D.R. Horton Inc (DHI) — Q1 2016 Earnings Call Transcript

Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the first 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 which is filed with the Securities and Exchange Commission. For your convenience, this morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q in the next few days. After the conclusion of the call, we will post updated supplementary historical data to our Investor Relations site on the Presentations section, under news and events for your reference. The supplementary information includes historical data on gross margins, changes in active selling communities, product mix, and our mortgage operations. Now I’ll 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. Our D.R. Horton team started the year with a strong first quarter, setting us up for a great 2016. Our consolidated pre-tax income increased to $241 million on $2.4 billion of revenue. And our pre-tax operating margin improved 40 basis points to 10%. Our homes sold increased 9% compared to the first quarter of last year due to improved absorptions. These results reflect a solid performance of our core D.R. Horton communities and our Emerald Homes and Express Homes brands. We are striving to be the leading builder in each of our markets and to expand our industry-leading market share. We plan to maintain consistent, broad product diversity with our three brands over the long-term. Our continued strategic focus is to produce double-digit annual growth in both our revenue and pre-tax profits while generating positive cash flows and increasing our returns. With a sales backlog of 10,665 homes at the end of December, positive sales trends in January and a well-stocked supply of land, lots, and homes, we are well-positioned for the spring selling season and for 2016. Bill?

Net income for the first quarter increased 11% to $158 million or $0.42 per diluted share compared to $143 million or $0.39 per diluted share in the year-ago quarter. Our consolidated pre-tax income increased 9% to $241 million in the first quarter compared to $221 million in the year-ago quarter. And homebuilding pre-tax income increased 11% to $229 million compared to $206 million in the prior year quarter. Our first quarter home sales revenues increased 4% to $2.3 billion on 8,061 homes closed, up from $2.2 billion on 7,973 homes closed in the year-ago quarter. Our average closing price for the quarter was $290,400, up 3% compared to the prior year due to an increase in our average sales price per square foot. This quarter entry-level homes marketed under our Express Homes brand accounted for 22% of homes closed, and 15% of home sales revenue. Our homes for higher-end, move-up, and luxury buyers priced greater than $500,000 accounted for 7% of our homes closed and 16% of our home sales revenue. Mike?

The value of our net sales orders in the first quarter increased 12% from a year-ago quarter to $2.4 billion and homes sold increased 9% to 8,064 homes on a relatively flat active selling community account. Our average sales price on net sales orders in the first quarter increased 3% to $293,700. The cancellation rate for the first quarter was 23%, down from 24% in the year-ago quarter. The value of our backlog increased 16% from a year-ago to $3.2 billion, with an average sales price per home of $297,600, and homes in backlog increased 15% to 10,665 homes. Our backlog conversion rate for the first quarter was 76%, within the range we guided to on our fourth quarter call. We expect our second quarter backlog conversion rate to be in the range of 82% to 85%. Bill?

Our gross profit margin on home sales revenue in the first quarter was 19.9%, consistent with the fourth quarter and up 10 basis points from the first quarter of last year. The consistency in our gross margin reflects the stability of most of our markets today. We are raising prices or reducing incentives when possible in communities where we’re achieving our target absorptions and we’re also working to control cost increases. Our general gross margin expectations remain unchanged. In the current housing market we continue to expect our average home sales gross margin to generally 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. As a reminder, our reported gross margins include all of our interest costs. David?

In the first quarter, homebuilding SG&A expense was $243 million compared to $238 million in the prior year quarter. As a percentage of homebuilding revenues, SG&A improved 30 basis points to 10.3%, compared to 10.6% in the prior-year quarter. As our revenue increase improved our leverage of fixed overhead costs. We remain focused on controlling our SG&A, while ensuring that our infrastructure adequately supports our current and expected growth. Jessica?

Financial services pre-tax income in the first quarter was $12.3 million compared to $14.6 million in the year-ago quarter. 90% 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 51% of our home buyers. FHA and VA loans accounted for 50% of the mortgage company's volume, compared to 42% in the year-ago quarter. Borrowers originating loans with our mortgage company this quarter had an average FICO score of 714, and an average loan-to-value ratio of 89%. First-time home buyers represented 43% of the closings handled by our mortgage company compared to 40% in the first quarter last year. Mike?

At the end of December, we had 21,500 homes in inventory, of which 1,600 were models, 11,300 of our total homes were spec homes, with 7,700 in various stages of construction and 3,600 completed. Our construction in progress and finished homes inventory increased by $291 million during the quarter, as we prepare for seasonally higher demand in the spring. Our first quarter investments in lots, land, and development totaled $627 million, an increase of 11% from the first quarter last year. $360 million was to replenish finished lots and land and $262 million was for land development. We expect that our investments in land and development for the full year of 2016 will be at least 20% greater than fiscal 2015. David?

