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D.R. Horton (NYSE:DHI)
Q3 2019 Earnings Call
Jul 30, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings, and welcome to the third-quarter 2019 earnings conference call for D.R. Horton, America's builder, the largest builder in the United States. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jessica Hansen, vice president, investor relations for D.R.

Horton. Please go ahead.

Jessica Hansen -- Vice President, Investor Relations

Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the third quarter of fiscal 2019. 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 most recent quarter 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 this week. After this call, we will post an investor presentation and supplementary data to our Investor Relations site on the Presentation section under News & Events for your reference.

The supplementary data relates to our homebuilding return on inventory, homes sales gross margin, changes in active selling communities, our product mix and mortgage operations. Now I will turn the call over to David Auld, our president and CEO.

David Auld -- President and Chief Executive Officer

Thank you, Jessica, and good morning. In addition to Jessica, I am 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 of 2019.

Our consolidated revenues increased 11% to $4.9 billion. Pretax income was $627 million, and our pre-tax profit margin was 12.8%. The spring selling season was solid, and our homebuilding gross margins improved sequentially. These results reflect the strength of our operational teams, our ability to leverage D.R.

Horton's scale across broad geographic footprint and our product positioning to offer affordable homes across multiple brands. As we have discussed on our last few calls, affordability concerns caused some moderation of demand for homes in late fiscal 2018 and early fiscal 2019. And in response, we increased sales incentives to improve our sales pace. Interest rates on mortgage loans has since decreased, and we reduced the level of incentives offered as the spring progressed.

We continue to see good demand and a limit to supply homes at affordable prices across our markets. At the same time, economic fundamentals and financing availability remains solid. We are pleased with our product positioning and our sales volumes of the June quarter and in July, which were in line with our expectations and normal seasonality. Our strategic focus is to continue consolidating market share while growing our revenues and profits, generating strong annual cash flows and returns and maintaining a flexible financial position.

With a conservative balance sheet that includes an ample supply of homes, lots and land to support growth, we are well positioned for the remainder of 2019 and future years. Mike?

Mike Murray -- Executive Vice President and Chief Operating Officer

Net income attributable to D.R. Horton for the third quarter of fiscal 2019 increased 5% to $475 million, compared to $454 million in the prior-year quarter, and net income per diluted share increased 7% to $1.26. Our consolidated pre-tax income for the quarter increased to $627 million, and our homebuilding pre-tax income was $562 million. Our third-quarter home sales revenues increased 11% to $4.7 billion on 15,971 homes closed, up from $4.3 billion on 14,114 homes closed in the prior year.

Our average closing price for the quarter was down 2% from last year to $296,400 while the average size of our homes closed was down 3%, reflecting our ongoing efforts to keep our homes affordable. Bill?

Bill Wheat -- Executive Vice President and Chief Financial Officer

Net sales orders in the third quarter increased 6% to 15,588 homes, and the value of those orders was $4.7 billion, up 8% from $4.4 billion in the prior year. Our average number of active selling communities increased 9% from the prior year and 1% sequentially. Excluding the builders we acquired earlier this year, both our third-quarter net sales orders and our average number of active selling communities increased 3% year over year. Our average sales price on net sales orders in the third quarter was $302,000, up 1% from the prior year.

The cancellation rate for the third quarter was 20%, compared to 21% in the same quarter last year. Jessica?

Jessica Hansen -- Vice President, Investor Relations

Our gross profit margin on home sales revenue in the third quarter was 20.3%, up 100 basis points sequentially from the March quarter. The sequential increase in our gross margin from the March to June quarter exceeded our expectations and was primarily due to lower incentives and lumber costs. Based on today's market conditions, we currently expect our home sales gross margin in the fourth quarter to increase sequentially from the third quarter, subject to possible fluctuations due to product and geographic mix as well as the relative impact of warranty, litigation and purchase accounting. Bill?

Bill Wheat -- Executive Vice President and Chief Financial Officer

In the third quarter, homebuilding SG&A expense as a percentage of revenues was 8.1%, flat with the prior-year quarter. Year-to-date homebuilding SG&A expense was 8.8% of revenues, compared to 8.7% last year. We remain focused on managing our SG&A efficiently while ensuring that our infrastructure adequately supports opportunities to increase our market share over the long term. Mike?

Mike Murray -- Executive Vice President and Chief Operating Officer

We ended the quarter with 29,200 homes in inventory. 14,800 of our homes were unsold with 9,200 in various stages of construction and 5,600 completed. Our current inventory of homes puts us in a great position to finish the year strong. Our homebuilding investments and lots, land and development during the third quarter totaled $875 million, of which $470 million was for land and finished lots and $405 million was for land development.

Our underwriting criteria and operational expectations for new communities remain consistent at a minimum 20% annual pre-tax return on inventory and a return of our initial cash investment within 24 months. David?

David Auld -- President and Chief Executive Officer

At June 30, our homebuilding lot position consisted of 300,000 lots, of which 39% were owned and 61% were controlled. 29% of our total owned lots are finished, and 55% of our controlled lots are or will be finished when we purchase them. We continue working to increase our lot position being developed by third parties by supporting the expansion of Forestar's national lot manufacturing platform and expanding our relationships with lot developers across the country. Our current lot portfolio includes an ample supply of lots for homes at affordable price points and continues to provide a strong competitive advantage.

Jessica?

Jessica Hansen -- Vice President, Investor Relations

Financial services pre-tax income in the third quarter increased to $48.1 million from $30.3 million in the prior year. Financial services pre-tax profit margin for the quarter was 40.2%, up from 31.2% in the prior year, due to improved loan sale execution. 98% 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 58% of D.R. Horton homebuyers.

FHA and VA loans accounted for 45% of the mortgage company's volume. Borrowers' originating loans with DHI mortgage this quarter had an average FICO score of 720 and an average loan-to-value ratio of 88%. First-time homebuyers represented 51% of the closings handled by our mortgage company, up from 48% in the prior year, reflecting our continued focus on offering affordable homes for entry-level buyers. Mike?

