D.R. Horton Inc (DHI) — Q2 2017 Earnings Call Transcript

Thank you, Doug, and good morning. Welcome to our call to discuss our results for the second quarter of fiscal 2017. 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's no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K, which is filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q next week. After the conclusion of the call, we will post updated supplementary data to our Investor Relations site on the Presentations section under News and Events for your reference. The supplementary information includes current and historical supporting data on our homebuilding return on inventory, home sales gross margins, changes in active selling communities, product mix and our mortgage operations. Now, I will turn the call over to David Auld, our President and CEO.

Thank you, Jessica, and good morning. In addition to Jessica, I'm pleased to be joined 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. The D.R. Horton team produced solid second quarter results. Our consolidated pre-tax income increased 18% to $354 million on a 17% revenue increase to $3.3 billion. Our pre-tax profit margin was stable at 10.9%. We experienced a 16% improvement in our absorption per community as home sales increased 14% compared to last year. These results reflect the strength of our operational teams and diverse product offering across our broad national footprints, as well as a strong spring selling season. Our continued strategic focus is to produce double-digit annual growth in both revenues and pre-tax profits, while generating annual positive operating cash flows and increasing returns. For the trailing 12 months, our homebuilding return on inventory improved to 16%, up 220 basis points from 13.8% a year ago. We still expect to generate $300 million to $500 million of positive cash flows from operations in 2017. With 27,100 homes in inventory at the end of March and 227,000 lots owned and controlled, we are well positioned for the remainder of 2017 and for future growth. Mike?

Net income for the second quarter increased 17% to $229 million or $0.60 per diluted share compared to $195 million or $0.52 per diluted share in the prior year quarter. Our consolidated pre-tax income increased 18% to $354 million in the second quarter versus $301 million a year ago and homebuilding pre-tax income increased 14% to $322 million compared to $282 million. Our backlog conversion rate for the second quarter was 94%, above the high end of the range we guided to on our first quarter call. As a result, our second quarter home sales revenues increased 18% to $3.2 billion on 10,685 homes closed, up from $2.7 billion on 9,262 homes closed in the prior year quarter. Our average closing price for the quarter was $295,600, up 2% compared to last year. This quarter, entry level homes marketed under our Express Homes brand accounted for 29% of homes closed and 22% of home sales revenue. Our homes for higher end move up and luxury buyers priced greater than $500,000 was 7% of homes closed and 17% of home sales revenue. Our active adult Freedom Homes brand is currently being offered in 10 markets across eight states. Customer response to affordable homes and communities offering a low maintenance lifestyle has been positive. Bill?

The value of our net sales orders in the second quarter increased 17% from the prior year quarter to $4.2 billion. And homes sold increased 14% to 13,991 homes. Our average number of active selling communities was 2% lower than the prior year quarter but increased 2% sequentially from our first quarter. Our average sales price on net sales orders in the second quarter was $299,400. And the cancellation rate for the second quarter was 20%, consistent with the prior year quarter. The value of our backlog increased 9% from a year ago to $4.4 billion with an average sales price per home of $303,400. And homes in backlog increased 7% to 14,618 homes. Mike?

Our gross profit margin on home sales revenue in the second quarter was 19.8%, consistent with our expectation in the first quarter. In the current housing market, we continue to expect our average home sales gross margin to be around 20% with quarterly fluctuations that may range from 19% to 21% due to product and geographic mix as well as a relative impact of warranty, litigation and interest cost. Bill?

In the second quarter, homebuilding SG&A expense as a percentage of revenues improved 20 basis points from the prior year quarter to 9.3% at the low end of our guidance range. For the six months ended March 31, homebuilding SG&A was 9.4%, an improvement of 50 basis points compared to the same period last year. We remain focused on controlling our SG&A, while ensuring that our infrastructure adequately supports current and future growth. Jessica?

Financial services pre-tax income in the second quarter increased to $31.5 million from $18.6 million in the prior year quarter, driven by growth in revenue and an improved operating margin. 96% of our mortgage companies' loan originations during the quarter related to homes closed by our homebuilding operation. Our mortgage company handled the financing for 57% of our home buyers, up from 53% in the same quarter last year. FHA and VA loans accounted for 47% of the mortgage company's volume. Borrowers originating loans with our mortgage company this quarter had an average FICO score of 720 and an average loan to value ratio of 89%. First-time home buyers represented 46% of the closings handled by our mortgage company, consistent with the prior year quarter. David?

During the quarter, our total number of homes in inventory increased by 11%, as we prepared for higher closing volumes in the third and fourth quarters. We ended the second quarter with 27,100 homes in inventory, 13,200 of our total homes were unsold and 9,700 in various stages of construction and 3,500 completed. Compared to a year ago, we have 10% more homes in inventory, putting us in a strong position for the remainder of the year. Our second quarter investments in lot, land and development totaled $814 million, of which $512 million were for finished lots and land and $302 million was for land development. During the first half of 2017, we invested $1.7 billion in lots, land and development compared to $1.1 billion in the first half of last year. Our underwriting criteria and operational expectations for each new community remained consistent at a minimum 20% annual net return on inventory and a return of our initial cash investment within 24 months. We plan to continue to invest in land and lots at a rate to support our expected growth in revenues. Mike?

