霍頓房屋 (DHI) 2015 Q3 法說會逐字稿

Greetings and welcome to the D.R. Horton, America's Builder, the largest builder in the United States, third quarter 2015 earnings release conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jessica Hansen, Vice President of Investor Relations for D.R. Horton.

Please go ahead, Jessica.

Thank you, Kevin.

Good morning, and welcome to our call to discuss our financial results for the third quarter of FY15.

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 most recent quarterly report on form 10-Q, both of which are 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 later today.

After the conclusion of the call, we will post updated supplementary historical data on the presentations section of our Investor Relations site for your reference.

This supplementary information, which we encourage you to review, includes historical data on gross margins, changes in active selling communities, product mix and our mortgage operations.

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 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.

Our D.R. Horton team delivered an outstanding third quarter.

Our pre-tax income increased to $334 million on $3 billion of revenues.

And our pre-tax margin improved 330 basis points to 11.3%.

Our sales and fortunes continue to improve during the quarter as our homes sold increased by 22% from a year ago, on only a slight increase in active selling communities.

This reflects strong performance in our core D.R. Horton communities and the growth of our Emerald Homes and Express Homes brands, which have enabled us to expand our product offerings and our industry-leading market share.

Our continued strategic focus is to leverage our operating platform to produce double digit growth in both revenue and pre-tax profits while generating positive cash flows and increasing our returns.

During the third quarter, we generated $357 million of positive cash flow from operations.

With the sales backlog of 12,761 homes at the end of June, solid sales trends in July and a well-stocked supply of land, lots and homes, we are well-positioned to finish our year strong and have an even stronger 2016.

Mike?

Net income for the third quarter increased 96% to $221 million, or $0.60 per diluted share, compared to $113 million, or $0.32 per diluted share, in the year ago quarter.

Our consolidated pre-tax income increased 94%, to $334 million in the third quarter, compared to $132 million in the year ago quarter.

And home building pre-tax income increased 90% to $302 million, compared to $159 million in the prior year quarter.

Our third quarter home sales revenues increased 37% to $2.9 billion on 9,856 homes closed, up from $2.1 billion on 7,676 homes closed in the year ago quarter.

Our average closing price for the quarter was $290,000, up 7% compared to the prior year, driven primarily by an increase in our average sales price per square foot and to a lesser extent, a larger average home size.

Bill?

The value of our net sales orders in the third quarter increased 25% from the year ago quarter to $3 billion and homes sold increased 22% to 10,398 homes on a 1% increase in active selling communities.

Our average sales price on net sales orders in the third quarter increased 3% to $289,400.

The cancellation rate for the third quarter was 22%, compared to 24% in the year ago quarter.

The value of our backlog increased 15% from a year ago, to $3.7 billion with an average sales price per home of $293,400 and homes in backlog increased 12% to 12,761 homes.

Our backlog conversion rate for the third quarter was 81%.

We expect our fourth quarter backlog conversion rate to be in the range of 81% to 84% up from 76% in the fourth quarter of last year.

Jessica?

We are experiencing strong growth in revenues and profitability in our D.R. Horton branded communities which accounted for the substantial majority of our sales and closings this quarter.

We also continue to be pleased with the progress and performance of our Emerald Homes and Express Homes brands.

Emerald Homes are brands for higher end, move up and luxury communities is now available in 46 markets across 18 states.

In the third quarter, homes priced greater than $500,000, accounted for 16% of our home sales revenue and 7% of our homes closed.

Our Express Homes brand, which is targeted to the true entry level buyer focused primarily on affordability, is currently being offered in 44 markets and 14 states with a significant majority of our Express sales and closings to date coming from Texas, Florida and the Carolinas.

This quarter, Express accounted for 19% of our homes sold, 16% of homes closed and 10% of home sales revenue.

The average closing price of an Express home in the third quarter was $188,000.

We are striving to be the leading builder in each of our operating markets with all three of our brands and we plan to maintain consistent broad diversity in our product offerings over the long-term.

Bill?

Our gross profit margin on home sales revenue in the third quarter was 19.9%, up 20 basis points from the second quarter.