Mike Murray -- Executive Vice President and Chief Operating Officer

Forestar, our majority-owned subsidiary, is a publicly traded residential lot manufacturer now operating in 50 markets across 20 states. At June 30th, Forestar owned and controlled approximately 37,400 lots, of which 24,100 are under contract with D.R. Horton or subject to a right of first offer. During the 9 months ended June 30th, Forestar delivered 2,224 lots and is on track to deliver 4,000 lots in fiscal 2019, generating $320 million to $350 million of revenue and deliver approximately 10,000 lots in fiscal 2020, generating $700 million to $800 million of revenue.

These expectations are for Forestar stand-alone results. Forestar's making steady progress in building its operational platform and capital structure to support its significant growth plans. During the quarter, Forestar issued $350 million of senior notes. Forestar's liquidity, capital base and lot position at June 30th are sufficient to support their planned deliveries through fiscal 2021.

Subject to market conditions, Forestar expects to opportunistically access the equity and debt capital markets to provide additional long-term growth capital while managing to a net leverage ratio of 40% or less. Forestar hosted their quarterly earnings call last Thursday and has an updated presentation on their investor site at investor.forestar.com that describes Forestar's unique lot manufacturing model and its significant growth and value creation opportunity. David?

DHI Communities is our multifamily rental company focused on suburban, garden-style apartments with current operations primarily in Texas, Arizona and Florida. During the quarter, DHI Communities sold its second apartment project located in Houston for $60 million and recognized a gain on sale of $22,600,000. DHI Communities has five projects under active construction, one project that was substantially complete at the end of the quarter, which we currently expect to be sold in early fiscal 2020. DHI Communities' total assets were $167 million at June 30th.

Bill?

Bill Wheat -- Executive Vice President and Chief Financial Officer

Our balanced capital approach focuses on being flexible, opportunistic and disciplined. Our balance sheet strength and multiyear earnings and cash flow generation have increased our flexibility, and we are utilizing our strong position to enhance the long-term value of the company. During the first 9 months of fiscal 2019, our cash provided by homebuilding operations was $605.7 million. At June 30th, we had $1.6 million of homebuilding liquidity, including $578 million of unrestricted homebuilding cash and $1 billion of available capacity on our revolving credit facility.

Our homebuilding leverage ratio improved to 370 basis points from a year ago to 18.5%. The balance of our homebuilding public notes outstanding at the end of the quarter was $1.9 billion, and we have $500 million of senior note maturities due in the next 12 months. At June 30th, our stockholders' equity was $9.6 billion, and book value per share was $26.08, up 14% from a year ago. During the quarter, we paid cash dividends of $56 million.

We also repurchased 3.7 million shares of common stock for $159.3 million, utilizing the remainder of our outstanding authorization. Our stock repurchases for the first nine months of the year totaled 9.8 million shares for $375.5 million, resulting in a 2% decline in our outstanding share count at the end of the quarter compared to a year ago. Subsequent to quarter end, our board issued a new authorization to repurchase up to $1 billion of our common stock with no expiration date. Our top priorities free cash flow utilization remain to consolidate market share by investing in our homebuilding business and strategic acquisitions, reduce homebuilding leverage and return capital to our shareholders through dividends and share repurchases.

Jessica?

Jessica Hansen -- Vice President, Investor Relations

Looking forward to the fourth quarter of fiscal 2019, we expect to generate consolidated revenues in a range of $4.75 billion to $4.9 billion and to close approximately 15,700 to 16,000 homes. We expect our home sales gross margin in the fourth quarter to be in the range of 20.4% to 20.7% and homebuilding SG&A in the fourth quarter to be approximately 8.1% to 8.3% of homebuilding revenues. We anticipate the financial services pre-tax profit margin in the fourth quarter in the range of 31% to 34%, and we expect our income tax rate to be approximately 24.5%. For the full fiscal year of 2019, we still expect to generate cash flow from homebuilding operations of at least $1 billion, and we expect our outstanding share count to be down approximately 2% at the end of the year compared to the end of fiscal 2018.

Based on today's market conditions, our expected growth for fiscal 2020 is currently in the mid- to high single-digit percentage range for both consolidated revenues and homes closed. We expect to give further fiscal 2020 guidance on our November earnings call. David?

David Auld -- President and Chief Executive Officer

In closing, our results reflect the strength of our long-tendered, well-established operating platform across the country. We're striving to be the leading builder in each of our markets and to expand our industry-leading market share. We have been the largest builder by volume in the United States for 17 consecutive years. According to Builder Magazine's recent Local Leaders issue, in 2018, we were the No.

1 builder in all of the top five U.S. housing markets, and D.R. Horton was a top five builder in 31 of the top 50 housing markets. We are focused on consolidating market share while growing our revenues and profits and generating strong annual cash flows and returns while maintaining a flexible financial position.

We are well positioned to do so with our conservative balance sheet, broad geographic footprint, affordable product offerings across multiple brands, attractive finished lot and land positioned and, most importantly, our outstanding experienced team across the country. Thank you to the entire D.R. Horton team for your focus and hard work. We are incredibly well positioned to continue growing and improving our operations.

This concludes our prepared remarks. We will now host questions. Thank you.

Questions & Answers:


Operator

Thank you. We'll now be conducting a question-and-answer session. [Operator instructions] Our first question today is coming from Carl Reichardt from BTIG. Your line is now live.

Carl Reichardt -- BTIG -- Analyst

Good morning, everybody. I wanted to talk a little bit just, first of all, on the South Central and the Southwest regiones, where we're off a little bit. Can you just talk, maybe Mike or David, about community count versus absorption rates there? I think Southwest is short in communities now, and the plan's to kind of to regrow those regions?

Mike Murray -- Executive Vice President and Chief Operating Officer

Yes. What we're seeing in the Southwest is that we are short in communities relative to where we were. And frankly, that's a function of our success we've had in those markets. We've sold communities at faster paces than anticipated and that replacement communities are not yet online, and we will be looking to replace those communities, replace those flags.

South Central, frankly, is going up against a very tough sales comp last year. I think they were up over 20% in this quarter. And while their community count's going to be about flat, absorptions did not grow as much. But we're, frankly, pretty satisfied with the absorptions we have there this year based on what we saw in the late fall and early winter, and then seeing the margin expansion that we've been able to achieve with a little stronger selling season.

