Good morning, and welcome to the First Quarter 2023 Earnings Conference Call for D.R. Horton, America’s Builder, the largest builder in the United States. There will be an opportunity to ask questions on today’s call. During today’s Q&A, we ask that participants limit themselves to one question and one follow-up. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton.

Thank you, Paul, and good morning. Welcome to our call to discuss our results for the first quarter and fiscal 2023. Before we get started, today’s call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to 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 factors 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 tomorrow. 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.

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 Officers; and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D.R. Horton team delivered a solid first quarter, highlighted by earnings of $2.76 per diluted share. Our consolidated pre-tax income was $1.3 billion, on a 3% increase in revenue with a pre-tax profit margin of 17.5%. Our homebuilding return on inventory for the trailing 12 months ended December 31 was 39.5% and our consolidated return on equity for the same period was 31.5%. Beginning in June 2022 and continuing through today, we have seen a moderation in housing demand due to affordability challenges caused by the significant rise in mortgage rates, coupled with high inflation and general economic uncertainty. Despite these pressures, we still closed over 17,000 homes and sold more than 13,000 homes in what is typically the seasonally slowest quarter of the year. We have seen increased sales activity in the first few weeks of January. While higher mortgage rates and economic uncertainty may persist for some time, the supply of both new and resale homes at affordable price points remains limited, and the demographics supporting housing demand remained favorable. We are well-positioned to navigate the current challenging market conditions with our experienced operators, affordable product offerings, flexible lot supply, and great creative supplier relationships. Our strong balance sheet, liquidity, and low leverage provide us with significant financial flexibility. We will continue to focus on turning our inventory and managing our product offerings, incentives, home pricing, sales pace, and inventory levels to meet market, optimize returns, consolidate market share, and generate increased cash flow from our homebuilding operations.

Earnings for the first quarter of fiscal 2023 decreased 13% to $2.76 per diluted share compared to $3.17 per share in the prior year quarter. Net income for the quarter decreased 16% to $958.7 million, on a 3% increase in consolidated revenues to $7.3 billion. Our first quarter home sales revenues were $6.7 billion, on 17,340 homes closed compared to $6.7 billion on 18,396 homes closed in the prior year. Our average closing price for the quarter was $386,900, up 7% from the prior year quarter and down 4% sequentially.

During the quarter, we continued to sell homes later in the construction cycle to better ensure the certainty of the home close date and mortgage rate for our home buyers with almost no sales occurring prior to the start of home construction. Our cancellation rate for the first quarter was 27%, down from 32% sequentially, but still elevated from our typical levels. Our net sales orders in the first quarter decreased 38% to 13,382 homes, and our order value decreased 40% from the prior year to $4.9 million. Our average number of active selling communities increased 4% from the prior year quarter and was down 1% sequentially. The average sales price of net sales orders in the first quarter was $367,900, down 4% from the prior year quarter. We are continuing to offer mortgage interest rate locks and buy-downs and other incentives to drive traffic to our communities, and we are reducing home prices where necessary to optimize the returns on our inventory investments. Our second quarter sales volume will depend on the strength of its spring selling season, and we currently expect significantly higher levels of net sales orders in the second quarter as compared to the first quarter based on historical seasonal trends, current market conditions, and our inventory of completed homes available for sale.

Our gross profit margin on home sales revenues in the first quarter was 23.9%, down 440 basis points sequentially from the September quarter. On a per square foot basis, home sales revenues were down 4% sequentially, stick-and-brick costs per square foot increased 2% and lock costs were flat. The decrease in our gross margin from September to December was in line with our expectations and reflects the increased construction costs we incurred during 2022, along with higher sales incentives and home price reductions. We expect both our average sales price and home sales gross margin to decrease further in our second quarter for fiscal 2023. We are continuing to work with our trade partners and suppliers to reduce our construction costs on new home starts. We are making progress in these efforts, but we do not expect to see much benefit from lower costs on homes closed in fiscal 2023.

In the first quarter, our homebuilding SG&A expenses increased by 6% from last year, and homebuilding SG&A expense as a percentage of revenues was 7.8%, up 30 basis points from the same quarter in the prior year. We are controlling our SG&A during this market transition while ensuring our platform adequately supports our business.

We slightly increased our home starts from the last quarter to 13,900 homes and ended the quarter with 43,200 homes in inventory, down 21% from a year ago and down 7% sequentially. 27,800 of our homes at December 31 were unsold, of which 7,100 were completed. We are focused on improving our housing inventory turnover. With more completed homes not available for sale, we expect our mix of homes sold and closed in the same quarter to increase back towards our normal historical levels. For homes we closed this quarter, our construction cycle time fully increased by a few days compared to the fourth quarter, which reflects lingering supply chain issues. However, we are seeing some stabilization in cycle times on homes that we have recently started, and we expect the cycle times to improve during fiscal 2023. We will continue to evaluate demand and adjust our homes and inventory and start pace based on current market conditions.

