D.R. Horton, Inc.

Good morning, and welcome to the third quarter 2021 earnings call for D.R. Horton, America's builder, the largest builder in the United States. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. We ask that you please limit yourself to one question and one follow-up during the Q&A portion of the call. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton.

Thank you, Daryl, and good morning. Welcome to our call to discuss our results for the third quarter of fiscal 2021. Before we get started, today's call includes 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 DR Horton on the date of this conference call, and DR Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about factors that could lead to material changes in performance is contained in DR Horton's annual report on Form 10-K and its most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at investor.deohorton.com, and we plan to file our 10-Q early next week. 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 Auld, our president and CEO.

Thank you, Jessica, and good morning. How are you? I'm pleased to also be joined on this call by Mike Burry, our Executive Vice President and Chief Operating Officer, and Bill Wheat, our Executive Vice President and Chief Financial Officer. The artwork team delivered an outstanding third quarter, highlighted by a 78% increase in earnings to $3.06 per diluted share. Our consolidated pre-tax income increased 81% on a 35% increase in revenues to $7.3 billion. and our pre-tax profit margin improved 490 basis points to 19.4%. Our home building return on inventory for the trailing 12 months ended June 30th was 34.9%, and our consolidated return on equity for the same period was 29.5%. These results reflect our experienced teams and their production capabilities, our ability to leverage the Overton scale across our broad geographic footprint, and our product positioning to offer homes at affordable price points across multiple brands. Housing market conditions remain very robust, and we are focused on maximizing returns and increasing our market share further. However, multiple disruptions in the supply chain combined with the improvement in economic conditions and strong demand for new homes have resulted in shortages in certain building materials and tightness in the labor market. which has caused our construction time to become less predictable. As our top priority is to consistently fulfill our commitments to our homebuyers, we have slowed our home sales pace to more closely align to our current production levels and are selling homes later in the construction cycle when we can better ensure the certainty of home close date for our homebuyers. We expect to work through these issues and increase our production capacity. We started construction on 22,600 homes this quarter, and our homes in inventory increased 44% from a year ago to 47,300 homes at June 30, 2021, positioning us to finish 2021 strong and to achieve double-digit growth again in 2022. We believe our strong balance sheet, liquidity, and loan leverage position us very well to operate effectively through changing economic conditions. We plan to maintain our flexible operational and financial position by generating strong cash flows from our home building operations and managing our product offerings, incentives, home pricing, sales pace, and inventory levels to optimize the return on our inventory investments. Mike?

Earnings for the third quarter of fiscal 2021 increased 78% at $3.06 per diluted share compared to $1.72 per share in the prior year quarter. Net income for the quarter increased 77% to $1.1 billion compared to $630.7 million. Our third quarter home sales revenues increased 35% to $7 billion on 21,588 homes closed, up from $5.2 billion on 17,642 homes closed in the prior year. Our average closing price for the quarter was $326,100. and the average size of our homes closed was down 2%. Bill?

The value of our net sales orders in the third quarter increased 2% from the prior year to $6.4 billion, while our net sales orders for the quarter decreased 17% to 17,952 homes. Our average number of active selling communities increased 1% from the prior year quarter and was down 3% sequentially. Our average sales price on net sales orders in the third quarter was $359,200, The cancellation rate for the third quarter was 17%, down from 22% in the prior year quarter. As David described, in this very strong demand environment, our local teams are restricting the sales order pace in each of their communities based on the number of homes in inventory, construction time, and lot position. They continue to adjust sales prices to market on a community-by-community basis while staying focused on providing value to our buyers. Based on the stage of completion of our current homes and inventory, production schedules, and capacity, we expect to continue restricting the pace of our sales orders during our fourth fiscal quarter. As a result, we expect our fourth quarter net sales orders to be lower than the third quarter. However, we are confident that we will be well positioned to deliver double-digit volume growth in fiscal 2022 with 32,200 homes in backlog, 47,300 homes in inventory, a robust lot supply, and strong trade and supplier relationships. Jessica?

Our gross profit margin on home sales revenue in the third quarter was 25.9%, up 130 basis points sequentially from the March quarter. The increase in our gross margin from March to June exceeded our expectations and reflects the broad strength of the housing market. The strong demand for a limited supply of homes has allowed us to continue to raise prices or lower the level of sales incentives in most of our communities. On a per square foot basis, our revenues were up 4.7% sequentially, while our stick and brick cost per square foot increased 3.5%, and our lot cost increased 1.7%. We expect both our construction and lot costs will continue to increase on a per square foot basis. However, with the strength of today's market conditions, we expect to offset any cost pressures with price increases. We currently expect our home sales gross margin in the fourth quarter to be similar to or slightly better than the third 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. Bill?

In the third quarter, home building SG&A expense as a percentage of revenues was 7.1%, down 80 basis points from 7.9% in the prior year quarter. home building SG&A expense as a percentage of revenues is lower than any quarter in our history and we remain focused on controlling our SG&A while ensuring that our infrastructure adequately supports our business. David.

We have increased our housing inventory in response to the strength of demand and we expect the current constraints on our supply chain to ultimately subside. This quarter we started 22,600 homes up 33% from the third quarter last year. bringing our trailing 12-month starts to 94,500 homes. We ended this quarter with 47,300 homes in inventory, up 44% from a year ago. 15,400 of our total homes at June 30th were unsold, of which 500 were complete. Mike?