Jessica Hansen -- Vice President, Investor Relations

And the specifics will be in our supplemental presentation, as they always are, Carl. But just for reference, our Southwest active selling communities were down 13% year over year, right in line with the sales orders. So very strong absorption still out of that market.

Carl Reichardt -- BTIG -- Analyst

Great. And then just as a follow-up, and we've talked a lot about local market share and the advantages that can bring. And we've seen some peers of yours move to lower price points, and they're delivering greater order growth than you, but at margins that are well below. Can you talk a little bit about, as the rubber meets the road here in what has been a soft-ish market, can you talk about how you've been leveraging market share to protect those margins, grow those margins and keep your absorptions reasonably strong? Thanks, guys.

David Auld -- President and Chief Executive Officer

Carl, this is David. We've been in this affordability push for the last five years. We have incredibly well-positioned communities, very deep, and lot supply. And it's not something that is going to continue to outgrow the overall percentage of what we grow.

It has driven growth for the last three or four years. It's fully rolled out. And from a competitive standpoint, yes, there are people pushing down in price. They're having to give away more margin than we are, but those are not as well positioned or as deeply positioned as we are.

So we feel very good about what we've done and where we've been, and I feel very good about the pace and margin balance that we're now executing, so.

Carl Reichardt -- BTIG -- Analyst

Thanks, David. I appreciate it.

Operator

Thank you. Our next question is coming from John Lovallo from Bank of America. Your line is now live.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Hey, guys. Thank you for taking my questions. The first one is on the $1 billion share repurchase authorization. That seems like a little bit of a pivot for you guys when we think it's pretty positive, but maybe if you could just give us a little help on what drove the decision.

And then in terms of expected cadence of repose, I mean, will you expect to be kind of consistent buyers each quarter? More opportunistically, how should we think about that?

Bill Wheat -- Executive Vice President and Chief Financial Officer

Thanks, John. This is Bill. This is the next step for us. We've begun being a more consistent repurchaser of our shares over the last couple of years.

And generally, the pace of our repurchases have been increasing over the quarters with an opportunistic fluctuations when we see a pullback in the stock, but we're repurchasing shares out of our cash flow. And as our cash flows increased, we've increased our repurchases. So we see this authorization as kind of the next step in that process. We do expect to continue to be a consistent repurchaser, but we will see some fluctuations quarter to quarter depending on where we see the opportunities.

The authorization has no expiration date, so it doesn't necessarily imply a specific cadence or a specific time frame they would all be spent. But we feel like that was the appropriate amount to authorize, to put out in front of us and signal to the market that we're going to continue to be a consistent repurchaser.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Yes, that makes a lot of sense. OK. And then in terms of July kind of being in line with normal seasonality, and's then that coupled with the 2020 outlook that you guys put out there, it seems like the market is doing reasonably well here. I mean, one of the pushback that we get from some folks is that lower interest rates have kind of resulted in some pull-forward orders over the past couple of quarters.

That doesn't seem to be the case, but I just wanted to get your view on that.

David Auld -- President and Chief Executive Officer

That's not my belief. I can tell you I think that there is tremendous opportunities, tremendous demand in the affordable market, households. We have foreman jobs being created, and there's just unlimited amount of supply even today. So I think the demand is there if you can position and drive a price that they can buy.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

OK. Thank you, guys.

Operator

Thanks. Our next question is coming from Alan Ratner from Zelman & Associates. Your line is now live.

Alan Ratner -- Zelman and Associates -- Analyst

Hey, guys. Good morning. Thanks for taking my question. Nice job with the margin improvement.

I think we were actually surprised that you were able to drive that level of improvement. And at the same time, it looks like you had a lot of success selling specs in the quarter. I think that this is the first time in quite a while where your homes and inventory is actually down slightly year over year. So just curious if you could talk a little bit about did you see -- was that a concerted effort to drive that spec count lower during the quarter or was that just a function of where the demand was? And I guess more broadly with your inventory position down slightly, is that by design or are there some headwinds that might be flowing a bit, the construction cycle, labor, weather, etc.? Just talk through all that would be great.

Thank you.

Mike Murray -- Executive Vice President and Chief Operating Officer

Sure. Thank you, Alan. This is Mike. What I would touch on a bit, seasonally, we would expect to see our homes inventory build in the earlier quarters and then start to kind of run down as we satisfy some of that spring selling demand.

I think this quarter, we had 38% of the homes we closed this quarter, were sold in the quarter as well. And so a lot of that reflected, with the enhanced margins, our reduced incentives and seeing a buyer return to the market and a little bit of a tailwind on some material costs, most notably lumber. We have inventory position where we like it right now. Going to our fourth quarter, we have more inventory right now than we had this time last year, and we expect to be well positioned at September 30th to start fiscal '20 as well.

We're not seeing any real elongated build times. I mean, we're continuing to do what we do.

Alan Ratner -- Zelman and Associates -- Analyst

Got you. No, that's helpful. And then just on the pricing environment, you mentioned pulling back on incentives, can you talk a little bit about the percentage of communities where you raised net prices either through lower incentives or outright base price increases? I think your order price actually ticked higher year over year, which was the first time in quite a while, but I know there's a lot of mix involved there. So are you see pricing power? What percentage are your committees or which markets are you seeing it in and to what magnitude? Thank you.

Jessica Hansen -- Vice President, Investor Relations

Generally, most of the improvement in our gross margin was driven purely by lower incentives and not from pricing power. I would say today versus at any point really last year in fiscal 2018, we still have less pricing power today than we did a year ago, but the pullback in rates has helped. So it's a little bit better sequentially in that regard, but the main driver to our gross margin in Q3 and also what we're expecting in terms of improvement in Q4 is more from the pullback on incentives and that continued rollback than it is pure pricing power.

Alan Ratner -- Zelman and Associates -- Analyst

Do you have those numbers handy, Jessica? Just a percentage of ASP that are incentives today versus a year ago, a quarter ago just so we could kind of see?