At March 31, our land and lot portfolio consisted of 227,000 lots, of which 118,000 or 52% are owned and 109,000 or 48% are controlled through option contracts. 77,000 of our total lots are finished, of which 30,000 are owned and 47,000 are option. Our option lot position increased 42% from a year ago, in line with our focus on developing strong relationships with land developers across our national footprint. Our 227,000 total lot portfolio is a strong competitive advantage in the current housing market and a sufficient lot supply to support future growth. Bill?

At March 31st, our homebuilding liquidity included $948 million of unrestricted homebuilding cash and $900 million of available capacity on our revolving credit facility. Our homebuilding leverage ratio improved 560 basis points from a year ago to 28%. The balance of our public notes outstanding at the end of the quarter was $2.8 billion. At March 31st, our shareholder's equity was $7.2 billion and book value per share was $19.23, up 14% from a year ago. Our balanced capital approach is centered on being flexible, opportunistic and disciplined. Our top cash flow priorities for fiscal 2017 include continuing to consolidate market share by both investing in our homebuilding business and through strategic acquisitions; paying off $350 million of our senior notes of maturity in May; and providing consistent dividends which are expected to total $150 million this year. Our balance sheet strength, liquidity and continued earnings in cash flow generation are increasing our flexibility and we plan to maintain our disciplined, opportunistic position to improve the long-term value of our company. Jessica?

We are updating our expectations for fiscal 2017 based on current housing market conditions and our financial performance to date this year. As we noted in our press release this morning, we are updating our annual guidance as follows; we are increasing the range of our consolidated revenues to between $13.6 billion and $14 billion and are increasing the range of homes closed to 44,500 and 46,000 homes. We now expect homebuilding SG&A for the full year in a range of 8.8% to 9.1% of homebuilding revenues and are increasing our guidance for our financial services pre-tax operating margin to approximately 35%. We currently forecast an income tax rate of 35.5%. Also, as outlined in our press release this morning, we are reaffirming our previously issued guidance for fiscal 2017 including a consolidated pre-tax profit margin of 11.2% to 11.5%. Our home sales gross margin for the full year of 2017 is around 20% and an annual diluted share count of approximately 380 million shares and $300 million to $500 million of positive cash flow from operations for fiscal 2017. Specifically for the third quarter of fiscal 2017, we expect our number of homes closed will approximate beginning backlog conversion rate in the range of 81% to 84%. We anticipate our third quarter home sales gross margin will be around 20% and we expect our homebuilding SG&A in the third quarter to be in the range of 8.6% to 8.8% of homebuilding revenues. David?

In closing, our second quarter growth in sales, closings and profits is the result of the strength of our people and operating platform. We are striving to be the leading builder in each of our markets and to continue to expand our industry-leading market share. We remain focused on growing both our revenues and pre-tax profits at a double-digit annual pace while continuing to generate annual positive operating cash flows and improved returns. We are well-positioned to do so with our solid balance sheet, industry-leading market share, broad geographic footprint, diversified product offering across our D.R. Horton, Emerald, Express and Freedom brands, attractive finished lot and land positions, and most importantly, our outstanding team across the country. We'd like to thank the entire D.R. Horton team for their continued focus and hard work, and we look forward to continuing to grow and improve our operations together. This concludes the prepared remarks. We will now host questions.

My first question, if I could just thinking about the pricing environment and costs. You raised the revenue guidance, held the gross margin guidance and we've heard from some other builders lately that pricing power seems to be re-emerging especially at the entry level, but at the same time there is obviously some uncertainty on the cost side, lumber is probably the biggest unknown just given the potential tariffs coming down the pike here. So I'm curious as you look at the full year gross margin and I guess just a little bit longer term, how you're thinking about those two offsetting factors and I guess just as a company as a whole, if you could just give a little bit of insight into how you purchase lumber and if you're doing anything differently to potentially offset rising costs. Thank you.

Good morning, Alan. This is Mike. Thank you for the question. We're seeing some pricing power in the communities where we have achieved the absorption pace, where we have been able to drive those communities too, and so that's been very helpful in maintaining our gross margin. At the same time, with our cost structure going forward, we're seeing an efficient building process yield savings in our vertical construction cost and so we've been able to offset some of the lot cost increases we've been seeing to protect the margins. Looking forward with regard to our cost structure, our teams are working very hard every day, and we're working really hard with our national supplier partners to protect that cost structure. I can't say we're doing anything radically different on buying lumber; it's something we look at market-by-market, analyzing the commodity market and trying to lock in pricing when we feel it's a good time, again market-by-market in lumber.

