D.R. Horton Inc (DHI) — Q4 2019 Earnings Call Transcript

Thank you, Melissa, and good morning. Welcome to our call to discuss our fourth quarter and fiscal 2019 financial results. 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 could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and our subsequent quarterly reports on Form 10-Q, all 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-K next week. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentations section under News & Events for your reference. Now, I will turn the call over to David Auld, our President and CEO.

Thank you, Jessica, and good morning. In addition to Jessica, I'm pleased to be joined on the 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 finished the year strong. Pretax income for the fourth quarter increased 9% to $660 million on $5 billion of revenue and our pretax operating margin was 13.1%. For the year, EPS increased 13% to $4.29 per diluted share and consolidated pretax income increased to $2.1 billion on $17.6 billion of revenues. Our consolidated pretax margin for the year was 12.1%. We closed 56,975 homes this year, an increase of over 5,000 homes or 10% from last year. Our homebuilding return on inventory was 18.1% and our return on equity was 17.2%. These results reflect the strength of our operational teams, our ability to leverage D.R. Horton scale across our broad geographic footprint and our product positioning to offer homes at affordable price points across multiple brands. Our homebuilding cash flow from operations in 2019 was $1.4 billion. Over the past five years, we have generated approximately $4 billion of cash flow from homebuilding operations while growing our homebuilding revenues by more than $9 billion or 117% and our earnings per share by 186%. During these five years in addition to organically growing the business, we have invested approximately $1 billion on acquisitions and returned over $1.4 billion to shareholders through dividends and share repurchases, while reducing homebuilding debt by $1.3 billion. As a result, our return on equity increased by 540 basis points, while our homebuilding debt to capital ratio decreased by less than half of its level five years ago. Our strategic focus is to continue consolidating market share while growing both our revenues and pretax profits, generating strong 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 and a good October sales base. We are well positioned as we begin 2020.

Diluted earnings per share for the fourth quarter of fiscal 2019 increased 11% to $1.35 per share compared to $1.22 per share in the prior year quarter. Net income for the quarter increased 8% to $505 million compared to $466 million. Our consolidated pretax income increased 9% to $660 million in the fourth quarter from $608 million, and homebuilding pretax income increased 3% to $594 million from $578 million. Our fourth quarter home sales revenues increased 10% to $4.8 billion on 16,024 homes closed, up from $4.4 billion on 14,674 homes closed in the year ago quarter. Our average closing price for the quarter was $299,500, flat with the prior year.

Net sales orders in the fourth quarter increased 14% to 13,130 homes, and the value of those orders was $4 billion, up 16% from $3.4 billion in the prior year. Our average number of active selling communities increased 9% from the prior year and was flat sequentially. Excluding the builders we acquired earlier this year, our fourth quarter net sales orders were up 11% and our average number of active selling communities increased 2%. Our average sales price on net sales orders in the fourth quarter was $302,300, up 1% from the prior year. The cancellation rate for the fourth quarter was 23%, down from 26% in the same quarter last year.

Our gross profit margin on home sales revenue in the fourth quarter was 21%, up 70 basis points sequentially from the June quarter. The sequential increase in our gross margin from June to September exceeded our expectations and was primarily due to lower sales incentives. Based on today's market conditions, we currently expect our home sales gross margin in the first quarter to be consistent with the fourth quarter, subject to possible fluctuations due to product and geographic mix, as well as the relative impact of warranty, litigation, and purchase accounting.

In the fourth quarter, SG&A expense as a percentage of homebuilding revenues was 8.5% compared to 8.4% from the prior year quarter. The increase in our fourth quarter SG&A year-over-year was primarily due to compensation accruals related to increases in our stock price. For the full year, homebuilding SG&A was 8.7% compared to 8.6% in 2018. We did not achieve SG&A leverage this year after we lowered our revenue growth expectations in our fiscal first quarter and worked to align our inventory levels and operations with our revised expectations throughout the year. We remain focused on controlling our SG&A while ensuring our infrastructure adequately supports our growth and we expect to improve our SG&A rate in 2020.

