D.R. Horton, Inc.

Good morning. Welcome to the second quarter 2020 earnings call for GR Horan, American's Builder, the largest builder in the United States. At this time, all participants are in a 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. Please note this conference is being recorded. I will now turn the call over to Jessica Hansen, Vice President Invest Relations for GR Horan.

Thank you, Sherry, and good morning. Welcome to our call to discuss our results for the second quarter of fiscal 2020 in addition to current market conditions. 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 GR Horan 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.O. Horton on the date of this conference call, and D.O. 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.O. Horton's annual report on Form 10-K and subsequent reports on Form 10-Q, all of which are or will be filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at .dohorton.com, and we plan to file or attend Q in the next day or two. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentation section under News and Events for your reference. Now I will turn the call over to David Ald, our President and CEO.

Thank you, Jessica, and good morning. Although we are in different locations while practicing social distancing, I am pleased to also be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer, and Bill Wheat, our Executive Vice President and Chief Financial Officer. We'd like to first express our gratitude to our country's dedicated field of healthcare workers and all who are on the front lines caring for our communities. Our thoughts remain with those affected by this pandemic, and before we talk about our second quarter results, I will address current market conditions while we, along with the rest of the world, navigate through the impacts of COVID-19 on the economy and our business operations. Housing market and economic fundamentals were solid throughout most of the second quarter. As interest rates on mortgage loans remained low, new home demand was strong, and there was a limited supply of homes at affordable prices across most of our markets. However, during the latter part of March and into April, the impacts of COVID-19 and related widespread reduction in economic activity across the United States began to negatively affect our operations as well as the demand for new homes across all of our markets. We experienced increases in sales cancellations and decreases in sales orders in late March and to date in April as compared to the same period last year. In almost all municipalities across the U.S., where social distancing and other restrictions have been implemented, residential construction, lot development, financial services have been designated as essential businesses as part of critical infrastructure. We have continued our operations in those markets where allowed and have made appropriate adjustments to comply with social distancing and other standards as the health, safety of our employees, customers, and trade partners is our number one priority. We believe we are well prepared to operate in this uncertain environment with our experienced operating teams, low leverage in a strong liquidity position. We plan to maintain our flexible operations and financial position by generating strong cash flows from our home building operations, limiting land acquisition and land development spending, and adjusting our product offerings, incentives, home pricing, sales space, and inventory levels to optimize the return on our inventory investments in each of the communities based on local housing market conditions. Our team delivered a strong second quarter during this unprecedented time for our nation and while making significant adjustments to our operational practices in March. Our consolidated pre-tax income for the quarter increased 34% to $621 million on a 9% increase in revenues to $4.5 billion. Our pre-tax profit margin improved 260 basis points to .8% and our net sales orders increased 20%. Our home building return on inventory for the trailing 12 months ended March 31st was .2% and our consolidated return on equity for the same period was 19.1%. Mike?

Mike? Deluded earnings per share for the second quarter of fiscal 2020 increased 40% to $1.30 per share compared to 93 cents per share in the prior year quarter. Net income for the quarter increased 37% to $483 million compared to $351 million. Our second quarter home sales revenues increased 10% to $4.4 billion on 14,539 homes closed up from $4 billion on 13,480 homes closed in the prior year. Our average closing price for the quarter was up 2% from last year to $300,100 and the average size of our homes closed was down 2% reflecting our ongoing efforts to keep our homes affordable.

Bill? Net sales orders in the second quarter increased 20% to 20,087 homes and the value of those orders was $6 billion up 22% from $4.9 billion in the prior year. Our average number of active selling communities increased 1% from the prior year and was flat sequentially. Our average sales price on sales orders in the second quarter was $299,700 up 2% from the prior year. The cancellation rate for the second quarter was 19% flat with the same quarter last year. As we disclosed in our preliminary release our March net sales orders increased 6% from last year to 6,491 homes and our cancellation rate for the month was 24%. As a result of the pandemic our sales orders began to decrease in late March and into April and our cancellations have remained elevated throughout April to date. Although April is not quite over yet our net sales orders month to date are approximately 11% lower than the same period a year ago. This month to date net sales trend may not be indicative of the full month of April because a significant number of our sales cancellations typically occur in the final days of each month. However, we have seen an increase in our net sales order volumes in the most recent two weeks compared to the preceding four weeks. Jessica?

Our gross profit margin on home sales revenue in the second quarter was .3% up 30 basis points sequentially from the December quarter up 200 basis points compared to the prior year and in line with our expectations. We remain focused on managing the pricing, incentives, and sales pace in each of our communities during this uncertain environment to optimize the return on our inventory investments and adjust to local market conditions and new home demand. If economic conditions remain difficult and the recent decline in new home demand persists we expect that our gross margins will decline from current levels. Bill?