At June 30th, our home building lot position consisted of approximately 517,000 lots, of which 24% were owned. 25% of our total owned lots are finished and at least 44% of our controlled lots are or will be finished when we purchase them. Our growing and capital efficient lot portfolio is a key to our strong competitive position and will support our efforts to increase our production volume to meet home buyer demand. Our third quarter home building investments in lots, land, and development totaled $1.8 billion, of which $910 million was for finished lots $540 million was for land development, and $350 million was to acquire land. $300 million of our total lot purchases in the third quarter were from Four Star.

Bill? Four Star, our majority-owned subsidiary, is a publicly traded, well-capitalized residential lot manufacturer operating in 55 markets across 22 states. Four Star is delivering on its high growth expectations and now expects to grow its fiscal 2021 lot deliveries by approximately 50% year-over-year to a range of 15,500 to 16,000 lots, with a pre-tax profit margin of 11.5% to 12%, excluding their $18.1 million loss on extinguishment of debt recognized during the quarter. At June 30th, Four Star's owned and controlled lot position increased 91% from a year ago to 96,600. Sixty-one percent of Four Star's own lots are under contract with D.R. Horton or subject to a right of first offer under our master supply agreement. Four Star is separately capitalized from D.R. Horton and had approximately $470 million of liquidity at quarter end, with a net debt to capital ratio of 37.8 percent. With its strong lot supply, capitalization, and relationship with D.R. Horton, Four Star plans to continue profitably growing their business. Jessica.

Financial services pre-tax income in the third quarter was $70.3 million, with a pre-tax profit margin of 37.3%, compared to $68.8 million and 43.9% in the prior year quarter. The year-over-year decline in our financial services pre-tax profit margin was primarily due to lower net gains on loans originated this quarter, caused by market fluctuations and increased competitive pricing pressure in the markets. For the quarter, 98% of our mortgage company's loan originations related to homes closed via home building operations, and our mortgage company handled the financing for 66% of our homebuyers. FHA and VA loans accounted for 45% of the mortgage company's volume. Borrowers originating loans with DHI mortgage this quarter had an average FICO score of 721 and an average loan-to-value ratio of 89%. First-time homebuyers represented 58% of the closings handled by the mortgage company this quarter. Mike?

At June 30th, our multifamily rental operations had 11 projects under active construction and an additional four projects that are completed and in the lease-up phase. Based on leased occupancy and our marketing process, we expect to sell two or three of these projects during the fourth quarter of fiscal 2021. Our multifamily rental assets sold $458.3 million at June 30th. Last year, we began constructing and leasing homes as income-producing single-family rental communities. After these rental communities are constructed and achieve a stabilized level of leased occupancy, each community is marketed for sale. During the third quarter, we sold our second single-family rental community for $23.1 million in revenue and $11.4 million of gross profit. At June 30th, our home building inventory included $303.1 million of assets. related to 44 single-family rental communities compared to $87.2 million of assets related to 10 communities at the beginning of the fiscal year. We are pleased with the performance of our single and multi-family rental teams, and we look forward to the growing contributions to our future profits and returns. Bill?

Our balanced capital approach focuses on being disciplined, flexible, and opportunistic. During the nine months into June, our cash provided by home building operations was $276 million, even while we have reinvested significant operating capital to expand our home building inventories in response to strong demand. At June 30th, we had $3.7 billion of home building liquidity consisting of $1.7 billion of unrestricted home building cash and $2 billion of available capacity on our home building revolving credit facility. We believe this level of home building cash and liquidity is appropriate to support the increased scale and activity in our business and to provide flexibility to adjust to changing market conditions. Our home building leverage was 16% at the end of June, with $2.5 billion of home building public notes outstanding and no senior note maturities in the next 12 months. At June 30th, our stockholders' equity was $13.8 billion, and book value per share was $38.54, up 27% from a year ago. For the trailing 12 months into June, our return on equity was 29.5%, compared to 19.9% a year ago. During the quarter, we paid cash dividends of $72.1 million, and our board has declared a quarterly dividend at the same level as last quarter to be paid in August. We repurchased 2.6 million shares of common stock for $241.2 million during the quarter, for a total of 8.1 million shares repurchased fiscal year-to-date for $661.4 million. Our remaining share repurchase authorization in June 30th was $758.8 million. We remain committed to returning capital to our shareholders through both dividends and share repurchases on a consistent basis and to reducing our outstanding share count each fiscal year. Jessica?

In the fourth quarter of fiscal 2021, based on today's market conditions, we expect to generate consolidated revenues of $7.9 to $8.4 billion and our homes close to being a range between 23,000 and 24,500 homes. We expect our home sales gross margin in the fourth quarter to be in the range of 26 to 26.3%, and home building SG&A as a percentage of revenues in the fourth quarter to be approximately 7%. We anticipate a financial services pre-tax profit margin in the range of 40 to 45%, and we expect our income tax rate to be approximately 23.5%. For the full fiscal year of 2021, We now expect consolidated revenues of $27.6 to $28.1 billion and to close between 83,000 and 84,500 homes. This year, we have prioritized reinvestment of our operating capital to increase our housing and land and lot inventories to support higher demand. Our other cash flow priorities remain balanced. Among increasing our investment in our multi and single family rental platforms, maintaining conservative home building leverage and strong liquidity, paying a dividend, and repurchasing shares to reduce our outstanding share count by approximately 2% from the beginning of fiscal 2021. David?

In closing, our results reflect our experienced teams and production capabilities, industry-leading market share, broad geographic footprint, and diverse product offerings across multiple brands. Our results also illustrate the growth opportunity in front of us as we increase production capacity in response to home buyer demand. Our strong balance sheet liquidity and low leverage provide us with a significant financial flexibility to capitalize on today's robust market and to effectively operate in changing economic conditions. We plan to maintain our disciplined approach to investing capital to enhance the long-term value of the company. which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D.R. Horton team for your focus and hard work. As a result of these efforts, we are incredibly well positioned to continue growing and improving our operations. This concludes our prepared remarks. We will now host questions.