Our home building lot position at December 31 consisted of approximately 551,000 lots, of which 25% were owned and 75% were controlled through purchase contracts. Our total homebuilding lot position decreased by 22,000 lots from September to December. 32% of our total owned lots are finished and 53% of our controlled lots are or will be finished when we purchase them. Our capital-efficient and flexible lot portfolio is key to our strong competitive position. We continually underwrite all of our lot and land purchases based on future expected home prices and cost. We are actively managing our investments in lots, land, and development based on current market conditions. During the quarter, our Homebuilding segment incurred $4.8 million of inventory impairments and wrote off $19.4 million of option deposits and due diligence costs related to land and lot purchase contracts. We expect our level of option cost write-offs to remain elevated in fiscal 2023 as we manage our lot portfolio. Our first quarter home building investments in lots, land, and development totaled $1.7 billion, down 21% from the prior year quarter and up 16% sequentially. Our current quarter investments consisted of $900 million for finished lots, $690 million for land development, and $130 million to acquire land.

Financial services pre-tax income in the first quarter was $18.2 million on $137 million of revenues with a pre-tax profit conversion of 13.3%. The lower profitability of our financial services business this quarter was primarily due to lower gains on sales and mortgages, increased competitive conditions, and a lower volume of interest rate lots by homebuyers during the December quarter. We expect our financial services pre-tax profit margin for fiscal 2023 to be higher than the first quarter, but lower than the full year of fiscal 2022. During the first quarter, 99% from the mortgage company's loan originations were related to homes closed to buyer home building operations, and our mortgage company handled the financing for 77% of our homebuyers. FHA and VA loans accounted for 45% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 7.2 and an average loan-to-value ratio of 88%. First-time home buyers represented 55% of the closings handled by our mortgage company this quarter.

Our rental operations generated $328 million of revenues during the first quarter from the sale of 694 single-family rental homes and 300 multi-family rental units, earning pre-tax income of $110 million. Our rental property inventory at December 31 was $2.9 billion, which included approximately $1.9 billion of single-family rental properties and $1 billion of multi-family rental properties. We expect our rental operations to generate significant increases in both revenues and profits in fiscal 2023 as our platform matures and expands across more markets. For the second quarter, we currently expect no multifamily rental sales and to close fewer single-family rental homes than in the first quarter.

Forestar, our majority-owned residential lot development company reported total revenues of $216.7 million on 2,263 lots sold and pre-tax income of $27.9 million for the first quarter. Forestar's owned and controlled lot position at December 31 was 82,300 lots. 57% of Forestar's owned lots are under contract with or subject to a right of first offer to D.R. Horton. $190 million of our finished lots purchased in the first quarter were from Forestar. Forestar is separately capitalized from D.R. Horton and had more than $580 million of liquidity at the quarter's end with a net debt-to-capital ratio of 28.7%. Forestar is well-positioned to meet the current challenging market conditions with its strong capitalization, lot supply, and relationship with D.R. Horton.

Our balanced capital approach focuses on being disciplined, flexible, and opportunistic. We are committed to maintaining a strong balance sheet with low leverage and significant liquidity to provide a firm foundation for our operated platforms during changes in market conditions and to support our ability to provide consistent returns to our shareholders. During the first three months of the year, our cash provided by homebuilding operations was $313.9 million, and our consolidated cash provided by operations was $829.1 million. At December 31, we had $4 billion of homebuilding liquidity, consisting of $2 billion of unrestricted homebuilding cash and $2 billion of available capacity on our homebuilding revolving credit facility. Our liquidity provides significant flexibility to adjust to changing market conditions. Our homebuilding leverage was 12.8% at the end of December, and homebuilding leverage net of cash was 4.4%. Our consolidated leverage at December 31 was 22% and consolidated leverage net of cash was 13.3%. At December 31, our stockholders' equity was $20.2 billion and book value per share was $58.71, up 33% from a year ago. For the trailing 12 months ended December, our return on equity was 31.5%. During the quarter, we paid cash dividends of $86.1 million and our Board has declared a quarterly dividend at the same level as last quarter to be paid in February. During the quarter, we repurchased 1.4 million shares of common stock for $118.1 million.

