D.R. Horton Q2 2022 Earnings Call Transcript

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Provided by Quartr
April 26, 2022

Key Takeaways

  • Q2 earnings surged 59% to $4.03 EPS, with pretax income up 60% and a 23.5% consolidated pretax profit margin, highlighting robust operational performance.
  • Housing demand remains strong with 33,900 homes in backlog and a 25%+ revenue growth target for the full year, despite a mortgage rate rise.
  • Supply chain and labor shortages extended average construction cycle times by two weeks sequentially and over two months year-over-year, constraining home closings.
  • The company maintains a strong balance sheet with $3.2 billion in homebuilding liquidity, low net leverage of 11.2%, and ample lot supply of 570,000 controlled lots.
  • For Q3, D.R. Horton expects revenues of $8.6 billion to $9 billion, home sales gross margin of 29–29.5%, and full-year closings of 88,000–90,000 homes.
AI Generated. May Contain Errors.
Earnings Conference Call
D.R. Horton Q2 2022
00:00 / 00:00

There are 16 speakers on the call.

Operator

Good morning, and welcome to the Second Quarter 2022 Earnings Conference Call for D. R. Horton, America's Builder, the Largest Builder in the United States. At this time, all participants have been placed on a listen only mode and the floor will be open for your questions and comments after the presentation. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.

Operator

R. Horton.

Speaker 1

Thank you, Holly, and good morning. Welcome to our call to discuss our results for the Q2 of fiscal 2022. 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.

Speaker 1

Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward looking statements are based upon information available to D. R. Horton on the date of this conference call and D. R.

Speaker 1

Horton does not undertake any obligation and to publicly update or revise any forward looking statements. Additional information about factors that could lead to material changes in performance is contained in D. R. Horton's annual report on Form 10 ks 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.

Speaker 1

Drorton.com, and we plan to file our 10 Q in the next day or 2. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentations section under News and Events for your reference. Now, I will turn the call over to David Auld, our President and CEO.

Speaker 2

Thank you, Jessica, and good morning. I am pleased to also be joined on this call by Mike Murray and Paul Romanowski, our Executive Vice Presidents and Co Chief Operating and Bill Wheat, our Executive Vice President and Chief Financial Officer. D. R. Horton team delivered an outstanding second quarter, highlighted by a 50 9 percent increase in earnings to $4.03 per diluted share.

Speaker 2

Our consolidated pretax income increased 60% to $1,900,000,000 on a 24% increase in revenues and our consolidated pre tax profit margin improved 520 basis points of 23.5%. Our homebuilding return on inventory for the trailing 12 months ended March 31 was 40.3% and our consolidated return on equity for the same period was 34%. These results reflect our experienced teams, the production capabilities and our ability to leverage D. R. Horton's scale across our broad geographic footprint.

Speaker 2

Housing market demand remains strong despite the recent increase in mortgage rates, and we There are still significant challenges in the supply chain, including shortages in certain building materials and a very tight labor market. Our construction cycle times were extended further this quarter and we continue to work on stabilizing and then reducing our cycle times to historical norms. After starting construction on 24,800 homes this Our homes in inventory increased 30% from a year ago with only 600 unsold completed homes across the nation. With 33,900 homes in backlog, 59,800 homes in inventory, A robust loss supply and strong trade and supplier relationships, we are well positioned for consolidated revenue growth of greater than 25% this year. We believe our strong balance sheet, liquidity and low leverage position us to operate effectively through changing economic conditions.

Speaker 2

We plan to maintain our flexible operational and financial position by generating strong cash flows from our homebuilding operations, while managing our product offerings, incentives, home pricing, sales pace and inventory levels to optimize returns. Mike?

Speaker 3

Earnings for the Q2 of fiscal 2022 increased 59% to $4.03 per diluted share compared to $2.53 per share in the prior year quarter. Net income for the quarter increased 55% to $1,400,000,000 compared to $930,000,000 Our 2nd quarter home sales revenues increased 22% to $7,500,000,000 on 19,828 homes closed, up from $6,200,000,000 on 19,701 homes closed in the prior year. Our average closing price for the quarter was $378,200 up 21% from the prior year quarter, while the average size of our homes closed was down 1%. Paul?

Speaker 4

Our net sales orders in the 2nd quarter decreased 10% to 24,340 homes, while the value increased 10% from the prior year to $9,700,000,000 Our average number of active selling communities increased 1% from the prior year quarter and was up 4% sequentially. The average sales price of net sales orders in the 2nd quarter was $400,600 up 23% from the prior year quarter. The cancellation rate for the Q2 was 16% compared to 15% in the prior year quarter. New home demand remains very strong despite the recent rise in mortgage rates. We are continuing to sell homes later in the construction cycle to better ensure the certainty of the home close date for our homebuyers with virtually no sales occurring prior to the start of home construction.

Speaker 4

We expect to continue managing our sales pace in the same manner for the rest of the year. Bill, our gross profit margin on home sales revenues in the 2nd quarter was 28.9%, up 150 basis points sequentially from the December quarter. The increase in our gross margin from December to March reflects the broad strength of the housing market. The strong demand for homes combined with a limited supply has allowed us to continue to raise prices and maintain a very low level of sales incentives in most of our communities. On a per square foot basis, home sales revenues were up 4.8% sequentially, while stick and brick cost per square foot increased 2.5% and our lot cost increased 2.8%.

