D.R. Horton Inc (DHI) — Q4 2022 Earnings Call Transcript

Thank you, Tom, and good morning. Welcome to our call to discuss our fourth quarter and fiscal 2022 financial results. Before we get started, today's call includes 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 factors that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and subsequent 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 towards the end of next week. After this call, we will post updated investor and supplementary presentations to our Investor Relations site on the Presentations section under News and Events for your reference. Now I will turn the call over to David Auld, our President and CEO.

Thank you, Jessica. And good morning. We are also joined on this call by Mike Murray and Paul Romanowski, our Executive Vice President and Co-Chief Operating Officers, and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D.R. Horton team finished the year with a solid fourth quarter, which included a 20% increase in consolidated pretax income to $2.1 billion and a 19% increase in revenues to $9.6 billion. Our pretax profit margin for the quarter improved 10 basis points to 21.4%, and our earnings per diluted share increased 26% to $4.67. For the year, consolidated pretax income increased 42% to $7.6 billion on $33.5 billion of revenue, which increased 21%. Our pretax profit margin for the year improved 350 basis points to 22.8%, and our earnings per diluted share increased 45% to $16.51. We closed a record 83,518 homes this year in our whole building and single-family rental operations. Our homebuilding SG&A as a percentage of revenues of 6.8% was an all-time low. Our homebuilding return on inventory for the year was 42.8%, and our consolidated return on equity was 34.5%. Our strong financial performance during a year of significant challenges and volatility reflects the strength of our experienced teams, industry-leading market share, broad geographic footprint, and diverse product offerings. Our homebuilding cash flow from operations for 2022 was $1.9 billion. Over the past 5 years, we have generated $7.5 billion of cash flow from homebuilding operations while growing our consolidated revenues by 138% and our earnings per share by 503%. During this time, we also more than doubled our book value per share, consistently kept our homebuilding leverage under 20%, and increased our homebuilding liquidity by $1.8 billion, all while significantly increasing our returns on inventory and equity. During most of the year, demand for our homes was strong. In June, we began to see a moderation in housing demand that has continued and accelerated through today. The rapid rise in mortgage rates, coupled with high inflation and general economic uncertainty, has made many buyers pause in their home-buying decisions or choose not to move forward with their home purchases. However, the supply of both new and resold homes at affordable price points remains limited, and the demographics supporting housing demand remain favorable. The uncertainty of this market transition may persist for some time and could get more challenging if mortgage rates continue increasing. However, we are well positioned to meet changing market conditions with our experienced teams, affordable product offerings, flexible lot supply, and great trade and supplier relationships. Our strong balance sheet, liquidity, and low leverage provide us financial flexibility. We will continue to focus on turning our inventory and managing our product offerings, incentives, pricing, sales pace, and inventory levels to beat the market, optimize returns, increase market share, and generate increased cash flow from our homebuilding operations.

Diluted earnings per share for the fourth quarter of fiscal 2022 increased 26% to $4.67 per share. And for the year, earnings per share increased 45% to $16.51. Net income for the quarter increased 22% to $1.6 billion. And for the year, net income increased 40% to $5.9 billion. Our fourth quarter home sales revenues increased 23% to $9.4 billion on 23,212 homes closed, up from $7.6 billion on 21,937 homes closed in the prior year. Our average closing price for the quarter was $403,700, up 17% from last year and up 3% sequentially. We closed fewer homes than we expected during the fourth quarter due to a slower sales pace, increased cancellations, and continued construction delays. In addition, we estimate that approximately 730 home closings in Florida and South Carolina were delayed from September due to Hurricane Ian.

During the quarter, we continued to sell homes later in the construction cycle to better ensure the certainty of the home close date and mortgage rate for our homebuyers, with almost no sales occurring prior to the start of home construction. Our net sales orders in the fourth quarter decreased 15% to 13,582 homes, and our net sales order value was down 10% from the prior year to $5.4 billion. Our cancellation rate during the fourth quarter was 32% compared to 19% in the prior year quarter and 24% in the third quarter. Our average number of active selling communities increased 8% from the prior year and was flat sequentially. The average sales price on net sales orders in the fourth quarter was $399,600, up 6% from the prior year but down 4% sequentially from the June quarter. In October, as mortgage rates continue to increase, our net sales orders were below prior year levels, and our cancellation rate remained elevated. As a result, we currently expect our first quarter net sales orders to be down approximately 25% to 35% year-over-year.

