D.R. Horton, Inc.

Good morning and welcome to the third quarter 2020 earnings conference call for D.R. Horton, America's builder, the largest builder in the United States. At this time, all participants are in listen-only mode. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Jessica Hansen, Vice President Investor Relations for D.R. Horton. Jessica, please go ahead.

Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the third 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 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 subsequent reports on Form 10-Q, all of which are or be filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at .drhorton.com, and we plan to file our 10-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 Ault, our president and CEO.

Thank you, Jessica, and good morning. 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 would like to first again express our gratitude to our country's dedicated field of healthcare workers and to all who are on the front lines caring for our communities. Our thoughts remain with those affected by this pandemic, and our priority continues to be the health and safety of our employees, customers, trade partners, and the communities we serve. During the latter part of March, the impacts of COVID-19 and related widespread reductions in economic activity across the United States began to negatively affect our business. During April, when restrictive -at-home orders were in place for most of our markets, our sales orders decreased and our cancellations increased, and our April net sales orders were 1% lower than a year ago. However, as restrictive orders began to be lifted across many markets and economic activity resumed, our sales increased significantly and our cancellations rate returned to normal levels. In both May and June, our net sales orders increased by more than 50% compared to the last year, resulting in a net sales order increase of 38% for the quarter. We sold 5,931 more homes this quarter than the same quarter last year, positioning D.R. Horton to achieve further gains in market share and scale. We have continued to see strong increases in net sales orders in July compared to the same month last year. Despite the disruption from COVID-19 on our operations, the D.R. Horton team delivered a record third quarter, including net sales orders of 21,519 homes, a 25% increase in consolidated pre-tax income to $782 million, and a 10% increase in revenues to $5.4 billion. Our pre-tax profit margin for the quarter improved 170 basis points to 14.5%, while our EPS increased 37% to $1.72 per diluted share. Our home building return on inventory for the trailing 12 months into June 30 was 21.6%, and our consolidated return on equity for the same period was 19.9%. While housing market conditions are very strong today, we remain cautious as to the impact of COVID-19 may have on the overall economy and our operations in the future. We believe our strong balance sheet, liquidity position, and experienced operating teams position us very well to operate effectively through changing economic conditions. We plan to maintain our flexible operational and financial positions by generating strong cash flows from our home building operations and managing our product offerings, incentives, home pricing, sales space, and inventory levels to optimize and return on our inventory investments in each of our communities based on local housing market conditions. Mike?

The diluted earnings per share for the third quarter of fiscal 2020 increased 37% to $1.72 per share compared to $1.26 per share in the prior year quarter. Net income for the quarter increased 33% to $631 million compared to $475 million. The current quarter results included income tax benefit of $38.1 million related to federal energy efficient home tax credits that were retroactively reinstated earlier in the year. Our third quarter home sales revenues increased 10% to $5.2 billion on 17,642 homes closed up from $4.7 billion on 15,971 homes closed in the prior year. Our average closing price for the quarter was essentially flat with last year at $295,200 and the average size of our homes closed was down 3% reflecting our ongoing efforts to keep our homes affordable. Bill?

Net sales orders in the third quarter increased 38% to 21,519 homes and the value of those orders was $6.3 billion up 35% from $4.7 billion in the prior year. Our average number of active selling communities was essentially unchanged from both the prior year and sequentially. Our average sales price on net sales orders in the third quarter was $294,500 down 2% from the prior year primarily due to a decline in the average sales price for our West region as more of the region's mix shifted to our entry level express brand during the quarter. The cancellation rate for the third quarter was 22% up from 20% in the prior year quarter. Our net sales orders in both May and June increased by more than 50% compared to the prior year periods. We believe the increase in demand after April has been fueled by increased buyer urgency due to lower interest rates, the limited supply of homes at affordable price points and to some extent pent up demand. We were and remain well positioned for this increased demand with our affordable product offerings, lot supply and housing inventories particularly completed homes and those close to completion. Jessica?

Our gross profit margin on home sales revenue in the third quarter was 21.6%, up 30 basis points sequentially from the March quarter and up 130 basis points compared to the prior year quarter. We remain focused on managing the pricing, incentives and sales pace in each of our communities to optimize the return on our inventory investments and adjust to local market conditions and new home demand. We currently expect our home sales gross margin in the fourth quarter to be similar to the third quarter, however, there is uncertainty regarding the future impacts of COVID-19 on the economy and new home demand which could negatively impact our gross margins in the future. Bill?