And I'll just add that the supply-demand equation is allowing us also to work with our suppliers. We've seen that vary commodity-by-commodity. Land prices are going up, the price of houses goes up; it ultimately comes down to positioning and efficiency, and we get up every day working on those two things.

We do feel very confident about forward margin guidance, and it remains consistent as it has for the past few years.

Got it. I appreciate that; and on the cost side, I might have missed it. But do you have, however you look at it price per square foot, what your material and labor costs are on a year-over-year basis, and just curious within the lumber component specifically, have you already seen that inflation hit your P&L or is that going to be more on a go-forward basis?

So Alan, this is Jessica. Year-over-year we saw revenue per square foot up 3% and our stick and brick costs were only up 1%. What was offsetting that is we do continue to see slightly higher land prices falling through our P&L on a per square foot basis. Sequentially, our revenues per square foot in our stick and brick were really right in line; they were both just very low single-digit percentages. In terms of lumber specifically, we haven't seen any noticeable impact from lumber. Generally, when I talk to our purchasing teams, they say whatever that market price is doing, we are generally taking some lesser price increase when we're out there locking in our prices for our backlog and our homes under construction.

Very helpful, thanks again. Good luck.

I wanted to ask about community count. I know we've talked about it being flat to a little bit down for the balance of the year, but when do you guys think that's likely to inflect and begin to track up as you look forward?

Carl, this is Bill again. We've talked about it; we have visibility to exactly where the community count is pretty good for our quarter too, but beyond that it gets a little murky just given the timing of when communities roll off. So as we look at the next couple of quarters, we continue to believe we're going to stay relatively stable, plus or minus flat within a couple of percentage points. However, we do believe that over the long-term as we get into '18 and beyond, as we continue to expect to grow at a 10% to 15% pace on the top line, that will require some community count growth. And so as we make those investments to prepare for that growth, we would expect that as we get into '18, our community counts to start to rise at a modest pace. We still expect to continue to improve our absorptions and are very focused community-by-community on executing as well as we can to continue to drive some of our growth through absorption improvement as well.

Okay, thanks Bill. And then, if I can ask about Freedom and the rollout. When we went and looked at the product, I'm curious about whether or not you're concerned about cannibalization of the Express product. We talked about Express; one of the reasons it's been successful is because you saw a larger percentage of customers in that product who were effectively move-down buyers. So, I think the thinking is, well if you're opening Freedom near Express, you may see some level of cannibalization. So how do you think about and balance that, and has there been any impact to Express absorptions because of nearby Freedom product?

Carl, this is David. We haven't seen any negative impact to Express. The concept of Freedom is to capture and expand the offering to include the people that just don't want to live next door to a two-story house full of kids, and those buyers are out there. We're trying to set these communities up as kind of lock-and-leave opportunities, something that they don't have to be there every day to maintain, and that was a buyer segment that to be honest with you, we were not actively pursuing at the level we are now. We think it's a huge opportunity for the company and a little more difficult to roll out in Express because it is a specific type of community that we're launching Freedom; you can't just go build it on a lot. From my perception and what I'm hearing from our people, Freedom is not going to cannibalize, it's going to augment and I think support Express.

Thanks so much guys. I'm sorry, go ahead.

It's still early in our analysis, but the average price points for Freedom are currently about 10% to 15% higher than those of Express. This indicates that while these homes remain affordable for buyers, they are positioned at a slightly higher price tier than Express homes. Additionally, there are homeowners association fees included for community maintenance and other services that are not present with Express, creating some distinction from an economic perspective.

Okay, thanks guys.

Your guidance for revenue for the full year suggests you're slowing down in the second half and your backlog growth today is a whole lot different than your growth in the fourth quarter of last year. So I'm trying to understand, is it just conservatism or are you all seeing something out there that will take longer to deliver on the homes? What's driving that reduced growth rate in the second half?

Well Stephen, you know we got off to a really good start to the start of the year, and the spring helps drive where we're going to be for the end of the year. We're raising our guidance for the year to a higher annual growth rate. And as we get a little bit closer, if we see that we need to raise a bit more, we certainly will do that, but I wouldn't try to imply necessarily anything as far as a moderating growth rate at all. We're right in line, right in the range of what we've been investing for and planning for the year.

Okay, all right appreciate that. And then, you talked about your capital allocation which I appreciate. You talked about M&A; sort of couple part question here. One, you talked about M&A; there are a lot of non-traditional buyers out there right now and I'm wondering, is it disrupting the market? You don't have the strategic buyers; we're not seeing being that active and just wondering why the strategic buyers aren't as active or the non-traditional guys pushing pricing too far etc. And just how you all are thinking about it? And then, no conversation of share repurchase in your capital allocation and while I'm not a huge repo guy, when I look at the impact, it can have on your returns, your ROEs that can make a big difference, so just your thoughts there.