Thank you. We will now be conducting a question and answer session. 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. As a reminder, we ask that you limit yourself to one question and one follow-up question. One moment, please, while we poll for your questions. Our first questions come from the line of Stephen Kim with Evercore ISI. Please proceed with your questions.

Thanks very much, guys. Impressive results and really interesting times here. I wanted to talk a little bit about this restriction of sales, which we've been seeing you and others do throughout the June quarter. You indicated you expected that to continue in the September quarter. I was wondering if you could provide a little bit more color around that. Are you expecting the restrictions to be similar in severity in the September quarter? Do you think those restrictions might continue past September? you know, to a meaningful degree. And I guess it's really related to your starts. And so in that regard, your starts were down, I think, 5% sequentially or so. I was curious when you thought that that could grow. And you talked about building the infrastructure needed to do higher level of housing starts. I wanted to see if you could provide a little more color around that. So more color on the starts outlook. And are you going to be continuing to restrict sales at the same degree in September and maybe past September?

Well, when it starts out, we have a plan, and our plan is to consistently be out there community by community, increasing production over time. If you look at our quarterly run rate, we're in the 22,000, 23,000 starts each quarter. That was the plan. for this year. Our plan is to take that up next year. And we position land lodge people to affect that plan. So demand out there is just unlike anything I've ever seen. And I think our focus is on how to meet that demand in the most efficient manner. And injecting a homeowner into the process sooner rather than later impacts our ability to get the houses built and extends that time. And it makes it harder for our trades and our superintendents. I can tell you, it is, through our history, to have somebody walk into our models and to tell them, we don't have a house for you to buy today, is something that is foreign to us and is as difficult as anything I've ever seen on our salespeople It is a tough environment to be in a sales office today. In our travels, I talk to our people. We're going to provide a home for everybody walking in. We just need to keep them patient and understand their frustration. Again, it's a market I've never seen. Demand is just unbelievable today.

Okay, that's great.

I can't remember the rest of the question.

Largely they were to look ahead and the restrictions, are they likely to continue to the same degree into September quarter and will they, do you anticipate, continue past September?

We are continuing to put things in place to expand our production capability. We've increased the phase size of our log deliveries because we see, in my history, if a buyer walked into a model and you hadn't figured out how to get them on a contract in a week, 10 days, they had bought somewhere else. I've got an email this month from a buyer who's been in our models at every release for the last year and hasn't been able to buy a house, and he's still waiting. You can multiply that thousands and thousands of times across the country with multiple builders out there. We did not restrict sales as soon as the general market did, which just geometrically increased our demand. Again, we're all managing through a market that none of us have ever seen. And probably the difference in this cycle than the prior super demand cycle that I was a part of is that the builders are disciplined this cycle. We're all focused on capital efficiency. We're all focused on improving returns. And it's... I think it's going to extend the cycle, Ken. Again, we're in uncharted waters from a demand aspect right now.

And, Steve, in terms of just specifically restricting sales, those decisions are going to continue to be made on a community-by-community basis. So where we can get the starts accelerated is where we'll open up for more sales more quickly.

Where we can get the starts accelerated as well as get better certainty to production timelines. The worst thing we want to do is put a homeowner, a homebuyer, into the backlog and then not be able to deliver our commitment to them as to when their home's gonna be ready. It's very disruptive. We want them to have a great experience and be very happy with their house when they move into it. As we've worked through a lot of the supply chain disruptions, we've adopted some of our processes, sharing more information earlier in the process with our trade partners, helping us with longer lead times. That's helping to work through some of the supply chain issues. We're hopeful that those things are resolving as we work them through, but for the fourth quarter, I can foresee us continuing to restrict sales. Again, the decision made community by community based upon current local conditions, but those restrictions will likely remain in place in the fourth quarter.

Okay, appreciate that. Your order ASP was remarkably up about 10% sequentially from the March quarter. I was wondering how much of that increase in order ASP was actual price, do you think, versus mix shift. And as you look at that order ASP flowing into your gross margin in the next quarter or two, I was curious if you could help us understand what kind of lumber cost cadence we should be thinking about. Obviously, it's gyrated quite a bit here over the past year. So if you could give us a sense for was this quarter absorbing peak lumber costs, you know, or is it next quarter? Just help us understand how the lumber cost cadence fits in as well as the mix shift effect in your order ASP.

Steve, I'll take the lumber cost. I don't think we saw peak lumber costs coming through in our June quarter closings. I'm expecting, you know, to your word, gyrating was a good word for the lumber market. Seeing the higher lumber costs coming through in our September quarter deliveries and early into our fourth quarter deliveries. I'm very confident that the order price trends that we've seen have more than offset that lumber cost, and we've been able to absorb that well into margins that we'll see in our fourth quarter deliveries.

In terms of mix, Steve, our sales orders are a good indicator of our forward closing price, but it doesn't typically flow through. directly like that. So, we wouldn't expect our closing price next quarter to be up the same magnitude or equivalent to our sales orders, but we haven't seen a whole lot of mix. So, I mean, we are seeing, and you can see it flowing through on our closings and our gross margin, a lot of like-for-like price improvement.

Great. Thank you very much, guys.

Thank you. Thank you. Our next question has come from the line of Carl Reichardt with BTIG. Please proceed with your questions.

