Jessica Hansen - Vice President of Investor Relations David V. Auld - President & Chief Executive Officer Michael J. Murray - Chief Operating Officer & Executive Vice President Bill W. Wheat - Chief Financial Officer & Executive Vice President.

Stephen F. East - Wells Fargo Alan Ratner - Zelman & Associates Eric Bosshard - Cleveland Research Co. LLC Kenneth R. Zener - KeyBanc Capital Markets, Inc. Robert Wetenhall - RBC Capital Markets LLC Nishu Sood - Deutsche Bank Securities, Inc.

Michael Jason Rehaut - JPMorgan Securities LLC Jack Micenko - Susquehanna Financial Group LLLP Susan Marie Maklari - UBS Securities LLC John Lovallo - Bank of America Merrill Lynch Michael G. Dahl - Credit Suisse Securities (USA) LLC (Broker) Alex Barrón - Housing Research Center LLC Jade Rahmani - Keefe, Bruyette & Woods, Inc.

Will Randow - Citigroup Global Markets, Inc. (Broker).

Good morning. And welcome to the Third Quarter 2016 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. As a reminder, this conference is being recorded.

It is now my pleasure to turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton. Please go ahead..

Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the third quarter of fiscal 2016. Before we get started, today's call may include comments that constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D.R.

Horton believes any such statements are based on reasonable assumptions, there 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 issues that can lead to material changes in performance is contained in D.R.

Horton's Annual Report on Form 10-K and our 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 next week.

After the conclusion of the call, we will post updated supplementary data to our Investor Relations site on the Presentations section under News & Events for your reference.

The supplementary information includes current and historical supporting data on our homebuilding return on inventory, gross margins, changes in active selling communities, product mix and our mortgage operations. Now, I will turn the call over to David Auld, our President and CEO..

Thank you, Jessica, and good morning. In addition to Jessica, I'm pleased to be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer; and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D.R. Horton team delivered a strong third quarter.

Our consolidated pre-tax income increased to $379 million on $3.2 billion of revenue, and our pre-tax profit margin improved 40 basis points to 11.7%. Our homes sold increased 13% compared to the third quarter of 2015 as we continued to see improvement in absorption per community. These results reflect the consistent solid performance of our core D.R.

Horton communities and our Emerald Homes and Express Homes brands as we strive to be the leading builder in each of our markets. Our focus is to produce double-digit annual growth in both our revenues and profits, while generating positive cash flows and increasing returns.

During the nine months ended June, we generated $89 million of cash from operations, on track for our second consecutive year of positive cash flows. For the trailing 12 months, our homebuilding return on inventory improved to 14.3%, up from 12.1% a year ago.

With a sales backlog of 14,670 homes at the end of June and a well-stocked supply of land, lots and homes, we are well positioned for the fourth quarter and next year.

Mike?.

Net income for the third quarter increased 13% to $250 million or $0.66 per diluted share, compared to $221 million or $0.60 per diluted share in the prior year quarter. Our consolidated pre-tax income increased 13% to $379 million in the third quarter versus $334 million a year ago.

And homebuilding pre-tax income increased 16% to $349 million compared to $302 million. Our third quarter home sales revenues increased 9% to $3.1 billion on 10,739 homes closed, up from $2.9 billion on 9,856 homes closed in the prior year quarter.

Our average closing price for the quarter was $290,400, essentially flat both sequentially and compared to last year. This quarter, entry-level homes marketed under our Express Homes brand accounted for 28% of homes closed and 20% of home sales revenue.

Our homes for higher-end move-up and luxury buyers priced greater than $500,000 were 7% of our homes closed and 16% of our home sales revenue.

Bill?.

The value of our net sales orders in the third quarter increased 14% from the prior year quarter to $3.4 billion, and homes sold increased 13% to 11,714 homes on a slight decrease on our average active selling communities. Our average sales price on net sales orders in the third quarter was $293,300.

The cancellation rate for the third quarter was 21%, consistent with the prior year quarter. The value of our backlog increased 17% from a year ago to $4.4 billion, with an average sales price per home of $298,600 and homes in backlog increased 15% to 14,670 homes.

Our backlog conversion rate for the third quarter was 78%, at the midpoint of the range we guided to on our second quarter call.

Mike?.

Our gross profit margin on home sales revenue in the third quarter was 20.3%, up 40 basis points from the second quarter. The improvement in our margin this quarter was primarily due to controlling cost increases while also reducing incentives or raising prices in communities where we are achieving our targeted absorptions.

Our general gross margin expectations remain unchanged. In the current housing market, we continue to expect our average home sale gross margin to be around 20%, with quarterly fluctuations that may range from 19% to 21% due to product and geographic mix, and the relative impact of warranty and interest costs.

David?.

In the third quarter, homebuilding SG&A expense was $280 million, compared to $258 million in the prior year quarter. As a percentage of homebuilding revenue, SG&A improved 10 basis points to 8.9%, compared to 9% in the prior year quarter.

For the nine months ended June, our SG&A improved 40 basis points to 9.5% compared to 9.9% in the same period in the prior year. We remain focused on controlling our SG&A while ensuring our infrastructure adequately supports our current and expected growth.

Jessica?.

