Good morning, and welcome to the Third Quarter 2023 Earnings Conference Call for D.R. Horton, America's Builder, the largest builder in the United States. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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 third quarter of 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 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.drhorton.com, and we plan to file our 10-Q early next week. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentations section under News & 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. For the third quarter, the D.R. Horton team delivered solid results, highlighted by earnings of $3.90 per diluted share. Our consolidated pre-tax income was $1.8 billion on an 11% increase in revenues to $9.7 billion, with a pre-tax profit margin of 18.3%. Our homebuilding return on inventory for the trailing 12 months ended June 30 was 31.8%, and our return on equity for the same period was 24.3%. Despite continued high mortgage rates and inflationary pressures, our net sales orders increased 37% from the prior-year quarter, as the supply of both new homes and existing homes at affordable price points is limited and demographics supporting housing demand remain favorable. We are focused on consolidating market share by supplying more homes to meet homebuyer demand while maximizing the returns and capital efficiency in each of our communities. With improvements in both labor capacity and availability of materials, our cycle times are decreasing, positioning us to release homes for sale earlier in the construction cycle. We are pleased that we were able to increase our homebuilding starts to 22,900 homes this quarter, which was supported by a 6% sequential increase in our active selling communities. Our homebuilding operating margins are lower than the record high margins we reported last year due to cost inflation and pricing adjustments and incentives we implemented to address homebuyer affordability challenges caused by higher mortgage rates. However, our margins improved sequentially from the March to June quarter as home prices and incentives have stabilized and some reductions in construction costs are now being realized in our homes closed. We are well-positioned with our experienced operators, diverse product offerings, flexible lot supply, and strong capital and liquidity position to produce and sustain consistent returns, growth and cash flow. We will maintain our disciplined approach to investing capital to enhance the long-term value of our company, including returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Paul?

Earnings for the third quarter of fiscal 2023 decreased 16% to $3.90 per diluted share, compared to $4.67 per share in the prior-year quarter. Net income for the quarter decreased 19% to $1.3 billion on consolidated revenues of $9.7 billion. Our third quarter home sales revenues were $8.7 billion on 22,985 homes closed, compared to $8.3 billion on 21,308 homes closed in the prior year. Our average closing price for the quarter was $378,600, flat sequentially and down 3% from the prior-year quarter. Mike?

Our net sales orders in the third quarter increased 37% to 22,879 homes, and order value increased 26% from the prior year to $8.7 billion. Our cancellation rate for the quarter was 18%, flat sequentially and down from 24% in the prior-year quarter. Our average number of active selling communities was up 6% sequentially and up 8% year-over-year. The average price of net sales orders in the third quarter was $381,100, up 2% sequentially and down 8% from the prior-year quarter. To adjust to changing market conditions and higher mortgage rates over the past year, we increased our use of incentives and reduced the sizes of our homes to provide better affordability to homebuyers. Although home prices and incentives have begun to stabilize, we expect to continue utilizing a higher level of incentives compared to last year. Our sales volumes can be significantly affected by changes in mortgage rates and other economic factors. However, we will continue to start homes and maintain sufficient inventory to meet sales demand and aggregate market share. Bill?

Our gross profit margin on home sales revenues in the third quarter was 23.3%, up 170 basis points sequentially from the March quarter. The decrease in our gross margin from March to June reflects a decrease in incentive costs and lower stick-and-brick costs on homes closed during the quarter. On a per square foot basis, home sales revenues and lot costs were both flat sequentially, while stick-and-brick cost per square foot decreased 4%. As Mike mentioned, we expect to continue offering a higher level of incentives compared to 2022. But due to the recent stabilization in home prices and some reductions in both incentives and construction costs, we expect our homebuilding gross margins to be slightly higher in the fourth quarter compared to the third quarter. Jessica?

In the third quarter, our homebuilding SG&A expenses increased by 6% from last year and homebuilding SG&A expense as a percentage of revenues was 6.7%, up 10 basis points from the same quarter in the prior year. Fiscal year-to-date homebuilding SG&A was 7.2% of revenues, up 30 basis points from the same period last year as we've maintained the capacity of our platform to grow market share. Paul?

We started 22,900 homes in the June quarter, up 15% from the March quarter. We ended the quarter with 43,800 homes in inventory, down 22% from a year ago and flat sequentially. 25,000 of our homes at June 30 were unsold, of which 5,700 were completed. For homes we closed in the third quarter, our construction cycle time decreased by over a month from the second quarter, reflecting improvements in the supply chain. We expect to see a further decrease in our cycle time for homes closed in the fourth quarter. We will continue to adjust our homes and inventory and starts pace based on market conditions. Mike?