In the third quarter home building SG&A expense as a percentage of revenues was 7.9%, down 20 basis points from .1% in the prior year 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 third quarter with 32,800 homes in inventory, 12,700 of our total homes were unsold of which 2,900 were completed. We also had 1,900 model homes at the end of the quarter. Due to our significant increase in sales in May and June, the portion of our backlog that is not yet under construction is higher than normal and our number of completed unsold homes is lower than in recent years. As a result, we have accelerated our pace of home starts across most of our communities to ensure we maintain an adequate number of homes. At June 30th, our home building lot position consisted of approximately 335,000 lots of which 34% were owned and 66% were controlled through purchase contracts. 32% of our total owned lots are finished and at least 52% of our controlled lots are or will be finished when we purchase them. Our current lot portfolio includes an ample supply of lots for homes at affordable price points and continues to provide us a strong competitive position. David?

Our third quarter home building investment in lots, land and development totaled $1.1 million of which $390 million was for finished lots, $380 million was for land development and $290 million was for land. $180 million of our land and lot purchases in the third quarter were from 4Star. After slowing our lots and land and development investments in March and April, we have since increased our pace of investments to ensure we maintain an adequate number of finished lots to support our home construction pace. Bill?

4Star, our majority owned subsidiary, is a publicly traded residential lot manufacturer operating in 51 markets across 22 states. Our strategic relationship with 4Star as a well-capitalized lot supplier across much of our operating footprint is serving us well during this volatile time and is presenting opportunities for both companies to gain market share. 4Star is delivering on its high growth expectations with revenue growth of more than 200% and net income growth of 80% fiscal year to date in 2020. At June 30th, 4Star's lot acquisition consisted of 50,700 lots of which 38,300 are owned and 12,400 are controlled through purchase contracts. 77% of 4Star's own lots are already under contract with Deer Horton or subject to a right of first offer under our master supply agreement. 4Star is separately capitalized from Deer Horton and has approximately $700 million of liquidity which includes $350 million of unrestricted cash and $350 million of available capacity on its revolving credit facility. At June 30th, 4Star's net debt to capital ratio was .2% and their next senior note maturity is in 2024. With low leverage, ample liquidity and its relationship with Deer Horton, 4Star is in a very strong position to navigate through changing economic conditions and continue to grow their business. Jessica?

Financial services pre-tax income in the third quarter was $68.8 million with a pre-tax profit margin of .9% compared to $48.1 million and .2% in the prior year quarter. Despite the disruption in the secondary mortgage markets in March and April caused by COVID-19 and the uncertainty of the impact of the CARES Act, our mortgage company has continued selling the mortgages it originates at strong net gains. We began retaining servicing rights on some of our FHA and VA loan originations during the third quarter due to disruptions among mortgage servicers and we will continue to monitor developments in the mortgage markets and adjust our operations to adapt to changes in market conditions. For the quarter, 97% of our mortgage company's loan originations related to homes closed by our home building operations and our mortgage company handled the financing for 71% of our home buyers. FHA and VA loans accounted for 53% of the mortgage company's volume. Borrowers originating loans with DHI mortgage this quarter had an average FICO score of 718 and an average loan to value ratio of 91%. First time home buyers represented 57% of the closings handled by our mortgage company reflecting our continued focus on offering homes at affordable price points. Mike?

The DHI Communities is our multi-family rental company focused on suburban, garden-style apartments that had four projects under active construction and one project that was substantially complete at the end of the quarter. After selling two projects earlier this fiscal year, no other projects were scheduled to be marketed and sold during our third or fourth quarters of the fiscal 2020. We expect to market and sell a couple of projects in fiscal 2021 based on our current pace of construction and leasing activity. After pausing construction starts and new acquisitions by DHI Communities in March, April and May, we began selectively resuming plans for new projects in June and we still plan to grow the DHI Communities platform. DHI Communities assets totaled $225 million at June 30th. We also continue to evaluate our opportunities in the market for single-family rental homes. We are currently building and leasing homes in nine single-family rental communities across our operations as we are in the early stages of our participation in this growing segment of the housing market. 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 effectively operate in changing economic conditions and we plan to maintain our disciplined approach to investing capital to enhance the long-term value of our company. During the nine months into June, our cash provided by home building operations was $1.2 billion compared to $6.6 million in the prior year period. At June 30th, we had $3.7 billion of home building liquidity consisting of $1.9 billion of unrestricted home building cash and $1.8 billion of available capacity on our home building revolving credit facilities. Our home building leverage was .4% at the end of June with $2.4 billion of home building public notes outstanding and $400 million of senior note maturities in the next 12 months. At June 30th, our stockholders' equity was $11 billion and book value per share was $30.38 up 16% from a year ago. For the trailing 12 months into June, our return on equity was .9% compared to .3% a year ago. During the quarter, we paid cash dividends of $64 million and our board has declared a quarterly dividend at the same level as last quarter to be paid in August. We did not repurchase any shares during the third quarter and we expect 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. Our outstanding share count is down 2% from a year ago and we currently have an outstanding share repurchase of $535 million. Jessica?