In the second quarter home building SG&A expense as a percentage of revenues was .3% down 70 basis points from 9% in the prior year quarter. 55 basis points of the reduction in SG&A this quarter related to a decrease in the liability for our employee deferred compensation plan resulting from the decline in the stock market during the quarter. Our home building SG&A expense as a percentage of revenues is at its lowest point in our history and we remain focused on controlling our SG&A while ensuring that our infrastructure appropriately supports our business. Mike?

We ended the second quarter with 33,400 homes in inventory. 16,700 of our total homes were unsold of which 4,700 were completed. We also had 1,900 model homes at the end of the quarter. We are cautiously managing our inventory of homes under construction relative to demand in each of our communities by controlling our construction starts of unsold homes and closely monitoring the number of unsold completed homes in inventory. At March 31st our home building lot position consisted of approximately 330,000 lots of which 36% were owned and 64% were controlled through purchase contracts. 32% of our total lots are finished and at least 54% of our controlled lots are or will be finished when we purchase them. David?

Our second quarter home building investment in lots land and development totaled 1 billion dollars of which 460 million dollars was for finished lots 350 million dollars was for land development and 230 million dollars was for land. Beginning in late March we have temporarily stopped our purchase of raw land and we are closely managing all finished lot purchases and development spending. We are also working closely with our third party lot developers including 4 Star to adjust the timing of our take down schedules to match current demand levels. Mike?

4 Star, our majority owned subsidiary, is a publicly traded residential lot manufacturer operating in across 21 states. At March 31st 4 Star's lot position consisted of 52,300 lots of which 35,800 are owned and 16,500 are controlled through purchase contracts. 80% of 4 Star's own lots are already under contract with D.R. Horton or subject to a right of first offer under our master supply agreement. 4 Star is separately capitalized from D.R. Horton and has approximately 790 million dollars of liquidity which includes 440 million dollars of unrestricted cash and 350 million dollars of available capacity on its revolving credit facility. During the quarter 4 Star issued 300 million dollars of 5% senior notes due to 2028 and repaid 119 million dollars of .75% convertible senior notes in cash at maturity. At March 31st 4 Star's net debt to capital ratio was .5% and their next senior note maturity is in 2024. With low leverage, ample liquidity, and its relationship with D.R. Horton 4 Star is in a very strong position to navigate to these uncertain economic conditions. Jessica?

Financial services pre-tax income in the second quarter was $24.7 million with a pre-tax profit margin of .6% compared to $34 million and .5% in the prior year quarter. In late March and April our mortgage company experienced lower pricing and gains on sales of mortgage loans and servicing rights due to disruption in the secondary mortgage market. Many purchasers and servicers have limited their purchases and tightened their credit standards due to liquidity and operational challenges caused by COVID-19 and the uncertainty of the impact of forbearance provisions from the CARES Act. We are closely monitoring developments in the mortgage markets and are prepared to make adjustments in our operations to adapt to further changes in market conditions. For the quarter, 98% of our mortgage company's loan originations related to homes closed by our home building operations and our mortgage company handled the closing of our mortgage company. We are also financing for 67% of our home buyers. FHA and VA loans accounted for 48% of the mortgage company's volume. Borrowers originating loans with .H.I. Mortgage this quarter had an average FICO score of 720 and an average loan to value ratio of 89%. First time home buyers represented 53% of the closings handled by our mortgage company reflecting our continued focus on offering homes at affordable price points. David?

.H.I. Communities is our multifamily rental company focused on suburban garden style apartments with operations primarily in Texas, Arizona, and Florida. During the quarter, .H.I. Community sold an apartment project in Florida for $67 million and recorded a gain on sale of $28.2 million. This was .H.I. Communities' fourth project sale and it was the final sale we were expecting this year. .H.I. Communities has three projects under active construction and one project that was substantially complete at the end of the quarter. We are continuing lease-up and construction of these four projects but are delaying new acquisitions and deferring starting construction on other projects until we have clear visibility into market conditions. .H.I. Communities' assets totaled $203 million at March 31st.

Bill? Our balanced capital approach focuses on being disciplined, flexible, and opportunistic. Our strong balance sheet, ample liquidity, and low leverage provide us with significant financial flexibility to withstand difficult economic conditions and we plan to maintain our disciplined approach to investing capital to enhance the long-term value of our company. During the first six months of fiscal 2020, our cash provided by home building operations was $52 million compared to $216 million of cash used in the prior year period. At March 31st, we had $2 billion of home building liquidity consisting of $1 billion of unrestricted home building cash and $1 billion of available capacity on our home building revolving credit facility. Our home building leverage improved 370 basis points to 19.2%. The balance of our home building public notes outstanding at the end of the quarter was $1.9 billion and we have $400 million of senior note maturities in the next 12 months. At March 31st, our stockholders' equity was $10.5 billion and book value per share was $28.77, up 15% from a year ago. For the trailing 12-month period ended March 31st, our return on equity was .1% compared to .6% a year ago. During the quarter, we paid cash dividends, $64 million and our board has declared a quarterly dividend at the same level to be paid in May. We also repurchased 4 million shares of common stock for $197 million. Our outstanding share count was down 3% year over year. We plan to cautiously manage our level of share repurchases in the near term to maintain financial flexibility until we have better visibility to future market conditions and our expected operating results. Jessica?