Our homebuilding lot position at June 30 consisted of approximately 555,000 lots, of which 25% were owned and 75% were controlled through purchase contracts. 34% 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 a key to our strong competitive position. Our third-quarter homebuilding investments in lots, land, and development totaled $2.2 billion, up 25% from the prior-year quarter and 27% sequentially. Our current quarter investments consisted of $1.2 billion for finished lots, $700 million for land development, and $290 million for land acquisition. Paul?

During the quarter, our rental operations generated $162 million of pre-tax income on $667 million of revenues from the sale of 1,754 single-family rental homes and 230 multi-family rental units. Our rental property inventory at June 30 was $3.3 billion, which consisted of $1.9 billion of single-family rental properties and $1.4 billion of multi-family rental properties. Our rental operations are generating significant increases in both revenues and profits this year, as our platform expands across more markets. For the fourth quarter, we expect our rental revenues to be greater than our third quarter and our rental profit margin to be lower than our third quarter. Bill?

Forestar, our majority-owned residential lot development company, reported total revenues of $369 million for the third quarter on 3,812 lots sold with pre-tax income of $62 million. Forestar's owned and controlled lot position at June 30 was 73,000 lots. 57% of Forestar's owned lots are under contract with or subject to a right of first offer to D.R. Horton. $270 million of our finished lots purchased in the third quarter were from Forestar. Forestar is separately capitalized from D.R. Horton and had more than $780 million of liquidity at quarter-end, with a net debt to capital ratio of 19.1%. Forestar is uniquely positioned to capitalize on the shortage of finished lots in the homebuilding industry and to aggregate significant market share over the next few years with its strong balance sheet, lot supply, and relationship with D.R. Horton. Mike?

Financial services earned $94 million of pre-tax income in the third quarter on $229 million of revenues, resulting in a pre-tax profit margin of 41.2%. During 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 74% of our buyers. FHA and VA loans accounted for 51% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 723 and an average loan-to-value ratio of 88%. First-time homebuyers represented 56% of the closings handled by our mortgage company this quarter. Bill?

Our balanced capital approach focuses on being disciplined, flexible, and opportunistic to support and sustain an operating platform that produces consistent returns, growth, and cash flow. We continue to maintain a strong balance sheet with low leverage and significant liquidity, which provides us with the flexibility to adjust to changing market conditions. During the first nine months of the year, our cash provided by homebuilding operations was $2.1 billion and our consolidated cash provided by operations was $2.3 billion. At June 30, we had $4.6 billion of homebuilding liquidity, consisting of $2.6 billion of unrestricted homebuilding cash and $2 billion of available capacity on our homebuilding revolving credit facility. Homebuilding debt at June 30 totaled $2.7 billion, which includes $400 million of senior notes that we redeemed early in July. Our homebuilding leverage was 11.1% at the end of June and homebuilding leverage net of cash was 0.7%. Our consolidated leverage at June 30 was 22%, and consolidated leverage net of cash was 11.2%. At June 30, our stockholders' equity was $21.7 billion, and book value per share was $64.03, up 23% from a year ago. For the trailing 12 months ended June, our return on equity was 24.3%. During the quarter, we paid cash dividends of $85 million, and our Board has declared a quarterly dividend at the same level as last quarter to be paid in August. We repurchased 3.1 million shares of common stock for $343 million during the quarter for a total of 7.7 million shares repurchased fiscal year-to-date for $764 million. Jessica?

As we look forward, we expect current market conditions to continue with uncertainty regarding mortgage rates, the capital markets, and general economic conditions that may significantly impact our business. For the full year, we currently expect to close between 82,800 and 83,300 homes in our homebuilding operations and between 6,500 and 7,000 homes and units in our rental operations. We expect our consolidated revenues for fiscal 2023 to be in a range of $34.7 billion to $35.1 billion. We expect to generate greater than $3 billion of cash flow from operations in fiscal 2023, primarily from our homebuilding operations. We also expect our fiscal 2023 share repurchases to be approximately $1.1 billion, similar to last year. For the fourth quarter, we currently expect to generate consolidated revenues of $9.7 billion to $10.1 billion, and homes closed by our homebuilding operations to be in the range of 22,800 to 23,300 homes. We expect our home sales gross margin in the fourth quarter to be approximately 23.5% to 24%, and homebuilding SG&A as a percentage of revenues in the fourth quarter to be in the range of 6.7% to 6.8%. We anticipate our financial services pre-tax profit margin of around 30% to 35%, and we expect our income tax rate to be approximately 24.5% in the fourth quarter. We will 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. David?

In closing, our results and position reflect our experienced teams, industry-leading market share, broad geographic footprint, and diverse product offerings. All of these are key components of our operating platform to sustain our ability to produce consistent returns, growth, and cash flow while continuing to aggregate market share. We will 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 continued focus and hard work. This concludes our prepared remarks. We will now host questions.