Our gross profit margin on home sales revenue in the fourth quarter was 28.3%, up 140 basis points from the prior year quarter, but down 180 basis points sequentially from the June quarter. On a per square foot basis, our revenues were up 4% sequentially while our stick and brick cost per square foot increased 8% and our lot cost increased 3%. The decrease in our gross margin from the third to fourth quarter reflects the increase in our stick and brick costs and increased incentives provided to homebuyers to ensure the closings of our homes and backlog during the rapid rise in mortgage interest rates. We are offering mortgage interest rate locks and buydowns and other sales incentives to address affordability concerns and to drive sales traffic to our communities. As we adjust to market conditions and focus on turning our inventory to maximize returns, our incentive levels have continued to increase, and we are adjusting base home prices where necessary. We expect our average sales price and home sales gross margin to decrease from current levels in fiscal 2023. As a result, we are working with our trade partners and suppliers to reduce our construction costs on new home starts and are pleased with our early progress.

In the fourth quarter, homebuilding SG&A expense as a percentage of revenues was 6.7%, down 20 basis points from 6.9% in the prior year quarter. For the year, homebuilding SG&A expense was 6.8%, down 50 basis points from 7.3% in 2021. Our annual homebuilding SG&A expense as a percentage of revenues is at its lowest point in our history, and we will continue to control our SG&A while ensuring that our platform adequately supports our business. In fiscal 2023, our homebuilding SG&A as a percentage of revenues will likely increase from current levels.

We started fewer homes this quarter as we work to position our inventory with an appropriate number of homes relative to market conditions. We started 13,100 homes during the quarter in our homebuilding operations as we began negotiations to lower our construction costs on future new home starts. We ended the year with 46,400 homes in inventory, down 3% from a year ago and down 18% sequentially. 27,200 of our total homes at September 30 were unsold of which 4,400 were completed. For homes we closed this quarter, our construction cycle time increased by a week compared to the third quarter, which reflects continued lingering supply chain issues. However, we are beginning to see some stabilization in cycle times on homes we have recently started, and we expect our cycle time to improve in fiscal 2023. We expect our start pace in the first quarter of fiscal 2023 to increase versus our fourth quarter pace.

At September 30, our homebuilding lot position consisted of approximately 573,000 lots, of which 23% were owned and 77% were controlled through purchase contracts. Our total homebuilding lot position decreased by 25,000 lots from June to September. 29% of our total owned lots are finished, and 50% of our controlled lots are or will be finished when we purchase them. Our capital-efficient and flexible lot portfolio is key to our strong competitive position. We continually underwrite all of our lot and land purchases based on current and expected home prices and costs. We are actively managing our lot and land pipeline and our investments in lots, land, and development to meet our needs during this transition in the housing market. During the quarter, our homebuilding segment wrote off $34 million of option deposits and due diligence cost related to land and lot option contracts we terminated or expect to terminate in the future. We expect our level of option cost write-offs to remain elevated in fiscal 2023 as we manage our lot portfolio. Our homebuilding segment had no inventory impairments during the quarter or the year. Our fourth quarter homebuilding investments in lots, land, and development totaled $1.5 billion, down 19% from the prior year quarter and down 15% sequentially. Our current quarter investments consisted of $780 million for finished lots, $560 million for land development, and $150 million to acquire land.

For the fourth quarter, Forestar, our majority-owned residential lot development company, reported total revenues of $381.4 million, 3,914 lots sold, and pretax income of $66.4 million. For the full year, Forestar delivered 17,691 lots, generating $1.5 billion of revenues with a pretax profit margin of 15.5%. At September 30, Forestar's owned and controlled lot position was 90,100 lots. 59% of Forestar's owned lots are under contract with D.R. Horton or subject to a right of first offer. $250 million of D.R. Horton's lot purchases in the fourth quarter were from Forestar. Forestar is separately capitalized from D.R. Horton and had approximately $620 million of liquidity at year-end with a net debt-to-capital ratio of 26.9%. Forestar is well positioned to meet changing market conditions with strong capitalization, lot supply, and a relationship with D.R. Horton.