The consistency in our gross margin in the first three quarters of the year reflects the stability of most of our markets today and the normalization of housing market conditions we have seen over the last year.

We are raising prices or reducing incentives when possible in communities where we are achieving our target absorptions.

And we are working to control cost increases.

These factors have enabled our gross margins to stabilize within our normal historical range.

Our general gross margin expectations remain unchanged from what we have shared the past several quarters.

In the current housing environment, 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.

For the upcoming fourth quarter, we expect our home sales gross margin will be consistent with our margins for the first three quarters of the year, in the high 19% to 20%.

Mike?

Home building SG&A expense for the quarter was $258 million, compared to $222 million in the prior year quarter.

As a percentage of home building revenues, our SG&A improved 160 basis points to 9%, compared to 10.6% in the prior year quarter, as our significant revenue increased this quarter improved our leverage of fixed overhead cost.

Based on our projected backlog conversion, we expect our SG&A as a percentage of home building revenues in the fourth quarter, to be in the range of 8.7% to 8.9%, which would be a year-over-year improvement of 100 to 120 basis points.

We are very pleased that our home building SG&A in FY15 will be below our long-standing target of 10% and we believe we will further improve our SG&A leverage in FY16.

Jessica?

Financial services pre-tax income in the third quarter increased 140% to $31.7 million, from $13.2 million in the year ago quarter.

88% of our mortgage company's loan originations during the quarter related to homes closed by our home building operations.

FHA and VA loans accounted for 49% of the mortgage company's volume, compared to 43% in the year ago quarter.

Borrowers originating loans with our mortgage company this quarter had an average FICO score of 716 and an average loan to value ratio of 89%.

Mike?

At the end of June, we had 21,200 homes in inventory of which 1,600 were models, 9,400 were spec homes in all stages of construction and 3,600 of these specs were complete.

Our construction in progress and finished homes inventory decreased by $100 million during the quarter, while our number of homes in inventory remained relatively stable.

Our completed specs declined by 12% during the quarter.

Our third quarter investments in lots, land and development totaled $575 million, of which $311 million was to replenish finished lots and land, while $264 million was for land development.

Our residential land and lot inventory increased by $82.5 million during the quarter.

David?

At June 30, 2015, our lot portfolio consisted of 120,000 owned lots with an additional 54,000 lots controlled through option contracts.

65,000 of our lots are finished of which 32,000 are owned and 33,000 are optioned.

Our 174 total lots owned and controlled provide us a strong competitive advantage in the current housing market with a sufficient lots to apply to support strong 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 inventories to remain relatively stable during the remainder of 2015, and in 2016, which will allow continued positive cash flow from operations.

In the third quarter, we generated $357 million of positive cash flow.

For the nine-month period ended June, we generated $189 million, an improvement of $762 million, from the same period in the prior year.

Bill?

During the third quarter, we recorded $3.7 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 $11.7 million of inventory impairment charges, of which $7.4 million were in our west region, primarily related to a long-held inactive land parcel that we intend to sell to improve our returns by redeploying the capital into more productive assets.

Our inactive land held for development of $235 million at the end of the quarter, represents 12,800 lots, down 25% from a year ago.

We continue to formulate our operating plans 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.

We also will continue to evaluate our inactive land parcels for potential impairment which may result in additional impairment charges in future periods but the timing and magnitude of these charges will fluctuate as they have in the past.

Mike?

During the quarter, we acquired the home building operations of Pacific Ridge Homes for $70.9 million of cash of which $2 million was paid subsequent to quarter end.

Pacific Ridge operates in Seattle, Washington.

We acquired approximately 90 homes in inventory, 350 lots, as well as control of approximately 400 additional lots through option contracts.

We also acquired a sales order backlog of 42 homes, valued at $18.7 million.

Bill?

At June 30, our home building liquidity included $767 million of unrestricted home building cash and $881 million available capacity on our revolving credit facility.

We had no cash borrowings and $94.3 million of letters of credit outstanding on the revolver.

Our gross home building leverage ratio was 37.5% and our home building leverage ratio net of cash was 31.6%.