Thanks. Morning, everybody. In the release, you've mentioned that you're building out infrastructure to support the higher level of housing starts going forward. And can you expand on that a little bit, David? So are there incremental costs? What specifically are you referring to there? And when is your expectation that such infrastructure will be in place to support those start levels? And I guess really what I'm asking is how much of this is really in your control versus the demand side or the supply chain side that isn't?

I think what we can control, we are controlling, Carl. We can control the number of lots that we push into the phase. We can control communication with our trade partners and make sure they understand the levels and timing of what we're pushing out and our staffing levels. Generally, that's been the least of the problems because it's absorption per community, so you have to add support in the communities, but it's just a very efficient process. It really just has to do with field operations as far as driving that capacity and aggregating and consolidating trade base within those sub-markets, which is a process that we go through every day. I mean, we did start almost 95,000 homes in the trail in 12 months. And that's, you know, I don't think anybody else has ever done that. And it's a result of scale and just, you know, incredibly hard work.

Thanks, David. And then in the past and this cycle, too, we've seen builders use sales price to try to put a break on turnover rates. And I think there's some concern in the market, which I share, that that pricing dynamic may be beginning to negatively impact sales rates. I'm curious if that's something you felt that you saw. You've said a lot of positive things about demand and whether or not now the restriction on sales it looks like is far more important to you to manage absorption pace than pricing is. And I also know that decision is made at a local level. So can you sort of help untangle that for me? Are we really not using price and just using price to cover costs because demand is good or you still feel like you're using price as a break on sales?

I think today we're seeing very little price pushback. I don't know that you could impact demand with price today.

Our restriction on sales is not being driven by and large by just let's just increase pricing until people stop buying. We are not releasing homes for sale. until we're through a certain stage in the production process, which varies by community. But it's not just using price to adjust the pace that we're going. We're actually not releasing the homes for sale. When the homes do get released for sale, we're seeing very quick absorption of those particular homes by buyers that are waiting to buy homes and to go under contract and then take delivery of the homes.

still very focused on affordability, Carl. Even with increases in our ASP, it's still significantly lower than the rest of the public builders by and large. And that's a focus that we don't want to lose. We do want to maintain affordability, and we've seen the credit profile of our buyers continue to keep pace with where ASPs have gone. And so really, even when we do stress tests on our backlog, It looks like our buyers are in very good shape, even in spite of the price increases we've seen in the market.

Thanks so much, everyone. Appreciate it.

Thank you. Thank you. Our next question has come from the line of Deepa Raghavan with Wells Fargo Securities. Please proceed with your questions.

Hi. Good morning, all. Thanks for taking my question. Can you talk through some of the early outlooks on pricing and margin into 2022, if you're able to? It feels like you should get good leverage from your double-digit revenue growth outlook, and hopefully commodities may moderate into 2022 early, just given that all the builders are pacing sales here, giving the breathing time for supply chain to catch up. And you may not feel compelled to give all that benefits back. So should we think about flat to up gross margins, or would they still be pressures to gross margins from a tough 2021 comp?

Sure. Thanks, Deepa. You know, we have commented and guided to a slightly up gross margin into our Q4, into our September quarter of 26 to 26.3%. And based on what we can see today in our backlog with the pricing that has already been taken in our sales orders over the last quarter or two, we believe we're in position certainly to maintain or slightly see increases in our gross margin over the next quarter or two in excess of the cost increases that we're seeing come through. So in the short run, the next quarter or two, we do expect stability or maybe a slight upside to our current gross margin. Obviously, beyond that, we don't have as much visibility, but clearly we feel like we have good stability in our margins for the near term.

Okay, that's fair. You also mentioned some new or incremental supply chain constraints in the quarter. Can you please elaborate on those? And also, as we talk about the supply chain whack-a-mole constraints, any new constraints Any new ones that cropped up in the prior quarter, in the quarter one? And two, have you seen any easing on the flip side as well?

So on the supply chain, if anything was construed, if there were new constraints, I don't want to imply that there were any new constraints. You know, I think we referenced last quarter that the supply chain challenges have been a bit of a whack-a-mole and that one pops up and the teams jump on it and work with the suppliers individually in that particular category to solve those issues. One of the things we have done is adjusted internally with a lot of our lead time, how far in advance of actual production start that we're communicating with the supply chain partners to make sure that product is available for us. But I could not point to any one particular item as new or incredibly acute right now. There's just a series of issues that we solve every day in the business. That's part of what we do. It's how we've delivered over 20,000 homes this last quarter.

Thanks. I'll pass it on.

Thank you. Our next question has come from the line of Michael Rehout with J.P. Morgan. Please proceed with your question.

Hi. Thanks. Good morning, everyone. I wanted to get a better sense a little bit of the approach to orders relative to production pace and supply constraints. And, you know, obviously a bit of discussion here already on the call, but what I'm a little confused on is, you know, you'd said that your starts pace, you know, is kind of tracking the plan at 22 to 23,000. You just said that also there are no really new constraints out there it's more ongoing supply constraints yet your orders are down 17% and you know that's in contrast to prior commentary of flat to down single digits so just wanted to understand what really has been the difference in approach and if there's something that really changed during the quarter that's driving that different result on the order side relative to your prior commentary?

Well, Mike, I think what we have seen is an elongation of our construction times beyond what we were seeing previously, which is really a cumulative effect of a number of things that have been ongoing that are impacting supply chain, which are manifesting themselves in longer construction times. And so as we're managing that and trying to manage the customer experiences as best we can, that has resulted in us releasing sales in more communities later in the construction cycle than we were previously. So it's been, I would say, an incremental restriction of sales that's resulted in probably a bit more of a sales order restriction than we would have anticipated a quarter ago. But it's something that, you know, as we work through the supply chain issues and start to have better visibility, and get more of our production later in the construction cycle and essentially catch up a bit on production, then we'll be able to probably resume a better pace on sales orders.