Thank you. At this time, we will be conducting a question-and-answer session. And the first question today is coming from Stephen Kim from Evercore ISI. Stephen, your line is live.

Thank you very much, everyone. Another impressive quarter. Congratulations on that. I wanted to discuss your construction pace and your future goals. You mentioned increasing your starts this quarter compared to last quarter. However, if we look back a year or a year and a half ago, there were a few quarters where you started approximately 25,000 units a quarter. I'm curious if you believe that is a target you could reach in the near term, and if not, what are the reasons behind that? Also, could you elaborate on whether seasonality will play a role in your starts cadence?

Yes, Stephen, we have seen, as we talked, about a 30-day reduction in our cycle time and see consistency and improvement as we travel throughout our divisions and seen pretty good balance with our trades and all the supplies that we need to continue with improvement in cycle time. If you look at our starts pace, it did tick up some and stayed pretty consistent with our closings, which is a cadence that we expect to see as we look towards the fourth quarter. Based on our sales pace and the strength of the market, and where we have the lots and the ability to push that up a little bit, we will, but not looking to outpace the market and continue to keep in that cadence and position ourselves for continued growth.

It seems I didn't get a clear impression of whether 25,000 holds significance for you. Why is that a target we couldn't reach or revisit? It wasn’t long ago that you achieved that for two consecutive quarters. Additionally, I have a second question regarding your rental platform. You indicated some guidance about higher revenue but lower margins in the fourth quarter compared to the third quarter. Could you elaborate on your plans for rental inventory in terms of dollars on the balance sheet? What level of investment should we expect, which I believe is currently $3.3 billion? Will that amount increase significantly as we move into 2024 and beyond, or are you comfortable with that level and perhaps starting to harvest some of it? Thank you.

Hey, Steve, regarding the 25,000 starts per quarter, we are focused on gradually increasing starts each quarter. We believe that by continuing this process, we can consolidate the availability of labor. With the consolidation of labor and materials, our ability to schedule our starts and continue building houses while gaining efficiency in that process is an ongoing effort. We don’t have a specific target number we need to reach. Our goal is to consolidate markets and increase our market share on a case-by-case basis. As we do this, we will naturally continue to grow. I’ll let Mike address the rental question.

Hey, Stephen. So, we expect that the margin on the fourth-quarter closings in the rental segment will probably have a lower profit margin, largely on the basis of a mix of projects that are delivering between Q3 and then into Q4. A lot of it's on a cost basis difference between those homes that were built at different times and when they're delivering.

And then, in terms of our forward investment level, we're at a total of about $3.3 billion of inventory today. We've seen a significant growth ramp in that over the last two years. We do expect to continue to grow that platform and we will see our inventory levels continue to grow over the next couple of years, but we do expect that growth pace to moderate from what it's been in the last two years.

Okay. Great. Thanks very much, guys.

Thank you. The next question is coming from Joe Ahlersmeyer from Deutsche Bank. Joe, your line is live.

Thanks, and good quarter, guys.

Thank you.

I wanted to follow up on the community count. That's up about 9% year-to-date, calendar year-to-date that is. And I'm just wondering is there anything in there that we should consider that's more temporary in nature? I'm not going to straight-line that release or anything that sequential number, but should we expect that to go down into the back half, or are we going to sustain those levels? And then I have a follow-up.

Sure, Joe. We've been really focused on our flag count. I mean, we clearly have the lot position to open new communities and to grow our community count, whereas the last couple of years, it's not moved more than a low-single digit percentage. We do feel like we're positioned to be closer to the mid-single digits going forward. So not necessarily 9% going forward, but around the mid-single digits quarter-to-quarter. There can be some choppiness just determining when we close out of communities and ultimately bring them online, but our lot position is there and our operators are focused on growing their flag count.

Makes sense. And just thinking about the homes and inventory number, that was actually sequentially flattish the last couple quarters, even as you did grow those communities. So, is it right to think that maybe this is part of returning to higher levels of inventory unit turnover? Or should we expect that the total homes and inventory will sort of catch up on a lag as you continue to grow starts?

We're very focused on improving our inventory turn and as our construction cycle times have improved, that's facilitating that. You look historically, we typically when we go into a year with our number of homes in inventory, we've been able to turn that 2 times in the following year. The last couple of years has been slower than that, and so we're looking to get back to that more historic inventory turn level as we look to fiscal '24.

Going back to the initial question, a factor in our starting pace is ensuring that we have the capacity to continue delivering these houses in a faster and more efficient manner. Everything works together so that we can actually deliver more houses with fewer homes and inventory from quarter to quarter.

That's great to hear. Thanks very much, and good luck.