The balance of our public notes outstanding at June 30, was $3.3 billion.

We have no debt maturities for the remainder of FY15 and we have a total of $543 million of senior note maturities in the next 12 months.

At June 30, our shareholder's equity balance was $5.6 billion and book value per share was $15.35, up 13% from a year ago.

Jessica?

Looking forward to the fourth quarter, we expect our number of homes closed to approximate a beginning backlog conversion rate in the range of 81% to 84% at an average sales price in the range of $285,000 to $290,000.

We anticipate our home sales gross margin in the fourth quarter will be consistent with the first three quarters of the year, in the high 19% to 20%, subject to potential fluctuations from product mix, warranty and interest costs.

We expect our fourth quarter home building SG&A to be in the range of 8.7% to 8.9% of home building revenues.

We estimate that our fourth quarter financial services operating margin will be in the range of 35% to 40%.

We expect our tax rate in the fourth quarter to be between 35% and 36%, and our fourth quarter diluted share count to be approximately 371 million shares.

Our projected revenues and profitability for the full-year of FY15, are in line with the expectations we have been communicating since the beginning of our fiscal year.

Our expectations are based on today's housing market conditions.

Our current preliminary expectations for FY16 are for our consolidated revenues to grow by approximately 10% to 15% and for our consolidated pre-tax margin to be in the range of 10.5% to 11%.

We also expect to generate positive cash flows from operations of approximately $300 million to $500 million for the full fiscal year, which we expect to use primarily toward debt maturities.

We anticipate our tax rate for FY16 will be between 35% and 36% and that our diluted share count next year will increase by approximately 1%.

David?

In closing, our third quarter growth in sales, closings and profits is a result of the strength of our operating platform and we are excited about the opportunities ahead.

With the expectations Jessica shared for the fourth quarter, we believe our closings for the full-year of 2015 will increase by approximately 27%, representing an increase of 8,000 homes and land right in the middle of the range outlined at the start of the year of around $36,500.

We remain focused on growing on both our revenue and pre-tax profits at a double digit pace while generating positive cash flows and increasing our returns.

We are well-positioned to do so with our solid balance sheet, industry-leading market share, broad geographic footprint, diversified product offerings across our D.R. Horton, Emerald and Express brands, attractive finish lot and land positions and most importantly, our tremendous team across the country.

We made considerable progress this year toward our goal of producing sustainable positive cash flow from operations.

While still growing the business we generated $189 million of cash in the first nine months of the year, an improvement of $762 million from the same period of 2014.

We expect continued positive cash flow in 2016.

We would like to thank all of our employees for the continued hard work.

In my opinion, the best of the industry.

Now go forth and finish the year strong.

This concludes our prepared remarks.

We will host any questions.

(Operator Instructions)

Our first question today is coming from Ken Zener from KeyBanc.

Please proceed with your question.

Good morning, everybody.

Good morning.

David, you talked about FY16.

You didn't have to go there, no one even asked you.

Can you walk us through the process of why you wanted to do that now?

Your revenue top line of 10% to 15%, what type of community count does that involve or absorption or just talk about how you get there and the confidence around your EBIT given a very strong fourth quarter SG&A guidance?

Kind of a broad question, but take what you want.

Well, thank you, Ken.

I guess, I am excited because I think we just delivered a great quarter.

But I think the positioning we did or have done over the last 12, 18 months, has set us up for a good run.

And we just see general solid markets across the country.

Nothing's exploding.

But everything seems to be getting a little better on a month to month, quarter to quarter basis.

And the way we are positioned and what we are focused on right now, and what we have accomplished, leverage on the SG&A, and just controlling costs, I think sets us up to continue what we have been doing.

On the community count front, Ken, the 10% to 15% consolidated revenue growth, that is really mainly driven by volume, coupled with a little bit of price.

In terms of community count, we would expect it to be low, maybe top out mid single digit growth.

So the majority of that revenue growth is coming from further improvement in our absorptions.

We are not guiding to the 20% to 30% up next year like we did this year, so we don't have to expand our absorptions quite as dramatically as we did in FY15.