A goal being to have our customers in backlog for a shorter period of time, the time from when they sign the contract to when we deliver the home. We're consciously trying to compress that time frame to give them more certainty in the process and give us more control of when we deliver the home to them.

When you move the release date on a particular house from slab to frame to windows installed, that is an extended period of time right now. And so reading demand or any significant change into this quarter adjustment as we have pushed out that release date, to me is just not indicative of what is out there in the market. We really are trying to improve the experience of the home buyer. When we give somebody a date to close, we intend to keep it because their whole life revolves around that. As the certainty of close date was impacted by windows, insulation, anything and everything appliances that was taking place through the last six months, it just became obvious to us that we needed to be more restrictive in what we were doing. Trust me, it is soul-crushing to our salespeople to have somebody walk in ready, willing, able to buy and being told that... We have houses that will be coming available in 30 to 45 days, and we will be glad to call you. What is different to me this market cycle than any other that I've ever been a part of is that 30 or 45 days later you call that person, and yes, they're still trying to buy a house. So it's a tough market to be a buyer in.

Right. No, no, I appreciate those comments, David, and obviously not disappointing your customers is a key part of it. You know, second question, I just wanted to circle back a little bit to the order ASP, you know, essentially around 360, up over 22% year over year, the backlog up over 13% year over year. You know, it stands obviously in stark contrast to 2018 through 2020 where you also had periods of home price appreciation, not anywhere near the same level, but you were able to maintain that average closing price right around 300 for three straight years. So the question is, um, what are you doing, you know, going forward to, you know, I understand that, you know, obviously you have a price that's maybe below most of your peers, but, Still, that monthly payment has been something that you guys pride yourselves on. Is there any actions that you can take over the next year or two to perhaps reverse that trend, either through building slightly further out or maybe slightly different footprints or more attached products, whatever it might be, to perhaps reverse that trend, particularly to the extent that rates might rise. You know, the real concerns here in the marketplace is that, you know, the current price, maybe it's okay in the current backdrop, but might be more vulnerable in the next year or two. So anything that you're doing in terms of your product mix, your geographic mix, that might help solve those issues.

Well, we have decreased our square footage of houses, so you will probably continue to see that take place. We are reducing the number of two-story homes that we offer in communities. And by offer, I mean we have a production model. We're detailing. We're picking the houses we're going to build and the release schedule that we're going to send them to the market with. So, again, we are very sensitive to price point. We are very sensitive to the FHA loan limit that to us is a risk mitigator because that's where the vast majority of buyers are in the people we service. So, trust me, we're monitoring, we're tracking it, We do believe that as our production capabilities continue to improve and increase, and we consolidate labor in these markets, that we will continue to be able to offer affordable homes. If rates take up, then yes, more pressure on price. But we will meet that challenge when it comes.

Thank you.

Thank you. Our next questions come from the line of Matt Bowley with Barclays. Please proceed with your questions.

Morning. Thank you for taking the questions. I guess not to belabor the point, but just back on the restricting of sales pace, because it seems like it was affected to a really similar degree consistently across your markets, despite these you know, local community by community decisions. So can you sort of go over the mechanics, I guess, of how you all, Horton Management, really communicates the strategy to, I believe you said earlier, these sort of frustrated individual operators and sales folks. What are you telling people to look for in terms of, I think you said homes and inventory and extended cycle times, you know, today versus ideally where you want them to be in order to begin releasing those sales again.

Thank you. I think what we're looking for is to get a level of inventory in front of the buyers. Typically, this time of year, we'd be sitting on 40%, 45% specs. Today, the only specs we have are at our houses we haven't released to the market. Again, we're We're trying to drive efficiency in the process. And by controlling when that house is sold, it does help both meet customer expectation and it also eliminates a lot of frustration on the building site where a buyer is coming out and they have been told, maybe they bought a house in January, and they've been told they'd be moving in in June. and the house isn't ready to move into. So they're out there every day monitoring the progress of their house against the progress of every other home in the community. And it just adds a level of difficulty that, to be honest with you, right now, today, we don't want and we don't need. Somebody gets frustrated in the build process, they stay frustrated for a very long time, very hard to meet the expectation. once they get upset. So by limiting that, by pushing the maturity of our inventory further down the process before we inject a buyer into it, we're trying to take some of the pressure off our trades and our builders. And when did that process take place? I will tell you, in some divisions, it started in January, and then it went other divisions in February, And really by April, end of April, first of May, it took hold in some of our very large divisions in the state of Texas. And it just got to the point where we were spending more time, we were spending a significant amount of time dealing with the customer's frustration on the closed state of their house at the expense of other things we could be doing that would drive future efficiency and production capabilities. Again, it was a process that took place over multiple months, beginning in one division and really ending in Texas. Don Horton has said many times, never thought he'd see a day when he couldn't build every house he could sell in the state of Texas. I can tell you today, there's not enough lots or trade capacity to meet demand in the state of Texas. I don't care if you're Don Horton or any of the other public builders out there. It's very difficult to get a house built today. We're doing a better job than anybody else, and we're going to get better at what we're doing. There is a tremendous amount of demand out there.

No, that's really helpful color there. And it's actually a segue into my follow-up, which is when you talk about how strong demand is and exceeding your current capacity and you're clear around your own restrictions, what are you looking at in your communities that quantifiably, I guess, that gives you the confidence to say that? And in fairness, you know, when you look at the, I guess, traffic perhaps in your communities, are you also seeing traffic slip more than you might expect seasonally? And was that part of the shortfall in orders, you know, or is it really just simply what you previously said, that demand is just far exceeding capacity?