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

Good morning, guys. Thank you for taking my questions. The first one is, it looks like the sequential improvement or the sequential cadence of orders from the second quarter to third quarter was better than normal seasonality by a bit. I mean, I think normal seasonality would suggest down about 5%. It looks like they were down about 1%. As we move into the fourth quarter, how should we sort of think about seasonality, which looks like it's typically down, call it, 15% to 20% on a quarter-over-quarter basis? Is that a reasonable way to think about the fourth quarter, or are the dynamics getting a little bit better out there where you might be able to do a bit better than that?

Yeah. Thanks, John. I think we are seeing more normal seasonality this year in terms of just demand traffic patterns. And so, I think our base expectations would be that orders would show a bit closer to normal seasonality going forward. But to our approach in trying to be as consistent as we can and providing starts pace and a consistent level of inventory, we're still a short supply of inventory out there in the existing home market and in the new home market. We're going to make sure we've got enough homes out there to capture whatever demand there may be. And so, our hope would be, over the longer term, we could see a bit more consistency there. But there still is a natural seasonality and an ebb-and-flow to consumer demand that I think is getting back to a more normal level.

I believe we will have many more houses to sell this year due to the shortened cycle time and our ability to provide a definite closing date. Last year, we faced limitations on the number of homes available. Therefore, the comparison for this quarter to the same quarter last year will likely appear more favorable than typical seasonal trends.

That makes sense. Okay. And then maybe just a bigger picture question. If we look at 2019, D.R. Horton delivered around 57,000 homes, compared to nearly 83,000 homes expected this year. Industry-wide single-family starts were pretty similar in 2019 to what's anticipated today. Clearly, Horton and other public builders have been gaining market share for years, but this represents almost a 45% to 50% increase since 2019. So, I guess the question is, how sustainable are these gains? How crucial is your build strategy to this performance? And how significant is the shortage of existing home inventory to overall homebuilder success today?

I believe we've made significant progress in simplifying our business and establishing consistency that wasn't there in previous decades. I often refer to it as building a real business, and I think we have achieved that. Following the downturn, there was a great opportunity to consolidate our market, but we lacked the liquidity and balance sheet to seize it. Over the last 15 to 20 years, our objective has been to develop a company with the financial strength to capitalize on any market disruptions. Since 2019, it appears that we have frequently faced such disruptions. Our platform's strength is becoming evident, and we emphasize this often. It's about people, location, and product, all aimed at simplifying our business and providing affordability that others cannot match. This will drive market consolidation.

Thank you very much.

Thank you. The next question is coming from Carl Reichardt from BTIG. Carl, your line is live.

Thanks. Good morning, everybody. Bill, you mentioned stick and brick down 4% per foot, I think, year-on-year. Could you break that out in terms of what materials are helping most, obviously, lumber and then labor? And the reason I ask is, I'm assuming that we're starting to see some leverage from the single-family and multi-family rental platform. Part of the reason you're trying to grow that business is to add scale in your markets to lower overall construction costs. So, I'm wondering if that's starting to help there.

Right now, as we look at the components of the home across the materials, it is primarily lumber right now. There are some minor moves in both directions, really across the other components of the homes. It's primarily lumber there. I think we are on the front edge of starting to realize some improvement in labor as the homes that we have been starting over the last quarter or two have been at a lower cost than what we had there for a while. But I think we still expect a bit more improvement there with lumber. And then really, the forward cost structure really depends on what the capacity of the industry is and what all builders are doing. So, a bit more improvement there, but as we continue to add scale, which does include our rental platform as well, we definitely have advantages and opportunities to continue to leverage that to drive our cost structure down, especially relative to the rest of the industry.

Thank you, Bill. David, regarding the private builders we're in discussions with, we've observed some normal seasonal patterns in a market that appears to be slower than they anticipated as summer began. This might be influenced by the unique challenges of smaller, private builders. They face difficulties with buy-downs and have more limited capital for higher-end projects. You acquired a private builder during the quarter and have a presence in several markets where smaller private builders are primarily your competitors, and in some instances, they are the only ones. Has there been any significant change in their interest or willingness to sell, considering their current challenges compared to the advantages that public builders have? Thank you.

Carl, we talk about it a lot, seems like in the last couple of years, but it is really hard to put a lot on the ground. It is really hard to build houses. And these private guys, now, they've got to struggle with capital from either private or banks increasing in cost. So, do we have the opportunity to talk to a lot of these guys? Yes, we do. But it's going to take unique opportunities for us to invite them into the family, because we do have a special culture here and we're not going to screw it up trying to force a square peg in a round hole.

Excited about the most recent Truland in terms of already having been one of our largest lot developers in our Gulf Coast region. And so, we picked up Truland's homebuilding operations, but Nathan Cox and his team will continue to be a key component in terms of developing lots to us and for us in the Gulf Coast.