As we mentioned in our press release, we have withdrawn our previously issued fiscal 2020 guidance due to the current uncertainty in the U.S. economy and our business operations resulting from COVID-19. We expect to provide new annual guidance when we have clearer visibility into our business and market conditions. David?

In closing, our results reflect the efforts of our dedicated operational teams who continue to provide homes to families across the United States. We are well positioned to effectively operate in this uncertain environment with our experienced team, industry-leading market share, broad geographic footprint and diverse product offerings. Our strong balance sheet, capital liquidity and low leverage provide us with significant financial flexibility to withstand difficult economic conditions and we plan to maintain our disciplined approach to investing capital to enhance the long term value of our company. Thank you to the entire Deo Horton team for your focus and hard work. Your efforts and positive, caring spirit during this unprecedented time have been remarkable. We are proud of your work ethic and creativity in finding ways to safely continue helping our customers close on their much anticipated new homes. This concludes our prepared remarks. We will now host questions.

Thank you. If you would 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 would 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. Please ask one question and one follow-up question and then re-queue for additional questions. Our first question is from John Lovallo with Bank of America. Please proceed.

Hey guys, thank you for taking my call and I hope everyone is doing well. First question is, can you just help frame the magnitude of the improvement or in-order activity over the past two weeks, maybe on a -over-year basis? I mean, are we talking about kind of down mid-single digits? Is it closer to flat -over-year? Any color would be helpful.

John, this is Bill. We're commenting on specific weeks. From week to week, sales, you know, gross sales, can activity, net sales can be quite volatile. So we provided our commentary on a -to-date basis because we feel like that's the most representative information that we can provide. We did indicate that our cancellation level has remained elevated into April, which obviously affects net sales as well.

Okay, I understand. And then maybe just in terms of the order decline in April, were there any particular regions that stood out, you know, maybe on a positive or, you know, on a negative basis? And then, you know, in the regions that are starting to open up in some of these states, are you guys doing anything different in preparation there?

Good morning, John. This is Mike. We've seen probably Texas and Florida hold up pretty well, but I would say every market is down and down, you know, fairly consistently outside of Texas and Florida. It's been a pretty broad base impact.

Got it. And then are you guys doing anything different in some of the states that are planning to open early?

Well, fortunately, as we mentioned in our prepared remarks, residential construction has been designated an essential business as part of critical infrastructure. So we really haven't been heavily impacted in terms of shutdowns. The biggest place we would have been impacted is Seattle, since the state of Washington did not consider residential construction as part of an essential business. The state of Washington was about 3% of our closings in calendar 2019. And then the other areas that have been, you know, quote, shut down for construction has been the Bay Area, New Jersey, and Pennsylvania. And when you combine those with the state of Washington, we're still only around 4% of our closings last year. So really, the biggest impact has more been on just the ability to interact with consumers face to face as we want to make sure we comply with social distancing protocols. So majority of our offices, our sales offices are by appointment only. Our trades are limited to one trade per job site at a time, among numerous other new operational protocols we've put in place, which has slowed our build cycles and impacted the business. But by and large, the true shutdowns have happened mainly in markets where we don't operate heavily.

Thank you guys.

Our next question is from Carl Richard with DTIG. Please proceed.

Thanks very much. Hope everyone's safe and well. My first question is on pricing and incentives. And maybe you could talk generally, Abe or whoever would like to, about generally how you're looking at pricing and incentives now, where you've adjusted, what kinds of pricing and incentive adjustments you've made, and how consumers are responding to them.

Carl, this is David. We were responding, I guess, community by community. We've kind of reset expectations on absorption, rerun, pace. Again, it kind of gets old saying, but to me it's a flag by flag operation. You've got to maintain a certain level of pace. And we adjust the incentives to maintain that pace. So reality is Texas, Florida have held up better, given all the constraints. And really after the shock of the first couple of weeks, our people out there have kind of got a rhythm and figured out how to sell houses. And all in, from my perspective, things are better than I had, than I was concerned they might be.