Matt, we can look across and see the stage of construction all our unsold homes are at. And by and large, they are at early stages of construction and likely not available to release for sale. And we're not writing sales contracts, by and large, for pre-sales, for anything we haven't started yet, and generally reaching a more mature stage of construction so we can deliver with certainty a closing date to that buyer at the time we sign the contract with them.

And so many of our communities have wait lists or interest lists that far exceed even what we have under construction, which is why you continue to hear us answer every single question so far that the demand is still there and the demand is extremely robust. And this was an internal decision that was based on our production capacity and taking care of our homeowners and homebuyers.

Perfect. Well, thank you for the caller and congrats on the results. Best of luck in the next quarter.

Thank you. Thanks, Matt.

Thank you.

Our next questions come from the line of Alan Ratner with Zellman and Associates. Please proceed with your questions.

Hey, guys. Good morning. Thanks for taking my question. So first question, Jessica, you made a comment earlier that I'd love to drill in on a little bit in regards to the credit profile of your buyers. I think, you know, obviously a lot of questions on the home price increases and what impact that could have on affordability. You said you've seen the credit profile of your buyers keeping pace with the home price increases you've instituted up to this point, which I was a little surprised at just given the fact we know incomes are not up 20% year over year and rates are pretty stable now after obviously going down quite a bit in the second half of last year. So should I interpret that to imply that maybe the mix of your buyers or the buyers in your interest lists are different? kind of slowly shifting maybe towards more of a move-up buyer or at least a more affluent first-time buyer than you've historically seen over the last few years?

We really haven't seen a change in our mix across our brands, which would be our best indicator of entry-level versus move-up. And really, even if we look at the credit profile across all of our brands, we've seen this year an improvement in FICO score, a slight reduction in debt to income even with a higher average loan amount as a result of the higher average sales prices that we're experiencing. So, no, I wouldn't attribute it to that. I mean, we still have almost 55% to 60% of our buyers are first-time buyers.

There's a very large number of unsatisfied buyers out there, people that want to buy a home, And we look at the existing home inventory levels that are available in given marketplaces. They're just not there. And so the quick move in homes, the specs we had that were completed last year, obviously they were absorbed very quickly into the marketplace. We restricted the sale of a lot of our homes to give better certainty to that home buyer in the process of their delivery date. And in a rising price environment when we're Restricting the sale date, we're able to price to market at the time we sign the contract, which is then closer to the delivery date.

Got it. Okay, and I appreciate that extra color there. So, you know, I guess the follow-up to that point then is obviously it's an incredibly tight supply environment today. You know, you guys are holding back sales, restricting sales. a lot of other builders are kind of doing or saying the same thing. So it would seem like if you kind of connect the dots here, a lot of homes are being started today. Not a lot of those homes yet are released for sale. So at some point in the future, you would think inventory is going to come to the market in a pretty meaningful way. And the question then, of course, is will the demand be sufficient to absorb that? Because right now, it's probably a little tricky to get a firm grasp on what that demand is when you're turning buyers away. So Are you tracking that on your kind of a local basis, what other builders are doing in terms of restricting sales but starting homes? And how would you anticipate responding if, you know, let's just say later this year or in your fiscal 1Q, you know, you start releasing more homes for sale, other builders do the same thing, and the demand is not quite what you expected it to be? Are you willing to accept a lower absorption pace? Are you going to start at that point to maybe discount a little bit? What would the thought process be?

It's going to be a different answer community by community. Usually our first read, Alan, is on the existing home side. Our local guys are very in tune with what's going on with both existing home inventory and the other public builders in their market. As always, we can adjust our start schedule up or down based on market conditions. If what you're saying were to come true and there start to be signs of some sort of increased supply in the market that the demand's not going to be there for, which right now feels like we are a long ways away from, we would be able to adjust our starts accordingly community by community where we saw those signs, like we always do to make sure we don't end up with an excess supply of completed specs. But with 500 completed homes across the country today, We're just so far from having that conversation on a national level. But those are things that our local operators certainly pay attention to all the time when they're looking at their business plan and what they're going to do going forward. Our plan would be to continue to consolidate market share regardless of market conditions. And we believe we're going to continue to be the best position to do that kind of regardless of what the demand profile looks like in future periods.

And again, we're focused on the lower end of the price scale. I can assure you, even if we look at the other public builders out there, their price points are higher. Any slowdown in the market, at least in my opinion, is going to be driven by the house payment. It just does not feel like that is anything on the horizon right now.

I don't think we look at what we have available for sale today, what we've started and what we plan to start. I don't believe that's going to satisfy the demand that we're seeing in our sales offices today. And I don't believe any of the other builders have near the amount of inventory coming at them and starts coming at them that we do. So I just don't see that the new homes builders being able to push a lot of inventory into the marketplace available for sale in any kind of a short to medium-term horizon, that's going to dent significantly this demand. That's why, as Jessica said, we watch at a local level what's happening in the existing home market.

That's very helpful. I appreciate the thought process there, and it'll be interesting to see over the next few quarters. Can I sneak in one last one? You know, David, you mentioned obviously many times this is unlike anything you've seen in terms of having to turn buyers away. When I look at your business, obviously the one big thing that's changed in terms of your strategy now versus prior cycles is on the land strategy. You own a lot fewer lots or a much smaller supply of land on a year's supply basis than you have in the past, and you're more reliant on third-party developers through option contracts, et cetera. So I'm curious what you're seeing from the developers. Are they facing – outsize pressure on their development timelines, you know, vis-a-vis perhaps what you're seeing on your own portfolio, and is that in any way slowing the process down? It's not just you, obviously the whole industry is shifting more towards that strategy, but I'm curious with a smaller supply of own land, does that inhibit your ability to grow perhaps more than it had in the past?