As we look forward, we expect challenging market conditions to persist with continued uncertainty regarding mortgage rates, the capital markets, and general economic conditions that may significantly impact our business. We provide detailed guidance for the second quarter as is our standard practice, but it is still too early to know what housing market conditions will be during the height of the spring selling season, so we are not providing specific guidance for the full year yet. We currently expect to generate consolidated revenues in our March quarter of $6.3 billion to $6.7 billion and homes closed by our homebuilding operations to be in the range of 16,000 to 17,000 homes. We expect our home sales gross margin in the second quarter to be approximately 20% to 21% and homebuilding SG&A as a percentage of revenues in the second quarter to be approximately 8% to 8.3%. We anticipate a financial services pre-tax profit margin of around 20%, and we expect our income tax rate to be approximately 23.5% to 24% in the second quarter. We are well-positioned to aggregate market share in both our homebuilding and rental operations. Our goal remains to generate consolidated revenues in fiscal 2023 or slightly higher than fiscal 2022. However, it is realistic to expect that our full year revenues will decline year-over-year, given the environment and pricing actions we are taking. The low end of our current range of expectations includes consolidated revenues down from fiscal 2022 by a mid-teens percentage, which is unchanged from last quarter. We forecast an income tax rate for the year of approximately 23.5% to 24%. We expect to generate increased cash flow from our homebuilding operations and on a consolidated basis in fiscal 2023 compared to fiscal 2022. We also plan to repurchase shares at a similar dollar amount as last year to reduce our share count during this year with the volume of our repurchases dependent on cash flow, liquidity, market conditions, and our investment opportunities. We have $700 million of senior notes that matured during the remainder of fiscal 2023, which we are currently preparing to repay from cash. We plan to continue to balance our cash flow utilization priorities among our core homebuilding operations, our rental operations, maintaining conservative homebuilding leverage and strong liquidity, paying an increased dividend, and consistently repurchasing shares.

In closing, our results and positions reflect our experienced teams, industry-leading market share, broad geographic footprint, and diverse product offerings. Our strong balance sheet, liquidity, and low leverage provide us with significant financial flexibility to effectively operate in changing economic conditions and continue aggregating market share. We plan to maintain our disciplined approach to investing capital to enhance the long-term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D.R. Horton team for your focus and hard work. We are incredibly well-positioned to continue improving our operations in providing homeownership opportunities to more American families. This concludes our prepared remarks. We will now host questions.

Thank you. The floor is now open for questions. And the first question is coming from Carl Reichardt from BTIG. Carl, your line is live. You may go ahead.

Thanks. Good morning, everybody. I just want to ask about inventory, unsold inventory. So about two-thirds of the inventory that you've got now is unsold. I think normally, it's about half when I went back and looked, so I just want to make sure, should we be optimistic because you've got product ready to go for the spring or in the supply chain perhaps is normalizing a little which is allowing you to get that ready, or should we be more pessimistic because you haven't necessarily priced that inventory to move yet? That's my first question.

Well, Carl, as you know, I'm always optimistic. We feel very good about our inventory position. And you know, through the last three, four quarters, we limited sales to better align inventory costs, demand, and our ability to deliver. We are now positioned more in what I would consider a normalized inventory position and again, feel very good about our position and where we're heading into this quarter.

Normally coming into the spring selling season, we'd be a little heavier than our normal 50% spec ratio. But we feel really good about what we have in front of us right now for demand.

I noticed that our market presence has grown to about 109 markets compared to around 80 four years ago, which is significant. Post-COVID, we've taken advantage of entering many smaller markets that have shown strong demand after the pandemic. Now that this surge may be leveling off, could you share how the newer smaller markets are performing over the past six months? Are they faring better than some of the major markets with lower competition, or is growth starting to decline as we see a return to the office in larger cities? Thank you.

Carl, we've seen these newer markets and secondary markets performing well for us due to limited competition in those markets. We certainly saw a strong push to all the secondary markets with a pandemic moving people making them more mobile that we've been happy with the progression in the secondary markets and glad that we entered them.

You know, Carl, even before the pandemic, we did very well in the small markets. And ultimately, it comes back to SG&A and control and the ability to deliver houses, which incrementally adds a competitive advantage to what anybody else out there is able to do. So, that's been a part of our program and I think you're going to see it continue to be a part of our program.

Thanks, David.

Thank you. And the next question is coming from Matthew Bouley from Barclays. Matthew, your line is live.

Morning everyone. Thank you for taking the questions. I want to ask about the construction cost environment; I think I heard you say at the top that you were making some progress, but I'm paraphrasing but perhaps not expecting to see as much benefit on the construction cost side on homes closed through fiscal 2023? Obviously, some of your peers have sort of quantified some of the benefits they might already be seeing on the construction cost side. So, just curious if you can parse that out a little bit as you guys sort of aggregate market share as we think about your ability to press on costs here? Thank you.

We've been really successful working with a lot of our trade partners in lowering our costs. And we've gotten a little bit of a tailwind from certainly from the lumber price reductions that have occurred, but it just takes a while for those cost changes on the front end to actually show up in the closing, especially with the more recently prolonged build times. So, it's just a function of the calendar working those new cost structures through the pipeline. So, the deliveries we see in 2023 were largely, first half of the year especially started in fiscal 2022 in a different cost environment.

And typically, lumber prices go up as we move throughout the spring. So, although we're seeing a benefit from lumber today, if typical seasonality holds, lumber would actually be a headwind against the cost reductions that we are seeing on those new home starts that Mike just alluded to.