Jessica Hansen -- Vice President, Investor Relations

So we don't typically quantify incentives because, to us, whether it's price or if it's something flowing through cost of sales, it all falls out in the margin. So to us, margin's the best grade, and we don't typically try to quantify incentives that way.

Operator

And our next question is coming from Eric Bosshard from Cleveland Research Company. Your line is now live.

Eric Bosshard -- Cleveland Research Company -- Analyst

To follow up, just to make sure we understand the path forward with incentives and pricing, is talk about your comfort of what you're doing in both those areas now, if the progress that you saw in this quarter is the new normal or if you feel like there's further opportunity in the area of incentives and price.

Mike Murray -- Executive Vice President and Chief Operating Officer

I think, Eric, it's something we continually measure and manage community-by-community, and our operators in the field are making those pricing decisions to meet the market that they see in front of them. So I would expect that we would, as Jessica mentioned in the gross margin guidance, continue to see a little bit improved margin into our fourth quarter based on the selling environment we're in today and the strength of the buyer that's coming to our doors. We feel really good about that. I think we're going to see some further expansion in margin and as well as maintaining the pace that we're at.

Eric Bosshard -- Cleveland Research Company -- Analyst

And then secondly, the guidance looks like now your full-year deliveries will be at the high end of the range you established earlier. What's different with demand? Is that a better market or better market share? How would you sort of segment between those two factors that are contributing to you getting to the high end of the range?

Mike Murray -- Executive Vice President and Chief Operating Officer

I think it's just a bit better visibility as we've gotten through the spring, and we've been able to see our pace continue at a solid pace. We have a greater confidence level in our ability to sell and sell through the homes that we have and deliver on during this fiscal year. Just the sequential improvement visibility, I think, was the primary factor. It's a very solid market, as evidenced by our ability to pull back incentives throughout the quarter.

And I think we're still seeing a very solid market out here as we go into our Q4.

Operator

Thank you. Our next question is coming from Truman Patterson from Wells Fargo. Your line is now open.

Truman Patterson -- Wells Fargo Securities -- Analyst

Good morning, everybody. First, I wanted to look at your option lot count. As a percent of total lots, it ticked down a little bit sequentially. I figured you guys would have continued increasing this given Forestar, etc.

Could you guys just discuss a little bit about what drove this and then lay an environment in general? Are you seeing the availability of option land or developers improving?

Bill Wheat -- Executive Vice President and Chief Financial Officer

In terms of the change and the option percentage stream, I think that number is very dynamic. It moves every time we sign a contract or take down lots or cancel a contract. And so there's a lot of volatility in that. Directionally, the general trend we've had over the past few quarters and past few years, frankly, as we've been working on this has been to push it higher, and we're continuing to work at that.

We're working with developers, both Forestar and other third-party developers, constantly, looking for ways to expand that controlled lot position and partner with them to deliver communities and lots to us. Availability, it's still a tough job to find the right land and to get it entitled in today's market and bring it into production. It is something our team across the country works very hard at every day.

Truman Patterson -- Wells Fargo Securities -- Analyst

OK, thanks for that. And then you guys gave us a little bit on 2020 guidance, I believe mid- to high single digit revenue growth. Could you just maybe break that out, how you're thinking about market conditions, and with that you all's community account growth possibly versus absorption improvement?

Jessica Hansen -- Vice President, Investor Relations

Sure, Truman. That's our preliminary fiscal 2020 guidance. And so, today, it's only July. We're going to sit with just consolidated revenue growth and homes closed in the mid- to high single digit percentage range, and we'll give further breakdown and color in November when we've completed our fiscal year-end.

Mike Murray -- Executive Vice President and Chief Operating Officer

Obviously, the only perspective we can give on that is based on today's market conditions.

Jessica Hansen -- Vice President, Investor Relations

Yes.

Mike Murray -- Executive Vice President and Chief Operating Officer

So that's assuming the conditions remain relatively consistent with today.

Truman Patterson -- Wells Fargo Securities -- Analyst

Directionally, would you assume that your core community count continues to grow?

Jessica Hansen -- Vice President, Investor Relations

We've never given specific guidance on community count, and we're just going to stick with what we currently expect for fiscal '20. And we may have a little bit of non-specific guidance about color on community count in November, but, today, that's what we feel comfortable with for our preliminary guidance.

Truman Patterson -- Wells Fargo Securities -- Analyst

OK. Thank you. Nice quarter.

David Auld -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question is coming from Michael Rehaut from J.P. Morgan. Your line is now live.

Michael Rehaut -- J.P. Morgan -- Analyst

Thanks. Good morning, everyone, and congrats on the results. First question I had was on sales pace and, I guess, it's a little bit of a pace versus price question but more focused around sales pace. You've had some competitors that have sales pace up anywhere from mid-single digits to healthy -- very healthy double digit rates.

You guys are a little bit more plus or minus flattish this year, but in contrast, you've had strong double-digit sales pace growth for the prior year, three, four years. So my question is, are you just at a point in the mark -- in your own shift toward first time, which kind of led the industry kind of in a more of a steady state and just kind of taking the market as it is? Because it seems like most other builders talk about this improved strength or improving strength at entry level that's driving that higher sales pace, whereas you might already have been there and benefited I'm trying to just reconcile that because, obviously, also it seems like you're a little bit more comfortable today not necessarily adhering at any price, adhering to the double digit top-line growth and focusing a little bit more on a balanced approach. So just trying to get a sense of, it's a long-winded question, I apologize, but that more flattish sales pace, kind of how that reconciles with some of the other builders we're seeing and versus your own positioning in over the last few years.

Mike Murray -- Executive Vice President and Chief Operating Officer

Michael, thank you very much. This is Mike. I think the way to start with the answer to the question is we've tried to move to the entry level to the affordable product positioning with express five years ago. And we have been out rolling that out and seeing very good absorption and demand for their product.

It's very well received over the past five years, and we did fuel a lot of years of double digit top-line growth in units. We've, as David mentioned before on the call, secured a lot of very good, long land positions and opportunities in that, and we are now at a place in our rollout that is fairly mature. We're getting good absorptions for community. And from a balanced perspective, we're look at the pace and price and focusing on what's driving the best returns for our inventory investment.