Stephen, this is Mike. On the M&A question, we're continuing to be very active and looking at a lot of opportunities and the most important thing for us is finding a good homebuilder, a good operation that fits with us culturally and lot-wise, and equally as important is a reasonable seller and reasonable seller expectations, and there has been a little bit of dislocation in that, but I would say that seems to have died down a bit and we might see the bid-outspread and a little bit coming going forward.

Stephen, this is Bill. I'll tag onto the rest of the question; in terms of our overall allocations, acquisitions are part of that, but we're going to remain disciplined. We certainly have the room to make large investment there if we find the right deal that fits our return strategy. In terms of share repurchase, we have an outstanding authorization from our board of $100 million which we have not used as of yet and when we talk about our top priorities, our most significant priorities for this year, we've laid those out but that is something, and we've talked about this previously that as we look further and as we generate cash flow for our third consecutive year over the longer term, we would expect there to be some level of share repurchase in our overall allocation, but as of yet we have not purchased any shares back.

All right, fair enough. Thanks a lot guys.

So this focus on absorption growth versus raw community count growth has obviously been successful for you; this trend I guess dates back probably about two years or so. Current pace puts you at about 46,000 to 47,000 orders for fiscal 2017. How much upside is there as you think about getting all over communities to their optimal absorption rate? I mean does that take us to 55,000 to 60,000 on the current footprint? And I understand you mentioned community counts might begin to rise again in 2018; just trying to think about how much upside there is left on this absorption push?

Nishu, we're just focused every day, every community getting incrementally a little bit better. If you had asked us three years ago if we'd be exactly where we're today, I'm not sure what our answer would have been because we're just trying to get better every day. What I'd tell you is that our operators through the field and our division presidents who are out there working hard every day, they're finding ways to get better every day, and so we do believe there is continued upside, there are continued opportunities to continue to get better. We've got certain markets that can significantly do better; we've got others that may be getting closer to that potential. We're going to keep trying to work to improve it, and we do believe that in this year and into next year we will continue to find ways to improve our absorptions. Exactly what that full potential is, I’m not sure there is ever a ceiling. We're just going to keep working to get better.

Nishu, it's never going to be good enough with our Chair and active shareholders we have here, so we're just going to keep rolling.

Got it. Okay, so it sounds like still some runway left there. The southwest division had some pretty good metrics this quarter in terms of the orders and the pricing etc. Can you dig down into that? Obviously, the closings were up nicely as well. Can you just dig down into that and walk us through the drivers of that please?

Go ahead, Mike.

Thank you for noticing. The southwest market has been a little bit of a smaller area for us, and we have been repositioning that group and making some investments in opportunities in Phoenix primarily, and that team has done a great job of taking advantage of those opportunities in a market that's kind of been rebounding. So we’re very happy with the positioning that our team has done and their execution against that position, and so that's really simply what it is right there.

Nishu, we spend a lot of time talking about people. We've got an operational focus and a leader in that division today that we can support with capital, and she's doing a tremendous job of turning that into growth and profitability, so kudos to her.

Great, thank you.

I'm thinking Toy Story, infinity and beyond for your order pay.

Absolutely, Ken.

Yes, so looking at from operational metrics your orders were basically seasonal in 2Q that's quarter-over-quarter pace. You guys did very well in 1Q, so it's good you maintained that. But when I think about your guidance which is related to closing, I think about comms that are totally about which includes all your specs, so you used under construction. Your guidance went from I think 8% to 13%, it's like 10% to 14% for year-over-year now and little bit. But your units under construction was 14% growth in 1Q, now we're down to 10%. Can you talk about the decisions that are being made to have that lower growth? Was it warmer weather that enabled you to put more units in the ground and you're really targeting 10% because the delta shows that you're decelerating your units under construction, which obviously build up in the year closing. So can you kind of talk about that actual capital allocation if we use units under construction, year-over-year as the indicator for your forward, best speedometer?

Sure, Ken. We've talked quite a bit about the fact that we were starting this year much stronger in position back on October 1 and then January 1 with our units under construction to prepare ourselves for the spring, and so we had a stronger year-over-year comparison in those first couple of quarters. I wouldn't say that we're decelerating at all in order versus our expectations; we just simply got an earlier start and so now we're into a good mode of just replacing homes and maintaining on that level that we believe will support the growth that we're expecting and position to start to position ourselves then for next year as well, so I wouldn't read too much into just this quarter and positioning on a year-over-year; we're in a good position with our homes under construction.

Go ahead, David.

We are focused on a community-by-community process and market shifts and starts and plans, targeted closings. We're trying to be disciplined, we're trying to be smart, and we're trying to maximize every flag, so again we set annual targets; we operate quarter-to-quarter and we adjust, but don't read anything negative into that number.