You know, these third-party developers are great partners of ours. I mean, we've We work with these guys day in, day out. We've been working with them day in, day out for multiple years now. We know these guys. We know their capabilities. And if one of them gets in trouble, I mean, we step in and help. And we've done that a couple of times this year where, you know, a local guy got out over skis and we had to step in and bring the loss to market. And that's, you know, it's the... And we talk about the flexibility of our capital structure and our balance sheet and liquidity that we maintain. That's why we do that. And then we got the added benefit of a very close relationship with Four Star, who has been, they have done an exceptional job of building out their platform over the last five years. And they have really good people controlling the operations and developments of these lots and we are their biggest customer. I was thinking about that this morning. When you look at the embedded lot counts that we own and control and our ability to actually have a production plan to drive a set number of starts every week in every market on a consistent and growing basis, that is just, in today's world, That is an incredible competitive advantage. It allows us to communicate with our trades so that they know where we're going to start. The vast majority of our key trade partners right now know our start pace in October, November, December, and January. That's when we're going to start the homes. They are aligned with our vision of what we're trying to accomplish. I mean, it's been a lot of work getting to this position, but there's never been a platform in this industry that is anything like what the DR Worden platform is today. And we're very proud of that, and we think we're going to deliver outstanding results as a result of it.

And just for reference, our controlled lot position, so in addition to what we own, is up 78% from a year ago. So we have got the lots in front of us. and feel very comfortable about our lot position not being the hindrance to our ability to grow. It's actually what supported us being able to grow like we have and to continue to do so in the future.

I appreciate that, guys. And just to clarify, I wasn't implying you don't control the lots. It was more getting those lots developed. Yeah, understood. But thank you, Jessica.

Appreciate it, guys. Thank you.

Good luck.

That's a valid concern, and it's something that we monitor regularly. And whether we own the lots or we're buying them on an option, we have people in the divisions working with on every community to make sure those lots get delivered.

Thank you. Questions come from the line of Anthony Petanari with Citi. Please proceed with your questions.

Good morning. Last year, you know, the pandemic kind of threw seasonality out the window. As you look at home buyer behavior in terms of underlying demand, are you seeing any return of seasonality or, you know, should we expect another year of people looking to buy homes, you know, the week of Thanksgiving, the week of Christmas? And then your cancellation rate, I think, you know, extremely low by historical standards, but I think it ticked up very modestly, sequentially in the quarter. Was there anything behind that? It sounds like price wasn't an issue, but just wondering. If there was anything you saw there that's just kind of noise.

Nothing to point out on the cancellation rate. I mean, that's still at a historical low. Typically, we're very comfortable, and our normalized range is in the low 20s versus the 17, I think, that we mentioned today. So nothing of note there. To the first question, seasonality, yeah.

Again, if we... I don't know how you define seasonality. It's based upon the number of houses you start and when you release them for sale. We're building that process program to improve that. I think you're going to see our sales track our inventory releases. And as we release more houses, we're going to sell more houses.

And sales historically has been a very good indicator of demand in the marketplace as we've had a broad range of homes at various production stages available for sale and pre-sales available. And that would be a good indicator of demand in the marketplace. Today, it's our supply of homes is indicating what we're going to be able to sell and deliver. And with almost 50,000 homes in production, and the starts we've had over the past 12 months, we're in a great place to continue to deliver double-digit growth in our deliveries. We feel really good about fiscal 22.

Great, great. That's very helpful. And then just as a follow-up, I mean, I think in the past you've talked about community count rising low single digits. As you pivot to selling homes a little bit later, is there any change to that estimate or it's intact?

Our goal as we focus on gaining market share, consolidating market share, we would expect over the longer term our community count to continue to grow. Obviously, today with the strong demand, there are some communities where we have sold out sooner, and so you see some quarterly fluctuation in that. But over the longer term, we'd expect the trend to be for community counts to continue to grow at a modest pace, at a low to mid single-digit pace over the longer term.

Okay, that's very helpful. I'll turn it over. Thank you. Our next question has come from the line of Truman Patterson with Wolf Research. Please proceed with your questions.

Hey, good morning, everyone. Thanks for taking my questions. So, first question on, you know, you alluded in your press release about double-digit unit growth into 2022, and You know, my question doesn't really pertain to, you know, demand or the demand outlook really, but I'm just hoping to understand what are some of the biggest risks to achieving that growth on the supply side? You know, we've heard issues with lot development availability, community approvals, material shortages, a little bit of labor issues. I'm just hoping that you can explain, you know, some of these risks that, you know, might impede that double-digit growth. and how some of those constraints you see playing out into 22?

Terminate really is a little bit of everything you mentioned, but it's nothing new. It's all things, as Mike said earlier on, we've been working through this entire time. So if we didn't feel confident in the double digit and the ability to continue to manage through those, and ramp up our production to more adequately meet the demand that's in the market. We wouldn't be saying that here in July. But there are constraints, and we wouldn't say it's any one thing. It's everything you outlined, and it varies by market, essentially on a daily basis what the constraint is. But our operators are doing a fantastic job of navigating through that.

But the positioning we can see in our inventory, our inventory did increase by about 1,000 units this quarter, up 44% year-over-year. On a trailing 12-month basis, we've started 94,500 homes. That in and of itself is double-digit growth over what our planned deliveries are this year. So we're already in position to deliver double-digit and working to improve on that and expand on that as we move into 22. So we feel like we're in great position to do that. There'll be challenges. There'll be unknown challenges that we haven't dealt with yet, but we're confident in our teams and our ability to continue to maintain the current pace and incrementally improve on it as we move into 22 on our starts.