And I will say, I've had a personal relationship with Nathan Cox for 15 plus years, and he is an example of somebody that absolutely mirrors our culture. He's a super quality guy. He's built a good company, and somebody who we're going to be in business with for a long, long time.

Great. I appreciate it. Thanks all.

Thank you, Carl.

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

I wanted to follow up on your earlier comments regarding your fourth quarter demand and order trends. Last month, Lennar mentioned that their third quarter orders were slightly higher than in the second quarter, and KB indicated that normal seasonality was less pronounced in their third quarter, attributing this to strong demand as well as addressing the supply shortages. Bill, you suggested that we might see normal seasonality, and David, I believe you mentioned it could be better than normal. I would like to get a more detailed understanding of your capacity to meet demand. Can you take orders at a level similar to the third quarter if demand is present? I assume you're interested in capturing as much market share as possible. Also, are there any production constraints that could limit your ability to fulfill orders?

Sure, Mike. So, I mean, we're not in this for quarterly results. We're in this for the long term and to build as much shareholder value as we can over the long term. So, quarter to quarter to quarter, as you've heard David say over and over, we're focused on being consistent, and, as we've talked about, it's all tied to our starts pace. So, we're not managing to a sales number in Q4. If the market's there and our cycle times continue to improve, we might be able to see a little bit better than normal seasonality. If the market were to weaken for some reason or we don't get as many homes started ultimately, it could be less than normal seasonality. Right now, we feel like we're positioned to increase our starts slightly from where we were in Q3. And also, as we've talked about, our construction cycle times have continued to improve and our flag count has grown. So, we feel like we're very well-positioned. But frankly, we're more focused on positioning for '24 at this point than we are worried about Q4. I mean, we're going to finish out the year very strong and generate strong returns and continue to add to book value and position ourselves to go do the same in 2024.

Okay, I appreciate that. Looking ahead to 2024, if you consider your backlog conversion at the start of the year compared to what you deliver, you achieved a turnover of about four times, meaning your backlog turned over four times in terms of the closings you accomplished. The peak was in 2020 at 4.8 times. It seems that you could be closer to five times or even six times depending on your backlog at the end of this fiscal year. Given your goal for community count growth, is it still reasonable to anticipate a high-single or low-double digit growth in closings for next year, or are there constraints regarding turnover and cycle times that we should be aware of?

Sure, Mike. As we look ahead to fiscal '24, we aim to position ourselves with our lot position and homes in inventory to deliver close to double-digit growth, around 10%. We're working on our inventory to ensure we are prepared for the current market conditions. I believe the opportunity is there if we can align our lot positions and homes in inventory accordingly. With improved cycle times, we enhance our inventory turnover. Our primary focus is on inventory turnover and conversion rather than backlog. Backlog merely reflects when we decide to sign a sales contract on a home. We concentrate on our pace of starts, the homes in our inventory, and we adjust our sales strategy based on our confidence in delivering those homes. Every home we begin construction on will close, and improving our turnover rate will enhance our inventory turnover, which in turn increases visibility regarding our closings. Ultimately, it’s about our pace of starts, the positioning of our inventory, and our efficiency in turning that inventory.

And as a reminder, we sell and close generally 35% to 40% of our homes intra-quarter, so you never see those in our backlog that we're reporting at a quarter-end anyway, which is why Bill is alluding to home starts and our homes in inventory being a better driver and an indicator of what we're going to close in a forward period.

Great. Thanks so much.

Thanks, Mike.

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

Good morning. Thank you for taking the questions. I wanted to ask about lot costs. I think you said lots on a per square foot basis were actually flat sequentially, which is maybe a little surprising, given the shortage of lots out there, as you alluded to. Could you speak to a little around what's implied near term in your margin guidance around lot costs? And then just sort of more broadly, how are you thinking about managing inflation in lots going forward? Thank you.

What we're seeing today in the closings are lots that were contracted and acquired quite some time ago and coming through. So, we're not seeing a lot of cost pressure coming through. Going forward, along with the lot scarcity, we're expecting to see lot costs coming through in forward margins at a higher level. There has certainly been inflation in land and in lot development costs and in finished lot prices. So, we expect to see that, but that's factored into our guidance and the way we're planning for the business next year.

Thank you for your insights. On the topic of mortgage rate buydowns, could you explain how this dynamic might change with fluctuations in prevailing mortgage rates? If mortgage rates were to increase, what is the maximum rate buydown you could implement? Conversely, if rates decrease, would you continue to buy down at the same level, or would you reduce the size of your mortgage rate buydowns? I’m interested in your thoughts on how this could unfold. Thank you.