Speaker 4

We expect our costs will continue to increase. However, with the strength of today's market conditions, we expect most cost pressures to be offset by price increases in the near term. We currently expect our home sales gross margin in the 3rd quarter to be slightly better than the 2nd quarter. Jessica?

Speaker 1

In the 2nd quarter, homebuilding SG and A expense This quarter, our homebuilding SG and A expense as a percentage of revenues was lower than any quarter in our history and we remain focused Our SG and A while ensuring that our infrastructure adequately supports our business. Paul?

Speaker 4

We started 24,800 homes during the quarter, up 5% from the Q2 last year, bringing our trailing 12 month starts to 95,300 homes. We ended the quarter with 59,800 homes in inventory, up 30% from a year ago. 26,000 of our total homes at March 31st were unsold, of which only 600 were completed. Our average construction cycle times for homes closed in the 2nd quarter increased by almost 2 weeks since our Q1 and over 2 months from a year ago. Although we have not seen improvement in the supply chain yet, We continue working to stabilize and then reduce our construction cycle times to historical norms.

Speaker 4

Mike?

Speaker 3

At March 31, our homebuilding lot position consisted of approximately 570,000 lots of which 23% were owned and seventy 7 when we purchased them. Our large capital efficient lot portfolio is a key to our strong competitive position. Our 2nd quarter homebuilding investments in lots, land and development totaled $2,100,000,000 of which $1,200,000,000 was finished lots $630,000,000 was for land development and $260,000,000 was to acquire land. Paul?

Speaker 4

Forestar, our majority owned residential lot development company continues to execute well. During the second quarter, Forestar reported total revenues of $421,600,000 and pre tax income of 63,200,000 For the full year, Forestar expects to deliver 19,500 to 20,000 lots and generate $1,700,000,000 of revenues with a pre tax profit margin of 14% to 14.5%. At March 31, Forestar's owned and controlled lot position increased 14% from a year ago to 96,500 lots. 57% of Forestar's own lots are under contract with or subject to a right of first offer to D. R.

Speaker 4

Horton. $390,000,000 of our finished lots purchased in the 2nd quarter were from Forestar. Forestar is separately capitalized from D. R. Horton and had approximately $580,000,000 of liquidity at quarter end With a net debt to capital ratio of 29.9%, Forestar's strong capitalization, lot supply and relationship with D.

Speaker 4

R. Horton positions them to continue their profitable growth. Bill? Financial Services pretax income The quarter was $92,800,000 with a pre tax profit margin of 41.8 percent compared to $107,700,000 47.8 in the prior year quarter. For the quarter, 99% of our mortgage company's loan originations related to homes closed by our homebuilding operations and our mortgage company handled the financing for 68% of our homebuyers.

Speaker 4

FHA and VA loans accounted for 41% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 724 and an average loan to value ratio of 88%. First time homebuyers represented 55 percent of the closings handled by the mortgage company this quarter. Mike?

Speaker 3

Our rental operations generated pre tax income of $103,000,000 on revenues of $223,000,000 in the 2nd quarter. During the quarter, we sold 1 multifamily rental property consisting of 126 units for $50,000,000 and we sold 3 single family rental properties totaling 368 homes for $173,000,000 Our rental property inventory at March 31 was $1,500,000,000 compared to $544,000,000 a year ago. Rental property inventory at March 31 included approximately $600,000,000 of multifamily rental properties and $900,000,000 of single family rental properties. As a reminder, our multifamily and single family rental sales and inventories are reported in our rental segment and are not included in our homebuilding segment's homes closed revenues or inventories. During the quarter, Our rental operations subsidiary, DRH Rental entered into a 4 year $750,000,000 senior unsecured revolving credit facility.

Speaker 3

Availability under the rental revolving credit facility is subject to a borrowing based calculation based on unrestricted cash and the book value of DRH rental real estate assets. There were no borrowings outstanding on the rental credit facility at quarter end. We now expect our rental operations to generate more than $800,000,000 in revenues during fiscal 2022. Our 3rd quarter rental sales will be lower than the 2nd quarter and 4th quarter sales will be the highest of the year. We also now expect our total rental platform inventories to grow by more than $1,500,000,000 in fiscal 2022 based on current projects in development and a significant pipeline of our future projects.

Speaker 3

We are positioning our rental operations to be a significant contributor to our revenues, profits and returns in future years. Bill?

Speaker 4

Our balanced capital approach focuses on being disciplined, flexible and opportunistic. At our March 31, we had $3,200,000,000 of homebuilding liquidity, consisting of $1,200,000,000 of unrestricted homebuilding cash and $2,000,000,000 of available capacity on our homebuilding revolving credit facility. Our homebuilding leverage was 16.4% at the end of March and homebuilding leverage net of cash was 11.2%. Our consolidated leverage at March 31 was 24.9 percent and consolidated leverage net of cash was 18.9%. At March 31, our stockholders' equity was $16,800,000,000 and book value per share was $47.66 up 33% from a year ago.