Financial services pre-tax income in the third quarter was $29.4 million, compared to $31.7 million in the prior year quarter. 92% of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operations, and our mortgage company handled the financing for 56% of our homebuyers.

FHA and VA loans accounted for 50% of the mortgage company's volume compared to 49% in the prior year quarter. Borrowers originating loans with our mortgage company this quarter had an average FICO Score of 716 and an average loan-to-value ratio of 89%.

First-time homebuyers represented 45% of the closings handled by our mortgage company, compared to 41% in the third quarter last year.

Bill?.

At the end of June, we had 25,300 homes in inventory, of which 1,600 were models. 11,300 of our total homes were spec homes with 8,200 in various stages of construction and 3,100 completed. Our construction in progress in finished homes inventory increased by $218 million during the quarter due to seasonal construction activity.

Our third quarter investments in lots, land and development totaled $823 million, of which $586 million was to replenish finished lots and land and $237 million was for land development. For the nine months ended June, our investments totaled $2 billion, an increase of 18% from the same period last year.

We expect a continued increase in our investments in land and development in the fourth quarter as compared to the prior year.

David?.

June 30, 2016, our land and lot portfolio consisted of 202,000 total lots, of which 112,000 or 55% are owned and 90,000 or 45% are controlled through option contracts. 73,000 of our total lots are finished, of which 30,000 are owned and 43,000 are optioned.

Our 202,000 total lots owned and controlled provide us a strong competitive advantage with a sufficient lot supply to support solid growth in sales and closings in future periods.

Bill?.

During the third quarter, we recorded $2.9 million in land option charges for write-offs of earnest money deposits and due diligence costs for projects that we do not intend to pursue. We also recorded $5.2 million of inventory impairment charges primarily due to an expected land sale in the East region.

We will continue to evaluate our inventories for potential impairment which may result in future charges, but the timing and magnitude of these charges will fluctuate. Our inactive land held for development of $156 million at the end of the quarter represents 9,100 lots, down 29% from a year ago.

We continue to work through each of our remaining inactive land parcels to improve cash flows and returns and we expect that our land held for development will continue to decline.

Mike?.

At June 30, our homebuilding liquidity included $863 million of unrestricted homebuilding cash and $882 million of available capacity on our revolving credit facility. Our homebuilding leverage ratio improved 730 basis points from a year ago to 30%.

During the quarter, we repaid $373 million of senior notes at their maturity and the balance of our public notes outstanding at June 30 was $2.8 billion. We have $350 million of debt maturities in the next 12 months. At June 30, our shareholders' equity was $6.5 billion and book value per share was $17.50, up 14% from a year ago.

Jessica?.

Looking forward to the fourth quarter, we expect our homes closed to approximate a beginning backlog conversion rate in the range of 81% to 84% at an average sales price around $290,000.

We anticipate our home sales gross margin in the fourth quarter will be around 20% and we expect our fourth quarter homebuilding SG&A to be in the range of 8.4% to 8.7% of homebuilding revenues. We estimate that our fourth quarter financial services operating margin will be around 35%.

We expect our tax rate in the fourth quarter to be around 35% and our fourth quarter diluted share count to be approximately 377 million shares. And we continue to expect $300 million to $500 million of positive cash flows from operations for the full year of fiscal 2016. Our expectations are based on today's housing market conditions.

Our current preliminary expectations for fiscal 2017 are for our consolidated revenues to grow by approximately 10% to 15% and for our consolidated pre-tax margin to increase to a range of 11.2% to 11.5% for the full year.

We also expect to generate positive cash flows from operations for the third consecutive year in a range of approximately $300 million to $500 million. We anticipate our tax rate for fiscal 2017 will be between 35% and 36% and that our diluted share count next year will increase by approximately 1.5%.

David?.

In closing, our third quarter growth in sales, closings and profits and the improvement in our pre-tax profit margin are the result of the strength of our people and our operating platform. We are striving to be the leading builder in each of our markets and continue to expand our industry-leading market share. D.R.

Horton has been the largest builder in the United States for 14 consecutive years. And according to Builder Magazine's recent Local Leaders issue, in 2015, we were the number one builder in 13 of the top 50 U.S. housing markets and a top five builder in 30 of the largest markets. Since 2009, our market share has increased from 5% to 8%.

We remain focused on growing both our revenue and profit at a double-digit annual pace while continuing to generate positive cash flows and improved returns. We are well positioned to do so with our solid balance sheet, industry-leading market share, broad geographic footprint, diversified product offering across our D.R.

Horton, Emerald and Express brands, attractive finished lot and land position and, most importantly, our tremendous team across the country. We'd like to thank the entire D.R. Horton team for their continued focus and hard work, and we are excited and looking forward to our opportunities ahead. This concludes the prepared remarks.

We will now host questions..

Thank you. Our first question today is coming from the line of Stephen East from Wells Fargo. Please proceed with your question..

Thank you, and good morning, everybody..

Good morning, Stephen..

Good morning. David, maybe I'll ask you a little bit. Thanks for the guidance on all that. That's very helpful. And if I look at the cash flow for 2017, another year that looks a lot like this year, I guess, a couple of things.

