Michael Rehaut with JPMorgan. Please proceed with your question.

Hi, thanks. Good morning, everyone. First question I had was on, you know, how you're thinking about, you know, growth next year and what I mean by that, obviously you gave the guidance much appreciated and in line with your prior expectations. But, you know, if you go back over the last five, 10 years, you've had a couple of different initiatives that I think have really been extremely helpful in driving the growth and taking share, you know, around the Horton Express and around the Emerald. You know, I think you've talked in the past about, you know, other strategic goals to allow for consistent growth going forward, including, you know, the Freedom Homes, the Active Adult, you know, maybe even getting deeper in the East footprint as areas of opportunity. You know, I was curious as you look over the next, you know, year or two, how prominent those, you know, those areas of strategic focus will be or the role that it will play in allowing you to, you know, continue to reach higher heights, you know, obviously getting the 60,000. You know, you're up, you know, now consistently for the last three or four years, you're going up, you know, four or five, six thousand closings per year. So I was just curious, you know, as you look at the next year or two, you know, achieving the next, you know, ladders up of growth, is that going to be more broad based, you know, just kind of market driven or do you see specific gains in some of those, you know, strategic initiatives that you've talked about in the past?

You know, I think on the last call Bill talked about the fact that we're only top five and, oh, yeah, top five, number one and 13. Top five in 30, 32 markets. So we've got a lot of runway in those markets and as to the brands, you know, we're trying to drive optionality for the buyers and to create a focus and product to meet everybody's needs in the market. So I just, I feel like we've got, we've got all kinds of runway to get better in markets that we're not doing as good as we should be and offer products that everybody's going to want to buy. So

Rehart, in addition to product positioning and our current footprint and deepening our market share in our current footprint, we have continued to expand where we operate and our market count this quarter actually moves from 87 markets up to 90. And so we continue to assess, you know, where there's good permits and jobs and areas that there isn't affordable housing on the ground, which honestly is almost every market across the entire U.S. So we'll look to continue to expand our footprint as well. And

then you did mention kind of the East and the Midwest with our acquisitions a year ago in the Midwest, we're working with those teams and they're growing their platforms. There's opportunity for that to be a stronger contributor for growth for us going forward. And then we've talked about the Northeast and we continue to day by day improve our operations there and our teams are working hard and we think that's going to be an increasing driver of our continued growth as well.

That's great. I appreciate all the color there. I guess, secondly, you know, as you think about, you know, order growth or closings growth next year, you know, this year, you kind of moved from, you know, sales pace, you know, being, you know, maybe, you know, flatish or, you know, slightly up to flat. And then this quarter, you know, excluding acquisitions, you had, you know, more of a high single digit type of growth. And that's consistent with a lot of the builders that have seen it improved, you know, market as well as an easier comp. As you get into next year, you know, how should we expect the balance of community count and sales pace to influence, you know, the overall, you know, unit volume growth?

And Mike, after we cycle through this next quarter, really that's when we acquired the three companies we did and really what has been putting our community count growth in that high single digit range. So without those acquisitions, we've been trending in a pretty low single digit range, only a percent or two on a year over year basis. And I think we really just kind of anticipate more of the same in fiscal 20. So community counts slightly up and it can be a little choppy along the way.

But we are seeing, with our refocus on affordability and ensuring that we're driving that everywhere that we can, we are seeing improved absorption per community. And so with our guide of mid to high single digit growth on a community count of low single digit, we're assuming further improvement in per community sales pace.

Great. Great. Very helpful. Thanks a lot, guys. Appreciate it. Good luck for fiscal 20. Thank you, Mike. Thank

you. Our next question comes from the line of Megan McGrath of Buckingham Research Group. Please proceed with your question.

Thanks. Good morning. I guess I wanted to ask, if you think about this fiscal year 2019, you know, we went through a lot of movements and interest rates, both up and down and kicking back up a little bit. But I guess looking back, could you tell us, did anything surprise you in terms of the reaction of your buyer groups to those rate moves, which had been debated for a while, what would happen? And if rates continue to pick up, is there anything you would do differently or adjust your strategy as we move forward?