Speaker 4

For the trailing 12 months ended March, our return on equity was 34% compared to 27.1 percent a year ago. During the 1st 6 months of the year, our cash used in homebuilding operations was $416,000,000 which reflects our increased homes and inventory to meet demand and the impact of extended construction cycle times. During the quarter, we paid cash dividends of $79,100,000 and our Board has declared a quarterly dividend at the same level as last quarter

Speaker 5

to be paid in May.

Speaker 4

We repurchased 3,100,000 shares of common stock for $266,000,000 during the quarter for a total of 5,800,000 shares repurchased fiscal year to date for $544,200,000 an increase of 30% compared to the same period a year ago. Subsequent to quarter end, our Board authorized the repurchase of up to $1,000,000,000 of our common stock replacing our prior authorization. The new authorization has no expiration date. We now expect to reduce our outstanding share count by 3% during fiscal 2022. 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.

Speaker 4

Jessica?

Speaker 1

As we look forward to the Q3 of fiscal 2022, We expect market conditions to continue to reflect strong demand from homebuyers with continuing supply chain challenges. We expect to generate consolidated revenues in our June quarter of $8,600,000,000 to $9,000,000,000 and homes closed by our homebuilding operations to be in a range between 21,520 2,500 Homes. We expect our home sales gross margin in the 3rd quarter to be in the range of 29 to 29.5% and homebuilding SG and A as a percentage of revenues in the 3rd quarter to be around 6.6%. We anticipate a financial services pretax profit margin of approximately 40% and we expect our income tax rate to be roughly 24% in the 3rd quarter. For the full fiscal year, we expect to generate consolidated revenues of $35,300,000,000 to $36,100,000,000 and homes closed by our homebuilding operations to be in a range of 88,000 to 90,000 homes.

Speaker 1

We forecast an income tax rate for fiscal 2022 of roughly 24%, and we now expect that our share repurchases will reduce our outstanding share count by approximately 3% at the end of fiscal 2022 compared to the end of fiscal 2021. We still expect to generate positive cash flow from our homebuilding operations this year and we will continue to balance our cash flow utilization priorities among our core homebuilding operations, increasing our rental inventories, maintaining conservative homebuilding leverage and strong liquidity, paying an increased dividend and consistently repurchasing shares. David?

Speaker 2

In closing, our results and position reflect our experienced teams and production capabilities. Industry leading market share, broad geographic footprint and diverse product offerings across our multiple brands. Our strong balance sheet, liquidity and low leverage provide us with significant financial flexibility to continue aggregating market share and effectively operating 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.

Speaker 2

R. Horton team for your focus and hard work. We are incredibly well positioned to continue growing and improving our operations during the remainder of 2022 and in future years. This concludes our prepared remarks. We will now host questions.

Operator

Ladies and gentlemen, the floor is now open for questions. And one follow-up each. We also ask that while posing your question, you please pick up your handset if listening on speakerphone to provide optimum sound quality. Please hold while we poll for questions. Your first question for today is coming from Carl Reichardt with BTIG.

Operator

Carl, your line is live.

Speaker 6

I think at the end of or in January, you talked about orders being Flat, maybe up slightly in the quarter, they were down 10%. Can you talk a little bit about the progression of orders over the course of the quarter? And when I'm assuming you recognize that the production side was not catching up and in fact was deteriorating and you decided to slow order pace or is there a demand component to this as well?

Speaker 3

Carl, I think it was all Our decision to slow sales orders based on production capacity, I think we saw and continue to see very good demand and more buyers qualified buyers out there for our homes today when we release them for sale. But we did see during the quarter that our cycle times Continue to extend and we made the decision in several of our geographies to delay the release of homes until we could give a better delivery date to those customers and provide a better experience for them in the backlog process. So we saw very strong demand in the quarter, but we did see the cycle times elongate. I think we added 2 weeks this And we wanted to make sure we did not create more buyers and backlog with an unhappy experience.

Speaker 6

Great. Thanks, Mike. And then, you didn't discuss the Dittler Water transaction, and I would just like you to give sort of An overview of the strategic rationale for that deal and whether or not this is a function of the assets related to water rights or if this is a business that you think potentially could grow? Thanks very much.

Speaker 1

Sure, Carl. We put out What we're going to say about Fiddler in the press release in terms of them owning a portfolio of premium water rights and other water related assets across several of our Southwest markets that generally lack adequate supply. We mentioned the total value of the transaction is Approximately $290,000,000 and we do expect it to close in the next month or 2. But considering it's subject to the successful completion The tender offer, we don't have much more to say at this time, and I look forward to talking about that in coming quarters after it closes.

Speaker 6

Well, I tried. Thanks, Jess. Thanks, everybody.

Operator

Your next question is coming from John Lovallo with UBS. John, your line is live.