Financial services pretax income in the fourth quarter was $2.4 million on $134 million of revenue, with a pretax profit margin of 1.8%. As expected, our financial services pretax profit margin decreased this quarter primarily due to a significant pullforward of revenue from rate lock commitments in the third quarter, as we discussed on last quarter's call. Also during the fourth quarter, there were increased competitive pressures in the mortgage market and increased cost of rate locks provided to customers due to rising rates. For the year, financial services pretax income was $291 million, on $795 million of revenue, representing a 36.6% pretax profit margin. We expect our financial services pretax profit margin for fiscal 2023 to be higher than the fourth quarter but below the full year of fiscal 2022. During the fourth quarter, 99% of our mortgage company's loan originations related to homes closed by our homebuilding operations, and our mortgage company handled the financing for 73% of our homebuyers. FHA and VA loans accounted for 42% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 724 and an average loan-to-value ratio of 87%. First-time homebuyers represented 57% of the closings handled by our mortgage company this quarter.

During fiscal 2022, our rental operations generated $510 million from the sale of 775 multifamily rental units and 774 single-family rental homes, earning pretax income of $202 million. In the fourth quarter, our rental operations generated $21 million of revenues from the sale of 96 single-family rental homes and incurred a pretax loss of $13 million, which were below our expectations going into the quarter. We had several single-family rental projects in Florida, totaling 562 homes that were scheduled to close in September, but were delayed due to Hurricane Ian. These projects closed in October and will be reflected in our first quarter results. Also, one multifamily project and multiple single-family rental projects that were expected to be sold and closed in the fourth quarter were delayed due to changes in the capital markets that affected the timing of buyers' financing. Our rental property inventory at September 30 was $2.6 billion, which included approximately $900 million of multifamily rental properties and $1.7 billion of single-family rental properties. As a reminder, our multifamily and single-family rental operating results are separately reported in our rental segment and are not included in our homebuilding segments homes closed revenues or inventories. We expect our rental operations to generate significant increases in both revenues and profits in fiscal 2023 as our platform matures and expands across more markets.

Our balanced capital approach focuses on being disciplined, flexible, and opportunistic. We are committed to maintaining a strong balance sheet with low leverage and significant liquidity to provide a firm foundation for our operating platforms during changes in market conditions and to support our ability to provide consistent returns to our shareholders. During fiscal 2022, our cash provided by homebuilding operations was $1.9 billion and the cumulative cash generated from our homebuilding operations for the past 5 years was $7.5 billion. At September 30, we had $4 billion of homebuilding liquidity, consisting of $2 billion of unrestricted homebuilding cash and $2 billion of available capacity on our homebuilding revolving credit facility. Our liquidity provides significant flexibility to adjust to changing market conditions. Our homebuilding leverage was 13.2% at fiscal year-end and homebuilding leverage net of cash was 4.4%. Our consolidated leverage at September 30 was 23.8%, and consolidated leverage net of cash was 15.4%. We repaid $350 million of senior notes at maturity this quarter, and we have $700 million of senior notes that mature during fiscal 2023. At September 30, our stockholders' equity was $19.4 billion, and book value per share was $56.39, up 35% from a year ago. For the year, our return on equity was 34.5%, an improvement of 290 basis points from 31.6% a year ago. During the quarter, we paid cash dividends of $78.2 million for a total of $316.5 million of dividends paid during the year. During the quarter, we repurchased 3.6 million shares of common stock for $251.7 million for a total of 14 million shares repurchased during the year for $1.1 billion. As a result, our outstanding share count is down 3% from a year ago. Based on our strong financial position, our Board of Directors increased our quarterly cash dividend by 11% to $0.25 per share.