Financial services pretax income in the fourth quarter was $61 million and the pretax operating margin was 44.8%. For the year, financial services pretax income was $166 million on $442 million of revenues, representing a 37.6% pretax operating margin. 97% 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 63% of our homebuyers. FHA and VA loans accounted for 48% of the mortgage company’s volume. Borrowers originating loans with the DHI Mortgage this quarter had an average FICO score of 720 and an average loan to value ratio of 89%. First-time homebuyers represented 50% of closings handled by our mortgage company, up from 49% in the prior year quarter, reflecting our continued focus on offering homes at affordable price points for entry-level buyers.

We ended the year with 27,700 homes in inventory, essentially flat with last year 16,000 of our total homes were unsold, of which 5,200 were completed. Our fourth quarter homebuilding investments in lots, land and development totaled $990 million out of which $610 million was to replenish finished lots and land and $380 million was for land development. For the year, we invested $3.7 billion in lot, land and development.

At September 30th, our homebuilding lot position consisted of approximately 307,000 lots of which 40% were owned and 60% were controlled. 30% of our total owned lots are finished and at least 54% 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 growth 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.

Forestar, our majority-owned subsidiary is a publicly traded residential lot manufacturer, now operating in 51 markets across 20 states. At September 30th, Forestar’s lot position consisted of 38,300 lots of which 29,700 are owned and 8,600 are controlled through purchased contracts. 79% of Forestar’s owned lots are already under contract with D.R. Horton or subject to a right of first offer under the master supply agreement. Forestar exceeded its guidance for this year by delivering 4,132 lots and generating $428 million of revenue for its fiscal year ended September 30th. Forestar expects to deliver 10,000 lots and generate $750 million to $850 million of revenue in fiscal 2020 and to deliver 12,000 lots and generate $900 million to $1 billion of revenue in fiscal 2021. These expectations are for Forestar’s standalone 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 approximately $6 million of its common stock in a public offering. Net proceeds from this offering were approximately $100 million which will help support Forestar's future growth. After the issuance, D.R. Horton’s ownership percentage of Forestar decreased from 75% to approximately 66%. Forestar plans to opportunistically access the capital markets as necessary to provide additional capital for long-term growth. Forestar is separately capitalized from D.R. Horton and is targeting a long-term net debt to capital ratio of 40% or less. We are excited about Forestar’s growing operating platform and the value this relationship will create over the long term for both D.R. Horton and Forestar’s shareholders.

DHI Communities is our multifamily rental company, focused on suburban garden-style apartments with current operations primarily in Texas, Arizona and Florida. DHI Communities currently has four projects under active construction and two projects that were substantially complete at the end of the quarter, one of which was on a contract to sell at September 30th. During 2019, DHI Communities sold two multifamily rental properties for $133,400,000 and recorded a gain on sale of $51.9 million. DHI Communities’ total assets were $204 million at the end of the year. We expect DHI Communities assets to increase significantly in 2020 as its pipeline of multifamily rental projects grows. We also expect to sell two rental properties in 2020.

Our balanced capital approach focuses on being flexible, opportunistic and disciplined. Our balance sheet strength and operating results have increased our flexibility and we are utilizing our strong position to enhance the long-term value of the Company. During fiscal 2019, cash generated by homebuilding operations was $1.4 billion, bringing our cumulative cash generated from homebuilding operations for the past five years to approximately $4 billion. At September 30th, we had $2.2 billion of homebuilding liquidity, consisting of $1 billion of unrestricted homebuilding cash and $1.2 billion of available capacity on our revolving credit facility. Our consolidated leverage improved 100 basis points from a year ago to 25.3%. And homebuilding leverage improved 440 basis points to 17%, the balance of our homebuilding public notes outstanding at fiscal year-end was $1.9 billion and we have $500 million of senior note maturities due in the next 12 months. Subsequent to year-end, we issued $500 million of 2.5% senior notes due in 2024. We also extended the maturity date of our revolving credit facility by just over a year and increased its capacity to $1.59 billion. At September 30th, our stockholders’ equity was $10 billion, and book value per share was $27.20, up 14% from a year ago. During the quarter, we paid cash dividends of $55.5 million and repurchased 2.1 million shares of common stock for $104.3 million. For the year, we paid cash dividends of $223.4 million and repurchased 11.9 million shares of common stock for $479.8 million. As a result of our share repurchases this year, we reduced our outstanding share count by 2% compared to a year ago. The Company's remaining stock repurchase authorization at September 30th was $895.7 million with no expiration date. Based on our financial position and outlook for fiscal 2020, our Board of Directors increased our quarterly cash dividend by 17% to $0.175 per share. We currently expect to pay dividends of approximately $250 million in fiscal 2020.