What does that imply? Again, going back to your capital allocation that I always ask you, but what does that imply for being able to grow your communities and what growth rate are you expecting? Is it in that 10% to 15% range that you have for revenues? And then, as you look out, what's your next use there? Is it – are you seeing M&A out there? Do you have more debt pay down, et cetera?.

Stephen, I think, right now, we're looking at every opportunity that's out there. As we've talked before, our goal is to be consistent and kind of take advantage of situations as they appear in our market. Community count growth, I would think we're probably going to take community count up single digit, mid-single digit maybe.

Certainly, paying down debt to me is always a good thing, deleveraging the balance sheet and creating opportunities as they arise is something that we believe in. And as far as our guidance for next year, I think it's just – we see a consistent solid market out there.

And we're well positioned to take advantage of it and just going to continue to try to improve our execution and get better at building, selling, closing houses every day..

Okay. And just going back to the M&A, what are you seeing out there from the privates? And then, switching gears, it sounds like so, for next year, you've got your absorption rate continuing to improve.

Is that really just being driven on the Express side of the world or are you seeing anything else in the markets?.

Well from the – the absorption rate, yes, the Express definitely drives higher absorption rates than even the core Horton brand and has – we continue to expand that brand. We're in 51 markets I think right now. We're going to continue to push that brand into other markets.

And I think we will see added absorption developed on a division standpoint, improved the absorption division-by-division which drives the overall. But I do think that we will see growth in communities next year..

And, Stephen, this is Mike. On your M&A question, we continue to see various private builders across the country testing the waters. We've been very fortunate with the acquisitions we've made. We've been very selective, brought on a lot of good people, lot of good teams. And we'll continue to be selective.

We've set a high bar internally and we're looking for the best opportunities that either expand our geographic coverage or bring us new customers, new customer segments..

All right. Thanks a lot..

Thank you. Our next question today is coming from Alan Ratner from Zelman & Associates. Please proceed with your question..

Hey, guys. Hi. Good morning and congrats on another strong quarter..

Thank you, Alan..

David, and I think I might have asked you this last quarter, too, but the option lot count, I mean, 90,000 now, you're almost 70% from a year ago, 45% of your total lots controlled option.

What are you seeing in the land market that you've been able to drive that success? Because, obviously, that's going to be a huge positive for returns and it seems like you're not really anticipating those options having much of an impact on your margin because you're still keeping the same language for roughly 20% gross margin.

So, is it just that the land market is opening up and developers have access to capital and they're more willing to flip through these lots on options or are you kind of going outside the box and doing something unusual, because none of your competitors seem to have had as much success as you have?.

Well, we've got a huge advantage in it. We've got a great big footprint, and our absorption per community is something that developers that are putting lots on the ground look to. So, good market, then we're going to build houses. And I think our outreach to the development community, we are a much friendlier buyer.

I think it's becoming – our goal is to really partner with these guys and to put their capital at play and avoid some of the longer-term negatives of owning as a builder, as a public company. So, it's just focus, to be honest with you; focus and execution. Our guys out there have been asked to do it, and they're getting it done..

And generally, you're able to underwrite these deals and keep a pretty similar gross margin as if you were to own that land outright or is there a margin differential when you do this? And just the final follow-up there is, is it widespread across the country where you're having a success or are there certain geographies where the majority of those option lots are located? Thank you..

As far as across the country, we've got option. We've been able to create option lot situations in California. And I could tell you in the last market, there was never a chance of doing that. So it really is just focus. And as far as margin, yes, the margins may be a little bit lower but the returns are significantly higher.

And that's, to me, we value capital. We want maximize the return we get on capital. And so, creating a nominal amount of margin for a significantly higher return is a good way of helping our shareholders, maximizing the value of the shares..

Thank you. Good luck..

Thanks..

Thank you. Our next question today is coming from Eric Bosshard from Cleveland Research. Please proceed with your question..

Thank you. Interested in Express from a competitive standpoint and also from a customer standpoint what you're observing evolving, as this product has continued to move forward..

Eric, this is Bill. Certainly, from a competitive standpoint, we've been very pleased with what we've seen with Express. We're offering a great value, an affordable value for buyers out there, and there's still very limited inventory and very limited supply of affordable product out there in the market.

So we're still seeing what we've been seeing as we've rolled it from market to market. We've been introducing Express into some of our western markets over the last couple of quarters and we're seeing very positive responses there as well.

We've commented in prior quarters about in markets like Florida where there are perhaps more retirees, we have seen more of – a larger mix of older buyers buying the Express Homes because they see the same value there. And so that's been a nice observation as well that I think will serve us well going forward.

That's just another element of demand for that product line..

In terms of the runway with this product, both from a competitive standpoint and your ability to source land where the economics work for this product, and then as well as a percentage of your total business, where are we and what's the runway from here look like moving forward?.

We expect to continue to expand that footprint, as David mentioned earlier. Today, we're in 51 markets and 17 states. It was 28% of our sales, it was also 28% of our closings and 20% of our revenues. If you recall when we first introduced this and got the question about when this is rolled out, what does that look like.

We've generally talked about, over time, about 60% of our revenues coming from our core D.R. Horton brands, 20% from Emerald, 20% from Express, which would infer probably closer to 30% in units on the Express side.