Thank you for that information. I want to follow up on the pricing environment. We've noticed that some of your competitors have adopted various pricing strategies, and as we approach spring, we might anticipate that some builders will respond more aggressively in terms of pricing. It seems like you have been at the forefront of this trend. As we enter spring, what are your expectations for competition regarding price reductions? Do you foresee additional decreases in pricing and margins as this unfolds? Thank you.

We have still addressed our incentives with a balance of rate buy-downs, financial incentives, along with adjusting price community by community to drive the returns that we're looking for. As we enter the spring selling season, we're seeing some seasonality that we're happy with as the market starts to lead and we'll continue to adjust to drive the absorptions by community.

All right. Thank you very much, and good luck.

Thank you. And the next question is coming from John Lovallo from UBS. John, your line is live.

Good morning, guys, and thanks for taking my questions. The first one is you mentioned the first few weeks of January saw increased activity. Can you maybe just elaborate a little bit on that and maybe frame it sequentially or year-over-year? And how were incentives in the first few weeks of January relative to December?

Yeah. So we talked about on the call that we do expect to see normal seasonality in terms of the move from Q1 to Q2 sales. And so what we saw in terms of the increased sales activity in the first few weeks of January was a positive early indicator. It is still too early to ultimately say what's going to happen this spring, but it gave us the confidence to say that we could see normal seasonality, which typically would be about 50% up from Q1 to Q2 in terms of net sales orders. We also did see a slight improvement; it’s only a few weeks, which doesn't make a quarter, but we've seen a slight improvement in our cancellation rate in January as well, which also helps give us the confidence to say an increased level of net sales orders in Q2 versus Q1.

Got it. That's helpful. And then maybe could we talk just about cash flow expectations. It seems like it's going to be pretty robust here. I mean you're buying back stock, paying dividends, paying down $700 million in debt. So maybe just your expectations for cash flow and what the expectation for rental investment might be?

Yeah, we still expect increased cash flow from our homebuilding operations in fiscal 2023 versus fiscal 2022. We saw our inventory step down slightly this quarter. We will be increasing our start pace as we move into the spring and then adjusting that to what we see in market demand. So we may not continue to see the same pace of cash generation as we did in our first quarter, but we do still expect to see robust cash. And then we're going to continue to take our balanced approach to deploying that first and foremost of the homebuilding business next to the rental business. We will still see a substantial increase in our assets in the rental business this year; we're not guiding to a specific growth number there quite yet for fiscal 2023 because we're still evaluating the market and evaluating investments as we move through the year, but we do expect that level of inventory to increase while we see a significant increase in revenues in that business. And then past that, we will continue to pay dividends and continue to repurchase shares. We expect to repurchase shares at a similar dollar volume as last year, which would indicate greater than $1 billion of share repurchases for fiscal 2023. And then finally, on the balance sheet front, while we're very pleased with our leverage level, we do have $700 million of senior notes that mature in fiscal 2023, $300 million in February, $400 million in August. And currently, just given the overall environment and our cash flow expectations, we're preparing to pay those debt maturities off with from cash. But obviously, we'll evaluate capital markets along the way to determine whether we want to refinance or not. But right now, we are preparing to pay those from cash.

Great. Very helpful. Thank you.

Thank you. And the next question is coming from Stephen Kim from Evercore ISI. Stephen, your line is live.

Thank you for the information, everyone. I wanted to follow up on Matt's question about the cost negotiations. Last quarter, you indicated that you expected to start seeing the benefits from repositioning your product by your fiscal third quarter. I’m curious if that process is taking a bit longer or if it's separate from your comments on labor and product negotiations. In your response to him, you mentioned you were anticipating an increase in lumber costs. Could you clarify how much of an increase you are projecting? Are you conservatively estimating it might rise to about halfway back to where it was last year? Please provide us with your outlook for lumber, understanding that you don't have complete visibility at this point.

Most importantly, we don’t know. We are taking a conservative approach considering that, seasonally, in a typical environment, we usually see lumber costs rise during the spring. If we are witnessing some normalized demand returning with the spring selling season, we would expect seasonality to push lumber prices up, which would counterbalance some of the cost reductions we have achieved. We have successfully launched new products and new home starts that align with the current market, focusing on smaller and more affordable homes. However, regarding an increase in like-for-like cost benefits, it will take some time for those products to have a significant impact on the system.

It does feel, Stephen, like there is some normalcy returning to the market. And so you go back pre-pandemic and you look at what happened – costs get inflated during the last year, 18 months? Yes. Are we fighting to get that back? Yes. Our commodity price like lumber may go up, may go down, may stay the same. But are we going to be conservative in our guidance? Absolutely, we are.

