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D.R. Horton Sticks With Caution

Shares surge after earnings top forecasts, but the company says the housing market may get worse.

Updated from 9:22 a.m. EST

D.R. Horton

(DHI) - Get D.R. Horton, Inc. Report

closed more home sales than expected in the fourth quarter, helping the homebuilder beat earnings estimates even as profits fell 51%.

Investors bid up the company's shares, but the country's largest homebuilder said that the housing market still may see further deterioriation and signaled more challenging times ahead.

For the quarter ended Sept. 30, Horton earned $277.7 million, or 88 cents a share, down from $563.8 million, or $1.77 a share, a year earlier. Analysts, on average, expected EPS of 69 cents, according to Thomson First Call.

Revenue fell 4% to $4.8 billion, but beat analysts' mean estimate of $3.93 billion. The main driver of the beat was higher-than-expected home closings of 17,261 units, compared with the company's guidance that pointed to about 14,162 closings, said Bank of America analyst Daniel Oppenheim in a research note Tuesday.

"We think investors are likely to focus on the upside to the quarter based on the higher closings," wrote Oppenheim, who rates the stock neutral. "However, the higher closings result in a lower backlog as the company heads into fiscal '07, which may be a challenge given the continued weakness in order trends."

Horton's orders in the quarter fell 25% to 10,430 units. The company's backlog of homes sold but not yet delivered was 18,125 homes, or a dollar value of $5.2 billion, compared with 19,244 homes, or $5.8 billion, a year earlier.

Shares of Horton rose $1.67, or 7.5%, to $24.05 in midday trading.

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Though investors were optimistic, Horton CEO Donald Tomnitz took a cautious tone on the conference call, saying the upcoming two quarters will be even more challenging for the company.

"We're in the early stages of a declining market...most of these downturns are longer and deeper than we envision at the beginning," Tomnitz said on the call.

To deal with the slowing market, Tomnitz said the company is severely restricting speculative home starts. About 50% of the company's current housing inventory is "spec" homes, or homes that are being built without a specific buyer lined up. The company said it is seeking to move to a "low 30% range" as soon as possible.

Tomnitz emphasized that most of its free cash flow next year will go to paying down debt and strengthening the balance sheet, and not to buying new land. Horton has five years' worth of land, which allows it "plenty of time to wait for land prices to come down," Tomnitz said.

During the third quarter, the company recorded a $142 million inventory impairment charge and a $57.2 million write-off of deposits and pre-acquisition costs related to abandoned-land option contracts.

About 70% of the land-impairment charge in the quarter came from lots in California, with about 65% of that coming in San Diego.

Horton management said on the call that the company has not needed to write down much land in the rapidly cooling areas of Florida and Phoenix even though home sales are slowing in the regions. Horton said those sales are still profitable for the company and are projected to remain so, thus there's no need for a writedown.

The company also gave an update on the age of its land inventory. About 65% of the owned lots the company controls today were contracted in fiscal 2004 and prior, but the company said it didn't have the data immediately available on how much was purchased in 2004.

Builders' profit margins are expected to come under

even more pressure going forward as the companies are forced to work through their newer land to build homes. Horton's gross margins on home sales fell to 21% in the quarter from 25% a year earlier.

Horton didn't provide a forecast for fiscal 2007 earnings. Analysts currently expect the company to earn $2.22 a share next year, compared with its fiscal 2006 earnings of $3.90 a share.