Speaker 7

Good morning, guys, and thank you for taking my questions. The first one is activity at some point will likely moderate given higher rates and higher prices. And The question I have and I think the concern that some investors have is that if and when activity does moderate, how does this sort of change, if at all, your thoughts on capital allocation? I mean, will you sort of back off on take the foot off the pedal on buying land and maybe switch more towards share buybacks, things of that nature?

Speaker 4

Thanks, John. We're always focused on aggregating market share and we're positioning ourselves to continue to do that through Any economic cycle, certainly at some point impact of rates and impact of affordability will have some impact on demand and we certainly will adjust our capital allocation at that time. But we believe we're in a strong position to continue to grow. But certainly, those impacts on demand would impact our decisions in land at that point in time.

Speaker 7

Okay. That's good to hear. And then on The option percentage getting up to 77%, I mean that's much higher than I think anyone thought it when the Forestar acquisition occurred and Stephen going back a few years ago. I mean could this get much closer to call it 90% and that's just a random number, but just 90% plus, getting closer to what NBR does. And how does this impact the strategy with Forestar as it's grown and You don't become spread across a lot of your communities.

Speaker 7

I mean, you do have the option to bring that ownership position down pretty significantly and still maintain the favorable contract term. So just curious how you're thinking about Forestar longer term?

Speaker 2

From the overall auction Lot percentage. We have been focused on it. We're going to continue to focus on it. There is Obviously, it's going to be capped at 100%, but our goal is just to continue to get better and more efficient. And as to Forestar, very happy with Forestar.

Speaker 2

I mean, at some point, yes, it will deconsolidate, There's still a lot of markets that we think we can help scale Forestar into. And if you look at just the earnings we're making, our shareholders are making all Forestar, It's a very good investment and kind of not a bad place to be. But yes, at some point it will deconsolidate, But it's more geared toward their platform build out that it is a higher desire to Liquidate some percentage of our shares.

Speaker 7

Thanks guys.

Speaker 1

Thanks, Jeff.

Operator

Your next question for today is coming from Stephen Kim with Evercore ISI. Stephen, your line is live.

Speaker 8

Yes. Thanks very much guys. Congratulations on the strong results.

Speaker 9

Obviously, with big rise

Speaker 8

in rates, everyone's concerned that things are going to slow.

Speaker 9

I think John mentioned that that's people's expectations. I guess Two questions with respect to the rise in rates. One is, is there anything that you are planning in terms In terms of the communities which would likely come online in the next year or 2, let's say the next year, new communities opening, Were you making adjustments to your planned home sizes, amenity levels or anything like that and would that have an impact on the gross margin? And then secondly, can you just sort of talk about, why do you think we have not seen In your communities, despite obviously affordability being more judged, why do you think we haven't seen it yet in terms of your conversations with customers? Do you are they can you talk about the role of rate locks or just anything that would be helpful for understanding why we maybe haven't seen anything yet.

Speaker 4

Stephen, I think to your first question in terms of community design, plan design, I think we are going to continue to focus The affordable range and work towards those buyers. I don't see a significant change in How we build, what we build. But if it continues to be a push on affordability, Then we'll put the appropriate homes in place. It may mean some smaller homes, but not a significant shift from where we are today. In terms of in our communities and in our sales offices, certainly there is concern from the buying public over rates, but selling later in the process like we do.

Speaker 4

We don't have as much exposure as we could if we were selling Far out to the shifts in rate conditions and that's why we've continued to restrict our sales to a later time frame, so that we're putting people in backlog is closer to the rate that they're going to close at.

Speaker 9

That makes a lot of sense. In this quarter, can you give us Thanks for how many of your closings were done with a rate lock that The closings I'm referring to not the orders.

Speaker 1

Yes. So I looked at it actually on a forward looking basis and we have essentially our next So April 100 percent locked and then as you would expect that percentage ticks down, but it's the majority of the quarter's closings that are locked and you got to get to 4 plus months out before that's a more de minimis percentage.

Speaker 8

Okay, great. Thanks very much guys.

Operator

Your next question for today is coming from Ivy Zelman with Zelman and Associates. Ivy, your line is live.

Speaker 10

Thank you. Good morning and congrats on the strong results. Maybe you guys can just give us some perspective on the rental business with both the merchant built single family rental communities as well as your multifamily projects. Can you talk about how many of them when you're developing them are already pre sold? And have you seen any changes in valuation As it relates to selling with the surge in rates as we hear chatter that values at least within multifamily I've really started to be pressured and just the overall buying appetite that's out there with so much capital still appears to be chasing this asset class.

Speaker 3

Thank you, Ivy. We do see a lot of very strong demand and strong execution on the pricing. We do not sell any of our communities at this point during the development phase. We're selling them at in the lease up phase at stabilization. So we're seeing still very good demand, and very good pricing execution on those transactions that we have closed on.

Speaker 3

So current outlook, you would expect cap rates could be affected by rising interest rates, but we're also seeing very strong leasing demand and very strong rental growth, which certainly affect cap rate outlooks.

Speaker 1

And at a 40% to 50% plus margin on these sales, if the market were to Often a bit, we still expect to generate very strong profits and returns.