No complaints here. If lumber prices increase due to normalization, I think we can manage that. I noticed that your owned lot count has increased slightly, whereas it had declined over the past two quarters. I'm curious if you believe your owned lot count will continue to rise from here or if there might be a further decrease in the actual number of owned lots. Could you provide some insight into what that number might look like, not in terms of supply years but more in absolute units?

Yes, Stephen. We have put in significant effort to secure our lot position and foster our developer relationships. While it remains challenging to acquire lots, we anticipate our lot count as a percentage of owned and total lots will continue to grow. This will be somewhat influenced by the upcoming spring selling season and the rest of fiscal 2023. We do not foresee a decline, and we expect our owned lot supply to marginally increase relative to the market.

And as a reference, again, our owned lots finished percentage is only 32%, which is roughly 43,000 lots. So, we're by no means oversupplied from a finished lot perspective, which is what we're trying to continue to position ourselves forward community-by-community.

Got you. Thanks so much, guys.

Thank you. The next question is coming from Mike Rehaut from JPMorgan. Mike your line is live.

Thanks. Good morning everyone. I appreciate you taking my questions. I wanted to revisit your recent comments on trends and demand. You noted that the first few weeks of January experienced increased activity, and there could be a typical 50% improvement in orders in the second quarter compared to the first quarter. This suggests a year-over-year order decline of only about 20%. I'm interested to know if that’s the direction we should be considering, even though you haven’t provided specific guidance. Additionally, regarding the improvement seen in January, could you share any insights on the trends during the first quarter, particularly if January’s uptick indicates a shift in trends observed during your December quarter?

I would say during the December quarter, as we mentioned on the call, as you know, Mike, is the seasonally slowest quarter of the year. So, we generally don't extrapolate anything that happens in October, November, and December, and we don't generally give a whole lot of monthly color, but we felt like based on current market conditions that warranted talking about the first few weeks of January, and that's what we're pleased with is we've seen what we would typically expect to see as we move through these first few weeks.

In terms of the math that you laid out. If we do see that normal seasonality, yes, it still would result in net sales down year-over-year, but up very nicely sequentially.

Right. And secondly, I know there's been a couple of questions around the construction costs and the impact there. I think that's been covered pretty well. Obviously, another big part is the gross margin guidance for the second quarter, and you're expecting further declines. I wanted to also focus though on pricing trends in the market. And if you could give us a sense of on a total basis, how much net pricing has come down from June of last year to today? And how much of that has occurred in the last month or two?

In terms of just pricing, really, our net sales orders in the quarter and the average sales price on that is the best indication. Our net sales order price this quarter is around $367,000, I believe. And, of course, we peaked last year a little over $400,000. So you're already looking at roughly a 10% decline in our net sales orders. And as we look at our margin guide going forward, we're taking recent pricing into effect. We're hopeful that if we see some normal seasonality and normal demand during the spring that further significant pricing reductions would not be necessary, but we're going to assess that week-to-week and month-to-month as we go through the spring. But our gross margin guide takes into account recent pricing along with the cost trends that we've already been discussing.

Just to add, it is very hard to put a lot on the ground. It's very hard to build houses. And the overall market is still undersupplied. So long-term, I think we've got a great outlook what happens in the next quarter. We're going to deal with the market as it comes.

Great. Thanks so much.

Thank you. The next question is coming from Truman Patterson from Wolfe Research. Truman, your line is live.

Hey good morning, everyone. Thanks for taking my questions. So first, has the land market started to capitulate at all on takedown pricing with your ASPs down kind of 8% quarter-over-quarter? Are you actually starting to see the land market correct at all with more meaningful price declines, or is it still just too early to tell?

I think generally, it's still a little too early, Truman. Land is typically one of the stickier parts of the process. And as David and Paul both mentioned earlier in the call, it is increasingly difficult to get a lot entitled and on the ground. And so that is something that has held up pretty well. But anecdotally, there are situations where we're able to make some progress on the land residual with some of our land sellers, but not broad trends yet, for sure.

Okay, okay. Thanks for that. And then you all made a recent acquisition in Arkansas. Could you all just, kind of, walk through the drivers of that purchase? And are you seeing more small privates, their willingness to sell at a relatively attractive valuation pop-up given the market slowdown?

The acquisition of Riggins in Northwest Arkansas provided us with an entry into the market. Although we were already present in a few communities, this acquisition solidified our position in a market that continues to show strength with good employment growth and limited housing supply. It was a beneficial acquisition for us, allowing us to integrate a well-established community with a great lot supply, giving us immediate inventory and homes in progress from a respected builder that we are pleased to include in our portfolio. Regarding other acquisitions, we will continue to seek tuck-in opportunities like this one, and although we have potential options to explore, there is no significant change in our approach to evaluating builders and margins.

All right. Thank you all. Appreciate it.

Thank you. The next question is coming from Eric Bosshard from Cleveland Research. Eric, your line is live.