The rate buydown has been an effective tool for us, helping to provide certainty in closing dates and home payments as we improve our cycle times. We've maintained a rate about a point below the market, and we'll need to evaluate that as interest rates fluctuate, whether they go up or down. This approach has proven to be one of our most successful incentives, and we have been consistent in our execution. We will continue to assess this strategy as interest rates change in the future.

All right. Well, thank you, and good luck.

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

Thanks. The gross margin progress in the quarter was notable and you talked about, I guess, a bit more progress in 4Q. I'm curious if you could help us get a sense of how we should be thinking about the path of gross margins from here. You've done a good job historically outlining ranges. But in the world, which seems like it's stabilizing for you now, how should we think about the range of path of gross margin?

What we can see is primarily from our backlog and recent sales, along with our current cost levels. We've noticed that costs for our latest projects are lower, which gives us some insight into potential outcomes. Based on our recent backlog and sales, we are observing a slight improvement in margins, expected to reach the high-23% to 24% range in Q4. You mentioned stabilization, a term we used frequently last quarter, and we continue to observe that trend. We feel we are entering a more stable phase regarding costs, and demand remains consistent. While we don't anticipate a continuous upward trend in margins, the slight improvement we expect for the upcoming quarter appears sustainable in the near to medium term.

A lot of tailwind from limited inventory supply at affordable price points are helpful to margins. And then, interest rates are the biggest risk to margins. Significant increases in interest rates will compress our margins.

Within this, you mentioned a moment ago, buying rates down a point below market has been a silver bullet or something that's been a catalyst for consumers to go ahead and sign a contract. I'm curious if you're seeing that's just the way it's going to be, or if you're seeing consumers becoming more comfortable with the reality in the days of a 3% mortgage are long gone. I guess, what I'm trying to figure out is, can you get away with buying down rates less now? Are you seeing consumers a bit less sensitive? Or is this the medium-term reality that we should expect?

Yeah. The interest rate buydown is an incentive like many that we use, and we have a lot of different levers that we may pull market-by-market or community-by-community based on the needs of the buyers walking in the door. That has certainly been a hot-button today because of the meteoric rise in rates and people's adjustment to that. As that adjusts, it will just ebb and flow with different incentives, whether that's closing costs or price or included features. It's been a good tool for us today. We will adjust to the market as it comes at us.

It was still on a majority of the homes we closed in the third quarter, but it was at a lower percentage than it was in Q2 in terms of the number of buyers utilizing that incentive.

Great. Thank you.

Thank you. The next question is coming from Ken Zener from Seaport Research Partners. Ken, your line is live.

Good morning, everybody.

Good morning, Ken.

I want to ask two questions here. First, I'd like to focus on capital and cash flow, and the second will be about our business levels by community in comparison to the past. Your ability to align EPS with cash flow has been improving, showing around $3 billion in cash flow and approximately $4 billion in net income, which is about 75%. Obviously, multi-family is a factor in this. Could you specifically address the 53% of option lots you expect to be completed? What factors limit this from increasing, and what determines whether you opt for finished or raw land in those options? Also, please refresh us on the cost of a raw first developed lot so we can understand the inflation associated with those raw lots.

Sure, I'll begin, and then Mike or someone else will likely add insights regarding operations. Regarding the 53% of our option lots that we anticipate will be purchase-finished, this figure represents a specific moment in time. We have already identified which lots will be developed for us, and we plan to acquire them as finished lots. However, this is not a cap on our expectations. Currently, we are closing over 60% of our houses each quarter on lots purchased from third-party developers. In our regular operations as D.R. Horton, we typically contract with a land seller, secure an option on the contract, and then locate a land developer. Therefore, the 53% serves more as a baseline rather than a limitation.

I think you said it very well. We're going to take a piece of dirt and title it, and then, in that process, look to work with a third-party developer in some cases to assign that contract to. They'll acquire the land parcels and then they'll complete the lot development and sell us finished lots that we'll then start constructing homes on over time. So that 53% expected would go up, but we will choose, in some cases, to develop the neighborhood ourselves. In every one of our markets, we have great teams in place that are capable of developing their own lots, as well as negotiating to buy finished lots from third-party developers.

Ken, in response to your earlier point about capital, cash flow, and the percentage of cash flow in relation to our earnings, we are observing significant improvements this year, and we anticipate this trend will continue. This notable change is largely driven by enhancements in our construction cycle times. We have less capital tied up in inventory per home because we are able to turn those homes around more quickly. While the shift in our land strategy has contributed to this over the years, this year the focus is mainly on the improvement in the turnover of our homes and their inventory.

Great. As a follow-up to that, why would you choose to develop land as opposed to other builders? Also, I'm trying to understand why your starts pace per community is about 4.6 this year compared to 3.6 previously. Why is that the new normal? I don't want to unnecessarily reduce the sales pace, but why are we significantly above where we used to be as an industry? If you could clarify that, I would appreciate it. Thank you.