As you look at, as our community counts do start to get back to close to flat year-over-year and then rising into '17, obviously there are some homes that go along with those flags as well that I would expect to be coming into the picture as well.

I wasn't set up as a derogatory comment; it's just that I think people misunderstand that number or don't apply it enough. As you start moving into right from 2Q to 3Q to 4Q. 4Q is actually just multiply it every time by two and it's usually your forward volumes. So I'm just trying to think about not only the execution that you're doing this year, but how you're setting up conceptually '18 right from your capital allocation, as we think about that, and it seems as though labor is not an issue here; closing is a percent of units under construction is exactly what it was last year, so obviously labor is not an issue for you. So just determining how many units you are going to have in for spec.

We're very focused on maintaining; and I think, to be honest with you. Thank you.

A surprise, another great quarter to report; just wanted to understand your gross margin target a little bit better. It looks like you're increasing your financial services operating margin by a pretty healthy amount. But at the same time, you're reiterating your full year operating margin guidance. And I just want to understand kind of what the offset was. It sounds like cost pressures are actually rather benign, can you help us think through that a little bit?

Sure, Bob. This is Mike. What we have is financial services are not a component of our gross margin; that's down in our other area, operating margin. It's part of operating margin overall, but we're seeing gross margin to be consistent with where it's been. Financial services is improving a bit and will probably get some more SG&A leverage in the second half of the year.

Right. So, sorry, I misspoke; I meant to say you reiterated your full year operating margin for the company of 11.2 to 11.5. There seems like you got a very positive trend there on the financial services side with the consistent gross margin. So you're also getting the SG&A leverage, so I'm just trying to understand, at some point does operating margin inflect higher just because of what's going on?

It will depend on what happens with gross margin in the back half of the year. But if you look at it at the first six months of the year, we're only running 19.8%, so our margin is a little loose. We talk a lot about 19% to 21% as the broader range, so if we move into Q3 and Q4 and we do see that margin pick up over 20%, that could allow us to have some upside or at least hit the high end of our operating margin guidance. But because we're only running 19.8% for the first six months of the year, we don't feel like it makes sense to move that operating margin range up from where it is today.

That makes perfect sense. Thank you. And that's very helpful. And also too, just a follow-up question if I may. What should we expect about the conversion rate going forward, the backlog? Do you think it will just be consistent with last year or do you expect any change to the pace?

We're focused on improving that on a year-over-year basis, so we're projecting a lower conversion rate sequentially, but that's typical seasonality for us. But in terms of year-over-year, we would hope to see some improvement, although let's see, yes we guided to 81% to 84% which compares to last year's third quarter conversion rate of 78%.

Very impressive.

Just trying to get better every day, Bob.

I wanted to ask a question, if I could about the difference in the way you approach implementing price increases in communities which are perhaps lower price point, maybe more volume oriented versus more of your semi-customer or move-up product. In general, we're hearing that there is strength across the board, but probably more concentrated at the lower end, lower price points. And I was curious if you could give us a sense for if your strategy or the pace of implementation of price increases varies or is different when the strength you see is more in those lower price communities.

Stephen, we try to be consistent in our operation and absorption in these communities. So, based upon the season and timing within the year, but the best practice we found is small, incremental based on the number of units that are being sold. So if it's a 300-lot community and we want to sell 10 a month, then we would have a nominal increase every 10 houses. So if there is a consistency to the pricing, there is a set urgency to get people off the fence, and they buy now or they pay a little more next month. That's proven to be very effective; it not only creates urgency but it improves margin.

Got it, that's helpful. Thanks for that. And then the second question I had relates to kind of a more general question. I think one of the things that we're seeing that's really fascinating about the industry and the stocks right now is this sort of blend between things that are early cycle and later cycle. The valuations that we're seeing in the group, level of margins, the labor constraints you're running into and first-rate land spend as a percentage of revenue, those are all things characteristic of later cycle. And yet, I'm not the multiple the valuations are actually more early cycle. But we're also seeing that growing share at the entry level and the overall level in housing are to very cycles. So you have some aspects to the market that are kind of early cyclicish and then you have some aspects it seems like they're more later cyclicish. And I'm curious as to, as you look it where we are right now and you try to assess your strategy over the course of the next few years, let's say, where do you think we are in the housing cycle and which of these various metrics or things to look at do you think are the best gauge for determining where we are and what the right approach for your company should be from a cyclical perspective?

We operate subdivision-by-subdivision and drive growth within submarkets, and I can tell you we have submarkets that are very early cycle and others that feel more mature. It doesn't give a sense that it's an actuary or something like there will be some disruptions and things may change. But right now, in the markets that are producing at the top for us, there is more demand and less options or inventory out there than any forward that I have seen in this business. I think you can get too focused; sometimes we can get too focused on trying to judge a cycle and miss the tremendous opportunity. We're adjusting quarter-to-quarter and supporting the divisions that are improving returns. Mike?