Thanks, David. And then as a follow-up, can you talk a little bit about construction cycle times? If your supply chain has struggled at all, from a labor flow perspective, we've heard mixed things about labor availability, obviously social distancing, making it harder to get houses up. And then of course, inspection delays, things like that. What percentage of your cycle time has increased if they have in terms of sort of start to see about? Thanks a lot.

Thanks, Carl. This is Mike. We haven't really seen a lot of the cycle time changes coming through in the data yet, because these are fairly recent operational changes that we've made in the field, both ourselves and a lot of our governing municipalities with the cadence of inspections. So we'll let you know as we see those trends develop through the quarter, what they actually work out to be. I've been very impressed with our teams and their ability to to keep each other safe and respond to demand for housing and be out there building with labor. We see a lot of our labor onsite wants to work. We've not had a seeing lots of labor shortages at all. I've not been able to travel like I normally have, so I haven't seen as much coming into this call as I would have in prior calls. But driving the Dallas-Fort Worth markets, I've seen a lot of activity, the trades, a lot of signage around in our neighborhoods and other neighborhoods about maintaining social distancing and seeing a lot of our labor activity being executed with people not heavily congregating in the streets or on the job sites. So I've been very pleased with that and very pleased with the pace that we've been able to maintain in our communities.

Thanks Mike.

Our next question is from Stephen Kim with Evercore ISI. Please proceed.

Yeah, thanks a lot guys. Appreciate all the information and likewise hope you guys are staying safe. David, I wanted to follow up on the comment you mentioned made about how the tone of business thus far has been a little bit better than you would have initially feared it might be. And your indication that orders improved in the last two weeks prior to the previous four, relative to the prior four weeks. Is it fair to say that in what you have observed is that this increase was not driven by pricing actions but by something else? And if the latter, what do you think that surprising strength was related to?

Stephen, I like everybody else, you know, was a news junkie coming when this thing first broke and you turn on the president's briefing and you know the world's going to end. And so you kind of get hunkered down mentality and as news has come out more and more and more, you know, it just you get a sense that it's not going to be as bad as the initial thought might have been. And you know the key, I guess to me there's two things that really separate us from everybody else. It's the people we have out there representing the brand and then it's just the price points. And you know people want to be in a house right now. And by being affordable we have more opportunities to put them in a house than you know our competitors. So that to me is probably the, you know, the mood of the country seems to have improved significantly over the last 30 days. And our ability to kind of manage the process through systems and communications and just being more comfortable I think has given us a lot of an opportunity to make things happen. So I mean this is unprecedented times.

No doubt. But it's certainly encouraging that you're seeing what you're seeing in even in advance of many parts of the, well almost any part of the country really opening up, which I guess began this past weekend. My second question relates to cancellations and in sort of tempering your commentary on the orders and proving you, you mentioned the cancellations tend to be clustered in the last few days of the month. I was curious if you could give us a sense for roughly how much of the cancellation activity occurs in those last few days. Are we talking like three quarters of your monthly cancellations occur? Are we talking more like you know 25%? Just dimensionalize that for us a little bit. And in general are those cancellations that you have been seeing, the degree to which you have been seeing them already, are they tied to mortgage credit standards tightening or is it tied to something else as far as you can tell?

I think it's just timing. You know everybody wants to, our sales agents want to see people close, the buyers want to close. You push through on the credit to get to a closing point. And you know majority in this industry, the majority of people close the last week of the month. And when you're bringing everything to the point of closing, things fall out. And whether it's a cancellation or a push to the next month, that tends to happen. Now the percentage, I don't have any idea. I mean we have been very purposeful in making sure that our buyers in our backlog are going to be in a position to close. So historically that number may be -20% the last week. I don't know, maybe a little more. That's just not anything I track. It's just, go ahead Jessica, sorry.

And clearly right now you know it's always true that more happen at the end of the quarter, but we're anticipating there could be even more right now due to the ultimately qualify for the mortgage. So are we going to have some fallout because of tightening credit standards? Potentially I think the bigger driver right now is just job loss and loss of income certainty. And so there's a lot of buyers that are canceling because of some sort of impact of COVID-19 that's out of their control. And so I think that's the main driver for us putting that cautionary language in there. There are still a few more days in April and we just don't know.

This is phenomenal. We do see every month and we saw it at the end of March. We did see it at the end of March. There was definitely a higher level of cans around the last days of the month of March.

And David touched on it before is that most home buyers are trying to schedule their home closing towards the end of the calendar month because of the way their prepraised and the escrows are funded. It reduces their -of-pocket cash requirement and so the outside realtors often advise that. So we see more of our closings in a given month scheduled, trying to be scheduled by the buyers and their realtors for the last week of the month. As you bring those things together at the end of the month, that's when you find out you might have had an outside lender who could not get mortgage taken care of or something happens. It just a lot pushes all at once. And so that's why we added the language to the press release and to our commentary this morning.