But feel very confident that we can drive further absorption improvement as we move throughout 2016.

Very helpful.

Now, because you had such strong pricing momentum year-over-year, you have been right about six.

It sounds like you do not expect your successful mix shift towards Express to result in price degradation, realizing there is different mix, pricing mix there, between your different products.

You said positive price, correct?

I think slight to moderate price improvement, yes.

And that's what we've seen thus far.

We came into the year expecting relatively flat pricing due in part due to the expectation of the mix shift to Express.

And while Express has certainly grown sharply as a percentage of our business, that impact has been offset by price appreciation.

And to the extent we continue to see current market conditions as we move into 2016, hopefully that will continue.

Thank you very much.

Thank you.

Our next question today is coming from Stephen Kim from Barclays.

Please proceed with your question.

Yes, thanks very much, guys.

Very encouraging to see your land spend being very disciplined.

It is something that I certainly applaud what you are doing there and I think it is going to be very interesting.

So I guess my first question would be, with respect to, if you can continue to generate this kind of cash, you have already said this year, you're looking to do, applying it to the paydown, what should we expect going forward in 2016?

I know that in the past there has been some talk about your wanting to run at a much lower level of leverage than you have in the past but I also know there's been a little bit of conversation about that, shall we say, at the corporate office.

So I was wondering where your thoughts are right now in terms of where that is going to be in 2016?

Very opportunistic.

We are going to spend $2 billion plus just replacing what we deliver.

As we consistently generate and improve out a sustainable, it is going to give us a lot of opportunity.

I guess we will share that when we get there.

And just to clarify, Stephen, the comments towards debt reduction were specific to FY16.

We have $543 million in maturities in the next 12 months.

So that would be what we expect in FY16.

And then when we are looking further out, we will have more commentary to share later.

But as David said, opportunistic.

Got it.

That's helpful.

We'll continue to watch that.

My next question relates to Express.

Obviously good success there.

We have observed that your average price within Express has been rising pretty meaningfully.

I think it was up19% this quarter and it's been kind of accelerating there.

I was curious if you could share a little bit about what is going on there?

I imagine some of that may be just geographic mix shift but perhaps there is something additional going on there in terms of the kind of buyer that you are seeing come out for your product?

If you could share some thoughts there?

Stephen, this is Mike.

Most of what we are seeing with the Express price changes is mix shift.

As we have introduced it to more markets, that have a higher bar for the entry level buyer, we are seeing the result of those come through in the closings.

Pretty much the same entry level buyer buying the Express product.

Got it.

And in terms of where the markets are that you are going to, what should we be thinking about that?

Most of it we are seeing the impact in this quarter's ASP has been closings from the state of Florida.

Great success in Florida introducing Express over the past year and we are starting to see a greater proportion of the Express closings coming from Florida with the higher sales prices.

We are still about 80% of what we're doing in Express is Texas, Florida and the Carolinas.

And the size is in that order for those states in terms of percentage contribution.

We are opening it in a lot of other places but the vast majority of Express sales and closings to date are in those three states.

All right.

Thanks very much, guys.

Thank you, Steve.

Thank you.

Our next question today is coming from Stephen East, from Evercore ISI.

Please proceed with your question.

Thank you.

Good morning, guys.

When you, in your prepared remarks, I think everybody believes your volume growth is coming from Express.

Myself included.

But it sounded like more of it was coming from your core Horton brand.

Is that a fair representation of what is going on?

And could you talk about maybe the trends within the three products and where the gross margins break out into three products?

Yes, Steven.

This is Bill.

We are seeing growth really across all of our brands, solid growth, solid demand across all of our brands.

Naturally, with the rollout of Express being introduced into more and more markets, it is growing as a percentage of our overall business as we introduce the product in more markets.

But when we look at all three brands, we are seeing solid growth across all three.

In terms of the relative gross margins as we've kind of said all along, our expectations and what we have seen is that the Express comes in a little bit below our average margin for the Company.

But we have been encouraged by the margins that we have been able to generate in Express.

And then, our expectations for our Emerald, our higher end product, is that it will generate a bit higher gross margin than the average.