As we look forward to the first quarter of fiscal 2023, we expect challenging market conditions to persist with continued uncertainty regarding mortgage rates, the capital markets, and general economic conditions that may significantly impact our business. As we have already mentioned, we are utilizing more incentives in today's market and reducing home sales prices where necessary, which will impact our average sales prices and gross margins more in the first quarter than the quarter we just completed. We are providing detailed guidance for the first quarter as is our standard practice, but due to the current uncertainty in the market, our ranges for expectations are wider than normal. We currently expect to generate consolidated revenues in our December quarter of $6 billion to $6.8 billion, and our homes closed by our homebuilding operations to be in the range of 15,000 to 16,500 homes. We expect our home sales gross margin in the first quarter to be approximately 23% to 24%, and homebuilding SG&A as a percentage of revenues in the first quarter to be approximately 8% to 8.4%. We anticipate a financial services pretax profit margin of around 20%, and we expect our income tax rate to be approximately 23% in the first quarter. Looking further out into fiscal 2023, we have less visibility due to the macro-level uncertainties we have mentioned. It is too early to know what housing market conditions will be 3 to 6 months from now during the spring selling season, so we are not providing specific guidance for the full year yet. We will reassess each quarter and give more color on our expectations as we can. We are well positioned to aggregate market share in both our homebuilding and rental operations. Our fiscal 2023 home closings volume, pricing, and margins will be determined by future market conditions and our efforts to meet the market and improve our inventory turns, construction cycle times, and costs. Our goal is to generate consolidated revenues in fiscal 2023 that are slightly higher than fiscal 2022. However, the low end of our current range of expectations includes consolidated revenues potentially down from fiscal 2022 by a mid-teens percentage. We forecast an income tax rate for fiscal 2023 of approximately 23%. We expect to generate increased cash flow from our homebuilding operations in fiscal 2023 compared to fiscal 2022, and we plan to consistently repurchase shares to reduce our share count during the year with the amount of our repurchases dependent on cash flow, liquidity, market conditions, and our investment opportunities. We plan to continue to balance our cash flow utilization priorities among our core homebuilding operations, our rental operations, maintaining conservative homebuilding leverage and strong liquidity, paying an increased dividend, and consistently repurchasing shares.

In closing, our results and position reflect our experienced teams, industry-leading market share, broad geographic footprint, and diverse product offerings. Our strong balance sheet, liquidity, and low leverage provide us with significant financial flexibility to operate effectively in changing economic conditions and continue to aggregate market share. We plan to maintain our disciplined approach to investing capital to enhance the long-term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D.R. Horton team for your focus and hard work. Your efforts during 2022 were remarkable. This was a year in which we faced construction and operational challenges we have never faced before, with periods of unsustainably high demand followed by a historic rise in mortgage rates. Despite these challenges and market volatility, we closed the most homes in a year in our company's history, completing our 21st year as the largest builder in the United States with record profit and returns, and we are well positioned to continue improving our operations and providing homeownership opportunities to more American families in 2023. This concludes our prepared remarks. We will now host questions.

Thanks very much, guys, and thanks for all the information. Obviously, pretty solid performance in a tough environment. I wanted to ask you specifically about your starts outlook. Can you give us a sense for how much of an increase in starts we might expect in the December quarter, maybe year-over-year or quarter-over-quarter? And maybe alternatively, how many finished specs or total specs per community are you expecting to have as you enter the new calendar year?

Stephen, looking into the first quarter, we are finishing the year with 46,000 homes in inventory and positioned for our goals as we look forward to the year and look to maintain a similar balance as we work through the first quarter. So expect that our starts will keep pace with our closings through the first quarter.

Yes. In terms of the completed specs, Steve, we're in a more normal position now, with having some completed specs across more of our communities. That puts us in a good position to sell in the current environment given that buyers are concerned about what their interest rates are going to be. So if we have homes that are ready to move into quickly, they can lock their rates with confidence and close on a known schedule.

So the level of completed specs you have now is you're comfortable with sort of maintaining that level, right? That's what you're saying?

Yes.

Okay. And then the second question relates to your comments about navigating the difficult environment or the uncertain environment by managing your product offerings and negotiating lower costs is certainly the negotiation of lower costs. I understand that's going to be ongoing. But the managing of your product offerings, can you give us a sense for how quickly you're able to swap out models or at least floor plans that you're offering in your communities. Is that something that we could expect you to do in communities that are currently open? Or are we really looking at communities that are going to be new communities opening up? Maybe give us a sense for like what share of the communities you will have open, let's say, for the spring selling season will have a revamped product line.

In most of our communities across the country, Steve, we'll be able to start back smaller homes primarily and change specification levels in those homes that we have been starting in the most recent quarter and will be starting in the first quarter. There are some communities that are a little more locked in on product and planned neighborhood phases that may take 3 to 6 months to work through some changes in the product offerings. But by and large, most of our communities, those changes are starting today, and we'll continue to see that roll out through the next 6 to 9 months.