Yeah, that's encouraging. That's very helpful. I mean, I suppose it's encouraging that the credit standards have already tightened and hopefully they don't tighten a whole lot more from here, which would obviously help. But that's a very great call. I appreciate it and good luck with the rest of the quarter.

Thank you, Steve. Our next question is from Alan Ratner with Zelman and Associates. Please proceed.

Good morning, everybody. Thanks for all the info. Glad to hear everyone's doing okay and congrats on the strong performance so far in this difficult environment. My first question, historically, specs have accounted for I think about 70 to 80 percent of your sales and just in terms of that level of homes that started as a spec home. You might have sold it at various points of the construction. So I guess I'm a little bit curious how your specs starts have been trending. First, I guess, is there any reason to think that that percentage might move lower here just given some change in strategy that you guys might be imparting on? But the question is how much are your starts down year over year for April? Because that, I guess, in my mind should be a fairly good leading indicator of what future order activity might look like.

Alan, we don't have the April starts month to date number here with us. We can probably follow up with you on that or certainly by the end of the quarter we'll be putting that information out for the starts. But we're managing our spec strategy the same way we always have. It's at a community by community level measuring demand in that community and looking at what inventory is available today, the construction status of that inventory and seeing what needs to be available for those buyers in that given community. So that's a very local decision that our teams are making on a daily and weekly basis. It's nothing we're anticipating changing at this point in time. We are obviously looking at what we would call a build job, making sure that that buyer is still committed to the home before we start the house. If there's anything unusual with that house that it wouldn't otherwise be acceptable as a spec, if something happened to that buyer contract, we'd be happy to have that home and inventory to sell to another buyer if need be. That happens from time to time as well.

So we would anticipate the 70 to 80 percent that you reference not changing. What we have done is slow our start pace to match the reduction in current demand levels and we'll continue to make those adjustments community by community.

Got it. Yeah, that's what I was trying to get at is if that slowing of the starts, you know, it's tracking, you know, call it somewhere down 10 to 15 percent, kind of what you're experiencing on the orders or for some reason, you know, it's coming in lower than that. But you can follow up with me on that if you don't have the data handy. So second question, if I could just on the mortgage data you guys provided, I'm curious if you have any additional granularity there. You know, we've heard some tightening specifically on FHA VA, which is about half of your business, you know, below certain FICO scores, whether that's 640, 660. I'm not sure if there's a magic cut off from the investors you're dealing with, but do you have the percentage of your business that falls below, say, a 660 FICO score? And, you know, does the piece of your business that your mortgage company does not capture the 30 percent plus, does that profile look any different?

So I don't have insight to the outside mortgage company. But when you look at our inside mortgage company, we've been running about a 720 FICO score on average, and even our express buyers been around 700 to 710. So do we have some buyers that fall in the band you're talking about? Sure. But it's not a large piece. And typically our mortgage company does a fantastic job of when those credit overlays and changes in terms of FICO scores happen, working to figure out a different mortgage product to get that buyer into. So it's not generally 100 percent fallout, although there can be some fallout.

Got it. That's helpful. Thanks, guys. Good luck. Thank you, Ellen.

Our next question is from Michael Renaut with JP Morgan.

Please proceed. Thanks. Good morning, everyone. And congrats on the results so far. And also hope everyone's safe across the DR Horton organization. The first question I had was trying to look at or think about the April results from a different angle. Obviously very encouraging in terms of the down 11 percent, even with perhaps even a higher can rate in the last few days, expected. When you think about that relative to competitor reporting last week in terms of a sharper fall off in April and other companies talking about even more challenging March quarters. So I'm trying to get a sense. I was wondering if you could comment around how you guys are operating or perhaps how your positions that has allowed for the better results versus several of your peers, whether it be price point or you had also mentioned that if the current demand level persists, you'd expect gross margins to contract. I'm curious if the relative outperformance versus some of your peers and some of the stats is driven by existing, again, price point or geographic exposure or if you have made some more aggressive adjustments in your pricing or incentives. That's my first question.

Thanks, Michael. I completely appreciate the question. And I will say that I am most impressed with David mentioned for the teams of people we have out there that are operating that are empowered to make decisions at the local level. And they're generally operating a business model that has inventory on the ground. It has specs, quick move in homes that are available. And we're seeing a buyer come to us that may have been looking for an existing home and that's a very challenging transaction to make happen today. And so we're seeing some benefit of that and working with our real-time relationships, able to execute against that and bring those buyers to a new home situation where we have inventory on the shelf, ready to go. As David mentioned before, we are generally positioned to be an affordable option for the buyers in the markets. And finally, we're very encouraged by the level of activity we've seen the more recent weeks in April and that there are people out there that want a home and are able to qualify to get their contract for this home. And very enthusiastic as we see in watching our social media as those buyers are super excited about the home they're able to acquire at this point in time.