But our return expectations are the same across all brands.

Okay.

And then geographically, you talked some about Florida and the rollout.

Is that what really drove that market, was the Express rollout?

And could you talk some about Texas, what you are seeing?

Are you seeing any impact with energy in Houston, that type of thing?

The Florida market in general is just getting better.

Really, across all three brands.

The rollout which impacted the pricing mix on Express was when we initially launched, we launched in central Florida, middle part of the state, much more price competitive than where we are introducing the product later, which is kind of southeast, southwest.

So you are just seeing a lift from those two areas which I think it is a part of the overall increase in pricing in Express.

But now the State of Florida, we feel very good about the state.

And you mentioned Texas.

We are seeing solid demand across Texas.

Texas is still extremely strong for us.

And we saw essentially our south central region is largely Texas.

And so we are very pleased with the performance across the State of Texas.

Okay.

And no Houston dynamics going on right now with oil?

Certainly, we continue to watch Houston.

On a year-over-year basis, Houston sales were basically flat.

We saw higher average prices this year than last year in Houston.

But clearly, the Dallas market continues to be extremely strong, San Antonio seems to be picking up for us a bit and Austin continues to be solid for us as well.

We're definitely are watching Houston, but for it to still be at the level it is, is still encouraging.

Okay.

Thanks.

We grew very fast in Houston for about three or four years.

So kind of a flat year-over-year this year.

Did replenishing community count in that market, is that a problem with land pricing moving up?

We were very well-positioned in Houston, 2012, 2013.

And the community counts in Houston, again, we are very well-positioned.

We are still opening communities.

We have been preparing to open for the last year to 1.5 years.

New phases, new sections.

Got you.

All right.

Thanks.

Thank you.

Our next question today is coming from Nishu Sood from Deutsche Bank.

Please proceed with your question.

Thanks.

The first question I wanted to ask, you mentioned solid sales trends continuing into July.

There has been some concern obviously with rates rising, whether some threats to consumer confidence.

So I was wondering if you could just dig down into that a little bit and how things looked from the end of the spring selling season and into the summer?

And just your thoughts, if any, of those specific concerns if you have any perspective on whether or not those have affected your trends or not?

If we get up every day thinking about sales.

So yes, if we are up 30%, we are concerned if we're not up 50%.

If we're up 20%, we're concerned we're not up 30%.

That's just the nature of our Chairmen.

We travel in the markets.

Don Horton is out right now driving subdivisions.

And in the general field, across pretty much every market, is it's a little better today than it was last year.

And there is a confidence in our operators.

There is a confidence in our sales in our model homes.

Traffic is steady.

So it has been a slow recovery but consistent and it just seems to be continuing.

We feel good about it.

Got it.

So it would be fair to say then, it sounds like the momentum that we have seen so far this year has persisted into the summer?

Correct.

Got it.

Great.

Okay.

I wanted to also ask about the cash flow.

Very impressive cash flow performance this quarter.

I think you guided to $300 million to $500 million, if I got that number correctly, for next year.

And fourth quarter, your next quarter is typically a pretty big cash flow quarter as well.

Your guidance implied that share count will rise.

So no share buybacks and debt paydown.

My question was, with cash flow so strong, with your net debt to cap fairly low, against the kinds of typical historic builder norm of 40% to 45%, have you given any thought to allocating some to share repurchases?

Because based on what you're implying, you are going to have strong book value growth and are you going to pay down quite a bit of debt.

You're going to continue to delever and you're going pretty far below the historic norm.

What are your thoughts on share buybacks being a little more balanced about reallocating that cash?

Nishu, we're pleased to be in a positive cash flow position and we've been focused on achieving this and we feel like we are in a position now to continue to generate sustainable positive cash flow.

We are going to take a balanced approach to it.

We will always look first to our business, to invest in the business and be opportunistic there to the extent that we can generate returns there and that will include acquisitions as we continue to steadily be if that market.

With over $500 million of debt maturities coming due next year, that is a higher priority for us in FY16.

But then certainly as we get into 2016 and we look beyond that, other opportunities will be out there and available for us.