Good morning. I'm interested in the 40% reduction in starts. Could you explain the reasoning behind the decisions of what projects are not moving forward? You mentioned adjusting the product to meet a specific price point, but I'm curious if there's any insight into how you're determining which starts to cut back on.

A lot of our starts decisions are made within the quarter on the basis of what the sales trends are occurring at that point in time. And certainly, through late summer and into the fall, our first quarter, mortgage rates spiking up, cancellations increasing, looking at our current inventory positions neighborhood by neighborhood relative to recent sales paces certainly led us to slow down our starts. Coming into this fiscal – this calendar year, into the second quarter, seeing some improvement in our cycle time and supply chain issues unsnarling, we feel like we'll be able to start homes and complete them in a more timely fashion this year. So we are trying to meter our starts out a little bit to more closely match our sales demand right now.

And Eric, I think it's just indicative of the entire industry and lessons learned in the last downturn. I mean I do believe that there is a discipline around the industry, and it's not just short-term, chases every market every day. So we’re trying to do a lot in inventory levels with demand. And it ultimately comes back to if you look at the long-term position of the industry, there aren't enough lots for houses for the population and demand that we see taking place over the next three to five years.

Okay. And then related to this, the inventory per community number, it looks like it's up. And I guess the follow-on would be the path forward with starts from here is down 40% a pace you maintain for another quarter and then lift your heads up, or how do you think about the pace of managing the supply path going forward?

I think we saw the starts kind of align with our sales pace in the quarter, and I think we're going to look to try to maintain that relationship through this time of the year as we're seeing good sales demand in the early spring selling season, we'll be replacing those homes with new starts to continue having inventory on the shelf available to sell. We are certainly seeing more homes selling later in the construction process, and certainty of delivery date and certainty of mortgage rate and payment are big factors for our buyers. And we're also focusing very heavily on recovering our housing inventory turnover metrics and getting more efficient with those inventory dollars. We got to get our returns back up on our housing inventory.

And so as with everything, our starts are managed community by community, market by market by our local operators to focus on not piling up excess completed homes that have been sitting there for an extended period of time.

Okay. That’s helpful. Thank you.

Thank you. The next question is coming from Anthony Pettinari from Citi. Anthony, your line is live.

Good morning. Can you talk about the tenure of buyers who canceled this quarter? Were those contracts that were signed in fiscal 4Q or maybe even earlier? Is there a larger cohort of buyers who may be placed orders in the fall, but are still at risk of cancellation with rates rising? Just wondering if you can give any color around kind of cancellation trends there?

I think as you've seen, our cancellation trend moderated and the cancellation rate moderated. We have younger backlog that have signed contracts more recently. As Mike spoke to, certainty of the home close date and mortgage rate is very important. So as we have cycled through and we're improving our housing inventory turns, I think that's where you're seeing our reduction in cancellation rate.

Okay, that's helpful. And then just in terms of renegotiating prices for homes in backlog, has that sort of normalized or died down now that rates have stopped rising and to your point, cancellations have come down?

Hopefully, with the rate stabilization we've seen, we'll experience stability in incentives and the pricing environment moving forward.

Okay, that's helpful. I'll turn it over.

Thank you. The next question is coming from Buck Horne from Raymond James. Buck, your line is live.

Thank you. Good morning, everyone. I would like to ask a bit more about the incentives and tools being utilized in the field. It seems many builders are having success with a mortgage rate buy-down program that allows them to buy down or fix the mortgage rate below market, potentially for the life of the loan. This approach appears to be quite popular. Could you provide more details on whether you are using mortgage rate buy-downs? How does this process work, and what does it cost in terms of upfront margin impact or as a percentage of sales?

Yes, Buck, we do, as an ordinary course, use mortgage rate buy-downs, and many of those are for the life of the loan. That's been a program we've had in place for quite some time. The costs do vary from time to time, depending on market conditions and timing of when you tie up those positions. But that's something that we try to make sure that we have in the toolbox for our salespeople; it is to be able to offer attractive mortgage rates to buyers who come in.

Okay. Would you say that that's the most effective sales tool at the moment, is a buy-down, or are you using some other level of incentives?

It's going to vary community-by-community and over time as to what the most attractive incentive is, and we try to put a lot of tools in our division operators' hands to make the best decisions about what's going to motivate and drive their realtor and buyer traffic in their communities and excite our sales agents with a reason to call and a reason to drive some traffic this week. So it might be a little bit of a pricing adjustment on a few homes. It might be the rate buy-down; some mortgage financing incentives have been very popular, very heavily utilized. And it might be that supply chain is working back out that we're back to a washer-dryer Wednesdays. I mean there are plenty of incentives out there that we're going to use to drive a pace to hit a return we need to hit at every given neighborhood.

Thank you. I have a quick question about single-family rentals. It appears that the guidance for projected sales of single-family rental homes is slightly lower quarter-over-quarter. Is this a strategic decision to slow down the sales pace? Also, I would like to know what the current demand and pricing are like for stabilized single-family rental homes.