Megan, we saw the buyers, every time that affordability is constrained, the buyers have to readjust and there's certainly a pause in the marketplace. And interest rates are a big driver of affordability. At the same time, as Jessica mentioned earlier, that gave us the real focus to get back into our product and think about what we were offering and try to bring housing prices down for our customers at a way that still provided a good margin for the company. And we did that and will continue to adjust to the marketplace for whatever the interest rate environment gives us. You know, I do think one of the things that we are seeing is that there's continued job growth in the economy and there's some continued wage growth. And that's very helpful for households. And that large population, that large demographic is aging one year further down and they're having life events that often drive them to prefer single family housing as their housing choice. And we're well positioned to provide them, you know, with a home for that.

Great, thanks. And then just to follow up on gross margin, you talked about, you know, flattish from the fourth quarter. Could you maybe walk us through how you're thinking about the headwinds and tailwinds of the big components of gross margin as we look into next year generally, labor, materials and pricing?

This is really just more of the same, Megan. So what we're saying in that guide is that we don't have the same level to pull back on incentives as we did this year. We'll pretty much have cycled through the higher incentives that we had to institute last year at this time to drive the sales pace. So we continue to have some limited cost pressures on the labor front. That's consistently been, you know, somewhat of a headwind. But we've worked to offset it in other categories. And generally, now that we've also cycled the higher lumber costs, our material costs are net neutral. Our purchasing team is doing a great job of when we do have a category that the cost is going up, they find a category where we can look to offset it. So I think our base case would be just to be able to keep those costs in line with whatever type of pricing power or lack of pricing power we might have. As a reminder though, really, the fiscal 20 gross margin is going to be dependent on the strength of the spring selling season. And so this is where we sit today. We feel good about maintaining our gross margin around the range it is right now. But it's really going to be dependent on the spring.

As you know, we're focused first and foremost on returns. And so we're going to balance the margin pricing incentives and pace to generate the best return for community. Right now we see a good market in front of us. And so that would indicate we should be able to maintain margins.

Great. Thank you very much.

Thank you. Our next question comes from Jack Mithango with SIG. Please proceed with your question.

Hi. Good morning. Bill, I wanted to revisit the cash flow comment, I think from maybe the first leadoff question on the call. You know, a billion for this year, north of a billion next year. The October issue, very nice refi of the February 2020 coming due. Is anything around the cash flow guide contemplating the December 2020? I know that's a 2%. That's a pretty attractive yield. It's going to be probably hard to beat that. But is any of that in the guide for cash flow for next year?

No, that would be beyond our fiscal year. So we're kind of looking at that as a fiscal 21 event. So naturally with the .5% five-year notes we issued in October, that does essentially provide the funds to refi and pay off the maturity that we have in the spring, the $500 million we have in the spring. So that gives us flexibility in our liquidity as we go into the year to invest further or be able to be opportunistic as we need to.

Okay, great. And then on DHI communities, you know, can you maybe help us size what those gains? Obviously it's a market transaction deal, so not looking for zip code, but maybe area code around maybe gains, timing. And then 2B of the question, thoughts on single-family rental. You know, there are some going that way among your peers. Some have said that's not really for us. Just curious as you're growing the rental business overall, where your current thinking is on the single-family side. Thanks.

So DHI communities, we mentioned we do expect to sell another two projects in fiscal 2020, one of which is under contract to sell as of September 30th. So we would expect the first project to close in our first fiscal quarter. And then we expect one more over the course of the year. A little hard to comment on individual transactions around the size of potential gains until they close. But our projects are ranging in size from the high 200 units up to 350 to 400 units in general. And so they're in a fairly tight range in terms of size. So I would expect significant variations versus the ones we saw this past year. And

then in terms of single-family rental, we're continuing to look at that business deck. We think it's, we have an opportunity to provide some value in that space. And we're looking for the best ways we can do that right now.

All right. Thank you.

Thank you. Our next question comes from Mark Weintraub with Seaport Global. Please proceed with your question.