Certainly we continue to be a consistent dividend payer.

There is potential that that could increase as our earnings and cash flow continue.

And then share repurchases would be one of those items that we would look at in the balance as we are opportunistic.

And if we see that that is a good return and that is an appropriate use of our cash, it will certainly be considered alongside the other things.

Got it.

So the 1% increase in share count that you are talking about, that is a general range but there could be some flexibility around that?

There is always flexibility.

As we stand right now, with no Express intent of repurchasing shares in 2016, we would expect our share count to rise by about 1%.

Great, thank you.

Thank you.

Our next question today is coming from Robert Wetenhall from RBC.

Please proceed with your question.

Hey, good morning and nice job on the quarter.

Just wanted to ask on your preliminary 2016 guidance, you were coming in higher than we thought and higher than your pre-tax income margin for 2015.

So I am just trying to understand, is the way we should think about the 10.5% to 11% range you gave, derived from better gross margin performance, or is that all SG&A leverage?

What we are seeing, we showed it in the third quarter, it is an improved SG&A leverage.

Margins were essentially flat throughout this year, firmed up, nice and stable.

And we are seeing some improvement with our absorptions driving up in our communities.

We are seeing improvements in our SG&A leverage following right to the operating margin improvements we are seeing.

And we fully expect to continue to that into FY16.

Bob, this is David.

I can tell you, the general consensus is flat.

As we hit these absorption targets and as our market stays steady, I do think there may be a little upside in margin but we are going to guide to flat and attempt to do what we say we are going to do.

Okay.

Cool.

Those are ambitious targets.

I hope you get there.

Wanted to ask about your average order price is up almost 3% this quarter.

And just thinking through, you have an easy comp in the fourth quarter.

But can you talk about how you are thinking about the trajectory or pricing given mix through some commentary about bigger floor plans being a positive to more sales at the entry level product?

And I just kind of want to get a handle on how you think this involves into 2016.

Thanks very much and good luck.

So Bob, in terms of further price appreciation, we will see.

ASP is one of the hardest things for us to determine.

We don't necessarily look at Q4 as an easy comp though.

We had a very, very strong up last Q4.

I think in the high 30s, if memory serves.

So to us, that is not an easy comp.

But we are going to continue going out and every day hitting our targets on a community by community basis and continuing to drive sales improvement.

And if the market is there, we will get the price.

But the market is really going to determine that.

And from where we sit today, with the impact of mix from Express, we would continue to expect our ASP to be flat to slightly up in FY16 versus FY15.

290,000 ASP on deliveries and just shy of that on sales is pretty much an all-time record for us.

And with the continued mix impact from Express, I don't think we expect to necessarily move that needle a whole lot further.

Makes a lot of sense.

Good luck.

Thanks very much.

Thank you.

Our next question today is coming from Eric Bosshard from Cleveland Research.

Please proceed with your question.

Thanks.

Two questions.

In regards to leverage within the business, the community count plan and leveraging SG&A, just interested if strategically you're thinking differently or having a different level of success in both of these areas that is one of the factors that is helping your profitability improve?

I think we have always stressed leverage on the SG&A line and getting as much as we can out of our fixed overhead.

And so what we are seeing now is low to single digit growth in our community counts, driving greater absorptions from those communities and generally, we're probably replacing communities that are closing out with slightly larger communities that are opening up, allowing us greater opportunities for increased absorptions and better leverage at the community level.

For us, this business all happens at the community level.

The pace we drive at a different community helps drive improvements in margin efficiencies in the construction processes as well as better leverage of the overhead associated with that community.

And when we look at SG&A leverage, to the extent that we drive a good part of our volume growth from improved absorptions in existing communities, that drives even more SG&A leverage than driving growth from community count increases.

So our focus there on improving absorptions is definitely a big driver of our SG&A leverage.

And as we look at it going forward, we believe we got more opportunities to improve it.

And then if I could, one followup on gross margin.

After a couple of years of progress and a step-down, it sounds like stable to slightly favorable maybe gross margin outlook.

Just talk a little bit about the moving pieces you are seeing within gross margin now and as we project forward over the next 12 to 18 months.