Looking forward to the first quarter of fiscal 2020, we expect to generate consolidated revenues of $3.7 billion to $3.8 billion and our homes closed to be in a range between 12,100 and 12,400 homes. We expect our home sales gross margin in the first quarter to be approximately 21% and homebuilding SG&A in the first quarter to be around 9.5% of homebuilding revenues. Based on today's market conditions, our expected growth for fiscal 2020 is still in the mid to high single-digit percentage range for both consolidated revenues and homes closed. We currently expect to generate consolidated revenues for the full year of $18.5 billion to $19 billion, and to close between 60,000 and 61,000 homes. We are forecasting an income tax rate for fiscal 2020 of approximately 25%, and we expect to reduce our outstanding share count by approximately 2% at the end of fiscal 2020, compared to the end of fiscal 2019. We also expect to generate homebuilding cash flow from operations in excess of $1 billion, again during fiscal 2020.

In closing, our results reflect the strength of our well-established operating platform across the country. 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 position, and most importantly, our outstanding experienced team across the country. We congratulate the entire D.R. Horton team on closing the most homes in a year in company history, and we thank you for your hard work and accomplishments. We're incredibly well positioned to continue growing and improving our operations in 2020. This concludes our prepared remarks. We will now host questions.

Hey, guys. Thank you for taking my question. I guess, first of all, the cash flow from operations target of greater than $1 billion could be interpreted as being somewhat conservative, given the 2019 performance of $1.4 billion, and what appears to be set up here for improved profitability in fiscal year ‘20. What do you see kind of as the biggest variables here? And is there any reason that you can point to why cash flow would be lower on a year-over-year basis?

John, we expect to generate consistently strong cash flow in excess of $1 billion. Year-to-year that number can move around a little just depending on timing of investments in homebuilding, and given that we're early in the year and we want to see how demand goes through the year that could impact our investment levels in the business. So, a greater than $1 billion is certainly a solid range and that gives us flexibility as we move through the year and we’ll update that estimate as we need to.

Okay. That makes sense. And then, last year, I think, you guys outlined a potential acquisition target range of $400 million to $600 million. How are you guys thinking about that heading into 2020, and what does the pipeline look like?

We’re still actively looking at some opportunities, John. But, we're very selective and wanted to be very targeted in what we're doing there. So, while we're looking at some, they’re very hard to predict when they are going to actually happen. This year, we don’t have that same level of clarity to a number that we had at this time last year.

Hey, guys. Good morning. Congrats on a strong close to the year. So, my first question, I’ve always kind of thought about the homes and inventory data point that you guys provide as a little bit of leading indicator in terms of how you see the business growing over the next few quarters. And, I think, this is the first quarter in a while where you’ve actually been down a bit on a year-over-year basis. And I'm just curious, as you think about that mid to high single-digit growth targets in 2020, should we start to see that number move higher or is there any kind of change in the way you're thinking about having specs on the ground and homes in inventory, and maybe any shifts in demand for to-be-built homes versus spec that would be potentially driving that number lower than I would have suspected?

I think, Alan, we're seeing a similar breakdown between our to-be-builts and our available homes that we have in inventory. But, we're excited, looking at going into this year with a good demand environment and opportunity to continue improving our returns and part of the way we talked about last quarter is improving our home inventory turnover. And so, that’s something we're excited about the opportunity to deliver on in fiscal ‘20.