In terms of incentives, which I think was the other piece of your question, we have started utilizing just the typical incentives we would in a period of market weakness. So generally that will include higher co-broke commissions, more dollars towards closing costs if you use our internal mortgage company, and then just the array of employees that our marketers come up with in terms of free-fridge Friday, throwing in backyard landscaping, a lot of different things that they can just repackage from week to week to where it's not necessarily a bigger hit to gross margin down the road, but it drives buyer urgency to get a different incentive out there from week to week or month to month. So we have started to utilize a slightly higher level of incentive because of the market weakness, but that's what we would typically do in this kind of environment. And

oftentimes that's very helpful to energize and motivate our internal sales agents in their activity and their outreach program. So that's one of the reasons we would generally do activities like that.

Now that's helpful. And again, clearly your relative performance is impressive either way you look at it. So congrats on that. I guess the second question, also perhaps along these lines but from a different angle, is 4-star, as you had alluded to the results in your prepared remarks, they reported last week one interesting data point that they had was roughly only about 150 lot deliveries in the month of April or so far in April versus a rate of 650 to 700 in the February-March month. And so obviously that kind of points to a much sharper fall off, more similar perhaps to some of the other competitors that I alluded to before in terms of the fall off in order pace that they had been seeing. So I was just kind of curious, I was hoping perhaps you could reconcile how your April results have held up much better than that. Obviously as DR Horton is the major overwhelming customer of 4-star, if they are, if you guys aren't seeing as that type of a degree of magnitude of fall off, why has the 4-star lot deliveries fallen so much more dramatically?

Sure Michael, this is Bill. It's really a matter of timing. And as 4-star pointed out on their call, they're working with each of their builder customers, obviously we are the majority of their deliveries right now. And it's a matter of sitting down community by community, looking at the inventory levels of lots that the builder currently has, looking at the revised expectations of pace, and then determining the timing of what take downs need to be adjusted to. And so for the first few weeks post the change in the market conditions, it's really a matter of, I think everyone hits the pause button for just a short period of time to reassess. And so pushing out take downs will most affect the first month. And I think that's where 4-star is, but as we work through our adjustments, we would expect that their take downs would become more steady going forward. And it's going to be community by community really as we work our way through this. So there is a timing difference on lot purchases relative to sales, but ultimately to the extent that we're delivering, we're purchasing most of their lots, ultimately 4-star's pace will ultimately match or start to approximate Horton's after a period of time.

Any of those adjustments and delays related to a change in strike price for those lots, or is it more primarily driven within a degree around timing of the take downs? It's

primarily timing. That's the initial adjustment is to adjust to the pace community by community. So it's vast majority of adjustments are all in timing.

Great. Thank you very much.

Our next question is from Truman Patterson with Wells Fargo. Please proceed.

Hi. Good morning, everybody. And thanks for taking my questions. I'm glad to hear you all are safe and healthy. First, on SG&A, you had a very good number this quarter, great control. Could you just run through the drivers of this? And then also, looking forward, how are you all planning to adjust headcount going forward or whether or not you are planning on adjusting any headcount?

As Bill indicated on the call, the main driver of our year over improvement, our SG&A was down 70 basis points. 55 basis points of that was due to a decrease in the liability for our deferred comp plans for employees resulting from the significant declines in the stock market this quarter. So really only 15 basis points of the improvement was true leverage from the improved volumes we've seen in the market. And then, I think Michael Bill is going to chime in on your other question.

On the headcounts, Truman, I would say that we are continually looking for ways to be as efficient as possible in the business. Right now, we don't have any broad-based layoff or headcount adjustment plans. We're responding to what we see in demand in the marketplace, and we will continue to do that market by market. Our most important asset are the teams, the people that we have out there in the field, and we've done a lot of work over the past 12, 15 years positioning the company to prepare for whatever economic situation that we're forced to navigate through. And our people are the most important part of helping us get through all this.

We have in the near term instituted a hiring freeze just during the current market uncertainty.

Truman, as you well know, we're a very overhead conscious company, and we're at actually the lowest point in our history in terms of SG&A as a percentage of our revenues. And so clearly, we know how to manage our overhead relative to our revenues, and as we see where things go on a local basis moving forward, you can count on us to manage it well.

Okay. Okay. And then just jumping over to capital allocation, you guys have a billion in cash, two billion in liquidity. Assuming that the market just stays down and we'll call it 10 to 15 percent range moving forward, do you think you'd be able to restart the share repurchase in relatively short order? And then also jumping over to the M&A environment, I realize that's probably too soon, but have you seen any increase in potential deal flow or any kind of distress builders out on the market?