Speaker 10

Great. And then just secondly, with respect to the delays that you've And obviously, the industry is impacted. Can you walk us through on the development side with municipalities, like specifically where That those components of the overall impact is related to like the difference versus sourcing materials because some materials are Not a problem anymore, so everyone talks about it's a whack a mole, but what's it like on the development side as well as on the municipality side and how much of that is impacting the 2 month year over year increase in cycle time?

Speaker 4

Well, I think you've got certainly municipality challenges through the entitlement process In terms of bringing new lots to the market and we still haven't seen full return of municipalities when you're talking About permitting and or inspection process. So it certainly is impacting some of that as we work through The supply chain challenges and then you finally move homes on to the next stage. It is we do see some delays in inspections and Some of the municipality services that we received. So it's certainly been part of the impact to our cycle time extension.

Speaker 10

And let me just sneak in one last one, if I could, just with respect to the inflation that we've seen. Can you be more specific on recognizing your Land is predominantly controlled via option. Like what has changed on the pricing to tying up and controlling land? And how much overall are lot inflations that you are Buying outright are you seeing relative to a year ago? And maybe I have to be just general because it's obviously different by market.

Speaker 2

I'd say the overall land market has to track the sales price of homes. So it is good to be in a position where we control 550,000 lots at prices contracted 2 years ago, 3 years ago, 4 years ago, and Not be in a position today where we have to go buy something. So we are looking at that. We're monitoring it. Jim, I believe liquidity is going to drive market share gains And the ability to not be at risk of credit markets and or banks, is a huge competitive advantage for us.

Speaker 2

And And we're going to protect that. We're going to be conservative in our land searches. I mean, there are good deals out there that we put under contract this year that we will take to close. But we are not in a position where we have to go buy anything. And we're going to, I think, See a significant benefit of that as we proceed through this market.

Speaker 11

Thank you. Good luck.

Speaker 2

Thank you.

Operator

Your next question for today is coming from Matthew Bouley with Barclays. Matthew, your line is live.

Speaker 8

Good morning, everyone. Thank you for taking the questions. Just another question on what you do from a Sort of medium term perspective from what you can control, in a scenario where housing activity were to slow, as we're talking about this morning, What does D. R. Horton do from a supply perspective?

Speaker 8

To what degree does sort of your own plans for community replenishment or starts Kind of flex with these changes in interest rates and demand, just thinking again kind of medium term sort of annual volume How should we think about how you all are viewing that? Thank you.

Speaker 3

Matt, we're very much a bottom up community level driven company And we're going to evaluate demand we see at each individual community and submarket and look for home starts to match that demand that our local operators are And that couples with community replacement needs in those submarkets based upon demand we see in real time in the field. So In the near term, we'll continue to adjust starts. In the more medium term, we'll look at subdivision openings and phase sizing. And then as well as Paul touched on before, we may be adjusting some product to some smaller sizes if that's appropriate for the given market.

Speaker 8

Got you. Okay. That's very helpful. And then secondly, just zooming in back to the very near term, I think you've seen maybe in some of the housing data, maybe a little bit in our own survey work, it seems like some trends in the housing market might have become a little more Choppy in recent weeks, perhaps not surprising given the move in interest rates. But just anything you're seeing kind of on the leading edge on the margin, Whether that's any sort of pockets of changes in demand or again incentives appearing various markets.

Speaker 8

Just anything you're kind of seeing later into March and into April? Thank you.

Speaker 2

The rate increase is eliminating some people from the home buying experience. We still have more people trying qualified buyers trying to buy homes than we can produce today. One of the things that really I think has impressed me Back in 2018, when you saw a rapid rise in rates, demand just It was significantly reduced. And then After the rate shock was kind of mitigated, We saw demand come back and come back strong. But through this cycle, which is in even more rapid rate increases, Yes, we've had people that don't qualify anymore, but the demand side is still very strong.

Speaker 2

Just the desire to own homes and it may be the fact that prices have escalated very fast and rents Or escalating even faster than the price of new homes and all the talk about inflation and then locking in your housing costs for 20 years. I mean, it is homeownership is a cherished thing today. And the people coming out of the millennials coming out or even individuals relocating from other markets to kind of where the growth is taking place. It just they want to own a home. They want to lock in their housing costs And they want to get into neighborhoods that they can raise families in.

Speaker 8

Well, thank you for that, David, and thanks, everyone. Good luck.

Speaker 7

Thank you.

Operator

Your next question is coming from Anthony Pettinari with Citigroup. Anthony, your line is live.

Speaker 12

Good morning. Cancellation rates, I guess, ticked up 100 bps, maybe from record low levels. Would you characterize that as more kind of noise or maybe more clearly customers no longer able to secure mortgages? Would you expect Cancellations maybe decline again in 3Q if rates stay at their current level. And I think in the past you've provided kind of a sensitivity analysis Around sort of mid single digit, high single digit of backlog that potentially could be at risk with the 100 bps rise in rates.

Speaker 12

Any sort of Thoughts on how that has shaken out now that we're above 5% now on rates?

Speaker 1

Sure, Anthony. I mean, we look at a 1% Our cancellation rate is essentially flat. It's still abnormally low, historically low. We typically run-in the high teens to low 20s And that's a can rate we're very comfortable running at. The main reason continues to be that buyers can't ultimately qualify for the home purchase.