And Stephen, even with product lines that we've been offering as a spec builder, we release certain houses every month. So when the market is running red hot like it was the first half plus of last year, you have a tendency to release the bigger houses because your profit per house is higher. Now when a price point becomes much more important to the buyers, we made the release; they go from the 2,300 square foot 2-story down to the 1,600 square foot ranch, which drops the overall average selling price of the community without really changing the product or impacting valuations within the community.

Great. That's really helpful.

Just from geographically, it's the same markets that are experiencing an inflow of buyers. I mean, I think our relocate percentage—relocation buyers picked up last quarter again—there is a migration out of urban or out of urban into the suburbs. And there's still housing formation taking place that exceeds the supply of homes. It's easy to get caught up in the short-term. Our goal here is to stay focused on the long-term.

First one is the first quarter order guide implies quarter-over-quarter improvement, which would sort of buck normal seasonality. Can you just help us with some of the puts and takes there?

Well, really, we're just looking at our plans and what we're seeing right now week to week. We're already 5 weeks into our quarter. So we've got one month in the books. And as we just look at our pace that we're seeing right now and that we believe that that's where we're going to wind up. There are obviously seasonality; if you look at history, has been a little bit unusual in the last couple of years. And I think we're still in a little bit of an unusual time with what has happened with rates. But with our positioning across the board with our community count increasing, we feel like our order position in Q1 is in line with what we guided.

And as our production got further along as well, we felt more comfortable loosening up a lot of the sales restrictions you've heard us talk about. Even though we're continuing to sell later in the process, with some negligible improvement on our cycle times, but getting further along in the construction cycles, we have more homes available for sale going into Q1 than we've had.

Makes sense. Okay. Great. And then the ASP in the fourth quarter down about 4% sequentially. How much of that was like-for-like pricing versus mix?

Yes, at this point, it's like-for-like. I mean, we're—as we said, we're increasing incentives and then where necessary community by community, we're adjusting prices. And so I don't believe there's necessarily been a big change in mix yet. And so it's more likely from like-for-like.

You talked about cutting base prices where necessary. Can you give me a sense of how often it's been necessary, maybe a percentage of communities or percentage of orders this quarter where base prices were cut and what level of cuts are creating some elasticity in unit demand?

Carl, I don't know that we can get specific in terms of communities or by area. We are finding the market community by community and market by market. Those cuts on base have not been significant to this point. We have focused on financial incentives and interest rate and where needed to, we've been able to adjust price and find the market to drive additional traffic and sales.

And a lot of our guide is coming from what we know we're going to put into the market in terms of when we're opening new communities or new phases; we can reset our base pricing that way. And so we do expect our average sales price to shift down throughout the year. But as Paul mentioned, to date, it's been more heavily incentivized than it has been base price cuts.

Anecdotally, I was talking to a builder last week. He said he started a house in late August, and he's going to close it in December. So he was pretty excited about that. That's one story, one house out of a lot of houses.

Our homebuilding lot position consisted of approximately 573,000 lots, of which 23% were owned and 77% were controlled through purchase contracts. Our total homebuilding lot position decreased by 25,000 lots from June to September. 29% of our total owned lots are finished, and 50% of our controlled lots are or will be finished when we purchase them. Our capital-efficient and flexible lot portfolio is a key to our strong competitive position. We continually underwrite all of our lot and land purchases based on current and expected home prices and cost. We are actively managing our lot and land pipeline and our investments in lots, land, and development to meet our needs during this transition in the housing market.

Yes. As we noted, our companies have faced some challenges due to the rapid increase in mortgage rates, coupled with high inflation and general economic uncertainty, but we are managing these conditions well and are optimistic about our outlook.

In closing, our results and position reflect our experienced teams, industry-leading market share, broad geographic footprint, and diverse product offerings. Our strong balance sheet, liquidity, and low leverage provide us with significant financial flexibility to operate effectively in changing economic conditions and continue to aggregate market share. We plan to maintain our disciplined approach to investing capital to enhance the long-term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D.R. Horton team for your focus and hard work. Your efforts during 2022 were remarkable.