I think at this point, we would tell you that it looks like we will overshoot that during this cycle, because that's where the demand is right now, and we want to cater to that demand and what we believe it's still being underserved. So, we don't have any set targets on where it could go.

We'll continue to adjust our business based on what we see in the market to go capture as much market share as we can..

We're allocating capital based upon the highest returning projects. And right now, we have been pleasantly surprised with the demand for Express and have actually seen higher margins than we originally underwrote, and higher absorption levels than we originally underwrote. So, it is a great way to improve returns for the shareholders..

Great. Thank you..

Thank you. Our next question today is coming from Ken Zener from KeyBanc. Please proceed with your question..

Hello, gentlemen, Jessica..

Thanks, Ken..

Hi, Ken..

So, David, if you – I mean, we talked a long time ago about the housing market prices. Your Express Homes, obviously, it's differentiated. It's only 20% of revenue but it's obviously contributing to your volume. So, if you do that 28% of closings, 20% of revenue, you're at a house at about $210,000 in terms of price point.

So, what does it mean? I mean thanks for giving the FY 2017 guidance, many other builders wouldn't do that. What gives you the confidence? I know you have your visibility into 1Q based on your units under construction.

But what really gives you the confidence to be making these statements about the back half of 2017, A? And then, B, because it seems as though, as you get this growth, could we be seeing flat to down pricing on your average sales, realizing turns are offsetting that?.

On the pricing front, right now, we're anticipating it to stay essentially flat. But, yes, it could trend down with Express continuing to become a bigger mix. What we are seeing, though, is the markets we're rolling Express out in today are the higher priced markets, so it's not as much of an incremental drag on our ASP as the initial rollout was..

Right now, Ken, California is probably going to be, we think, a very successful Express market for us. We are early in the process rolling out there. It's – typical Express, only California's going to be over our average sales price right now..

And Ken, when we look at fiscal 2017 and our visibility and our confidence level, it's simply a reflection, number one, that we do see a good market. Right now, it's a good stable healthy market, some variability market to market certainly, but it's a relatively stable market. But what we see the most is our positioning.

Across our divisions, our division operators are doing a tremendous job of positioning communities, positioning lots in front of those communities and really executing well on our product offerings today.

And so as we begin to look forward the next several quarters, the next 18 months or so, we really do have good visibility and confidence level to be able to deliver consistently at a double-digit pace on the revenue line, continue to drive some additional SG&A leverage to improve our operating margin, and improve our returns.

And so we felt like it was appropriate to start to give some preliminary guidance to next year as we did last year at this time for fiscal 2016. And certainly, we've been pleased that we've essentially delivered on that preliminary guidance thus far this year..

Right, no, I think it's obviously nice to have that early communication. If I could go back to the gross margin still on these – on your guidance, A builder reported today modestly trimmed their guidance, another public builder talked about gross margin pressure.

So it seems as though the either construction cost or land inflation, given your roughly 20% gross margin, you feel that's defensible.

Is that because you're getting better pricing on perhaps on these Express than you are on the other pieces, or is it just that you bought the land at a lower targeted gross margin? I mean, what's – you can't comment on other builders but it seems as though you're not concerned about gross margin degradation next year..

We are always very focused on gross margin, Ken. But what we've seen is that we have taken some lot costs as a percentage of revenue, taken some of those increases and they would offset them with reduced incentives and controlling some cost increases on a stick and brick side.

When we get our community to the targeted absorption levels, at those points, we're able to bring incentives down or take pricing up and protect the margin. And overall on the balance, the team has done a great job of enhancing the margin on a consolidated basis this quarter.

And we feel good about with the range of the guidance we're giving on the margin that that's a defensible position for us going forward, as we continue to drive absorptions community-by-community.

Part of that's been Express and simplifying some of our operations behind the scene and that and delivering a house with fewer labor hours in it to get it built, and part of it's been some of the great land positioning we've been doing over the past few years..

Ken, we feel very good about next year. I mean what we're seeing in the markets, there's not a lot of lots being put on the ground that we're going to have to compete against. There is still pent-up demand at entry level and first move-up price points. It just feels good right now..

Thank you..

Thanks, Ken..

Thank you. Our next question today is coming from Bob Wetenhall from RBC Capital Markets. Please proceed with your question..

You guys are crushing it and I love the fact that you have that crystal ball somewhere in the office in Fort Worth into 2017. Wanted to ask you, when we're thinking about comments around 2017, it's kind of like flat ASP performance looking out.

How should we be thinking about the interplay between kind of like community absorption rates versus new community growth? Because I think to get to your kind of range of 10% to 15% against flat pricing, you can either deliver faster or you can open new communities.

What's the right way to think about that?.

Bob, we think in 2017 it will be a combination of driving further improvement in our absorption coupled with, at some point as we move throughout 2017, an increase in our community count.

Our community count on a year-over-year basis was down, which was not a surprise to us, and we would expect over the next couple of quarters, it to move up or down no more than a low to mid single-digit range.

But at some point, as we move throughout the year, we would expect an increase in that community count to help drive that 10% to 15% consolidated top line growth..

Got it..

And, Bob, we don't have a crystal ball, but Don Horton does tell us what it's going to be and we go do it..