I'll start with the share repurchase question. Truman, as we stated, we are cautiously managing that. It's too early to say exactly when or how we might be able to address that going forward. Base case, we would not expect to repurchase any shares in our third quarter as we assess market conditions and we see how things progress. But we do expect to maintain a balanced capital allocation over the long term, and we are focused on investing in our business, maintaining a strong balance sheet, maintaining a flexible position, and still delivering strong returns to our shareholders.

And then Truman, to the comment on M&A, I do believe it is still a bit early in the situation to see any opportunities that may present as a result of the most recent market change. But we continue to evaluate opportunities generally with smaller private builders that are complementary to our platform in various markets or product offerings. So, but we'll continue to evaluate opportunities as they present. It's nice to have the capital to make those decisions to invest in the business.

I'll just add, even though we're very happy with what we're seeing today, these are uncertain times and nobody really knows what the ultimate impact of all this is going to be. And being in a very liquid, deleveraged, de-risk position, I think will afford a lot of opportunity for, in the event that there is a distressed situation out there down the road. So we're looking at liquidity, deleverage has a very strong competitive advantage for us today.

Okay, thank you all. I appreciate that.

Our next question is from Matthew Boulay with Barclays. Please proceed.

Hey, good morning. Thank you for taking my questions. I hope everyone's well. Thanks for all the detail. So I wanted to ask on the construction labor side and maybe thinking a little more medium term, I think there's sort of a debate out there around perhaps increasing availability of labor that could emerge in the coming months as industry volumes come down and perhaps there's a wider pool of labor just given the unemployment situation we've seen across the market. What are you guys hearing on that front? Are you seeing the subs perhaps trying to attract additional labor here? Just how are you thinking about whether that labor tightness we've seen over these past few years will continue? Thank you.

Matthew, as you mentioned, if there's a reduction in the activity level of the industry broadly, that would create more labor available for the remaining starts that are out there. And then obviously if unemployment levels stay at elevated rates, that would create the opportunity to attract more people to the construction trades if they are as builders or starting homes. So we've seen adequate supply of labor largely from our long relationships and large market positions. We've not been heavily constrained with our labor and I expect that going forward we'll continue to be able to partner with those people and perhaps with additional labor available to us in a given market, we can create some other efficiencies for us.

Okay, understood. And then I wanted to follow up on the orders month to date, the down 11%. Any sense of how that shakes out by buyer group? I guess specifically what you're seeing with the entry level buyer through all this?

It's really been across the board in terms of reductions in demand. So a little too early for us to parse exactly if there's one buyer type that ultimately is going to be hit harder by the overall impact of what the whole world's going through right now. Right now it has just been broad-based declines in demand across all price points and buyers.

All right, thanks again everyone.

Our next question is from Susan McElary with Goldman Sachs. Please proceed. Thank you,

good morning.

Good morning.

My first question is just can you talk a little bit to what you're seeing in terms of input costs? Have you seen any deflation maybe coming through or how are you thinking about that as you look over the next few quarters?

Susan, our team's done a really good job of keeping control of the input costs for materials, especially. We've seen our stick and brick costs per square foot basically that it's been flat as a percentage of revenue sequentially and year over year this quarter. And so with that we've been really good. We've got national agreements in place with a significant portion of our manufactured materials that have been able to give us very strong pricing in the market. But we've not seen any significant deflationary effects come through yet.

Okay, thanks. And then you know looking a little bit further out perhaps thinking about what's going on on the ground, do you expect that there could be a shift or a material shift in your buyer segments and the breakout of the business? And what could that potentially mean as we think about maybe the margins and some of the trajectory on that going forward?

I see we're just going to continue to focus on homes at affordable price points. So that doesn't necessarily only mean entry-level buyers. We want to make sure we have an affordable or at least a value-priced product offering across our entire family of brands. I think a core piece of our business will always remain the entry-level first-time buyer because there's just such a big population. And clearly the more affordable you can be, the bigger that pool is of potential buyers. So really the focus for us isn't necessarily a specific demographic or buyer type. It's just being affordable across multiple price points and product offerings.

Okay, thank you.

Our next question is from Mike Dahl with RBC Capital Markets. Please proceed.

Good morning. Thanks for taking my questions. First question, just on the lending side, I think David, you mentioned kind of purposefully managing the backlog with respect to just getting visibility on the ability to close. But at the same time, everyone's pushing and invested in taking it as far along and as close to the finish line as possible. And I think, Jessica, you mentioned that job loss or income uncertainty has been the main driver of cancellation so far. But when we think about the three buckets of kind of broad issues, you've got job loss, you've got income loss or DTI issues, and then you've got the other credit standards. Maybe you'd bucket those slightly differently. But when you think across those, what percentage of your backlog have you been able to actively verify all three of those buckets or all necessary closing conditions at this point?