Thank you. Good morning. I certainly understand you with a strong backlog. You've got good visibility on the next six months, whatever margins, et cetera. I guess that's a little surprise that when talking about labor and materials, you wouldn't potentially be anticipating more pressure as we get to later into next year, given the order of growth that we've been seeing and given some of the inventory dynamics, which have affected you this year and probably the industry as well, which would suggest there's going to be more stress on the home building complex and so more stress on labor in particular. Any further thoughts on how you are thinking about that and your ability to be in a position? Because it sounded like it wasn't so much that you'd be raising prices, but you thought that those wouldn't be material impacts to your year ahead.

So part of the confidence we have at our cost outlook is looking at a lot of the national contracts we have from our scale. Secondarily, at a local level, the scale we have certainly supports great labor relationships that we've had over the years and our ability to continue to source adequate labor to build our homes in a timely fashion is very constructive for us. If there is cost pressure because the market is strong, we would also expect that there's potentially a lower level of incentives that would help us mitigate any of those cost leakage that we had come through.

I'll just add that we've worked very, very hard over the years to drive a process that has allowed us to drive more square footage with the same labor hours. And that gives us a lot of comfort and confidence that when labor does get tight again, which I anticipate it will in the spring, that we're going to command the greatest percentage of it.

And maybe just as a follow-on, do you think your local market scale acts as an even bigger advantage in that type of market than what we've been seeing, and how does that play out?

Well, absolutely. I think it's the local market scale. I think it's also our commitment to drive consistent production at each flag. So we get the trade base into the communities. Our absorption in our typical community is very, very high. And so we keep them there. And they're not out looking for work while they're waiting on us to start houses. So it's just a process. It's something we've been working on for a long, long, long time. And I think we do have a loyal trade base. And good markets, bad markets, I know they're going to get paid. So that is a competitive advantage for us.

Thank

you. Thank you. Our next question comes from Lyna Kenzender with KeyBank Capital Markets. Please repeat your question.

Good morning, everybody. Good morning. All right. Did you check in there?

It's getting close.

I

know. I know. Let's start with intra-quarter, quarter closings,

please. What percent

of closings were intra-quarter? Sure.

It was right where we typically expect it in the call it 35, 36 percent range. It fluctuates anywhere from 30 to 40 percent on average with a little bit of seasonality sometimes.

Right. So if I do that calculation, first what I believe was 34 percent last year, what that shows is your closings grew up about 7 percent out of your backlog. That's a nice cadence, but really spiked in the spec homes. Year over year if you just look at it at units. I asked that to get an understanding of how the margins for your spec first backlog are trending with a third of your closings being spec in an environment where pricing became firmer. Could you kind of talk about that a little bit?

We saw

spec margins compress or get closer to backlog margins. So they came up relative to backlog margins. That difference shrunk in the quarter. And what would you attribute that to? As what you said, it was a firmer pricing environment, a lower incentive environment in our fiscal fourth quarter than it was say in the fiscal second quarter.

Uh-huh. Now the guidance you gave for revenue, you talked about feeling good in October. Nice. It seems though, it seems like you guys, except for the first quarter, you guys have really been kind of following what I would consider normal seasonal trends. And then Bill, I think you said you expect pace to actually increase in FY20. Was I mistaken?

We do. We're expecting our community count to be up low single digit, but our overall pace to be up mid to high single digit, yes.

Why is that? What gives you that confidence is what I'm asking to expect, you know, seasonality to accelerate on an order pace basis.

Just in general, we would expect that on an annual basis as we've seen that, you know, as we're refocusing on providing attainable housing for people, that we're able to, you know, see communities perform at a higher sales per flag per week pace than other communities. I mean, so it's something that we've consistently seen for the past several years is that as these communities open, we're positioning them with the right inventory to get going out of the gates strong and run at very high absorption rates.

And I would agree with you, Ken. We're not seeing anything different than normal seasonality though, necessarily. We do expect we can run a little bit tighter on our housing inventory in fiscal 20 than we did in 19. We started strong and then as we adjusted our revenue expectations, we kind of spent the year adjusting to align. But we thought we were very well aligned going into fiscal 20.