As we noted last quarter, due to the uncertainty in the U.S. economy and our business operations from COVID-19, we withdrew our guidance for fiscal 2020. Based on today's market conditions, we are now providing our expectations for the fourth quarter of fiscal 2020. In the fourth quarter, we expect to generate consolidated revenues in a range of $5.5 to $5.8 billion and to close approximately 18,000 to 19,000 homes. We expect our home sales gross margin in the fourth quarter to be similar to the third quarter in the mid 21% range and home building SG&A in the fourth quarter to be 8 to .2% of home building revenues. We anticipate a financial services pre-tax profit margin in the fourth quarter of approximately 40% and we expect our income tax rate to be approximately 23%. We plan to provide annual guidance for fiscal 2021 when we have sufficient visibility into market conditions, hopefully on our next earnings call in early November. David?

In closing, our results reflect the strength of our experienced operational teams, industry-leading market share, broad geographic footprint, and diverse product offerings across multiple brands. Our strong balance sheet, ample liquidity, and low leverage provide us with significant financial flexibility to effectively operate in changing 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 D.R. Horton team for your focus and hard work. Your efforts during this time have been remarkable. We are proud of your work ethic and your positive spirit as you safely continue helping our customers close on their much anticipated new homes. This concludes our prepared remarks. We will now host questions.

Thank you. We'll now be conducting a question and answer session. If you'd like to be placed into question Q, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question Q. You may press star 2 if you'd like to remove your question from the Q. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star 1. One moment, please, while we poll for questions. Our first question today is coming from Alan Ratner from Zellman & Associates. Your line is now live.

Hey, good morning, guys. Congrats on a great quarter. I'm glad to hear everyone's doing well. First question on the spec inventory supply, not surprisingly, came down quite a bit just given the dynamics in the quarter and how strong demand was there. You mentioned obviously a greater percentage of your backlog right now is not yet started, which makes a lot of sense. I'm just curious as you ramp your start activity here, and I'm sure other builders are doing the same, to not only build out your existing backlog but replace the spec inventory, presumably. What do you see on the labor side as far as any tightness there, any inflation that's starting to build up because it seems like there's a pretty healthy ramp that starts coming?

You know, labor's been a challenge throughout this entire market cycle. So, you know, we focused early on driving efficiency through the operation, partnering with our labor trades, and have seen the benefit of that all the way through this cycle. The reality is, you know, as I think Mike will tell you, the build cycles continue to be very, very stable. And just the process of how we build and how we treat our trades has proven to be very effective in managing the situation.

Got it. Okay, that's helpful. Second question, you know, just as you start to think about 21 here, you know, the sustainability of this demand is certainly a big question at this point. You know, in the last several years, you've done a handful of M&A transactions on the private side, and I'm curious, you know, you mentioned buyback potential, buyback activity. How are you thinking about M&A right here given the climate, and what are you seeing as far as the pipeline is concerned?

Good morning, Alan. We continue to evaluate different opportunities, and it still comes down to where we can add to the long-term value of the company, where we can add product and new customer base to serve, but more importantly, people that are creative to the operating teams. So we continue to talk with several private builders. We're more inclined to look at the tuck-ins that we have done, either adding to existing markets or opening up new markets for us, but you won't see us probably do any massive public acquisitions, but I do think we will continue to evaluate the smaller privates.

Have you seen any changes in the privates' willingness to sell just given kind of the uncertainty in the climate today, or has this bounce-back in activity perhaps emboldened them a little bit to, you know, remain, you know, an independent company?

I would say it's both. It's going to vary based upon the situation of a particular private builder as to whether they're thinking it's still a good place to be or if it's time for them to do something different and to join a bigger operation.

Understood. Okay, guys. Thanks a lot. Good luck.

Thank you. I will add that, you know, we don't – we're not in a position where we need to go add, and it really does have to be a great fit, and at this point, they would have to want to join our family, and it's not going to be a stretch, you know, kind of a win-win for them at us.

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

Thanks very much, guys. Yeah, I wanted to follow up on the cycle time and spec question that Alan just asked. So you mentioned cycle times are very stable. That's obviously extremely encouraging and exemplary, I would say. But we have seen your specs are down, and obviously demand has surged significantly. So I guess the bottom line question for me is would you like to increase your spec levels from where they are today, and are you able to do so in an environment where demand is as strong as it has been?

The answer to your first question, yes, Stephen, we would like to increase our spec levels today. We have an aggressive starts plan to increase our specs. At the same time, we'll be starting our sold homes, and so it is a big plan to start houses. But as David mentioned before, we've been focusing early on on the efficiency in the product and the operational focus and partnering with our trades and being sure that they're capable of supporting the growth that we have in front of us. So we do think we'll be able to increase our spec inventory, but it's not going to be without a lot of effort. I can promise you that.