Mike, this is Bill. We're probably not going to have specific percentages on that. We do turn our backlog rather quickly because our backlog conversion rate was over 100% this quarter. So we do see fairly quickly with our spec strategy, we're selling homes during the process, we're getting to a scheduled closing date probably relatively quickly. And so we're essentially six weeks into this change, this significant change in market conditions. We've probably worked through a very good portion of the backlog. And as we work past the end of the month of April, I think there's another step in that process where we'll see really an appreciable move in terms of scrubbing the backlog. After we really get past the month of April, I would say largely, we will have a pretty good feel for where we stand with our backlog because a lot of our contracts, the union backlog at that point, will have been entered more recently. Not 100%, but more recently. And buyers who are signing new contracts after the beginning of the pandemic are probably looking at things a little differently than those that were in backlog prior to.

Okay, thanks. And my follow-up question, still on the lending side, when we look at mortgage loans held for sale, those are up over 70% year on year on the balance sheet. And clearly, revenues are only running up 10% for the quarter, potentially lower going forward. So can you explain that differential? Are you effectively underwriting more risk or balance sheeting more risk in order to get loans done today? Or what else explains that move?

No change in those factors. Our volume increase on the home building side is one factor. Also, our mortgage company is now capturing, their capture rate of mortgages in the builder business has increased significantly over the last year or so. And so the mortgage loans held for mortgage originations volume by our mortgage company is much stronger than actually our home building revenues.

Yeah, at this point, April, we've effectively sold all of our March loan originations from the mortgage company. So no change there. Servicing and loans.

So the data point on the capture rate, today, their capture rate for the second quarter was 67%. I think that might be the highest quarterly capture rate we've reported for the mortgage company. They've been actively working to capture more of the builder business. So that's been purposeful. And that compares to only a 56% capture rate last year at this time.

Okay, got it. So to be clear, I guess you are not underwriting any loans at this point that would not be eligible or from a practical standpoint can be sold into the secondary market with current standards.

Correct. We're continuing to underwrite virtually everything as agency eligible.

Okay, great. Thank you.

Our next question is from Ken Zimmer with KeyBank Capital Markets. Please proceed.

Good morning, everybody.

Good morning. Morning,

Ken. So, Jessica, can you guys talk about how many of your orders in two queue were interquarter closings? And if that shifted, and if you have it for April, that'd be great. But if you saw something shift in March versus that overall quarterly rate?

I don't have it for the quarter or for I don't have it for March or April specifically, Ken, but for the quarter, we sold and closed 48% of our homes in the same quarter, which was up from 40% sequentially and up from 45% year over year. So, you know, we did have a very strong backlog conversion rate, which is why you would anticipate that two of the more sold and closed in the same quarter this year than last year at this time.

Yep. So, the reason I asked that question is, and the trend seems to be that you closed more based on what you just said. Therefore, your pre-build approach, which obviously helps to turn your assets faster, also allows you to compete with the existing market. So, my question is, with your 33,400 units under construction, being that you're in two queue, done with two queue, historically, you close about 95%, give or take a couple points, of your under construction over the next six months. Therefore, it seems, and your comments don't seem to be that closing is the issue. You haven't really talked about a lot of construction delays, Bill, Michael. So, it seems like I understand you called guidance. So, would your concern more be about margins or, I mean, you have your units under construction. So, is it just, David, is it just that the demand might disappear, or I mean, is it just that it's so wise to not offer guidance and then potentially miss it? I mean, you have these units under construction, and it seems like your closing units, you've finished. So, where's the real volatility, you think, in your normal cadence of closings disappearing versus margins versus demand fading?

I would just say that this has been an unprecedented event taking place, and we're managing through the process and responding to what we see. So far, I would say it has been a better environment because of the, I think, primarily because the way we are positioned with inventory and with the very creative and energized sales force out there. And as we get more clarity, and as we get more clarity, I think we will probably share that with you. But, you know, it's just an unprecedented time.

David Morgan Yeah, no, I think it makes sense. It's just that it seems though your closings won't be off that much given you already have these units under construction and you're still closing a lot of units. And, you know, with your pre-billed model, it helps. So, totally understand. Thank you very much for your time.

Operator We have reached the end of our question and answer session. I would like to turn the conference call back over to David Holt for closing remarks.

David Holt Thank you, Sherry. We appreciate everyone's time on the call today and look forward to speaking with you again in July. And to the Dior Horton team, stay safe, stay strong. You are proving once again you are the best in the industry. Don Horton and the entire executive team, thank you for all you do every day. Have a great day.

Operator Thank you. This concludes today's conference. You may disconnect your lines at this time. And thank you for your participation.