Speaker 1

So that 15%, 16%, 17%, wherever it falls out each quarter, really no concerns from us on that end. In terms of the rate sensitivity analysis, We did run the same sensitivity as we've talked to each of the last few quarters. I think rates have already kind of run up to where that was run at a couple of weeks ago, as we prepped for this call, but it had only ticked up to call it roughly 10% of buyers and backlog today, would be at risk. As I mentioned earlier in answer to another question, all of April is already rate locked if they're going through a mortgage company. So that And then we also would work to look to move people from a different loan product or see if they could document additional income.

Speaker 1

And then to kind of second some things that the guys have already said today, for those buyers that do unfortunately fall out because they can't qualify, there's no shortage of buyers behind them to take their place.

Speaker 12

Okay. That's very helpful. And then just with higher rates, are you making any strategic shifts To target a different mix of buyers? Are you seeing buyers that you wouldn't normally talk to kind of moving down market to more affordable offerings? And Understanding your entire offering is fairly affordable, like which of your buyer types do you think is best positioned to maybe weather rising rates as it move up or Any thoughts there?

Speaker 4

We really haven't made any significant shift and don't see a need to as rates rise. It's going to be more of that shock to payment for folks when they have to reset maybe the size home or price that they can then qualify for. So we're going to catch those people that have been buying up that may fall down the price curve and or size of home and still be able to pick them up in majority of our community. So no real shift in what we're doing with any of our buyer demographics. We're still seeing strong demand as everyone's mentioned across the

Speaker 12

spectrum. Okay. That's helpful. I'll turn it over.

Operator

Your next question is coming from Mike Rehaut with JPMorgan. Mike, your line is live.

Speaker 13

Hi, thanks. Good morning, everyone, and thanks for taking my questions. I just wanted to revisit the Can rate, which I think as you mentioned, Jessica, is essentially flat and extremely low. We've kind of thought of it as a key metric to understand the potential impact of the rate move over the last 60, 90 days. And I was curious if you've seen any change throughout the quarter.

Speaker 13

Obviously, it was up 100 basis points versus a year ago and I think 100 basis points, I believe sequentially. But anything Throughout the quarter that maybe perhaps you ended the quarter at a higher number than at the beginning and If there's been any change in April, curious around that.

Speaker 1

It really was relatively flat Throughout the quarter, give or take, a 1% change. So sequentially, we were I guess, we were both A year ago and in the last quarter we were at 15%. This quarter we were at 16% and it was right around that range for the duration of the quarter.

Speaker 13

Okay. Also throughout the quarter, you kind of said that demand has remained strong, more demand than I would presume then that as a result, your pricing power and the incentives that you've had in the marketplace Really haven't changed at all. Obviously, your gross margins continue to improve and you expect further margin improvement in the Q3. Just wanted to make sure that was the case as well and if that was the case for yourselves as well as if you Witnessed any changes in the broader marketplace?

Speaker 4

Mike, we have seen consistent ability to raise prices through the quarter, See consistent increases in our sales order pricing that's then flowed through our backlog and through our closing pricing. That's what gives us the confidence Say that our margins are going to be slightly better next quarter because we can see those sales prices coming through in our closings in the next quarter. So to date, we have not seen a change in Our ability to raise prices. I think naturally as we look a little bit longer term with the impact of rates and an impact of overall price increases Some point we would expect that to moderate, but at this point we have not seen any signs of that as of yet.

Speaker 13

Okay. One last quick one if I could. Just the 3% reduction of year end share count versus 2% previously, sorry if I missed this earlier, But just want to make sure, is that a function of a greater amount of dollars Dedicated to share repurchase or in part driven by the recent reduction in share price in the market over the last in a couple of months?

Speaker 4

A little bit of both, Mike. As we look at our capital allocation for the year, Our expectations for how much we would utilize, how many dollars we would utilize as share repurchase has gone up versus our prior estimates. But then certainly the current valuation Of our stock does allow us to buy more shares per dollar as well. And so it's a little bit of both and that's allowed us to increase our estimate from a 2% reduction to a 3% reduction.

Speaker 13

Great. Thanks so much guys. Appreciate it.

Operator

Your next question for today is coming from Truman Patterson with Wolfe Research. Truman, your line is live.

Speaker 14

Hey, good morning, everyone. Thanks for taking my questions. Just wanted to follow-up on one of John's questions previously. I realize that cycle times have been extended. You have 60,000 homes under construction, which ties up Net working capital, but we're now halfway through the year.

Speaker 14

I'm just hoping you can give an update or possibly a number around your 2022 operating cash flow expectation. And then just on the capital allocation decision based on rates increasing. It seems like you're going to be a bit more or you're going to continue with programmatic Share repurchase, but how do you balance this with potentially even increasing liquidity, Given all the commentary from the Fed and possibly having a rainy day fund, if you will.