The focus right now is on driving a consistent sustainable start program week to week, project by project. And as we continue to execute that, I think our spec council will come back to what we historically have carried.

Yeah, that's great. Very encouraging of you. And obviously, we look to Horton to take on those challenges.

I

wanted to ask a second question about pricing and the pricing environment. It seems obviously that Express remains extremely strong. I'm curious if you're seeing increased interest in Freedom and the traditional DR Horton business more recently, and whether that allows for a little bit more pricing flexibility perhaps than we had seen in the past, particularly the DR Horton semi-custom business. And a second half of that question is whether or not you're seeing the mix of local demand versus -of-state demand driving what you saw in May and June. And is there a difference in your ability to price, push price for when you're selling to a local versus -of-state?

I would say as to the branding, we are seeing uptick in demand for both Freedom and the DR Horton brand. As to the estate question, I would say we're seeing increase in demand from both buying profiles. The relocation of people down to a more affordable tax friendly environment continues. And I think COVID maybe is even accelerating that. And pricing is something we track week to week based upon the demand at each individual flag. And I've always considered pricing an arc, not a science. You never want to be in a position where you push pricing so hard that you have to come back and adjust it back down. You always want people to feel like if they buy today, they'll save a little bit money. They'll save money versus buying six months or a year from now. So fortunately, our company, the entire structure and mentality is that those decisions are made in the individual communities and divisions. And the people that are closest to the market actually, we feel like make a better decision than we can make up here.

Great. No, that's very helpful. Thanks a lot,

David. Thank you. Our next question today is coming from John Lovallo from Bank of America. Your line is now live.

Hey, guys. Thank you for taking my questions. The first one, May and June at 50% year over year order birth is clearly very encouraging. I know you said July was strong, David. Just curious if you could help us frame that in any way, how strong it was on a year over year basis.

It's consistent with what we saw in May and June.

Okay.

It really is a testimony to our people and our positioning out there, but it's a very, very, very good market right now.

Okay. That's really encouraging. With that in mind, the overall tone maybe could be seen as just slightly more cautious than some of your peers, which is I think consistent with how you guys have always sort of run the business and I think it's prudent. But just curious, is this really conservatism just given unemployment, COVID, things that could happen, or are you seeing any signs anywhere of any slowing in traffic or whatever it might be?

No signs of slowing. It's just a lot of uncertainty out there that is completely outside of our control. If you just look at long-term trends in the industry demographics, where the supply is versus where the future demand is going to be or should be even today, you've got to feel very, very good about long-term. But in this industry, you saw what happened in the March completely out of the, from nowhere. So I do think we'll have a lot more visibility as we get into the November, December time period next year. And hopefully we can reinstate the guidance numbers that we can then turn around and hit. Thank you very much. We're always going to be conservative. I mean, you've got to wait for a CFO. You're going to have conservative.

Thanks,

guys.

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

Thanks. Good morning, everybody. I'm going back to Alan and Steve's question about spec and the amount of unsolds you have. And maybe Mike or David, is this, if you look at your backlog, your sold backlog, are you closer to completion with that than you would typically be at this time of year? And of your unsold spec, are you closer to finishing that than you normally would be this time of year?

So I would say that we are generally going to be in line with the started sold homes are, you know, across the range of production, largely this time of the year, delivering into the fourth quarter. And similar with the specs, we're probably maybe a little bit less finished with the specs because of the strong sales demand that we've had. They've moved to the sold category and we have them sort of set to close, if you will, sold to close in the September quarter. So we feel really good about the ability to deliver the fourth quarter and the starts plan that we have out and the building permits we're able to accumulate. We feel good about being able to reload the inventory and bring us back to sustainable inventory levels we need to support the demand.

Okay. Thanks, Mike. Obviously, it's a function of the vagary of this market, so I'm just trying to understand the map. And then a bigger picture question, in your release and on the call, you talked about low rates motivating folks and maybe some pent-up demand. You didn't talk about this idea of de-urbanization or de-densification driving demand. And I'm curious if that's something you think you've seen and if you have some sort of sense from the field or math that tells you that you're seeing more and more folks come from urban areas to purchase homes in suburbs or ex-urbs. And I'd just like your observations on that. Thanks a bunch, folks.

I think, well, this is David. I think that's a trend that was in place before the COVID-19 program. And I think it's really tied toward the millennial being a more conservative discipline by our homes than previous generations. And they were forming households later, having children later. And I think this pandemic has accelerated that trend. And, you know, what do you call it? Pent-up demand or pull-forward demand. There's just a whole lot of people out there that I think are going to be looking for housing over the next five-plus years.