And then, I guess, just a follow-up on that but implied there I guess is you are still confident that you can maintain the very high backlog conversion rates that you've delivered in the past and while keeping a lower inventory level, and in total, is that the way to interpret that?

I think you will see our inventory level increase from where we are at this point in the year. But, we're looking to be more efficient with the capital. So, we look to see a higher overall turnover rate.

That's helpful. If I could ask one more question, investors have been very focused on the 10-year treasury yield, which has been rising from recent lows, even though it's still at very low levels overall. You mentioned the strong sales environment in October, which aligns with the recent uptick we've seen. How do you perceive the current rate environment? Do you think there might be some buyers rushing in before rates go up further? Is this not a concern for you in the marketplace? Any insights you can share about what you are experiencing with the rate environment would be appreciated.

I think anything that impacts affordability is always going to be a concern. I will say, when you look at what drives homebuilding, which is job growth and the overall economy, we feel very, very good about what's happening there. And homes, they're as affordable as they're going to get. I do think yes, there may be a little bit of pull forward demand. But, right now, the market feels really, really good.

And Alan, one positive that came out of last year at this time, and what we experienced was a renewed focus in the field for us to make sure we have this affordable product offering, regardless of what interest rates are doing. So, we continue to see our average square footage come down slightly. It was down about 3% on a year-over-year basis again. And we've proactively gotten the houses out there that we believe are affordable in today's market and will continue to adjust as necessary to whatever rate environment we find ourselves in. But, clearly, today is a little bit better rate environment than it was last year at this time.

Thanks. Good morning, everyone. I wanted to ask David about the competition, particularly concerning entry-level markets. Many of your peers are moving in a direction similar to yours, and some smaller competitors have mentioned difficulties in finding assets but are interested in building smaller homes. Could you share your insights on the competitive landscape? The lot supply remains robust, but you will be competing for the same opportunities. I'm curious to hear your thoughts on this.

Carl, we compete every day. And yes, I do think that you’re seeing more people attempt to get lower in price point and drive better affordability. But again, like we've talked about in the past, our positions are very long, very deep. And we don't intend to give up market share in servicing that bar. I will say that demand is still very, very deep. And I think, from my travels that supply is still tight, especially as you achieve true affordability. But, we take a lot of comfort in the fact that we've got a long runway and a very affordable position, deep and long.

Thanks, Dave. Bill, I want to follow up on Alan's question about inventories. I believe we've made some adjustments regarding what is unsold versus moved models. Reflecting on about three years ago, you started the year feeling somewhat short on inventory, which affected delivery. I just want to confirm that you aren't experiencing that now and that you feel comfortable with your inventory as you enter this first quarter, unlike three years ago.

Paul, this is Mike. And I would say, it’s different from three years ago that we feel really good about the focus we’ve had on housing turns and how to improve that, as well as having lots on the ground to support the starts that we’ll need to be making over this quarter to support what we hope to be a really robust spring selling season. So, three years ago, we were struggling not just with the inventory levels of housing but also with our finished lot positions behind that.

And we feel very comfortable with the 60,000 to 61,000 annual target, but the reason we right now wouldn’t say we're comfortable moving higher than that for this next fiscal is because of where we're starting from a homes’ perspective. So, 60 to 61, we feel very comfortable with.

First, I wanted to touch on the SG&A. It came in a little bit above your guidance. Could you just walk us through the drivers of this and how we should think about incremental SG&A going forward? I'm really thinking about 2020. You mentioned some leverage. But, you guys are guiding mid to high single-digit revenue growth, which is pretty much what you all did in 2019 and your SG&A was kind of flattish. Could you kind of break it out why 2021 would improve while 2019 didn’t necessarily tick down?