It's simply a matter of when projects will be completed and ready for the sales process. We will have fewer projects ready to close this quarter compared to the last quarter.

The first quarter benefited from a few projects that were lined up to close in the fourth quarter of fiscal 2022 that had some storm impact, delayed some timing of a few closings there. So that 1Q number was probably a little higher than the original production sales schedule is set up for.

The business model is still complete lease-up market.

And you're starting to see some level of closings each and every quarter, but it is still choppy here in the earlier stages, and we would expect that to become more consistent over time as we get further along with the lots and the houses we have under construction.

Awesome. Thanks guys. Appreciate it.

Thank you. The next question is coming from Alan Ratner from Zelman & Associates. Alan, your line is live.

Hey guys, good morning. Thanks for taking my questions. First, I was hoping maybe you could just help me a little bit reconciling the closings results versus the orders. The closings for this quarter came in well above your guidance. The orders were a bit lighter versus what you signaled in mid-November. And I thought I heard you say that cycle times have been relatively stable, maybe even ticked up a little bit. So how did you drive the upside to closings without stronger order activity? Was it just that much of a greater mix of completed sales versus homes that were a month or two out from completion than you were anticipating? And I'm sure that ties into the 2Q guidance as well with your delivery guidance above your beginning backlog. So I'm just maybe looking for a little bit more color to understand what's going on there?

As we see marginal improvement in our inventory turns and home construction times, you're starting to see and you see that in our numbers, a larger percentage of our inventory homes on the completed side, which allows us to meet the market, which quite frankly is available to us today, which is shorter-term close. And so we're seeing more homes sell and close in the quarter, getting back more towards historical norms, and we expect to see that on a go-forward basis with the maturity of the home inventory that we have.

Got it. Okay. That's helpful. Second question, kind of, related, but tying in maybe the margin conversation as well. So when you look at your 7,000 completed specs, are you able to provide a little bit more detail on how many of those are maybe less than 30 days completed? What's more than 30? And how is your pricing strategy differ on completed specs as it hits certain thresholds? Is there a level or a point where you get more aggressive on price adjustments, or do you just look at it more holistically?

So generally, we talk about a completed spec; we have a pretty aggressive definition of what's completed. It's when it gets into the final flooring stage. So typically, from a home hitting that completion milestone for us, under normal conditions, it's probably going to take between two weeks to four weeks for that home actually to be move-in ready, and more likely to the four-week side of that. So if we look at how many houses we have out there that are aging in the buckets, we have about 190 houses that have been past our completion date by more than six months or more. So we still feel very comfortable about the freshness of that spec inventory, and this is the exact right time of the year to have that inventory, especially with the backdrop of very low existing home sale inventory available in the marketplace.

And that's something we manage very closely. Obviously, we've been building specs for a very long time. We have a lot of discipline around that. And so we do watch those completed specs as they start to age. And they get longer; if they get longer than 90 days, then yes, we will start to step up the efforts to ensure that we move them. But right now, we still have a very fresh batch of completed specs out there for springs selling season.

Great. Appreciate that. Thanks, guys.

Thank you. The next question is coming from Mike Dahl from RBC Capital Markets. Mike, your line is live.

Great. Thanks for taking my question. So the first one, just to follow up on the margin discussion. I understand there's not a lot of forward guidance you're going to get beyond this next quarter and a level of uncertainty. I'm wondering just as you see it today, if you look at your current orders, as you look at what you're expecting to sell in the quarter versus kind of the timing of some backlog still coming through in that gross margin that will be reported in fiscal 2Q. How should we be thinking about the likely cadence of margin beyond 2Q? Is it still barring some quick improvement in the market, going to be lower as you cycle off your backlog and into the recent sales as you get into fiscal 3Q, or any color on that?

Mike, we're only guiding to Q2 margin. And the reason we're only guiding to Q2 margin is we don’t know what margins or what the environment will be beyond Q2. The spring selling season, obviously, we've got some early encouraging signs but we don't know what conditions will be at the height of the spring selling season. So we have visibility to where our margins and our sales and our backlog and our pricing and our costs are today heading into the quarter, but even Q2 had some level of uncertainty to it. We would expect to sell and close 40% of our closings in the same quarter in the coming quarters. So while we believe that there's some possibility of some stability in the market with mortgage rates stable, that could change this afternoon. And so right now, we're giving you what we have. So our guidance for margins of 20% to 21% is what we can see today for Q2. There is some risk, both upside and downside there. I would say it's possible we could beat that range. But it's certainly possible that we might not. But past Q2, we simply don't have visibility right now.

We're going to continue to meet the market and do what we need to do to maximize returns community by community.