I believe that regarding lot development, we have skilled teams throughout our organization. There are times when it's crucial for us to have lots available for our start pace. Managing that process effectively and producing lots is a skill we plan to maintain and continue to develop. Some projects are more advantageous for us to take on based on factors like timing, structure, and size, so we will make those decisions on a community-by-community basis. As for our absorption rates per community, it seems that larger communities could be influencing our sales and positioning, which helps to enhance efficiency in both our construction and sales processes.

Yeah, I'm not sure I've got an answer for you for sure, Ken. If you don't know the answer, I'm sure we don't either in terms of why the industry has improved. The only thing I could come up with is, you have seen a shift in this industry to focus more on returns. And as we focused on returns, that really comes down to being more efficient with every asset you have. And so, if you can improve your absorption, improve your turns in each community, your returns on capital are improving. And so, perhaps you're seeing a little bit of that come through in your observation of looking at higher pace, higher absorptions over time across the industry.

Thank you.

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

Good morning. Thanks for taking my questions. A couple of follow-ups on the rental side. So, there was a pretty well-publicized deal between yourselves and a large SFR company. Within the quarter and the guide, any color you can provide on how much of that deal already closed in 3Q? And whether or not the increase in the guide for the year reflects the full closing of that, or if there's going to be some carryover into fiscal '24?

Sure. Our guidance will continue to reflect the homes we have closed and our leasing pace, along with the availability of those projects for sale and marketing. We've executed sales on an individual basis, but as we grow that segment, it's attracting more interested investors, particularly institutional investors who prefer acquiring a portfolio rather than just one project at a time. The deal you mentioned was based on speculation, and we haven't made any public comments regarding the specifics of that transaction. When we assess our rental communities, regardless of whether we're selling multiple projects to a single investor, each transaction remains an individual real estate deal. Therefore, we will continue to reference our disclosures on a unit basis regarding the number of completed homes and rental units, as well as what the forward sales pace looks like. We will maintain our strategy of selling individual projects and I anticipate that we will also continue selling package deals in the future.

Okay, got it. And I guess a follow-up there, so without the specifics. Given the total units you are now guiding to and the inventory that you've outlined, you will close a significant portion of your existing inventory in 4Q. And so, I fully understand that this is a growth part of your business for the next couple of years. But just circling back to a question, I think, earlier on the call around specifics on '24, should we be thinking that you've kind of pulled forward the timing of when some of that inventory you might have expected to close in terms of closing in '23 versus '24, so maybe it's a little lower in '24, or are you really in a position where even with this increased guide, you can keep growing in '24 off that?

We've generally been talking about our rental platform combined, but in our 10-Q, you can see a breakdown and we do give our unit breakdowns separately. So, '24 is going to be a pretty big growth year from a multi-family perspective and we're going to continue to scale the single-family. But as we scale both sides of the business, it could still be choppy quarter-to-quarter, year-to-year, with ultimate overall growth on an annual basis expected.

Okay, great. Thank you.

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

Hey, guys. Good morning. So, very impressive progress on the cycle times and the cost front. I'm guessing what we are seeing now is probably somewhat of a lagged effect of the big pull back in starts the industry saw late last year and the negotiating power you had over the trades at that time and, of course, the pull back in lumber. You are not the only ones ramping your start pace now. I think we are hearing similar messages from most of your larger competitors. Maybe some of that is at the expense of the smaller privates, but I think it is clear the industry start pace is going to be accelerating here for the next handful of quarters at least. So, what are your thoughts on the sustainability of the progress you have made on cycle times and costs heading into '24? And more specifically, what are you seeing from your trades? Are they ramping their headcount in anticipation of an accelerating start pace going forward? Are they seeing more capacity out there that would support this type of growth without cost inflation following?

Yes, it's something we work on every day. Aggregating market share involves aggregating trade base and materials within those communities. And we've been talking about a consistent start pace when we've been talking about simplifying the process and making it easier for our trades to get to and from the job with the right materials, with a complete understanding of what they're doing. That is allowing us to aggregate these trades. Our goal, our communication is we want to be the builder they want to work for. And we do a lot of things to try to make their job easier and more profitable without coming in and trying to renegotiate price every quarter. So, is it sustainable? Yes. I think that we are going to continue to focus on that. And as time goes on, we'll get better at it and basically build capacity month-to-month, quarter-to-quarter, on a continual basis.

I understand. Thank you for your insights. Jessica, earlier you mentioned that while mortgage rate buydowns are still being offered on most closings, there was a slight decrease in the share of closings that included them compared to the previous quarter. I was wondering if you could share that specific data with us, and if you're noticing any sensitivity in demand in the communities where you are reducing those buydowns. On one hand, the buydowns likely give you a strong competitive advantage against the resale market. However, given the tight inventory and seemingly strong demand, it seems you might have the opportunity to scale back on those without negatively affecting demand too much. I'm interested in understanding how these factors interact.