Stephen, I think you touched on it; not just geography, as David mentioned, but within markets, different customer segments have been coming into the housing equation at different times. I think coming out of the last downturn we saw more of the move-up buyers' pent-up demand being satisfied in that rush. And now I think we're seeing more of the entry-level first-time buyers coming into the marketplace now that there is some supply out there that is attainable for those folks. So we're, as David said, community-by-community being responsive to what we see in the market in front of us, and rather than looking at broad trends, we're focusing on a very micro level with our capital.

So we made a decision to push into the entry-level opportunities that we see out in California and I can tell you that certainly isn't late cycle because those opportunities haven't existed for the buyers out there. Don Horton traveled the west region over the last 30 days and you know, he's not an exuberant type guy, but he came back feeling better about what he saw in the west and specifically the opportunities in California than I have seen him in a long, long time. And I traveled Texas, Louisiana, and Arizona in the last couple of months, and I can tell you, I think I said two or three years ago Dallas was the best housing market I've ever seen; it's still an incredibly strong market, but with a strengthened Houston, and opportunity in Houston that the compressed oil industry kind of put on hold. Austin is red hot. Phoenix, we're opening a price point that didn't exist. So to say that, Phoenix is at some point in the cycle? I tell you from an affordable housing standpoint, it is at the very front end of the cycle. So it's just market-by-market and where people want to live and where there are no houses, we found the ability to sell houses.

Well, for a company that doesn't focus on the cycle, you guys are certainly been doing a lot of things that looked pretty present from a cyclical perspective, I have to say, over the last several years. Just to put a fine point or to make sure I understood what you said, you don't manage to a cycle per se, but you don't mean to suggest that when we go into the next down cycle or downturn in the economy that you think that the markets across the country will be completely immune to that, do you? The market is going to get affected.

No, I was around in '08, '09, '10; we're not in an inflated market.

Not at all; but the only way to respond, you can't respond at a global level effectively; you still have to respond on the ground in a subdivision what's the right decision day-to-day, and operating that community and what's going on around it. That's the way our operations set up, as to what all of our operations field are focused on every single day.

And over the backdrop for the past several years, the balance sheet strength we have garnered is going to give us regular flexibility through wherever the next cycle holds for the next stages of the cycle to make those best decisions, community-by-community.

The first question here is, and I don't want to beat a dead horse, but I just want to be clear because I do believe this is why the stock is under pressure today. If we look at the first half revenue growth, year-over-year it is about 18.8%. If we take the high end of your total revenue range of $14 billion, that's going to imply 15% growth for the full year. At 13.6%, it's about 12% growth. So it does appear like there is a deceleration, and the market is looking for any reason to say that growth is slowing. So what are you guys seeing? Is this really kind of just that you got up to a stronger start, do you see any indications that demand is slackening, that orders trail off through the quarter or are things looking a lot better than the market is actually giving you credit for today?

Well John, I think one element here is if we're looking at simply year-over-year trend, one part of that component is the prior year numbers. We had a slow start last year, honestly, and we've talked about that; we were trying to play catch up all year long with our homes and inventory and getting communities open. We got a lot of our growth last year in achieving our 10% to 15% of the growth in the second half of the year. We worked really hard to position ourselves to start this year in a better position. So when we performed in Q1 and Q2 versus a slower Q1 and Q2 last year, we've seen a higher annual growth rate. The year is still right in line with what we've expected; it's not a deceleration of growth. It's really more of a function of the comparison to the prior year on a quarter-to-quarter basis. We invest in this business on multi-year cycles; we plan our years out and we try to put ourselves and each of our communities in the best position possible to execute as well and give ourselves an opportunity to do better, and we believe we were in good position this year to do it. We're feeling really good about the rest of the year and our ability to position ourselves to grow double-digit again in fiscal '18; and we certainly don't feel like we're decelerating here. It feels like we're in position to do exactly what we were planning to do.

Okay, and that's really helpful. And then if we think about just kind of traffic that's been coming through your communities, interest rates have bounced around a bit; I know last quarter you mentioned that you didn't see any real notable impact. But how is traffic, how are folks feeling in general? Is there any continued chatter about interest rates that you guys are hearing?

Not a lot of chatter about interest rates; I can tell you the salespeople in our company today feel as good about the market as they have ever. Traffic numbers are up; we're selling houses; we’re well-positioned against competition, where we have competition, and it's just a good time to be in the business.

Okay, that's it. It's really helpful guys. Thank you.

Wanted to talk a bit more about Freedom; I know in the past you've talked about it being a growth opportunity next year. I think you said 10 markets in eight states today. Is it possible for you to size what that looks like a year from now, four, or five quarters from now? And if it is growing and the community count numbers are still flattish, what do Freedom communities displace or will that be the growth in community count?

This is David; I think Freedom will be growth within our community count. We're certainly not looking to displace any of our other brands; it is a kind of unique product and offering; it's not going to rollout at the same speed that Express did. But yes, I think in '18 and '19 it will be a big part of the growth story.