And that's what we're seeing today is that we've got a pace that we're very, very satisfied with in our communities, looking at each one of them individually, and then looking to see what can we do to adjust incentives, adjust product offering to enhance margin that then increases overall return in those communities as we're working through them? So by and large, we have done the rollout to the entry level. Now we're looking to kind of, if you would, turn the sales on the business plan a little bit to maximize the returns we're getting out of those communities and continuing to look for new communities to replace those. And so others -- yes, we've been saying for a long time, as we've opened up communities, we see great demand, and we were not able to satisfy all that demand. So some others have come in and are helping to meet a bit of that demand, but we still feel really good about our positioning and the performance we're getting out of those.

Michael Rehaut -- J.P. Morgan -- Analyst

Great. No, that's helpful, and it makes sense, obviously. I guess, secondly, on the lot positioning, I noticed that the option lot percentage ticked down a point sequentially in the third quarter after, again, several years of very impressive growth and gains in that number. How should we think about the option lot percentage course over the next couple of years? Obviously, the low 60s kind of exceeded your goal or hit your goal faster than expected. Should we kind of expect this type of range to be more of the new normal? Or is there kind of another leg up in the option lot percentage over the next couple of years?

Mike Murray -- Executive Vice President and Chief Operating Officer

I think you asked the question the right way in the term of years to look at this. It is a fairly volatile measurement, and we have been very fortunate the past several quarters that has done nothing but increase. But it will bounce a little bit from time to time. But directionally, over the next few years, we would still expect that control of lot position to climb above its current level.

I wouldn't say that there's going to be a rapid accelerated leg with that or anything we can point to as a catalyst to take it immediately up 3% to 5%, 7%, 10%. But continually, as we're continuing to adjust our business to focus on returns, we're looking to continue to control more land and partner with more third parties in delivering lots to the builder.

Operator

Thank you. Our next question is coming from Matthew Bouley from Barclays. Your line is now live.

Matthew Bouley -- Barclays -- Analyst

Good morning. Thank you for taking my questions. I wanted to ask back on the inventory side. Just looking at the finished versus under constructions spec.

It looked like the finish spec was a little higher as a mix than it typically is. Can you just elaborate a little on why that is? Obviously, you gave us that near-term margin guide, but just kind of any implications around margins or incentives from where that finished spec position is? Thank you.

Mike Murray -- Executive Vice President and Chief Operating Officer

No. We certainly are in a strong position to sell and to deliver on what our guidance is for Q4 fiscal '19 and fiscal '20, and the finished spec position gives us an ability to selling closed homes in the same quarter. So we're pleased with that positioning, but really no really implications on our margin guide. We expect our margin to still tick up into Q4 and feel good about our positioning in the market to continue to maintain margins at that level.

Jessica Hansen -- Vice President, Investor Relations

We have a very strong focus on completed and unsold specs over a period of time. And that number for homes greater than six months that have been completed and unsold has stayed in a really tight 400 to 600 homes range, which on our overall base of inventory of almost 30,000 homes is very manageable. And as Bill said, we feel like we're in a very strong position for Q4.

Matthew Bouley -- Barclays -- Analyst

OK, perfect. And then just secondly, back on the closings guide, 7% to 9% in the fourth quarter. But just looking at the backlog units, and as we just talked about that inventory units are down year over year, so clearly, the backlog conversion is stepping up nicely. So it really just what you're seeing in the sales environment in July? Is labor perhaps loosening? Just what are you guys seeing that's allowing for that type of improvement in backlog conversion? Thank you.

Mike Murray -- Executive Vice President and Chief Operating Officer

I think one of the things we discussed on is that we have a fair bit of completed homes, both unsold as well as sold, that we'll be delivering in the fourth quarter. In the aggregate, our homes in inventory are up year over year. They're down sequentially, which is seasonally what we would expect to do in our business plan. So we had the homes out there.

We're going to close in the fourth quarter.

Operator

Thank you. Our next question is coming from Ken Zener from KeyBanc Capital Markets. Your line is now live.

Ken Zener -- KeyBanc Capital Markets -- Analyst

Good morning, everybody. So if we could just do a little bit math here. Basically, you're running a lot more prebuilt homes in 1Q until you closed the higher percent in 3Q is how I look at your 38% number that you disclosed for intra-quarter orders closing. What I'm interested in is your closing for 4Q at the low end, 15,700 up to 16,000.

That's interesting in that you have that you have a high -- that's a pretty high percent of your under construction, which is how we do everything. Can you explain why that low in the guidance, which is 54% of your sort of construction would be up from 49% last year. I know you have spec prebuilt homes, which is normal, and you had it last year. So are you getting higher conversion cycles? Or what is it?

Jessica Hansen -- Vice President, Investor Relations

Well, to be specific about the completed specs that we've referenced a couple of times, we have almost 6,000 -- actually, 5,600 completed specs at the end of this year. Last year, we only had about 3,600. So we are in a very strong position to deliver on that guidance. And right behind those completed specs, we also have homes that are close to completion that we can also sell and close in the same quarter.

Ken Zener -- KeyBanc Capital Markets -- Analyst

OK. Now using that same logic, were you guys -- well, you guys referred to seasonal order pace, so kind of your pace sequentially. And in prior years, you've given guidance where your implication was because of the entry level or other type of products. You saw greater absorption.

Is there -- so my question to you is that -- I mean, is there any reasons you gave guidance for FY '20 that you would see anything other than normal seasonality?

Jessica Hansen -- Vice President, Investor Relations

Not that we see today. I mean, we don't have a crystal ball to what the spring selling season looks like. But where we sit today, we anticipate normal seasonality.

Ken Zener -- KeyBanc Capital Markets -- Analyst

And then last question, could you -- given the mix in the third quarter of 38% I think versus normally at 35% intra-quarter closings, what was the spread, would you say, between those prebuilt homes being ordered and closed versus your backlog?

Jessica Hansen -- Vice President, Investor Relations

The stuff we sell and close in the same quarter is almost 100% homes that were already started going into the quarter.