And, Carl, I think what you're referring to is a longer-term trend that I think is continuing. I think certainly the pandemic's had an effect on it. We would generally agree that that is a trend that probably is accelerating right now. But it's still too early to know the depth of that and the sustainability of it. So we try to just, you know, comment on what we see in front of us. And then we'll live into the rest and be able to comment on the depth of that as time marches on.

Thanks, Bill. Congrats, guys.

Thank

you.

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

Good morning,

sir. Good morning.

I'm curious in terms of what your plans are in terms of price and incentive. I know you had talked previously a quarter ago about sustaining incentives. But seeing where orders are, your inventory appears healthy. What is the strategy in terms of price and incentive in total? And then secondly, if you could just drill a little bit more into California specifically on that question as well.

So broadly on the pricing incentives, as David mentioned before, it's a very local decision that's made. I can say that we did see very strong sales demand. And so the level of incentives we were offering on sales later in the quarter were much lower than where we opened the quarter with. So we did see firming pricing trends, firming incentives, and in terms. But to see where that's going to go, we're going to meet the market. And right now we feel really strong about the sales trends that we're seeing without needing to do heavy incentives. But every day in every Deerhorn community, there is some level of incentives and potential pricing adjustments to meet the market, whether that's up or down. And we do see tremendous value created with the urgency for buyers by, as David mentioned before, feeling like they'll save a little bit of money if they act today rather than wait for a few more weeks.

As to California, we're seeing stability and consistency out there today. We have reset our product and positioning out there to the entry level pretty much everywhere we can. And it's driving better returns today than it has in the last four or five years.

Great. And then just one follow-up, if I could. In terms of land acquisition, is demand is improved broadly and it appears that builders broadly are more active and aggressive in buying land. Anything you're seeing different in terms of the competitive environment for securing land or any impact that's having on the cost of securing land?

You know, land prices are going to go up as the absorptions continue to move up. So, you know, our focus has been and will continue to be relationships with developers. The fact that our operational teams in these markets have been there a long time, have great relationships with land sellers, I think gives us an advantage. Our ability to close gives us an advantage. Our absorptions per flag, if you're developing lots, you want to be selling to somebody who is going to drive very high absorptions. So it's, you know, I do believe we have a competitive advantage, people and capital, and just operational efficiency. So I can tell you right now, we're seeing a lot of deals. The COVID scare, I think, really created opportunities for us to open relationships with sellers that had been primarily selling to other competitors. So I feel very good about our land position today and the things we put in place to sustain that over time.

If you would like to ask a question, please press star one on your telephone keypad. Once again, please press star one on your telephone keypad. Our next question is from Michael Rehaut of JPMorgan. Please proceed with your question.

Hi, thanks. Good morning, everyone, and congrats on the results. First question, I didn't catch and apologize if you had mentioned it, what your average community counted this quarter, either sequentially or on a -over-year basis. And, you know, obviously with the incredible amount of strength and sell-through right now, if you could give us any sense of, you know, higher thinking, you know, for Q-Mike trend, at least in the near term.

Sure, Mike. Our community count was flat, both sequentially and -over-year. And as you can imagine with our, you know, very strong sales pace, we might not be in a position to see community count growth in Q4. It'll probably stay closer to flat, maybe slightly down. But, you know, we have the lot position to continue to deliver homes and communities going forward. So we feel very confident in our ability to continue to drive absorptions and ultimately have some community count growth. And I think that may just be pushed a little bit further out later next year.

Okay. You know, also with, I was just kind of curious about, kind of on this topic, you know, with 4Star giving out guidance of, you know, midpoint of about 11,000 lots of deliveries for next year. And I believe that was a little bit below their prior guidance pre-COVID and understanding that obviously there was a disruption perhaps in some of the development activities for a month or two. You know, at the same time, you guys are looking at very, very strong results currently and, you know, into July. I was just trying to get a sense for maybe how that reconciles, you know, 4Star, maybe looking at a bit less of a delivery year than originally planned despite, you know, demand coming back extremely strong for you. You know, how those two kind of fact patterns work against each other. Because I would have thought perhaps, you know, and maybe it's just more of a timing issue, but a thousand lots is not immaterial. So just trying to get a sense of how to reconcile those two data points.

Mike, it is primarily timing. It's July of 2020 and, you know, 4Star was reestablishing just preliminary, you know, delivery guidance for fiscal 21 at a time in which their largest customers not providing 2021 guidance. So it's just early. Felt like it was important for 4Star to reestablish at least a baseline expectation for their top line growth next year, given that they are truly a growth story and the revenues have been up over 200% this year. But it is a bit conservative, we hope, and as we live over the next few months and as Debra Horton gets sufficient visibility to provide guidance for fiscal 2021, our hope would be, certainly if demand trends continue as they are right now, the strength continues in the industry, I would expect that 4Star would ultimately be able to exceed that and increase their guidance over time. It's really timing.