That's quite helpful. And you guys are speaking a lot about California, and I was hoping you could kind of – you know, I always think that's a cash market, not a option market. And I was hoping – it sounds like the torch is kind of being passed from really good growth in the Southeast to a very optimistic view of West Coast markets.

Could you just give us some flavor of what you're seeing in terms of land buying opportunity and your expectations for growth in both Northern California, Southern California and the Phoenix market? Thanks a lot..

Bob, the growth we're looking at there is at a new price point that hasn't existed out there. And we feel very optimistic based upon the land that we've been able to put in front of that program. So do we feel more optimistic about California than the balance of the country? Absolutely not.

I think Texas continues to be strong and our Southeast area just continues to outperform..

And we're introducing Express in Phoenix and certainly expect it to do very well there and expect to see some growth out of Phoenix as well. But really, the key is the affordable product that we're offering..

It just runs at a much higher absorption. And developers typically when they see that, they feel more comfortable putting less on the ground force..

Just to understand, are you saying the price point for what you're bringing to the California markets, just going to be way below competing entry level and first-time homebuyer product in the market?.

I'm not saying way below. I'm saying that the value combination is going to be superior..

(32:19).

And we've been able to capture market share with that product offering..

It makes sense. Good luck..

Thank you..

Thank you..

Thank you. Our next question today is coming from Nishu Sood from Deutsche Bank. Please proceed with your question..

Thanks. And yeah, just following up on the double-digit and I appreciate the guidance there and, obviously, the confidence that that shows. So, so far in the Q&A, you've touched on, obviously, some low single-digit rate of community count growth.

ASPs, selling prices continuing this kind of flattish trend that they've had this year, putting the burden, if you will, on absorption. Then Jessica, you just mentioned that in the prior question. How should we think about that? Is that absorptions across the portfolio? So on a same-store D.R.

Horton brand basis, we would see strong absorption growth there? Or is this – with – there's obviously a lot of community rotation, is this Express subbing in for other brands as its percentage grows, and naturally those are at higher absorptions. So that would drive the absorption again.

How should we think about it and how you're thinking about it for next year?.

Nishu, there's several pieces of it. And I think you touched on a lot of them, some of the Express communities rotating in. Also just within the core D.R.

Horton communities, some of the communities that we're closing out may have been smaller communities and what's been opening are communities with larger lot positions in front of them that are going to be running at higher absorption paces that are coming on line, have been coming on line over the past few quarters and will be coming on line into the future.

So, that's where we're seeing our double-digit growth within the existing community count. And we do expect, as David mentioned, that we'd probably be growing average selling community count slightly into 2017. But the nature of the communities, each one producing a few more sales than the ones that they're replacing..

Got it. Got it. That's really helpful. And then also, consolidated pre-tax, I believe that you've kind of got it to high 10%s, 10.7% to 11.2%, I think you'd said last quarter, and I think has specifically led up this quarter. But when thinking about 2017 and, Jessica, I think you'd mentioned below 11%s for next year.

A lot of that, I imagine, is coming from continued SG&A leverage. I was wondering if you could just provide some general color around that. Or also, the financial services profitability is part of the mix there as well, that's been pretty strong, consistent. So, was just wondering if you could give us your thoughts on trends on both of those..

You're correct, Nishu, that we do expect the majority of our operating margin improvement next year to come from SG&A leverage again like it did this year.

And so, we've guided specifically to 11.2% to 11.5% and we would expect our gross margins to be right around 20%, and to drive that better bottom line by further stretching our overhead structure -leveraging our overhead structure.

SG&A – or in terms of the financial services business, they did see a step down in our margin this year, which we've been expecting. They've had outsized gross margins for the last year or two. They're still operating at a very good level. We guided to Q4 for that to be around 35%.

They follow the homebuilder business seasonally, so in fiscal 2017, we would expect them to have lower operating margins in the first six months of the year and then to pick up in the back half of the year like we saw in 2016. We'd expect a similar trend in 2017..

Great. Thanks. Appreciate the color..

Thank you. Our next question today is coming from Michael Rehaut from JPMorgan. Please proceed with your question..

Hi. Thanks. Good morning, everyone..

Good morning..

First question I had was on the East region, I believe you highlighted the impairment in the quarter was largely driven by a partial sale or expected land sale there. And I was curious if that was the same parcel that you took the impairment on in the second quarter.

And just more broadly regarding the East, I think when we marketed a couple, did our own D.R. a couple of months ago. Kind of talked to the East as an area of opportunity maybe doing a little bit better, gaining some share there. An area that maybe a relative to some of your other regions, there's still some share to be gained there.

So, any just thoughts specifically on the impairment and secondly, on the opportunity you see in the region over the next year or two?.

Michael, this is Mike. That is not the same project that we impaired. We sold that project that we impaired in the second quarter. That's no longer with us. This project is a different project. It had been an older project in land held for development.

We evaluated it, determined the best course of action for us was to pull the capital out of it and move forward, redeploy that capital. And we do see opportunity for growth and improving our position in our East market. But that's not going to happen overnight. We're working hard on it every day.

We've had some changes in the teams up there and very excited about the direction they're taking us and the opportunities they're putting in front of us.