Okay, great. And then on the financial service margin, what is driving it higher? Is that just more volume or are you doing more FHA and VA that's driving the gain on sale profitability higher? What's behind the changing guidance on the financial service side?

We're seeing better loan sale executions, so we're seeing higher gains on sale. We're also continuing to see a higher average loan amount, particularly in this quarter. So that coupled with just this doesn't affect the operating margin, but the revenue growth that we saw and our increased capture rate again, our financial services operations have done a great job of capturing more of our homebuyers or D.R. Horton homebuyers. That all helps us drive better efficiencies and better G&A leverage to drive that higher operating margin.

Okay, thank you.

David, I wanted to follow up on the comment you made about California and D.R. 's tours a couple of questions ago and just to ask specifically, is the enthusiasm coming from the Express rollout or is it kind of across your brands? And then specific to the rollout of Express, can you give us a little more color on how that's going and whether or not there has been any impact from things like the rains that you've seen in parts of California?

I would say the enthusiasm was the alignment of our people out there with the opportunities in the market because he was not only in California looking at the Express program, he was also along the coast looking at our infill operations and up in Seattle and Portland. I mean it's just strong markets with aligned teams executing very well. And as for California Express question? I'm sorry.

Just if you could give us any update on how that rollout's going and whether or not it's been any impact from the rain?

Have not seen a big impact on the rain because everything in California it takes a lot longer. We have a significant number of projects identified and/or controlled, and we're launching. The impact that we're going to see is probably going to be in 2018, but just the opportunity and positioning that we've been able to accomplish is pretty exciting for us.

Got it. Thanks. My second question is going back to actually I think the first question around lumber, and I appreciate that you guys have the purchasing power to negotiate much better deals than some other across the industry, but just want to make sure we understand just mechanically the right way to think about it between how you contract out on lumber and then the cost allocation process that takes place as you incur potentially higher costs and then obviously your build cycle. So could you extend this most recent leg higher in lumber sticks, is that something that will impact the P&L in the second half or is it more likely to be something where you'd have it impacting fiscal '18?

Mike, so we would allocate the cost to the individual houses that we're buying the lumber for, and we're looking at lumber pricing. It varies on the lot 30, 60, 90 days, and some adjustments. So the buying, protecting our backlog and our plan spec starts in the near term. So as any lumber cost may come through in our purchasing production, they would show up in a house closing four to six months after that lumber was dropped on the lot, or two to six months after that lumber was dropped on the lot. You would see that particular cost line potentially having some pressure, but I would tell you that we would expect to see some of those things offset by other decreases in other material costs that we're seeing, as well as continued greater labor efficiencies that we're getting with our production processes in our neighborhoods, more with the Express and some of that Express concepts going into our other product lines.

Got it, and are there any things that you can point out specifically as far as the areas where you're seeing the decreases for the actual sticks and bricks cost?

Nothing to point out specifically; it's just that we've been working really hard with a lot of our national trade partners to focus on our purchasing power and some of the mutual benefits we can both have in expanding their market share in a given market.

First question; just wanted to circle back to community count and it looks like actually it was a couple questions earlier about maybe community count flat to slightly down, and you kind of I think earlier Bill talked about community count being stable for the year. But it seems like community count was actually up sequentially 3% during the quarter, and you also have, I think as you've alluded to earlier, you have a continued growth now in lock count for a few quarters up solid double digits. I didn't, I forgot the type in the total number for this quarter, but believe you're still at a healthy double-digit pace now for a few quarters. So why would lock count continue to drift up sequentially for the rest of the year, similar to the second quarter rate?

Are you asking if our lock counts are going to continue to drift up?

No, I'm sorry; the community count, excuse me.

Sequentially our community count on average was up 2%. So it was the first time we've seen a slight tick up in that community count. And we do have the lot for that to happen, but as Bill mentioned earlier, the timing of when communities roll off and when new ones roll on, it's pretty flexible and it's highly dependent on the sales absorptions we're seeing in currently open communities and then also just our ability to bring new communities online because there is a lot of moving part. So we could see that continue to go up, but we don't expect it to go drastically up. Any changes in our community count, both sequentially and year-over-year, we would expect to be in the low single-digit range.

Okay, fair enough. Also on the gross margin front, obviously still well within your guidance range, but essentially what you've had now a couple of quarters a touch below 20%, that was proceeded by the back half to '16 a little bit above 20%. So just curious if there is anything mixed driven so far in the first half of this year that you know resulted in it being a little touch below? It seems like your cost inflation is still very reasonable and not too much of a driver, if I'm interpreting those numbers correctly. So just curiously, if it was a little bit more mix driven or, you know, obviously the warranties sometimes play a role.