Ken Zener -- KeyBanc Capital Markets -- Analyst

And the margin differential between those in backlog?

Jessica Hansen -- Vice President, Investor Relations

We generally just look at our spec margin versus our build job margin. And generally, our specs run a slightly lower gross margin than our build jobs, but they turn faster. So from a return perspective, they're always accretive.

Mike Murray -- Executive Vice President and Chief Operating Officer

And then roughly 80% of the homes we close are specs. So really, our overall margin really does reflect largely our spec margin.

David Auld -- President and Chief Executive Officer

I would say that the houses we sold and closed in the quarter, we probably achieved a better margin on those than we would have if we would have sold them in the first quarter or the second quarter.

Mike Murray -- Executive Vice President and Chief Operating Officer

Right. Yes, it is interesting dynamic.

David Auld -- President and Chief Executive Officer

And I think that is part of the margin lift we saw and expect today.

Operator

Our next question is coming from Jack Micenko from SIG. Your line is now live.

Jack Micenko -- Susquehanna International Group -- Analyst

I wanted to just sort of back up on in terms a little bit. I think it's been pretty well telegraphed in the market that a large competitor has been using incentives to meet a volume goal. And I think some other larger peers of yours have sort of called it out. The margin beat this quarter, is it -- I guess I'm curious, was it the market and some of those pressures getting better? And David, earlier, you talked about positioning of your assets certainly the market segmentation at entry level.

I mean, your margin, is it -- how much of it is those three items? Is it the market just getting better or is it quarter specific?

David Auld -- President and Chief Executive Officer

I would say the affordability -- we gained affordability in the quarter because interest rates dropped. Levers for us were reduced a little bit. So it's both those things helped, I think, margin. But I can t.ell you, we get up every day thinking about positioning and how we're trying to put the right house, right lot, right community, and then have it priced to turn.

And so -- and I know it's sacrilege to say this, but we really don't look at the other builders much. At least I don't. So it's -- we're just trying to get better in our community presentations, our community offerings and stay competitive every day. So I would say it's more Horton than the market, but I'm probably slightly biased there.

Jack Micenko -- Susquehanna International Group -- Analyst

OK. And then on the apartment business, I know it started out -- it's been kind of a smaller initiative, but I think you've built I think so far a lot of these near master plans or areas where you're already building. Has that mandate or strategy changed? I mean, are you still merchant build? Do we see a pivot to some of these for cash flow? Obviously, there's a couple. The public's doing the same thing.

And then just a reminder on project level volume. Is that all on Horton's balance sheet? Are you partnering? How do we think about that a year from now?

David Auld -- President and Chief Executive Officer

I'd say when we started this, we thought it was going to work hand-in-hand with our homebuilding operation. Where we started it was in communities, where we had apartment-zoned land we owned that typically we would have sold, and felt like we could drive higher value for our shareholders by building it out and selling it. Our long-term strategy is to sustain and then scale that program. And whether we buy it, whether we hold them, sell them, is going to depend on market than cap rates and pipeline of bills we've got coming.

Right now, as we're learning the business, we're selling them. And they -- actually, even Bill Wheat was a little skeptical going into it, but they're driving pretty good returns. And as we look at our pipeline of stuff that's under construction right now, it looks like a business that's going to be able to -- we're going to be able to scale.

Jessica Hansen -- Vice President, Investor Relations

And Jack, in terms of financing, it's all on our balance sheet today. But we are assessing what that looks like in the future, and we'd expect to utilize some level of third-party capital at some point.

Mike Murray -- Executive Vice President and Chief Operating Officer

And ultimately, it comes back to people. And I can tell you what our community guys have done in establishing platform, and getting the right people in the right slots has been very impressive. So we like what we see so far.

Operator

Thank you. Our next question is coming from Stephen Kim from Evercore ISI. Your line is now live.

Stephen Kim -- Evercore ISI -- Analyst

Good quarter. I wanted to talk a little bit about your 2020 guide. In particular, this year, you decided not to include a margin guide in 2020, and I just wanted to get into that a little bit. Obviously, there's a lot we can't know about what the next year's going to bring in terms of the economy and demands from rates.

But there are two things, two factors that I think we can maybe think about qualitatively. One is the margin on spec and the second is the lumber benefit, which is you're seeing near term. On the specs, David, I believe you mentioned that you thought that your margins on specs are usually a little lower than the build to order, but not right now, and in part because of the drop in rates, I mean, acting so close -- wanted to close quickly and lock in those rates. That benefit to your margin on your specs relative to BTO, I would assume shouldn't -- we shouldn't assume that's going to continue unless rates drop further, which is not something that I would assume you would bake into your outlook.

And then secondly, in terms of lumber benefit. I'm thinking we don't know how much that was. I'd be curious if you could give it to us, but I assume that benefit shouldn't be assumed to continue in 2020 either. So these are two things that maybe would be in the margin next year.

Are there material offsets to these things that you could point to that might give us some hope that margins could grow next year?

Jessica Hansen -- Vice President, Investor Relations

Steve, it's Jessica. As we've kind of outlined, we give preliminary guidance with what we feel comfortable with today that we can commit to for fiscal 2020, and it's all subject to today's market conditions. We're going to focus, as we always have, on maximizing returns. And gross margin is going to be a product of both the overall market and what it takes from a price and pace perspective community-by-community to maximize returns.

And so we're not going to try in July to give any sort of gross margin color for fiscal '20 other than continuing to make sure we're balancing pace and price to maximize returns.

David Auld -- President and Chief Executive Officer

And Jess, I may have missed out, but just to clarify what I thought I said, the houses we sold and closed in Q3 were at a higher margin than if we would have sold and closed the houses we sold and closed in Q1 in specs. Because incentives have abated, and we are seeing less of a need to incentivize a finished house to get it under contract and closed.

Jessica Hansen -- Vice President, Investor Relations

But what -- yes, I said earlier about spec margins generally being lower than build job margins is still true. That was true this quarter, and that would be in any base case scenario we have.

Stephen Kim -- Evercore ISI -- Analyst

Got it. OK. That is helpful. Appreciate that.