Sure. Truman, this is Bill. Specifically, in the fourth quarter when we missed our guidance, that was specifically due to some of our compensation accruals tied to changes in our share price. And as our stock price increased pretty sharply in the fourth quarter, we had to increase a number of those accruals, and that entirely accounts for the miss versus our guidance for the Q4 SG&A rate. As you look back over the full year of ‘19 and as we look forward to ‘20 though, it’s a little bit of a broader discussion. As you recall, in fiscal 2019 at the start of the year, we had expectations to grow more to double-digit pace. But then, very early in the year as we saw softer market in the first quarter, we lowered our revenue expectations. But, we had our infrastructure in place and homes in place to support a higher revenue number. So, really throughout this year, we've been working to adjust our inventory levels and our operations to fit that lower revenue expectation. And we’ve been running typically about 10 basis points higher than the prior year all year along. As we go into fiscal 2020, while we have the same revenue expectations that we ultimately achieved in ‘19, we feel like our positioning is appropriate for that revenue. And with mid to high single-digit revenue growth, we should see SG&A leverage. And so, we do expect to improve on our SG&A rate versus 2019 as we go into fiscal 2020.

Okay. Thanks for that. And then, on the financial services side, I think it’s the best result you guys have had in history. Could you just walk us through the drivers of this, and possibly, how sustainable it is going forward?

Sure. Truman, it was mainly due to favorable market conditions just because of the low-interest rate environment. So, that was by far the strongest driver. Our mortgage company though has also done a fantastic job working on becoming more efficient; they’ve improved their capture rate. I think, 63% this quarter was one of the highest we’ve seen in quite some time. But, normal historical operating margin is more in the low 30s. And we do anticipate that’s what they’re ultimately going to return to. But, no question this year was a very strong performance for that business.

Good morning. A question on gross margin, as you look at price and incentives and gross margin, curious how you would compare your thinking for the coming year relative to the year you just completed?

I believe, Eric, we will continue to experience a similar trend. We are seeing lower levels of incentives compared to earlier in the year, while margins have improved significantly since reaching a low in the second quarter. We have been deliberate in our efforts to manage this to achieve the best returns. Looking ahead to fiscal 2020, our plans indicate that we expect margins to remain about the same as they were in the fourth quarter.

Could you discuss the progress you've made with Forestar and the options available, including where you see those numbers going and how you would describe the current situation?

Overall, we feel really well about the progress we've made to get to 60%. I know that's a little bit bouncy quarter-to-quarter. And we’ve talked about, it's a dynamic number that’s measured in any quarter and it's going to move a little bit directionally. I hope to get a little more progress on that this year, and the trend continues. Forestar continues to add to their operating platform, adding their team, which is a great first source for us, for a third-party developer. And at the same time, we work really hard developing relationships with other third-party developers as well, and continue to expand those relationships that we have in various markets. And getting people in markets, we have not historically been able to get developers to step in and complete lots for us. It's an ongoing, long-term process.

And the destination ultimately, the 60%, where would you like that number to get to and over what time frame?

Hard to say an ultimate number. Higher than where it is today. But it's something we'll probably be working at very hard for our entire careers here at D.R. Horton.

Yes. Thanks very much, guys. Mike, just wanted to clarify one thing, you just said I think with respect to margins in 2020 that you're thinking you could probably be flat with where you were in 4Q ‘19. So, in other words, kind of around that 21% gross margin in 2020 is kind of what you're thinking. Right?

Yes, sir.

I just wanted to clarify that. The second question relates to SG&A. Bill, you mentioned the impact of stock-based compensation in the fourth quarter of your September quarter, and you adjusted your accruals for the higher stock price. I was wondering if there shouldn't be any lingering impact from that. Suppose your stock price stays flat into next year. The reason I'm asking is that your first quarter guidance for SG&A is flat, even though your closings are up about 7%. I'm trying to understand why we wouldn't see a bit more leverage in the first quarter, as you expect to see for the full year.