Mike, this is Bill. We really think, incredible stability actually in our gross margin for quite some time now. At a core level, it's been very tight within 20 to 30 basis points from quarter-to-quarter-to-quarter, and that's why we guide around 20. We can see some quarterly volatility due to some of those other factors that you mentioned, in general our interest costs have been ticking slightly lower as a percentage of our costs and so that's been a slight help to our margin over the last eight quarters or so. We see more volatility in terms of our warranty line there and in recent quarters we've seen a little bit more of a negative impact from that; not too significant, but a little bit more of a negative impact there in the last couple of quarters, which is one factor why we've been slightly below 20%. But overall we would characterize our margins as very stable; we're seeing actually less volatility from all of those factors than we've seen over the longer term history in our company. And as long as we're continuing to guide to around 20%, but you'll see some movement either above 20% or below 20% from quarter-to-quarter.

And Mike, we'll post after the call, our supplementary data that has home sales growth margin slide in it that shows the specific basis point impacts either up and down to what we call our core growth margin, and some of those items that Bill and you've already touched on; you can see the specifics after the call.

On Express and Freedom, the two things we noticed touring those brands on our recent field trip is you're covering costs out of those homes. You're not using troughs for example. And that Freedom buyers specifically buying to live near their adult children in for example in Express community. So can you discuss how much costs you've carved out of Express and Freedom relative to your pure set on a dollar or a percentage basis? And secondly, what quantifiable benefits are you seeing from active adult buyers buying Freedom homes and communities near their children who possibly bought a Horton home?

Your question on the costs, was that related to troughs, we didn't quite hear you there.

Sorry, so yes. So you've carved out costs on troughs and in other places in a home, so that was my first one. Can you quantify the benefits? And second, what first derivative benefits are you seeing from active adults living near their children and co-located communities because we heard a few of your salespeople say that on your recent tour.

That's part of our overall analysis of Freedom; is that we're giving adult children and the parents an opportunity and an affordable opportunity to live near their children and grandchildren. I mean we just feel like that's a major factor and people relocating; and I've lived in Florida for 25 years, saw it every day where somebody was moving down. A job had brought the family, children and grandchildren down, and then the parents were coming on trying to find something to buy where they would have the home close to their grandchildren. I just think that's a big driver in the market. And as far as the overall cost and the design, what I mean that's a market-by-market determination. What we try to do with the Freedom product is drive as much efficiency and labor savings as we possibly could. Everything we're doing today is to drive better value to the customer and try to take labor out of houses where we can because that's going to be, that has been and continuously is the constraint on a market right now. There is not a builder out there that could sell more houses, if they couldn't build.

And I guess as a follow-up, realizing your exposure to California is smaller than those to your public peers, there have been concerns regarding the State of California mandating what type of labor be used via AB199 and in a number of markets, which can add thousands of dollars of cost to houses. And also a mandate to reduce emissions by 20% in 2017, which can add another $5,000 to $10,000 per house. We've heard AB199 as a moot point but the emission costs are real; can you comment on both the AB199 you may have as well as the emissions reductions costs for you?

Well, we compete market-by-market and we're going to be competitive in every market we're in, as David said, looking to provide the value on the ground; and it's a great thing about the country, we have different parts that act differently and meet with their population wants to see happen. So we have an exposure to California that may be a little smaller percentage-wise than some of our peers, but we do like our positions in California and the way we're positioned to take advantage of some affordable value plays we have there.

Just wondering if you could just maybe offer a little bit of color on the month-to-month trends in order growth activity, just how that progressed January through March and any comments you might be able to offer on how April is feeling right now?

Buck, through the spring, we really seem to have solid, good consistent demand out there; really good supply-demand dynamics, very little supply, so a really just a good solid, stable, consistent spring, and really thus far in April we're seeing the same kind of conditions; pretty healthy, good strong market out there.

Sounds good, and on just looking at your option lot position, since that's been growing so rapidly, and I know that's a determined strategy; so what opportunities are still out there to keep growing the number of lots you're controlling through option? How do you see that longer term mix of owned versus option land going, and does that impact your margins at longer terms?

Historically we like a 50-50 balance as far as the owned vs. option lot; the option lot contract typically extends over a period of time and your margin is on the front end of the community, maybe a little less, but if pricing power continues within the market, depending on times and the cycle, you can actually end up on the back half of those deals at market price lots with very strong margins.

About one more comment I'd make on that lot positioning and impact on margins, we're really focused on in underwriting our communities is our return that we get community-by-community. Optional lot positions can provide a very efficient, very high returning community to move forward with that. So it's not just the margin; that's one component of the returns that we're looking at in our underwritings. Returns are much more important to us today; generating cash flow.

Sounds good, thanks. Good quarter guys.

Thank you, Doug, and we appreciate everyone's time on the call today and look forward to speaking with you again in July. Again, a special thanks to the D.R. Horton team. Outstanding quarter, you continue quarter after quarter to outperform the industry, and we certainly appreciate it. Thank you.