At December 31, 2015, our portfolio consisted of 178,000 lots, of which 117,000 are owned and 61,000 are controlled through option contracts, which represents a 10% increase in our option position since year-end. 69,000 of our total lots are finished, of which 33,000 are owned and 36,000 are optioned. Our 178,000 total lots owned and controlled provide us a strong competitive advantage in the current housing market with a sufficient lot supply to support solid growth in sales and closings in future periods. Although our housing inventories will fluctuate as we manage each of our communities to optimize returns, we expect our land and lot inventory to remain relatively stable to slightly higher in 2016, which will result in positive cash flows. In the first quarter, we used $1.5 million of operating cash, an improvement of $128 million compared to the first three months of last year. Mike?

During the first quarter, we reported $1.5 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 $500,000 of inventory impairment charges. 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 as they have in the past. Our inactive land held for development of $185 million at the end of the quarter represents 10,500 lots, down 24% 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. Bill?

At December 31, our homebuilding liquidity included $1.2 billion of unrestricted homebuilding cash and $871 million available capacity on our revolving credit facility. We had no cash borrowings and $104 million of letters of credit outstanding on the revolver. Our gross homebuilding leverage ratio was 35.5%, and our homebuilding leverage ratio net of cash was 25.7%. The balance of our public notes outstanding at December 31 was $3.3 billion. On January 15, we repaid $170 million of senior notes after maturity and now we’ve $373 million of maturities remaining in fiscal 2016. At December 31, our shareholder's equity was $6.1 billion, and book value per share was $16.39, up 14% from a year-ago. Jessica?

Our expectations for fiscal 2016 remain unchanged from what we shared on our November call and are based on current housing market conditions. We continue to expect to generate a consolidated pre-tax operating margin of 10.5% to 11% for fiscal 2016. We also still expect to generate consolidated revenues of between $12 billion and $12.5 billion and to close between 39,500 and 41,500 homes. We anticipate our home sales gross margin for the full year of 2016 will be in the high 19%s to 20%, with potential quarterly fluctuations that may range from 19% to 21%. We estimate that our annual homebuilding SG&A expense will be in the range of 9.2% to 9.4% of homebuilding revenues, with the second quarter of the year higher than this range and the third and fourth quarters below the range. We expect our annual financial services operating margin to range from 30% to 33%. We are forecasting our fiscal 2016 income tax rate to be between 35% and 36%, and our diluted share count to be approximately 375 million shares. We also continue to expect to generate $300 million to $500 million of positive cash flow from operations. Our fiscal 2016 results will be significantly impacted by the spring selling season, and we will update our expectations each quarter as visibility to the spring and full-year becomes clearer. For the second fiscal quarter of 2016, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 82% to 85%. We anticipate our second quarter home sales gross margin will be in the high 19%s to 20%, consistent with the first quarter and we expect our homebuilding SG&A in the second quarter to be in the range of 10.3% to 10.6% of homebuilding revenues. David?

In closing, our first quarter growth in sales and profits and the improvement in our pre-tax margin are the result of the strength of our people and operating platform. We are excited and prepared for the spring selling season and opportunities ahead. We remain focused on growing both our revenue and pre-tax 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 positions; and, most importantly, our tremendous team across the country. We would like to thank all of our employees for the continued hard work and we look forward to working together to continue growing and improving our operations during 2016. Let’s keep the momentum from January going, week-by-week into the spring. This concludes our prepared remarks. We’ll now host questions.

Thank you for the detailed information. My first question is regarding the positive tone you mentioned for the start of the year. You talked about positive orders in January, which could mean many things. Could you provide more specifics? Also, the tone you're describing seems strong enough to support your revenue and closing expectations for the year. Could you comment on that as well?

Well, we have a positive tone, because we’re seeing positive things happen out in the market. And with the absorptions improvement on the relatively flat community count, less pressure on margins, it was a good first quarter, and what we’re seeing going into January gives us a lot of confidence.

And Nishu, to elaborate a bit on January, we are observing an increasing sales pace week-by-week, which aligns with our expectations for this month and is consistent with typical seasonal trends. We feel confident about our performance so far, and the sales we've experienced in January are in line with our plans. This is certainly adequate to achieve the volume we anticipate for the year.