But as with everything, nothing ever happens fast enough or quick enough for us, but we're working very hard to get more lots on the ground in front of us and get those communities open and drive more growth out of those..

Our public East region, Mike, just for clarification, includes our Northeast markets, which are the ones Mike was referring to, our Capital division and our New Jersey division. But the East publicly reported region also does include the Carolinas, which those are firing on all cylinders and very strong markets for us today..

Right..

Great. I appreciate that clarification. I guess a second question on the gross margin. Obviously, you're very clear in your guidance, but you did have a nice – a little better than expected result this quarter, and you highlighted a couple of the drivers. I was wondering if there was some particular elements of mix that also helped this quarter.

And I guess looking forward, do you still expect the gross margin to be in and around 20%? I was curious on that. You talked about Express coming in a little better than expected and, obviously, as you do more Express and more Emerald, I'd expect the efficiencies and experience to maybe result in a little bit better amount of profitability.

So, again, sorry for the two-parter, for my second question again, but mix on the quarter and then some of those improved operational efficiencies or experience benefiting the margin into next year..

Thanks, Mike. This is Bill. Nothing unusual on the margin this quarter other than just continued focus on execution and controlling our costs. We've been absorbing labor cost increases, some materials cost increases over time, and we've been working to offset those and we're making some progress there.

We're getting some traction on that, while we're still absorbing increasing land costs that are coming in. So we've done, I think, an improving job on controlling those costs and continuing to push price and then reduce incentives wherever we can.

So, we did see a nice little pickup this quarter, nothing unusual in that number, and it's really just in that normal range of around 20%, we would expect to see. A move of 30 basis points or 40 basis points is not really unusual in and around 20%.

But certainly pleased to post a quarter at a little bit above 20% and hopefully, we can – we're always focused on doing everything we can to maintain and improve on that while driving better returns..

And just thoughts around some of the better efficiencies as you gain experience in Express and Emerald, could that be ultimately showing up as a potential positive lift or is it just another element that allows you to combat, let's say, rising land costs and labor costs?.

Certainly, part of our strategy is to get better every day at what we do. The margins that we see across the three brands are actually pretty closely clustered together around the company average. And we do expect to get better in every community every day at what we do, and we have seen that. We have seen our margins moving up.

And we're held to a pretty high standard to expect to continue to see those margins, making progress on them every day..

And in a market, Mike, that does continue to improve and grow, there will be cost increases that come along the way, and these additional efficiencies that we are able to glean out of the business do help offset those other cost increases..

Great. Thanks very much..

Thank you. Our next question today is coming from the line of Jack Micenko from SIG. Please proceed with your question..

Hi. Good morning, everyone..

Good morning..

I wanted to understand the message on backlog conversion a little bit better. So 81% to 84% for the fourth quarter. You did the midpoint of the range this quarter.

If I go 84%, I get to the midpoint of the range, which I guess should mean if you had a sort of similar result this quarter than last, you'd be in the sort of – albeit, admittedly, it's a narrow range for the year on deliveries, but you'd be at the bottom half.

Is that the message, or is it conservatism on the guidance range? How do we think about that? And then on a broader base, is an 8 handle on the backlog conversion, I mean is that the new Horton norm, given the product mix is at – that number's sort of stepped up the last couple years?.

Jack, there's a lot of fluctuation in our backlog conversion rate, and there's a lot of things that impact that each quarter. But if you look at the last four years to five years on average, our Q3 to Q4 change in our backlog conversion has typically been about flat.

So, we are saying that it's going to go up a little bit to that 81% to 84% compared to what we did this quarter. I would not tell you there is a bunch of conservatism baked into that.

As you saw this quarter, we delivered at the midpoint of our range and in some of the headlines out there it's being called a miss, even though we are right in the dead center of the guidance we've provided. So, no conservatism on next quarter. We feel good about delivering 81% to 84%.

And it's a little bit better and we're focused every day on delivering the best we can. And we would like to continue to see a backlog conversion right in the 80% range, but there'll be some quarters that are in the 70%s..

From an operational efficiency and getting better, that's something we look at and strive to improve because that helps with the SG&A leverage, it helps with the inventory turn. Conversion rate is a great metric to determine whether you're actually getting better or not. So, we're not going to guide.

Optimistically, it's a consistent market, we've got a consistent solid performance and expect to continue that..

Okay. Thank you. And then, your FHA mix from the mortgage company was up a bit year-over-year. The rhetoric from some of the larger banks seems to suggest that they're moving away from that product somewhat with some of the inherent sort of legacy legal risks or tail risk to that program.

Are you seeing any shift from FHA to private mortgage insurance in your borrower base more granularly, or is it still pretty stable?.

I'd say it's pretty stable. The difference for us is with Express becoming a bigger piece of our mix, their percentage usage for those buyers of FHA loans is higher than our company average. It's closer to the mid-40%s. So, that's really the function there..

Okay. All right. Thank you..

Thanks. So our next question today is coming from Susan Maklari from UBS. Please proceed with your question..

Good morning..

Good morning..

You've mentioned the fact that you are seeing some more older buyers coming in to your Express communities, and as we think about the evolution of Express and maybe some of the demographic trends that we expect to come through, is that something that we could see sort of further come along and perhaps maybe even evolve from a marketing or branding perspective down the line?.