The use of the rate buy downs is about 10% less than it has been as we look over the last few quarters. And that sensitivity is a community by community and buyer by buyer process. We have great sales agents in each of our communities that go through that experience with every buyer that walks in and finding what's important to them is what they do very well. And so, we'll continue, as we mentioned, to utilize that. And certainly that reduction shows some stability in rates. Although they've moved up, they've remained in a similar range. And I think people getting comfortable with their purchasing power has allowed some of the relief of that use and/or them not being as concerned about it as the thing that is important to them in the purchase.

Great. Appreciate the color. Thanks, guys.

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

Hey, good morning, everyone. Thanks for fitting me in. First, this has been touched on a little bit earlier in the call, but just trying to get a big picture overview of the banking environment and what it means for Horton. Has the banking environment currently negatively impacted your developer partners kind of outside of 4 Star, their ability to access capital for future projects? For smaller private builders, are you actually seeing them kind of pull back on spec construction, land deals, et cetera?

I think with a lot of the third-party developers we work with, we have a long relationship with them. And in a lot of cases, their banking or financing sources are kind of looking through their developer, looking through to the land contract and working with us and they take great comfort in that. And we've been able to continue to sign up new deals over the past quarter that have secured new financing commitments for the third-party developers through the process. Is it as easy as it was or as inexpensive as it was? Certainly not. It is more challenging. I do think that the banking industry is being more selective in who and at what levels they're choosing to support third-party developers. On the private builder side, we've probably seen a little more opportunity to step into some positions and help those builders with some liquidity and opportunities by taking some of their lots or stepping into different positions. So, it has been, if anything, a bit accretive to the business, and we're just here to help.

Thank you. You have previously mentioned shifting to smaller square footage offerings to address affordability. Can you help us understand if consumers have been showing a preference for these smaller homes over the last six months? Or, based on your current offerings, are they still leaning towards larger homes?

They prefer what they can afford. So, what we generally see is that buyers continue to want as much square footage as they can get, but they're constrained by what they can afford, which is why we continue to start more and more of our smaller floor plans. We did see a slight tick down on a year-over-year basis again by about 2% in the terms of square footage on our homes closed. It was flat sequentially. So, we would expect just continued very gradual moves down in our average square footage today.

All right. Thank you, and good luck in '24.

Thanks, Truman.

Thank you. And the next question is coming from Rafe Jadrosich from Bank of America. Rafe, your line is live.

Hi, good morning. Thanks for taking my questions. You mentioned that build cycles have come down 30 days from peak levels and you expect them to continue in the fourth quarter. Can you just talk about where they are now versus historical levels? And then, beyond the fourth quarter as you look into next year, how should we think about further potential improvement, like what that could do for your asset turns?

We are currently at about five-and-a-half months in our current cycle time, which is still slightly above our historical averages. We are seeing a trend towards more normalized and consistent cycle times. This will depend on labor availability and our ability to continue to gather that labor. As space increases across the country, we might face some pressure on that, but we feel confident in our position and the trade capacity we have in the markets today.

Our build time of that at five-and-a-half months has come down about a month, and we probably have another month, month-and-a-half to go to get back to where we have been historically when we're operating at a more efficient level. And then, there's probably another 45 days to 60 days after that, what we call, construction completion until we hit the home closing date. So on average, we're looking to get to a 2 or a little better than 2 times turn of inventory units implies that six to slightly less than six months start to closing cycle time.

Thank you. That's helpful. So there's still more opportunity. And then, just on the rental profit outlook for the fourth quarter, the guidance is units will be up quite a bit, but you're thinking about rental profits being down. Should we think about gross margins there being lower than kind of core homebuilding longer term? Is there any dynamic that's driving that margin kind of cadence short-term, or is this something we should be thinking about it longer-term?

Yeah, it's really a short-term thing, as Mike mentioned earlier, part of it is the mix of the projects that we see coming through and the time in which those homes were constructed was the time when we were seeing higher construction costs as well. So, we really see that as a Q4 event and as we look longer-term from a gross margin perspective and really pre-tax margin perspective, we would expect the rental to still be higher than our homebuilding margins overall. Maybe a little bit of anomaly here in Q4, but not a long-term phenomenon.

Great. Very helpful. Thanks.

Thank you. That's all the questions we have time for today. I would now like to hand the call back to David Auld for 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 fourth quarter results in November. And finally, congratulations to the entire D.R. Horton family on producing a solid third quarter. Continue to compete, win every day. Thank you.

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