Speaker 4

It is a constant balance, Truman. We're not giving specific dollar guidance regarding our operating cash flow other than we do expect to generate Positive cash flow from our homebuilding operations. On a consolidated basis, our operating cash flow also includes the investments we're making our rental platform, which obviously are significant, Increasing those by $1,500,000,000 this year. And then certainly one factor today that is tying up some of our capital is the extension Of our build times being longer than 2 months, longer than a year ago, certainly does tie up a significant amount of capital, but Certainly, we are working towards stabilizing that and improving those cycle times, which we would expect would start to bring that Cash back some towards the end of fiscal 2022 and then certainly into fiscal 2023. So it is a balance.

Speaker 4

And as we Plan our capital allocation, we plan our liquidity targets. We are just seeking to make sure we stay in as strong and flexible position as possible to handle the what we see in the market today and position ourselves for further growth, aggregation of market share and generating returns to our shareholders.

Speaker 14

Okay. Thanks for that. And then, one final one on just current market conditions. Just are you seeing any metros that are maybe A little bit slower than the others. And then for the buyers purchasing today, I realize this might be Somewhat of an unfair question, but how long have they been in the market?

Speaker 14

Were they really searching before rates started to move? Or are we seeing incremental buyers continuing to come in after the higher rate environment that are kind of more recently entered if you will?

Speaker 3

Truman, I think on the markets, we see markets have varying levels of performance and demand, They're all very strong relative to where they've been. I mean, certainly the migration patterns within the country and the areas that are gaining population Have incredibly strong demand, but markets across our footprint, we still see more buyer demand than we have production capacity for today. And so we're still very encouraged by that. Some of those buyers have been in the marketplace for quite a while. Others are more recent entries, but we don't have any Hard data we could share with you on how exactly long they've been conducting their search.

Speaker 14

Okay. Thank you and good luck in the upcoming year.

Speaker 3

Thanks.

Operator

Your next question for today is coming from Deepa Braghaven with Wells Fargo. Deepa, your line is live.

Speaker 11

Thanks everyone for taking my question. Good morning. Of the supply chain incremental headwinds, is there a way to think about how much were Omicron related? I'm assuming that should be probably behind us now and how much is kind of carry forward. I think where I'm going with it is, Are you baking in any sequential improvement off of that 2 weeks elongated cycle time, assuming there must have been some relief from Omicron?

Speaker 1

Yes. I think we would agree with you on the Omicron front. I mean, there's certainly still labor challenges and labor Facilities distribution centers is still harder to come by, but it does seem to be slightly improving. Drivers continue to be a really big area of need to be able to get products to job sites. In terms of if we're baking in any incremental improvement in our build times, I think I would tell you for us to achieve the high end of our guidance range.

Speaker 1

And certainly to do any more of that, we would need to see improvement in our build times from what we've seen today. But we do feel like we're maybe in the early stages of that to where we felt comfortable still, although we lowered our closings guide, We did leave 90 in the range of closing 88 to 90 because we have the houses. It's just a matter of getting them completed and across the finish line with the

Speaker 11

Got it. Staying on the topic of the guide, I don't think you guided for the full year gross margins, unless I missed it. But it does definitely look like you have some good tailwinds that can extend into Q4 and give you some good Gross margin visibility, do you want to provide any color on that for Q4?

Speaker 4

Yes, April. We do only guide 1 quarter out on gross margin, but I would agree with you that currently we do have some tailwinds with the Average prices that have been in our backlog and in our recent sales orders that some of which will be homes that would close into Q4. I think we do have some tailwinds, but as we've said many times, our true visibility to margin really doesn't go far beyond the quarter. So we only guide Specifically to Q3, but we do feel like we're still going to see very good gross margins through Q4 as well.

Speaker 11

That's very helpful color. Thanks very much and good luck.

Operator

Your next question for today is coming from Susan Maklari with Goldman Sachs. Susan, your line is live.

Speaker 15

Thank you. Good morning. My first question is on the SG and A. I mean, obviously, the gross margin has been impressive, but so has your SG and A performance this year. You continue to come in well below where we are modeled and where you've guided to.

Speaker 15

Can you talk to the potential to continue to see that coming down now that we're solidly in that 6% range and maybe where we can get to over time there?

Speaker 5

Thank you, Sue.

Speaker 4

Obviously, an important part of Our culture and our business model, we are very focused on ensuring that we stay very efficient with our overhead, while still making sure We're building our overhead and our infrastructure to support the growth. But with the price appreciation that we've seen alongside that, that has certainly aided And dropping the SG and A percentage as a percentage of revenue a bit faster than honestly than we would have modeled as well. And so we've been very pleased with that. Certainly want to make sure we continue to position ourselves adequately there. But with the prices that we have seen and that we see coming Over the next quarter or so, we do expect to still see very good SG and A leverage.

Speaker 4

With the guidance that we're providing For Q3 that assumes another 50 basis points year over year improvement in SG and A. So yes, we do see ourselves With an SG and A rate getting down into the 6s and for at least the near term staying there.

Speaker 15

Okay. All right. Thank you. And then my second question is a bit longer term. David made the comment earlier around consumer confidence and Overall, the sort of desirability around homeownership today and how that perhaps is very different relative to where we were certainly coming out of the last cycle.