Right. Yes, the change in the accrual should not have any lingering effect that you are correct in that assumption. As we look at our absolute level of SG&A spend going into the first quarter along with our revenue guide, we believe 9.5% is the level that we feel like we will be at. If you go back a year ago though if you're comparing year-over-year, in the first quarter, we had some, I hate to say benefit, but we did have some benefit from a reduction in our stock price last year. So, some of those accruals were pulled down a year ago in the first quarter. So, it’s simply timing on that basis, but it does move the needle a bit. It can move to 10 to 20 basis points.

Got it. Yes. That's very clear. And then, lastly, I think, in your opening remarks, you talked about October off to a strong start. I was just wondering if you could give us a little bit more. Are we seeing any way an acceleration into October in any way, either in terms of being able to reduce incentives at a more aggressive pace or any other kind of color you can provide around the demand environment in October?

This October is looking much better than last October, and I can't help but feel a bit excited about what the rest of the year holds. While I don't expect to see an increase in margins due to anticipated competition, our current business performance is very strong. I feel confident in saying that we are anticipating relatively stable margins moving forward. As you know, we tend not to be the most optimistic group.

Right, but just the hardest working. I appreciate it, guys.

I want to start with the question on the Q1 gross margin guide consistent with Q4. Can you just go through some of the sequential puts and takes in that? So, I guess, what are you guys assuming around incentives and direct costs, and perhaps if there is any purchase accounting that’s still rolling off?

We are focused on our core lot level gross margin, assuming that all other factors remain constant. Therefore, there’s no significant influence from warranty, litigation, interest, or property taxes. While these factors can affect our results from one quarter to the next, they are difficult to predict. Currently, our gross margin is around 21%, and we expect it to remain relatively consistent with Q4. Additionally, we have been able to maintain a stable pricing environment, or one that increases at the same rate as our costs. In fact, we observed a sequential improvement this quarter due to a decrease in incentives, which we believe we've mostly navigated. Our revenues per square foot increased by about 2%, while stick and brick costs rose by approximately 1%.

I was curious whether you guys feel the growth in the overall industry is going to be pretty much in line with the growth you guys are guiding to.

Yes. Alex, I would think, we would continue to expect to take market share, and as we like to say, outperform the market, year in, year out, we expect to do better.

Okay. So, does that mean you expect your affordable percentage of homes to I guess keep growing?

You may not see it from a pure brand perspective in our business, but what we’ve been introducing really over the last year or so is more and more entry-level type houses in our Horton brand as well. So, the answer is yes, but you may not see our Express percentage of a business, climb from the mid-30s, where it is today.

And one last one if I may on the Forestar. As you guys are now incurring interest due to the debt you raised, is that going to be capitalized or is that going to be showing up in expenses in what you guys report?

Yes. Forestar, their active inventory is greater than their debt. So, they are capitalizing 100% of their interest into their inventory at Forestar.

Hi. This is actually Chris on from Mike. Thanks for squeezing me in here. So, my first question is just on M&A. Are you embedding any M&A in your 2020 guidance? And given the recent activity in the space, could you just give us an update how you’re thinking about public versus private opportunities?

We are not including any M&A activity in our growth guidance. Regarding our outlook for M&A, what typically works best for Horton involves private builders and add-on builders that provide us with new capabilities and teams in different markets. This will be our primary focus for now. However, we are always open to and continually assessing opportunities that may be suitable for us.

Got it. Thanks for that. And secondly, are you able to provide the percentage of communities that raised price this quarter, and any regional color, commentary you can provide on pricing power you saw in 4Q?

So, the communities we've raised price on isn't something we typically disclose. We clearly still don't have broad-based pricing power across the board. But, I would say, at this point, we've had an ability to pull back on incentives, which is a different function of price, across most of our footprint at this point, maybe a little bit less so at the higher price points where incentives have remained elevated.

Thank you, Melissa. We appreciate everyone's time on the call today and look forward to talking to you again in January to share our first quarter results. And to the D.R. Horton team, congratulations on finishing number one for the 18th consecutive year. You are truly the best of the best in this industry. Mike, Bill, Jessica and I are honored and humbled to represent you on these calls. Thank you.