Right. Right. One more quick one, if I could, if I could squeeze another one in. On the gross margins, obviously a lot of strength there and, you know, you mentioned that you're getting some pricing power back, obviously, which makes sense. Is there, and I know you're not giving, you know, fiscal 21 guidance at this point, but just conceptually, perhaps, you know, if you're looking at your gross margins and backlog currently and, you know, what you're seeing on the ground, you know, in terms of just, you know, achieving some incremental pricing, you know, achieving some incremental scale, et cetera. Is there any reason to think that you wouldn't be able to hit like a 22% gross margin next year with all those factors, just given the momentum you have right now? Again, just trying to think conceptually, you know, obviously, I know you're not giving guidance right now, but just along those lines, if you have any thoughts.

Conceptually, we would love a 22% gross margin, but looking forward, we could see that there could be some headwind coming at us from lumber later into the fourth quarter and into early 22, early 21, excuse me, I'm getting confused in my ears. And we do have a backdrop right now of the strong demand environment and some pricing power and relief on incentives. So we have some positive tailwinds, but we also have some headwinds. And there is still a broader outlook that we're looking at here of what's going to happen in the economy and how the pandemic progresses through the fall and into the winter of next year. So we feel very good about being consistent with our level of margins to drive the right pace that ultimately for us is looking to drive the right return. And that's what we're ultimately looking at in every community is how we maximize the return. We go with every.

Yeah, our comfort. I apologize for the background noise on the line. I'm not sure where that's coming from. Okay. And in terms of our overall company wide ROI, Mike, we're at 21.6%, which I think is probably a record return on inventory that we've generated that delivering, you know, almost 20% return on equity as well. So we'll continue to balance that pace and prices as Mike mentioned to maximize returns for both inventory and equity.

Mike, you're off mute now. Go ahead. If you said something,

sorry. No, thanks a lot. Appreciate it.

Our next question today is from Matthew Boulay from Barclays. Your line is now live.

Hey, good morning. Thanks for taking the questions. Hope everyone's doing well. I wanted to stick with the gross margin side. I guess specifically just given some of the underlying pricing strength in the market. How are spec margins comparing versus to be built today? And going forward, when you have this decline in available spec here and in particularly finished spec, how should we think about what the implication to gross margins would be as a result of that? Thank you.

Certainly in a strong demand environment where we've been selling a lot of completed specs, the gap between margins between specs and bill to order is narrower than normal. But still typically we do still see higher gross margins on a bill to order versus a spec. But today that gap's a little tighter than usual.

Okay, understood. And then just secondly, and apologies if I missed this, but Bill, if you could speak a little bit about the share repurchase plans and sort of what it will take to kind of foster reaccelerating that. Thank you.

Sure. There's a lot of moving pieces right now. We went through a very volatile quarter in terms of demand, in terms of what we had to do in our operations and the adjustments we've made there. And still going forward, it's in our forward visibility. We're seeing extremely strong demand. We've seen a sell-through of our spec inventory. So we're actively reaccelerating our specs now. So first and foremost, we're focused on our business and what we feel like we need to reinvest to keep our spec inventory at the level we'd like and keep our lot inventory replenished. And so until we get a better sense of what that need is in the core business, then we'll adjust our – then we'll put our plans in place for share repurchase. Over the next few months, we'll be sitting down with all of our operators across the company and putting in place our business plans for fiscal 21. And as we get that set, then that will help further define and give us better clarity on what we'll do in terms of our share repurchase. So our statement is we're going to cautiously manage our share repurchase, and we still have an authorization in place. And we'll update those plans accordingly as we get better visibility in our business.

Great.

Thank you for the call.

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

Hi. Good morning, everyone. Nice quarter. So just – I don't think anybody's really expecting you to run at %-plus order growth forever just given the supply side constraints. You know, are you all really focused on thinking next quarter to pushing price a little bit harder to kind of curb these absorptions, or are you pretty comfortable at this pace and running at these absorptions, you know, given, you know, your community count and lot count and everything, just trying to understand which lever you're really trying to lean on a bit more going forward?

Right now, we're very comfortable with our live position going out into 21. We have seen significant and competitive advantage result from the continued consolidation and market share gains. There is – what we focus on internally is consistent, sustainable operations and feel very good about our pace right now. Market is certainly there. And the pricing side, you know, short-term price increases actually increase demand sometimes. So again, it's an art. It's – you know, and we leave those decisions to local markets. So like Bill said, over the next 30 days, we'll be putting together an operating plan for 21, finalizing. I guess we've had one for some time, but finalizing it. And that will drive a lot more visibility about how we're going to position for 21 and then 22 and then 23.