Speaker 15

Can you talk to what sustains that level of confidence in homeownership? And What that perhaps could mean even as rates do rise in terms of keeping that demand pool there and people's willingness to sort of continue to stand and really try and make that effort to get into the home?

Speaker 2

I just I've been doing this for a long time. And The desire to own a home as I think kind of an American part of the American culture. It gives you a sense of safety and a nest to build your family. So I think the downturn in 2008, 2009, 2010 were Home values were just decimated. That put a big pause on the desire to own homes.

Speaker 2

I think As this cycle continues and I think is going to continue to elongate, the housing formation, The desire to get close to neighborhood schools, all those things that kind of returned home ownership to Kind of the American dream again. So it's Getting in a home today is hard, but it's not nearly as hard as it was when I bought my first home. So It feels like it's almost a cultural shift from or return to family, community And I think the demand is significantly higher than the homes that can be produced.

Speaker 15

Okay. Well, thank you for those thoughts and good luck with everything.

Speaker 2

Thank you.

Operator

Your next question for today is coming from Jay McCanless with Wedbush. Jay, your line is live.

Speaker 5

Thanks for taking my questions. Just wanted to clarify, I think you've discussed this already, but The reduction in the closing guidance for the full year, that's not a shift to homes into the rental operation. That's just you guys or slowing down orders in the field to keep up with production?

Speaker 1

It's when our homes are going to be completed and the ability To close those in what quarter? Yes, there's no transition to build for rent in those numbers. We've kept our humbling for sale completely separate from what we're reporting on a rental basis.

Speaker 3

We have a plan for both businesses, one for the for sale side of the business and one for the rent side of the business. And the change in the guidance has nothing to do with transitioning communities from one to another. It's solely dealing with Completion of homes, putting the buyer into a completed good looking house, when that house is ready.

Speaker 5

Got it. Okay. Thank you for clarifying that. And then my second question, I think David earlier was talking about liquidity Being the competitive advantage, especially with land prices moving up, I mean, when does this lack of liquidity, I think, especially for some of the smaller private builders, when does that really force A bigger wave of M and A than what we've seen so far post COVID.

Speaker 2

I don't know that it's going to force A larger M and A program. I do think that their inability to secure financing to move Forward on different projects or even to start houses is going to open up market opportunity for us, Both in our ability to aggregate market share on the home sales side and the ability to control longer and longer land positions at very favorable numbers. So it's when you look at the impact Of a 2 plus month expansion of our cycle time and what that's done to our liquidity. And then Understand that we are still building houses much faster than anybody else and we started at a and are going to continue to protect A very strong liquidity position. I got to believe there's tremendous pressure On especially the private builders.

Speaker 2

And at some point, these guys have made a lot of money over their careers And they're guaranteeing loans and at some point you just not going to put everything at risk. So I do think that's going to open up market share gains for us And we are very well positioned to take those market that market when it does open.

Speaker 5

Got it. That's great. And if I could sneak one more in. Bill was encouraged to hear that community count was up year on year and sequentially. How are you guys feeling about that for the full year just on a percentage change basis?

Speaker 4

Yes. We're still looking at the low single digit increase, But we yes, it has been good to see more communities get opened, starting to basically replenish our communities from We ran them down a bit early a year to 18 months ago. So still see a solid incremental increase in communities.

Speaker 1

And organic growth in our core markets is still going to be the biggest driver, but we did add a few more new markets to our market count this quarter. We're now in 104 markets and have another list of markets behind that that we're planning to expand into as well.

Speaker 12

Okay. That's great.

Speaker 5

Thanks for taking my questions.

Operator

Your next question for today is coming from Dan Oppenheimer with Credit Suisse. Dan, your line is live.

Speaker 8

Just a quick question, I guess. Given the success that you've had in terms of Express Homes taking share generally, What you're seeing in terms of buyers coming in from competition now and so just potentially Sorry, in terms of the gains for Express in terms of market share, given the efficiency and affordability there, How you're seeing that in terms of the what's happening to consumer right now?

Speaker 2

I think the ability to produce

Speaker 8

Great value at the lower end.

Speaker 2

It is a tremendous advantage that we have. The buyer pool Significantly deeper there, qualification maybe a little tougher. But as kind of referenced before, People really want to buy home and especially their first time. So I see that segment of our business just continue to get stronger. And whereas somebody may have pushed up in price at a very low rate, Which we had a lot of first time homebuyers buying in the Horton brand.

Speaker 2

Ultimately, it comes down to payment. And If there is a desire to own the home in a very, very nice community location, our competitive advantage just gets better and better.

Speaker 13

Great. Thank you.

Operator

Ladies and gentlemen, that's all the time we have for questions. I would now like to turn the floor back over to David for closing remarks.

Speaker 2

Thank you, Holly. We appreciate everybody's time on the call today and look forward to speaking with you again to share our Q3 results in July. And to the D. R. Horton family, Don Horton and the entire executive team, thank you and congratulate you on delivering an outstanding second quarter.

Speaker 2

We are incredibly well positioned today. You once again have proven you are the best of the best in this industry. Thank you.

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