Okay. Fair enough. And then my second question, there's been a lot in the press around Arizona, in particular, tightening up on some of the water rights and kind of permitting or lack of issuing permits in certain parts of the Phoenix Metro area given some of the requirements around water usage. You guys obviously had your Vidler acquisition last year. I think they do have some projects in Arizona. Can you give us a sense if the counties or municipalities are just outright refusing to issue permits to certain areas? Does your ownership of Vidler and the projects in those regions exempt you from that? Are you able to still get permits for your planned projects, or any color on what you're seeing there would be, I think, interesting in light of some of the press that's been out there?

There has been a lot of media coverage regarding water issues, which will continue to pose challenges throughout the Western region, not just in Arizona. Our acquisition and integration of Vidler has strengthened our position, providing short-term benefits, but it is primarily a long-term strategic move as we anticipate ongoing challenges in the future. Locally, there hasn't been a significant shift; the process of obtaining land entitlements and permits remains tough, as it has been for some time. Despite this, we are confident in our standing and the lot positions we hold in the Phoenix market. Our team there is well-equipped to navigate this challenging environment.

Okay, great. Thank you.

Thank you. The next question is coming from Jay McCanless from Wedbush. Jay, your line is live.

Hey, good morning everyone. So, Bill, going back to what you talked about looking to close 40% of the 2Q closings. I guess, how in, say, pre-COVID times, what would that percentage have been in normal Q2?

Sure, Jay. Our typical percentage, we were in just pretty consistently up until the last year or two in the 35% to 40% range. A quarter ago, we were in the high teens. A year ago, it was even lower than that. And this quarter, we were roughly 34%. So, when we talk about reverting to normal, we started to see that reversion in the first quarter, but we expect that to continue to tick up. So, whether it's actually 40% or closer to the 35%, 36%, we don't know. But typically 35% to 40% would be a pretty consistent range for us.

Okay. And then the second question I had, assuming you pay down the $1 billion in debt like you've talked about. Any idea of what benefit that might be to gross margin since it's going to be less amortized interest or interest being amortized?

Yes, we have $700 million in homebuilding notes maturing this year, and we intend to pay those off with cash. This comes from just under $3 billion in homebuilding debt, meaning we would pay down about 25% of the balance. If we do not refinance that debt, it would lower our interest expense over time. This benefit would mainly be visible in fiscal 2024 and later, as it takes time for the interest to be capitalized and reflected in our inventory. We expect it to reduce our interest expense by about 20 to 30 basis points as a percentage of margin in the long term.

Okay, great. Thanks for taking my questions.

Thanks Jay.

Thank you. And in the interest of time today, the last question will be coming from Rafe Jadrosich from Bank of America. Rafe, your line is live.

Hi, good morning. Thanks for taking the question. I just wanted to ask on the rental side. What are you seeing in terms of demand? And margins have been really strong last year and obviously this quarter. Just do you anticipate any type of normalization going forward, or do you think you'll have to hold those properties longer if demand comes down?

I think we're still seeing demand for the properties. I think the pricing and the margins we realized on our early project sales benefited from construction and lower construction cost environments coupled with a very attractive rate environment when we sold those, and that continued to some degree into our first quarter deliveries. We would expect to see some kind of a more normalized reversion to demand to a mean. And I think we'll see our margins come back in line to be closer to slightly above what we're seeing on the for-sale side, the traditional core sales side. But our business model is to develop the communities and sell them into the marketplace. That's what we do best; finding the land, building the homes, and bringing people to those communities is what we've been very successful with so far. So, still learning, still going to get better, but we do like that business.

Can you discuss the factors contributing to the improvement in demand you're observing this quarter compared to the previous quarter? Specifically, do you think the decrease in mortgage rates has played a role, or is there something related to consumer confidence that supports your expectation of a return to normal seasonality following the challenging housing market at the end of 2022?

I do think the credit markets have stabilized somewhat, consumer confidence improved a little bit. Job growth continues to be very good. So overall, if you look at product demand, at just a generalized economy becoming less bad, it's very good signs for housing. And we monitor our sales; we monitor cancellations week to week to week to week. And so when we see that trend returning to more of a normalized market, it's hard not to be optimistic that we're going to have a good spring. And that's the way we're positioned, and we'll get up every day and respond to what happens out there in the field.

Yeah, specific to Horton, those are other industry reasons, right? Specific to Horton, our inventory position puts us in a more confident place to be able to say we're going to see that pick up with the level of completed homes we have and the stage of construction, the homes behind those are at, because what we're seeing the most success in today is buyers who do want a home quickly because they can get that certainty of not only close date, but most importantly, interest rate. And so that is the majority of our buyers today, and that's why we feel very confident and are very happy with our inventory position right now.

Thank you. I would now like to hand the call off to David Auld for some closing remarks.

Thank you, Paul. We appreciate everyone's time on the call today, and look forward to speaking with you again to share our second quarter results in April. And finally, congratulations to the entire D.R. Horton team. We're producing a solid first quarter while navigating changing market conditions, go compete and continue to win every day. Thank you.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.