Okay. Thanks for that. It sounds like your lot positions may be bucking some of the industry trends recently. If I look at your fourth quarter implied backlog conversion rate, it looks like it falls to about 80 percent, you know, lowest level in, I don't know, five years or so. You know, I think that's pretty clearly a function of construction delays or maybe lack of starts during COVID. You know, do you think that you can get that back up and running where your backlog conversion gets, you know, kind of normalized or flat in the first quarter of 21 or second quarter of 21 somewhere in there? And then, you know, also on that, how long do you think it'll take for you to get your spec count kind of normalized in today's market?

Well, you know, first, we're not seeing really construction delays. Our cycle times have been very consistent really throughout. And backlog conversion really isn't a step that we focus too much on. We focus more on our inventory position and our inventory turns. And right now we're seeing our inventory turns accelerate. Our sales pace obviously has increased dramatically the last few months, which did work down our completed homes, completed specs. So our completed spec inventory is lower than it has been in some time. Also, the component of our backlog that is sold but not started is higher than normal. So as we accelerate our start pace, that will bring those two back to a closer, you know, closer to a normal level. And we expect to still, you know, deliver a very strong volume. But it takes really our lot position and our home position to support that.

Okay. Asked another way, your inventory turns will probably be, you know, lower in 4Q. Do you think that kind of gets back to more normalized levels in the first half of 21?

I think our inventory turns are actually higher than they were a year ago, and I think Q4 will continue that way. In fact, I think that was part of our original guidance for fiscal 20 was that we were expected to turn our housing inventory more quickly this year. And that is what we're doing.

Okay. Thanks for taking my questions.

Our next question today is coming from Susan McCleary from Goldman Sachs. Your line is now live.

Thank you. Good morning, everyone. My first question is just around, you know, obviously there's a lot of uncertainty as we think about the broader macro environment. And, you know, given your buyer base, have you done any analysis or have any thoughts on the impact of the reduction in the stimulus programs that are scheduled to come up later this year? You know, I was just wondering, you know, we're seeing a lot of changes this week. How do you think that that has kind of played into the demand that you've seen over the last couple of months, and how are you thinking about it going forward if there are changes there?

Morning, Susan.

I'm sorry. Go ahead,

Mike. Oh, you go ahead.

What I think we're seeing with most of our buyers in the traffic we're seeing is that those people are not directly participating in a lot of the stimulus programs or relief packages that are out there. The underwriting required for a mortgage today is generally going to first start with a job and a steady predictable income stream. And so we've not seen a direct impact of that to the extent there's a broader follow through to the economy. We'll have to wait and see. That's part of the conservatism, I think, in our outlook going forward to see how that plays through in the broader economy.

And just to add, the amount of stimulus that's already been pushed out and will continue to be pushed out, I think, between now and the end of the year is going to impact the markets for multiple years. It's just a lot of liquidity that will filter through the overall economy and I think have a positive impact on housing and people's ability to buy homes.

Okay. That's helpful. And then you noted in your commentary that the average size of the home came down 3% in the quarter. But as we kind of look out at some of the secular shifts that are perhaps coming through from COVID, more people working from home, their kids being home a lot more, are you seeing any of your buyers that are actually looking for a slightly larger home or more space or any kind of changes to the layout?

We are seeing more consideration given to a setting that accommodates a better work from home environment, whether it's an extra bedroom to be used for a classroom, an office, a playroom that provides a little more space. But a lot of our floor plans today accommodate at a lesser aggregate square footage, a lot of very functional space, whether that's flex rooms or four bedrooms that work very well for that today. So we're really pleased with the product offering that we have out there. But fortunately in most of our neighborhoods, we're able to respond to buyer demand very quickly and adjust to what the current buyers in our sales offices are asking for with our inventory homes with the next round of starts we have in a given neighborhood.

Okay. Thank you.

Thank you. Our next question today is coming from Buck Horn from Raymond James, your line of allies.

Hey, thanks. Good morning. Congrats on the quarter. Question on SG&A a little bit as you're trying to ramp back up on the land spend and get some more flags in the ground, is there any sort of near term, you know, disrupt, not disruption, but, you know, are you going to have to reinvest in hiring people or do you need to start re-accelerating technology investments to keep up with the pace of demand right now? Is there anything on the SG&A side that we should consider in the near term as demand is so rapidly increased that you need to accelerate some investments there?

You know, Buck, I don't think we see anything that will move the needle dramatically. It's just a continuation of what we've been doing. We did briefly, you know, have a hiring freeze during that month or so at the beginning of the pandemic, but we're back to normal in terms of hiring across our home building and financial services operation. We're not just hiring or growing the business. We're always hiring and adding where we need to. Same thing on technology. We've been making continuing investments over the last number of years, and we've redirected some of those during the pandemic to address, you know, the work from home environment and a few things like that. But those expenditures are not anything that's really out, it's going to move the needle in total because there's also things we're not spending as much money on today. Travel is not as big a portion of our spending as in the past. You know, hopefully at some point it can be, but we're at a company low in terms of our historical SG&A percentages and expect to be able to stay at that level going forward.