Yes. We are certainly focused on all the buyers that are responding to Express. And we're seeing great acceptance of Express in Florida, as Jessica mentioned before, with some of the retiree buyers and we're going to look to meet those buyers' needs and understand exactly what it is they want, and put a house on the ground for them at a great value.

People that are retiring on a fixed income are looking for value in a high quality, well-built home. That's exactly in the wheelhouse of what we do. And so I think you can expect to see that we're going to try to take advantage of every opportunity in front of us including that buyer demographic..

Okay.

And then as we think about some of the labor issues that remain out there and the experience that builders in general are facing, do we expect any change outside of the normal seasonality in terms of your spec pace or your start pace as we go through in the next few quarters?.

We're looking at our starts pace to just kind of continue as we go seasonally to build some inventory for the spring and to be prepared for the spring selling season next year. Hopefully, it's good or better as the one we just came out of. And we're seeing – certainly, labor is always a challenging component.

Our market positioning, the scale we have in so many of our markets gives us a great advantage on the labor availability front. And we watch very closely our build times and our cycle times, and we're not seeing an elongation of that. So we feel like our team is doing a great job of managing their trade base..

The absorption per community is a great deal to expand our option lot program, but it is also a great deal to secure and keep the labor force because they come in, they start, and we build through the communities instead of start, stop, start, stop, and they're always out chasing new job sites so there's a lot of benefits to what we're doing.

That's one of them..

Okay. Great. Thank you..

Thank you. Our next question today is coming from John Lovallo from Merrill Lynch. Please proceed with your question..

Hey, guys. Thanks for taking the call. First question is on Southeast conversions that have been a little bit light year-over-year in the first three quarters.

Was there anything in 2015 that made those exceptionally – the conversion exceptionally strong or is there something going on this year?.

I wouldn't say there's anything unusual, John. They did certainly see very strong absorptions last year. That's moderated a little bit this year, but we're still seeing very strong growth and expect very strong growth going forward in the Southeast. They're delivering right in line with our expectations..

Okay. Moving on. Valuations across the group have risen in the past couple of weeks in particular.

In your conversations with the private builders, are you hearing a general expectation for higher prices on the private side as well on the M&A front?.

We always probably have a bit of a valuation gap at the initial conversations. It takes time and that's why our bar's pretty high and we're very selective in what we're doing, and we're going to look to make the right acquisitions where it makes sense for us and the numbers work. We're not going to push. Fortunately, we're in a position.

Teams have done a great job in lots and product positioning that we don't feel the need we have to push and drive on making a deal work that otherwise might not. But we haven't seen any specific rise in the past couple weeks. I mean that private builder market's not quite as liquid as the public side..

Great.

And one last one, if I may, the 11.2% to 11.5% on margin for 2017, is that a homebuilding margin or consolidated pre-tax?.

That's consolidated pre-tax..

Great. Thank you..

Thank you. Our next question today is coming from Mike Dahl from Credit Suisse. Please proceed with your question..

Hi. Thanks. Wanted to ask first about longer-term thoughts on SG&A. So it sounds like, based on the preliminary guide for fiscal 2017, dipped below 9%, which historically at kind of in the low watermark. And so, clearly, success at driving absorptions and some of the efficiencies have done wonders for that.

If you think about other structural ways to reduce SG&A beyond those levels, we've heard some other builders talk about a couple different things.

Just curious to get your thoughts on if there's anything else you're exploring outside of just continuing to drive absorptions?.

The main driver, Mike, is absorption, so community-by-community, that's really where our expense structure resides. And as we continue to work to improve our absorptions, then we're able to drive better leverage on our SG&A structure both in the community and then all throughout our organization.

And each year, we look at what our expectations are to improve on the top line and then we assess how much we can leverage SG&A. But as we expect to grow top line double digit, we should expect to leverage SG&A further as well. And so, yes, that does imply we will get down below 9%, and there's not a magic floor there.

Each year, if we expect to grow, we would expect to continue to push more SG&A leverage. Certainly, some of the other things that have been talked about among other builders, we're doing a lot of those things as well. We're certainly taking advantage of technology wherever we can.

We're looking to drive ways to be more efficient in all areas of our business. But there's not one magic bullet. We're looking to do – get more efficient on every line of our financials. And certainly, those things are part of it as well..

Okay. Thanks. And then second question, just going back to some of the Express discussion. And so certainly appreciate that kind of first-mover advantage has been pretty powerful in terms of even out through next year. You don't have a lot of competition as far as things that are coming to market.

What about if we look at the land deals that you're looking at today, that would be 2018 or 2019? Obviously, people have taken notice of your success at the Express part of the market.

So, are you showing up and seeing significantly more competition for those types of deals as you look out the next couple of years?.

Mike, we have competition in every factor of everything we do. I believe, ultimately, it comes down to execution. And right now, our people are out there executing. We are the group that – or the builder that I think makes the most sense to align with. And so we're finding the land deals we need to support the growth that we're seeking.

So, do I think it's going to become more competitive? Maybe, but it's pretty competitive out there right now. We just got great people doing a great job..

Okay. Thank you..

Thank you. Our next question today is coming from Alex Barrón from Housing Research Center. Please proceed with your question..