And then I guess, could you give some color with respect to the lumber benefit? You didn't really talk specifically about that. Could you just dimensionalize that first in some manner?

Mike Murray -- Executive Vice President and Chief Operating Officer

We probably would quantify that as about our sequential margin improvement. Probably about 20 to 30 bps of tailwind came from lower lumber costs in the homes we closed this quarter versus what we closed in the second quarter.

Stephen Kim -- Evercore ISI -- Analyst

OK, that's really helpful. And then last one for me is, I think, you mentioned somewhere along your remarks that the build -- the cycle time had not changed. So your cycle time hasn't improved, and it hasn't deteriorated, I assume, is what that means. And then, therefore, I guess I'm thinking into next year or just as we go forward, if we're going to improve the returns without the margin, is it possible for you to do that effectively without increasing or shortening your build time on average?

Mike Murray -- Executive Vice President and Chief Operating Officer

We've not seen our build times lengthen this year, and they have not contracted as much as we would have liked either. But that does remain an area of focus to us, is how do we be better stewards of the capital and turn that capital more efficiently? And getting build times to be as efficient as possible is certainly a huge part of that, and that's something we do get up every day and think about how to do that. And David talked about we try to enhance margin every day. We also try to enhance the build time.

We talk about our cash flow cycles. And that's a big part of our cash flow cycle. So you're exactly right. That is an area that we need to focus on.

Operator

Our next question is coming from Mike Dahl from RBC Capital Markets. Your line is now live.

Mike Dahl -- RBC Capital Markets -- Analyst

My first question was still around kind of that pace versus margin or return discussion. And following up on, Jessica, what I think you just said and what Mike and David also touched on earlier, I know it's not all one-size-fits-all, but at a high level, what I'm trying to figure out is you go into the year with a, generally speaking, kind of a unit goal. You put inventory on the ground that positions you to meet that. And so the question is, as you go through the year and demand kind of fluctuates, is it the right way to think about what to expect from your results that the swing line is actually on gross margins versus upside or downside on units? Just because I think there's still a question of whether there's some bigger-picture strategic shift in the way you're thinking about volume versus margin or returns at this point or if this is really just a function of market dynamics.

David Auld -- President and Chief Executive Officer

We've got -- at least I talked about one of my tailwind divisions, margin is the grade. If you do a great job of positioning a product for the price point and demand that exist, then you're going to run a very high margin in excess of 20%. If you do a very poor job of positioning price point and product, then you're probably going to run a lower margin because you're -- we are going to hit a certain pace. We are going to maintain production in the community and then adjust off that process.

So we do put a plan out there. We do have expectations. And when we get everything right, the margins run very, very high. When the market's working with us, the margins improve.

So -- but we are going to run at a pace.

Mike Dahl -- RBC Capital Markets -- Analyst

OK, that's helpful. Thanks.

Mike Murray -- Executive Vice President and Chief Operating Officer

Yes. You'll see in the short term that margin grade is what the difference is between how well we do and how well we want to do. But -- and if you look at longer term, we can moderate and adjust the pace based upon market conditions as we're seeing to maximize the return. And more broadly, as we've -- over the past five years, 10 years, coming out of the downturn, I tamed a lot of market share and scale, we've been able to then focus on how best to maximize the company's return on equity and what are some of the levers we can pull there, and consistently driving cash flow, creating opportunities for us to derisk the balance sheet, invest in new opportunities for us to grow the business or to return more capital to shareholders that we think is the most accretive way to drive value for our shareholders.

Mike Dahl -- RBC Capital Markets -- Analyst

OK, thanks for that. And then my second question is just a follow-up to Steve's questions around lumber. You've quantified that it was a 20- or 30-basis-point sequential benefit in 3Q. I was wondering what the sequential benefit is in your 4Q guide versus 3Q specifically related to lumber.

And then can you give us, at a higher level, your direct cost trends on a -- I know your comp size is shrinking, so maybe on a per-square foot basis would be helpful.

Mike Murray -- Executive Vice President and Chief Operating Officer

I'll comment on Q4 first. It's a bit of a tailwind on lumber as a component of our guide of a sequential improvement of 10 to 40 basis points in gross margin in Q4. I don't have a specific component of that because mix will impact that in actuality. But it is a component of our guide for a sequential increase.

Jessica Hansen -- Vice President, Investor Relations

Yes. And outside of incentives in lumber really our revenues per square foot and our cost per square foot were relatively flat sequentially other than the two pieces that we called out, which drove the improvement on gross margin.

Operator

Thank you. our next question is coming from Jade Rahmani from KBW. Your line is now live.

Ryan Tomasello -- KBW -- Analyst

Good morning. This is Ryan on for Jade. Just first, thinking bigger picture, do you think that the fundamental structure of the homebuilding industry is really too fragmented and therefore presents an opportunity for someone like D.R. Horton to consolidate over the intermediate term?

David Auld -- President and Chief Executive Officer

Well, we've been consolidating. And I can tell you our plan is to continue to consolidate. If you look at the industry when we went public, it was public builders were about 3% of the overall market. And every year since then, they've -- the publics have gained more market share, and we have gained more market share against the other publics.

And I, for one, don't see that changing.

Ryan Tomasello -- KBW -- Analyst

And I guess, dovetailing off of that topic. Do you think that there are material scale economies that would further benefit the company in the majority of your markets? Or is that process somewhat over -- is that thought process somewhat overblown?

Mike Murray -- Executive Vice President and Chief Operating Officer

No, that's just a big focus of our us. While we're certainly the largest volume builder in the country, we're not No. 1 in every market. So we're focused on what can we do in each market to aggregate market share and become the largest builder? We're top five in 31 of the top 50 markets, so we see plenty of opportunity to can still consolidate market-by-market.

And really that happens at the community level every day.

Operator

Our next question today is coming from Jay McCanless from Wedbush. Your line is now live.

Jay McCanless -- Wedbush Securities -- Analyst

The first question I had, could you talk about how quarters trended on a monthly basis through the quarter, and then if you could quantify what you've seen so far in July?