Great. Thanks. And second question, you folks have had a strategy of being more capital efficient, focusing on return of inventory, call with the past 12 or 18 months or so. You’ve clearly been successful with that, judging from the amount of cash and liquidity that you’ve at the moment. So normally a build-up of cash like this is the way that you would behave, if you’re expecting a downturn in the market, or if you were trying to batten down the hatches. So without an increase in the dividend or a share buyback, what are your thoughts here, and is that characterization correct? I mean, how can you be drawing back inventory when we still have 50% to 60% upside potential in single-family volumes going forward?

Well, I don’t think we’re drawing back inventory. As a matter of fact, we’re guiding, I think, this year to be up 15%, 20% and what we’re pushing out.

Spending, yes. So the focus on efficiency gains and returns, I think have little to do with what we’re thinking about whether the market is going to be good or bad. It has a lot to do with, I think, driving to become the best Company in the industry. And the liquidity and strong balance sheet gives us a lot of flexibility and we will see what we do with the cash. I mean, it’s … Nishu, we continue to see opportunities for investment in the business. We expect our spending on land and development to increase by 20% this year. We are actively adding parcels under option contracts to facilitate future growth. However, as David mentioned, striving for a more efficient business model helps us enhance our operational disciplines overall. This focus will remain a priority for our company for the long term, and we are currently seeing positive results from these efforts. We also plan to use existing cash to pay down debt. We recently paid off approximately $170 million in January and have another maturity of $370 million coming up in April.

Thank you. Good morning, everyone. David, could you discuss Texas and the current situation with oil? Can you rank your cities in terms of the percentage of your business? Additionally, can you share insights on the demand trends you are observing and where you are making investments in the state? Are you focusing on communities, and are you targeting Express, Emerald, or is it more of a broader approach?

Stephen, pretty much across the board on what we’re targeting pushing out. The Express has been the driver, I think of market share gains, but Texas is in good shape. I’ve spent the last two weeks driving the Dallas Fort Worth areas and I can tell you, if you can put a house in Texas and pretty much any market and sell it to make a margin at 250, you’re going to sell houses. So we’re focused on improving the value of the customer. We are focused on driving absorption levels up on a community-by-community basis and that has been a successful strategy for us in Texas. Whereas revenues and by cities, yes number one, Dallas Fort Worth, like we’re 15% of the market share today. And to be honest with you, we believe we can expand that. So we love Texas.

All right.

We really love our operators in Texas.

Okay. And if I can just follow on the capital allocation that you talked about, your land and development be up about 20%? Did I understand you right, Mike, that your 370 this spring, you will actually pay that off? And then, as you look at M&A, one, what are you seeing out there, and what’s your appetite for it?

We have sufficient cash to pay off the 370 maturing today. We are open to refinancing a portion, or all of it, depending on market conditions and timing. In terms of mergers and acquisitions, we are actively exploring opportunities. The valuation of potential acquisitions is relatively high for us, and we are looking for deals that make sense. Our current operations are strong, and adding to them will require careful consideration. Therefore, we will maintain a disciplined approach regarding M&A.

Okay. Is the activity picked up?

It’s been running at a very high pace in terms of lots of activity for a while. I wouldn’t say it’s picked up in the past quarter. It’s been running at a good clip.

Hey, everyone. We had a strong quarter with a lot happening. My first question is about first-time buyer activity. On the entry-level side, as long as you do the right things, those trends go together. You've been leading the market with your express approach, and our data shows that since April of last year, first-time buyer activity has significantly improved, now up nearly 20% year-over-year. However, we still see that your competitors are not reporting enough activity to justify their efforts, which makes it a unique situation where you seem to have that market segment mainly to yourselves. Can you clarify if you're indeed noticing a pickup in the first-time buyer segment or the market since last summer? Also, do you have any insights on how you expect the competitive dynamics in that market to evolve in 2016?

Well as far as the market picking up, as we continue to push out the Express brand, we’re continuing to see consistent absorption and demand. So we’re in the process of pushing that brand out across the country and everywhere we’ve gone, we’ve seen good absorption and margins at or above what we underwrote them at.

To the competitive landscape certainly the entry level the lower end of the market is certainly the strongest right now and any time we see that in the market we expect further competition. You are right, we haven’t seen a whole lot in a lot of our Markets, we probably haven't seen as much as we expected, but we do expect more as time goes on.

Hi. Thanks for taking my questions.

You bet.