And I know that's a relatively high-level comment today. We're sitting in July. We haven't finished our fiscal year, so we would expect in November to give more specific guidance in addition to just the double-digit closings target.

Okay. Really what I'm kind of looking at is on the material side. We've heard of shortages kind of across the board, but especially windows, doors, concrete. I mean, it depends which market, right? But do you actually have contracts in place with your suppliers to actually get that level of product?

We have relationships with our suppliers. I mean, no matter what the contract says, you're going to get what they're going to give you, and they're going to deliver who they want to deliver to. And so we work very hard to be a good trade partner with our suppliers, both materials and labor, and making sure they understand what our production plans are, and our commitment is to them, and they've made the commitments to us.

Again, it goes back to scale within these markets. I mean, we're a very important customer to just about every material supplier in those markets. So Mike's right. It is about relationships, but it's about future relationships as well. So, you know, Is it going to be difficult? Absolutely, it's going to be difficult because they're saying no to somebody. We just don't want them to be saying no to us.

Understood. And then my follow-up question, just a follow-up, very strong order ASP, 10% quarter over quarter. We've just seen a lot of builders starting to employ a final and best bidding process. Just hoping to understand either, you know, what portion of your communities or the portion of that price hike came from the bidding process. And then on the other side of it, you know, just with affordability, you know, there's been some talk. Some believe in the industry that there's, you know, been some incentives taking up. Have you seen that in any of your local markets?

Certainly haven't seen any incentives sticking up. And we have used the final invest in certain communities where we have a very limited lot supply. But that's not a giant component of what we're seeing in sales price or margin. It certainly isn't viable and it's certainly happening in our extended longer communities. especially at the price points we're offering in the entry level. We don't like that. I personally don't like that process because in 05-06, there was a false demand by people running around putting houses under contract that they never intended to close. I don't want our operators to have a false expectation about the pricing that's achievable in the market by having a guy from California bid on a house against a blue collar guy in Texas. Then all of a sudden, every house is worth what a guy transferring in from California is willing to pay. We're trying to stay very close to these markets. Our goal is to so everybody walks into our model of a home. We're not there right now, but we're certainly going to get there.

Okay, okay. Thank you all for your time. I appreciate it.

Yes, sir.

Thank you. Our next questions come from the line of Ken Zenner with KeyBank Capital Markets. Please proceed with your question.

Morning, everybody.

Well, good morning, Ken.

And don't pick on the California folks there.

I love California.

We're making a lot of money in California right now. You can make more. All right, so... Look, all the stocks that are reporting today across all the categories, record margins, record demand, limited supply, right? What's different this cycle is that we have very low interest rates amid COVID, very high consumer credit, right? Governments are printing all the money. And structurally in housing, there's a very high propensity for institutional buyers, right? I mean, it's coming from builders like you, your, you know, other large builders, something, you know, five, six billion dollar portfolios all the time buying, you know, 15, 20,000 unit properties. So, look, I think you guys obviously have the best business model in many ways and you're working on, you know, your land supply. So, I understand all that. But where are... As an operator, I mean, you know, your WIP is less capitalized, you know, unison inventory divided by WIP, than it is historically, and your leverage is so low. I mean, what are you going to look for, I guess, to see when, you know, it seems like you're over-earning. Obviously, there's nothing that will indicate your margins are going down. You're actually going up. But, I mean, what do you think it will be there? How are you looking at the existing side? How are you looking at, you know, people bidding on properties that's maybe not an individual investor, but all this institutional money that's coming in because the cap rates are still good? What is it that you're looking at separate from the operations, you know, on the macro that causes you? Yeah, I don't know. There's a factor or two to look at rather than the operational side. That's it. Thank you.

I think from looking at what macro storm clouds might be, the things that might happen in the next six months or year that we never anticipated, like a worldwide pandemic that we didn't anticipate two years ago. There are certainly things like that that can happen that could impact the business. Rising interest rates always are a significant cost input into the value of the homes and the monthly payment. We monitor, obviously, that very closely and looking at affordability. I think Jessica touched on it before with two points and the stress testing we did, the backlog. The backlog can withstand some interest rate upward movement right now. In addition, the DTI, the debt to income levels we're seeing in our borrowers this most recent quarter, actually ticking down a little bit despite the average loan size going up. So the credit quality of our buyers are good. Looking at our for-sale communities, the vast majority of the buyers of those homes are owner occupied homes. We don't have any institutional relational outtake programs in our for sale communities. Our institutional focus would be on the build to rent communities, which are separate and apart from the for sale side of our business. It's hard to know all the things that may change in the future can. But one thing we do focus on and have focused on for many years is maintaining a very strong, flexible balance sheet, as you said, where we have great low leverage, strong equity capitalization, and very good liquidity. That allows us to take advantage of the market conditions as they change and continue to consolidate market share, especially at a local level where we can turn that local market share leverage into outperformance.

Thank you. Thanks, Ken.

Thank you. That is all the time we have today for the question and answer session. I would now like to turn the call back over to management for any closing remarks.

Thank you, Darrell. We appreciate everybody's time on the call today and look forward to speaking with you again to share our fourth quarter and four-year results in November. And to the D.R. Horton family, Don Horton and the entire executive team, thank you for your focus and hard work. I have tremendous accomplishments in delivering the first three quarters. Let's go finish strong and put numbers on the board that nobody's ever seen. Thank you.

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