All right, great. Congrats and very helpful. Thank you. Next question is on the single family rental component. It seems like your thoughts have evolved on that potential market opportunity and what you're seeing in terms of, you know, maybe the potential for, you know, a built for rent product offering in your communities. I'm just wondering if you could expand upon your thoughts at this point and is that something you would like to have a portfolio that you could operate internally? Would you look to sell those as you build them or partner with another operator? How do you think about single family rentals at this point?

Buck, that's something that we're still learning our way into. We feel really good about the handful of communities, I believe nine communities today, that we have homes being constructed for the purpose of rental. And we'll have to see. We'll have to see what the market brings us, if we bring some of those communities to market for sale or if we build a portfolio to operate or aggregate to a portfolio for eventual disposition. It's something we're learning our way into today. So we'll be back with you as that progresses.

Okay, fair enough. I appreciate it. Thanks and congrats on the quarter. Thank you.

Thank you. Our next question is coming from Mike Dahl from RBC Capital Markets. Your line is now live.

Morning. Thanks for taking my questions. The first question, I wanted to go back to the sold but not started in backlog and I think he has mentioned a few times and Billy, you responded to a previous question that percentage is higher than normal, which makes sense. Could you actually, could you give us what that percentage is in terms of what's sold but not started and how that compares on a year over year basis and maybe as part of that, I don't know if you have any quantification of kind of like, what an average, I know your build cycles flat, but what an average delivery quote would be in terms of what you're able to quote to new buyers today versus what you'd normally be able to.

I'll take the second part of the question while Bill and Jessica are looking for the answer to the first part. Right now we would not be able to quote to you an average because it's going to vary based upon which community you're in and the level of production that's available within a community and the type of product that it is. You know, some communities, we have a very quick build time and can deliver homes, you know, from start to completion in three months and others, it may be a four or five months build cycle. And then generally we're looking to have inventory that's available to move in, you know, within the next 30 days, as soon as you can clarify your mortgage situation and get qualified, you know, we'd like to have a home that's ready for you as soon as you can, you need it.

Got it. Thanks.

And then Mike on the sold not started, we're running a low double digit, you know, a little over 10% sold not started, which we normally I think would be in a low single digit percentage.

That's really helpful. And then the second question and not to belabor the case versus price too much, but understanding that it's a local decision. Are you getting the sense that your local operators are given some of the uncertainty that may still be out there? They are, you know, making the decision to let pace run a little hot for the foreseeable future, just capture what's out there while it's still out there type of mentality versus those operators. Pushing price more aggressively. I know you talked about incentives coming down, but just wondering if you have kind of a pulse of what your local operators are leaning towards today.

You know, like the base versus price versus margin has a lot to do with community size, or it is in the community. You know, you may push price in a community where you on the back end of it and, you know, your deliveries, sales base is going to be three or four months worth of inventory or six or seven months worth of inventory. And then you have other communities where you may have a thousand lots out in front of you and driving pace actually generates a higher return than trying to find that absolute right margin dollar that either cuts off sales or allows sales to increase. And, you know, we trust our operators in the field to make those decisions. We incentivize them to make good decisions. And, you know, it's a model that's been a part of the company for the 32 years I've been here, and it seems to be working. So it really is a community by community process.

Got it. Thanks. Just just quick follow up to that. Then, as you think about the 2021 plans, is that when you may introduce a little more kind of nudging in one direction versus the other or is it you're really just I mean, what you're seeing today is pleasing in terms of how everything's being

managed. You know, we could we could we could do better. You know, it's it's we can make better decisions pretty much every day. You get up and don't make a mistake. You probably didn't do anything. So we're going to walk through communities with our operators and we're going to talk to them. You know, are you are you making the decision that is going to drive the highest return for the shareholder? But ultimately, what we have seen over years and years and years is that when you empower people and you give them authority and responsibility, they become better managers and their relationship. You know, they it's a culture. I mean, it's it's it's who we are, and we're just not going to sit up here and try to drive pricing decisions in a community and. Pick any market you want to.

Fair enough. Thanks, David.

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to David for any further closing comments.

Thank you, Kevin. We appreciate everybody's time on the call today and look forward to speaking to you again in November and to the Dior Horton family. Once again, you have outperformed the industry, setting record, all time record for sales. Twenty five, twenty one, five thousand twenty one thousand five hundred sales. Unbelievable accomplishment. Don Horton, the entire executive team are humbled and thankful that we're here to represent you.

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