David, could you elaborate on the Texas market? It seems Dallas is performing exceptionally well, and your overall orders in the south central region are up 7%, suggesting Dallas is likely doing even better. What can you share about the year-over-year performance in Houston? We've heard from other builders about weakness in the $250K price range. You mentioned that homes at that price point sell well, but can you provide more insights on trends across different price segments in your Houston operations?

Houston has been relatively stable for us on a year-over-year basis. So we didn’t see a further slowdown in Houston, but we’re often not seeing any meaningful pickup. We continue to see our lower-priced Express homes, very steady demand, steady sales pace that has been mentioned a couple of times on the call. It’s definitely softer at the higher end. But we continue to see good, steady demand for the entry level and people moving out of apartments where we’re providing an attractive rent versus buy equation and driving people into the sales offices each week. So we continue to have a close eye on Houston. We are not heavily reinvesting in Houston right now. We are replenishing where it makes sense and where we can continue to add those entry level product offerings.

And Michael, to elaborate further, we have some highly valued project locations in Houston that are currently at a price point facing lower demand. We won't be accelerating or liquidating these positions, which means we expect to see reduced absorption in those communities. These are communities we cannot replace and do not intend to. Therefore, we will focus on protecting the value of our core projects, aiming for absorption in the 250 to 300 range. From my perspective, there is nearly no margin deterioration on the projects at the price point that are currently turning. We do not want to force sales in a core project where we have historically sold between 350 to 450 and are merely experiencing a reduction in our absorption rates. That’s my insight on Houston. I believe it will continue to be a significant market for us for the foreseeable future.

I guess just a follow-up on that last point. As you take a step back and say, look there is too much value in some of these A plus locations, to give them away. We have heard increased chatter in terms that competitors are starting to cut prices or kick up incentives. So how much of it is related to the market is trading away from you, and you’re not chasing it but the market has moved on price.

We are very strong in the 200 to 300 price point in Houston, and we intend to maintain that dominance. Moreover, our broad geographic footprint allows us to benefit in different markets; when the upper end in Houston slows down, the entry-level market in Denver picks up. We have many advantages at our disposal. I always tell the team that it will be us who succeed because we can meet our goals without having to sell undesirable projects at the current pace.

Got it. That is helpful, and yes good position to be in. If I could shift gears to yet another earlier discussion around community count and absorptions and just as it relates to the guide, I think you mentioned unit deliveries up 8% to 13%. If we looked at the orders, it seems like absorptions are up about 8%. How much of the delta between hitting the low end versus the high end of the units will come from increasing your absorption beyond that 8% on a year-over-year basis versus getting more communities open and getting that community count up into a low to mid single digit range by the end of the year?

We’re pretty much running on our absorption targets. So, I think we will, as we continue to push up the Express brand and follow up replacing the Horton positions, I think we will see some community count growth. We don’t have visibility in that today. We do have visibility in what we know we can deliver.

It’s hard to know exactly where the contributions are sitting here in January not knowing what the spring is doing the whole. We’re certainly seeing good early signs, but clearly the strength of the spring selling season will help determine our year, it will determine where we land in our range or whether we could perhaps exceed our range, so it’s here in January, feeling good. We feel good about our position, our preparations for the spring, and then we’ll go try to execute as best we can over the next few months, and we’ll know a whole lot more when we talk to you next quarter.

Hi. Good morning and thanks for taking my questions.

Good morning, Will.

I was curious on the implementation of The Know Before You Owe or TRID if you will. For you guys how that look like? How do you feel about I guess for lack of a better term the complexity as well as days its added to closings, and if you would share some color there?

We really haven’t seen an appreciable impact in a delay in closings. Our teams have worked very hard to prepare for the changing rules and worked with our captain mortgage company, GHM Mortgage those folks have done a yeoman’s job preparing for this change as well as working with our preferred lenders. So we really didn’t see a material impact on our closings for the quarter. We’ll continue to improve our processes and try to become more efficient and make it a good experience for the buyers.

Thanks for that. And then just as a follow-up, it was talked about a few times during Q&A. But on labor inflation, I think you guys are running at 2% to 3% in the prior reported quarter, well some of your competitors out there are running closer to 10%. Have you seen more inflation and has that been different for specs versus the total company?

I think the labor side has been minimized for us because we set absorption targets per community and drive to that. So we have consistency within the communities. And our trades are not out there looking for work one-week and then add twice what they can do the next.

And we are still just running a low single-digit percentage increase on cost per square foot, stick and brick.

Thank you, Kevin. We appreciate everyone's time today and look forward to speaking with you again in April. Again, special thanks to the D.R. Horton team, outstanding first quarter, outstanding start to the year.