Jessica Hansen -- Vice President, Investor Relations

Jay, I think we entered the call, David mentioned that we've seen in our June quarter and our July sales through. We can't talk about today yet, but through most of the month, we've just seen normal seasonality and in line with our expectations. So putting us right where we want to be to deliver the fourth quarter we've talked about.

Jay McCanless -- Wedbush Securities -- Analyst

OK. And then I think you all have commented on it a couple of times, but the expansion of the affordable product has basically been completed. I was wondering if that applies to freedom as well, and maybe what you're seeing from active adult demand and also move-up demand to be focused on affordable? I would love to hear how some of these other sectors are performing.

David Auld -- President and Chief Executive Officer

The freedom brand is still early in the rollout. We have gotten much better at positioning that product, but we are not anywhere near where we want to be at this point. I will say the -- every community we've rolled out seems to be a little better positioned, a little better reception from the customer. And it's a brand that's going to be a part of this company for a long time.

And I think we'll, at some point, approach 10%-plus of our deliveries. The luxury brand, we -- again, we continue to get better at it, nowhere near where we want to be. It gives us areas to focus. Right now, the affordable product lines have driven returns and growth.

And we pay our guys based upon returns and profits, so their focus has been on delivering what the buyer wants. So -- but I -- there will be a point in time where that will drive a better return than entry level, at least it has been in past cycles. So I'm very happy with everything we're doing. We just got to get better.

Operator

Our final question today is coming from Buck Horne from Raymond James. Your line is now live.

Buck Horne -- Raymond James -- Analyst

Question, I think you touched on the lumber benefit you're getting. I was wondering if you could quantify for us a little bit either on cost per square foot or otherwise just how labor costs have been trending throughout the quarter, and also what you're seeing in terms of land inflation that's out there?And my secondary question to that would just be, how do -- your pricing lots that are coming from Forestar, how do you negotiate those prices?

Mike Murray -- Executive Vice President and Chief Operating Officer

So first part of the question on in terms of labor costs, we're not seeing a lot of other changes really in our stick-and-brick costs. So labor costs right now quarter to quarter are holding in flat. We're pleased with the relationships and the teams we have out there negotiating those. Land and development costs are always a challenge that we work back against.

A lot of our depositions and market scale have helped with that. And we've not seen a lot of cost inflation coming through on this quarter's closings, so we're happy with the benefit that's produced. And then the third part of the question, I think it was Forestar's lot pricing. We look at -- for an opportunity that we bring to Forestar that we have tied up, we negotiate with Forestar, and they have returned hurdles and metrics that they have to achieve.

And our land teams know what those are, and they'll bring those projects to them, and then negotiate the take-down structures and the pricing to achieve those returned hurdles. And if it works for both parties, we go forward with the deal that Forestar does it. If it doesn't work, we can't find a way to make it work, then it's not a deal Forestar does. For an opportunity that Forestar sources, we have the opportunity to get up the house, the lots tied up, but that's really a right of first offer or first refusal on those parcels.

And they have their return hurdles. They're out there competitively bidding at the marketplace with other builders, and they'll work with us where it makes sense, and they'll work with other builders where it makes sense as well. So they sell both to Horton, and they sell to third-party builders as well.

Buck Horne -- Raymond James -- Analyst

That's great. And if I can have sort of one -- sorry, if I can have sort of have one last one in here sailing of, just to switch gears, the mortgage market a little bit. There was some concern or some questions out of the industry just with the FHFA discussing letting the -- I guess, the path around the VST loans and debt-to-income ratio letting that path expire in early 2021. I know we're a long way up from there, but just wondering if you could give us a feel or if you have any metrics around how many of your buyers could be affected by a change in those underwriting parameters? How many of your buyers have DTI ratios over 43%? Or anything around that could help.

Jessica Hansen -- Vice President, Investor Relations

Sure, Buck. I think you've kind of hit the nail on the head with how we would start, which is 2021's a long ways out. So I think a lot can happen between then. And does it fully expire and go away or does some middle ground be reached between now and then? We'll see.

It's a long ways out. In terms of our buyers and their debt to income for the buyers that are utilizing our mortgage company, on average, for our entire mortgage company this quarter, the DTI percentage was about 42%. So we do have a decent amount of our buyers that would be at that 43% or above, but that doesn't mean just because if the patch were to go away for conventional, there's not a product for them. They'd still be eligible potentially for an FHA loan.

And then the first question we also always ask is, do you have other sources of income that we can verify that we haven't yet to go into that equation? So typically, any sort of change that gets implemented like that is not 100% fallout. Our mortgage company does a phenomenal job of working with buyers in our pipeline to find them a different product. And if this patch were to expire, which I don't know that that's anybody's base case scenario right now, I feel confident that we'd figure our way through it without a lot of fallout.

Operator

Thank you. We 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.

David Auld -- President and Chief Executive Officer

Thanks, Kevin. We appreciate everybody's time on the call today, and look forward to speaking with you again in November. And to the D.R. Horton team, outstanding quarter.

Thank you. We are forever grateful up here for what you guys do out there. And I guess we'll talk to you sooner than November.

Jessica Hansen -- Vice President, Investor Relations

Thanks, everyone.

Operator

[Operator signoff]

Duration: 64 minutes

Call participants:

Jessica Hansen -- Vice President, Investor Relations

David Auld -- President and Chief Executive Officer

Mike Murray -- Executive Vice President and Chief Operating Officer

Bill Wheat -- Executive Vice President and Chief Financial Officer

Carl Reichardt -- BTIG -- Analyst

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Alan Ratner -- Zelman and Associates -- Analyst

Eric Bosshard -- Cleveland Research Company -- Analyst

Truman Patterson -- Wells Fargo Securities -- Analyst

Michael Rehaut -- J.P. Morgan -- Analyst

Matthew Bouley -- Barclays -- Analyst

Ken Zener -- KeyBanc Capital Markets -- Analyst

Jack Micenko -- Susquehanna International Group -- Analyst

Stephen Kim -- Evercore ISI -- Analyst

Mike Dahl -- RBC Capital Markets -- Analyst

Ryan Tomasello -- KBW -- Analyst

Jay McCanless -- Wedbush Securities -- Analyst

Buck Horne -- Raymond James -- Analyst

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