Thank you and good morning and great job, guys..

Thanks, Alex..

I was hoping maybe – I don't know if I missed this, Jessica, if you mentioned the stats for Emerald Homes, like the ones you mentioned for Express on closings, orders, revenues..

Sure. That will be in our supplementary data that we'll post at the end of the call. What we did say during our scripted comments were our homes priced greater than $500,000, were 7% of our homes closed and 16% of our home sales revenue. If you will get homes just marketed as Emerald, it's stayed constant at about 4% of our homes closed.

But if you look at that in terms of units on a trailing12-month basis year-over-year, Emerald has actually grown by over 50% for us..

Okay.

And the orders for that same group?.

The orders for Emerald were right at 4% as well..

Got it.

And then, I guess, as far as your outlook for what you guys are calling affordable homes or Express, I'm kind of curious to see what your outlook is going forward in terms of community count growth in terms of just – do you feel that that's where the biggest opportunity is at? And I guess, the second follow-up question, where do you guys generically think we are in the cycle at this point?.

I don't know where we are in the cycle. I can tell you it feels very good right now. And you look at the number of people and the country, you look at the housing formation, you look at job growth, all of those things are positive. So, we feel very good. And as far as – you had asked about the Emerald brand, I can tell you that....

The Express was the one where I was interested in, what your outlook is for that going forward..

Yeah.

But the first – your first question was Emerald, right?.

Yes. Yes. Yes..

Okay. Well, as far as confidence for us, when we see that brand starting to accelerate along with how we're executing on the entry level, I mean, that to me is a pretty positive sign of what 2017 could be..

Got it..

And I forgot – I wanted to answer my question. So, I forgot yours. So go ahead and just go ahead and ask your question again..

Yes. I guess, my question as it pertains to affordable homes and entry level, I feel like the entry level market has kind of been missing in action for the last few years, and you guys are one of the first to I guess kind of put your toe on the water a few years ago through the Express brand. And you've been growing it.

I'm just kind of curious if you guys feel as bullish or more bullish today than you did three years ago about that segment..

We're in 51 markets. We've got another 20-plus markets we can push into. We feel very good about the Express program.

And in the markets that we have been open and operating, are we going to continue to see the kind of growth we've had? No, probably not, because there's – but the demand is – still even after three years, the demand is incredibly strong. So, it just feels good right now..

Well, great. Good job..

Thank you..

Thank you. Our next question today is coming from Jade Rahmani from KBW. Please proceed with your question..

Thank you very much. Just wanted to ask about M&A and if you could share your thoughts on a potential for a larger-sized transaction than recent deals. We noticed your leverage levels are extremely low, which created some optionality.

And regarding leverage, is that based on conservatism on the cycle or a change in longer-term view about optimal leverage, or is to create this optionality around M&A?.

Well, I think it's to create optionality around a lot of things, investing in the business, reducing debt. Having a lot of flexibility in the business is good, with specific regards to M&A.

We continue to look at a lot of potential transactions, and we pursue those that make the most sense for us, whether they're larger or smaller, it's – we're kind of neutral to the size of the transaction. If it make sense at a small transaction, good team, good people, good positioning, we'll be interested.

If it's a larger transaction that fits well with us and there's alignment in what makes sense with the other side, we would look at that as well. We're not shutting either off at any point in time..

Thanks very much.

And just on your guidance, in terms of the underlying economic expectations, are you assuming sort of a low to mid-single-digit growth rate in existing and new home sales?.

We're assuming kind of more of the same in 2017 as what we saw in 2016. So when we say our expectations are based on today's housing market conditions, really just more of the same..

Thanks very much..

Thank you. Our next question today is coming from Will Randow from Citigroup. Please proceed with your question..

Hey. Good morning and thanks for taking my question. I know that you guys don't want to comment on necessarily where you think we are in the cycle, which is definitely fair. But how do you believe you're positioning D.R.

Horton within the cycle given generating free cash for this year and the prior year? And also, how does that influence your view on potential incremental M&A or returning share or cash to shareholders, if you will?.

Will, I think we're working to stay on a very balanced, flexible position. We're putting ourselves in position to continue to grow while we continue to see the good, stable healthy market conditions we see today.

But as we're utilizing our cash to further strengthen our balance sheet, that's giving us even more flexibility to be opportunistic when we see opportunities to invest and whatever form that may be.

And then, certainly, if things were not to continue as strong, we're in a very strong position there as well, whether – and so really great position to take advantage of M&A opportunities, to invest further on our business. Really, we're in a very good flexible position at the moment..

And just one follow-up that's unrelated, in terms of demand pacing through the quarter, did you see any influence from a relatively hot June, inclement weather and a seasonally – a relatively warm spring, if you will?.

On the sales demand side, no, not necessarily. Certainly, on the construction side, when you have a dry weather, there's no disruptions there. So, from that standpoint, that's always positive. But the summer is always hot..

Thanks, guys. Great quarter..

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments..

Thanks, Kevin. We appreciate everyone's time on the call today and look forward to speaking with you again in November to share our year-end results. And to the D.R. Horton team, great quarter, great year-to-date performance. Let's go finish this year and get started on 2017. Thank you..

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