And I'll just add, you know, our confidence level is really driven by what we're seeing out in the field. And, you know, we talk a lot about our people. We talk a lot about trying to get better year over year, quarter over quarter, day over day, really. And I would just say we are getting better. So even though our absorption per flag has been very high through this whole cycle, we are a better company today than we were a year ago. Better positioned and our people got another year's experience.

I understand and it appears that way for your results. Can you talk about how you're trying to control your user size -a-vis vendors? And if you are seeing, you know, whether it's lumber, appliances or these types of other things, you know, perhaps what you've learned over the last year and any changes that you're implementing for FY 20, thank you very much.

Thank you, Ken. I think

we're continuing to do what we have done with a lot of our national supply partners in that, you know, creating a good relationship for us and for them, providing a lot of consistent volume demand and potential halo effect into a given marketplace by bringing their product into the trade base. There's some follow on benefit and we participate in that and they certainly benefit from it as well. Thank you.

Thank you. Our next question comes from the line of Alex Barron with Housing Research Center. Please proceed with your question.

Yeah, thanks. I was curious whether you guys feel the growth in the overall industry is going to be pretty much in line with the growth you guys are getting to?

Yeah, Alex, I would think we would continue to expect to take market share and as we'd like to say, outperform the market. The year in, year out, we expect to do better.

Okay. So does that mean you expect your affordable percentage of homes to, I guess, keep growing?

You may not see it from a pure brand perspective in our business, but what we've been introducing really over the last year or so is more and more entry level type houses in our Horton brand as well. So the answer is yes, but you may not see our expressed percentage of a business climb from the mid-30s where it is today.

Got it. And then in your financial services segment, you guys got pretty nice leverage this quarter. Do you expect that to continue in 2020?

Yeah, yeah. We certainly have seen some improvement in efficiencies. Their cost per loan is down. They've increased their capture rate, which provides efficiencies on overhead as well. But a large part of the expansion margin is due to very favorable market conditions as rates drop for this year. The service release premiums are very healthy in that sort of a market and there's less competition because there's more re-buy business out there. So we wouldn't expect to sustain the same level of margins that should come down a bit, but we are pleased with the continued efficiencies we are building into that business.

And I'll just add our mortgage company did a spectacular job this year, not only driving efficiency through their process, but in aligning with our home-building operations to make the overall transaction better for our customers.

Okay. And one last one, if I may, on the four-star. As you guys are now incurring interest due to the debt you raised, is that going to be capitalized or is that going to be showing up in expenses in what you guys report?

Four-stars, their active inventory is greater than their debt, so they are capitalizing 100% of their interest into their inventory at four-star.

Okay. Thanks. Appreciate it. Best of luck. Thank you.

Thank you. Ladies and gentlemen, our final question this morning will come from the line of Mike Dahl with RBC Capital Markets. Please proceed with your question.

Hi. This is actually Chris Dahl from Mike. Thanks for squeezing me in here. So my first question is just on M&A. Are you embedding any M&A in your 2020 guidance and given the recent activity in this space, could you just give us an update on how you're thinking about public versus private opportunities?

We are not embedding any M&A activity into our growth guidance. With regard to our outlook for M&A, for what's right for Horton, typically it's been the private builders, the add-on builders that give us new capabilities, new teams in various markets. So that's where we continue to have our focus right now, but we are always open and are always evaluating whatever is right, going to be right for us.

Got it. Thanks for that. And secondly, are you able to provide the percentage of communities that raised price this quarter and any regional color or commentary to provide on pricing power you saw in 4Q?

Thanks. So the communities we raised price on isn't something we've typically disclosed. We clearly still don't have broad-based pricing power across the board, but I would say at this point we've had an ability to pull back on incentives, which is a different function of price across most of our footprint at this point, maybe a little bit less so at the higher price points where incentives have remained elevated.

Got it. Thanks. Appreciate that.

Thank you. Ladies and gentlemen, this concludes our question and answer session. I'll turn the floor back to Mr. Ault for any final comments.

Thank you, Melissa. We appreciate everyone's time on the call today and look forward to talking to you again in January to share our first quarter results. And to the D.R. Horton team, congratulations on finishing number one for the 18th consecutive year. You are truly the best of the best in this industry. Mike, Phil, Jessica and I are honored and humbled to represent you on these calls. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.