On a year-over-year basis, Eric, we continue to face headwinds.

Particularly on labor and materials and to a lesser extent, land.

But sequentially, those trends have been getting better.

Which is what you have seen in the stability in our gross margin sequentially as we have moved throughout this year.

So our GAAP between our revenue increase per square foot and our cost increase per square foot, this quarter, was the best we have seen in quite some time.

Our revenues per square foot were up 4.1% year-over-year, while our stick and brick costs were still slightly higher than that but at a 5.3%.

So that 120 BPs difference is one of the narrowest readings we have had over the last year, year and a half.

And to a lesser extent, as expected, we are starting to see on a year-over-year basis, slightly higher land costs on a per square footage basis as well.

But I think we feel really good about that moving into 2016, especially with the trends we have seen sequentially, and hopefully we can see a benefit next year.

It is only July.

So we are not going to go out on a whole lot of limbs yet, as far as gross margin is concerned in 2016, but we feel very good about it remaining stable.

And if we can move it up, we are going to move it up.

Great, thank you.

Thank you.

Our next question today is coming from Mike Dahl from Credit Suisse.

Please proceed with your question.

Hi, thank you.

A couple of followup questions.

First, on the discussion around Houston, I wanted to ask if you could give a little more of a breakdown on what you are seeing across price points?

Obviously some other builders have talked about some weakness at the higher end or mid to high end.

So what are you seeing across the different brands.

Is this really still being driven by Express?

And then also, if the overall orders are flat, what is the community count like in Houston year-over-year?

Our community count is roughly similar to what it would have been a year ago.

I think in general, we have heard commentary from other builders as well.

We don't have a huge presence at the high end.

We have a few communities at the higher end in Houston and so I am not sure where a good proxy necessarily there.

But we have clearly continued to see very strong reception at the entry level and first time move up level in our core Express and Horton brands.

And that's is really where the core of our business is in Houston and holding up relatively well.

We are very happy with Houston.

On a positive note then, some pretty strong trends in the southwest and wondering how much of that is being driven by Phoenix or Vegas and what is the absorption trends in those markets specifically?

Mike, what we are seeing out there, pretty much Arizona, Phoenix is picking up a little bit, seeing some good sales trends there, but it is coming off a pretty small base.

So it shows as a large percentage, but the prior year numbers were fairly small.

Las Vegas is actually in our west region, so it is not impacting our southwest numbers at all.

Got it.

I will say Phoenix for us has been a very good market in the past.

One of the leading in the Company and I have every belief that it will be again.

We are seeing life in Phoenix and glad to see it.

Thanks.

Thank you.

Our next question today is coming from Michael Rehaut from JPMorgan.

Please proceed with your question.

Hi, thanks.

Good morning, everyone and nice quarter.

The first question I had was just going back to the SG&A for a moment.

Obviously great improvement there and better than expected.

It looks like the full-year will be around 9.6% instead of 9.9% to 10.2%, your previous guidance.

Just trying to get a sense of perhaps what are the drivers of that leverage, or was there any type of cost take-outs that you were able to exact as you moved into the back half of the year?

And again, just confirming in terms of 2016, the pre-tax margin improvement all effectively, at this point, you expect it to be driven by SG&A as well?

SG&A will definitely be a big part of the driver of the improvement in our operating margin next year, probably the primary driver, at least as we sit here today in July.

SG&A, there is a lot of factors that go in there and it's a lot of focus that we spend in the Company on it.

As we talked a little bit earlier with our improved absorptions in our existing communities.

That is clearly a driver of SG&A leverage, as we are not having to add the incremental costs with additional community counts.

But also, I would attribute some of our focus on being more efficient with our inventory investments.

And our housing investments, trying to improve our turns there, that clearly drives more SG&A leverage.

You will see our speck counts are a little bit lower than where they have been here recently and that cuts out some SG&A costs as well.

And I would say there is just a general focus on the Company, that as we grow, while we continue to have to continue to add overhead to support that growth and our expected growth, there is a discipline that I think is in place across our organization to make sure that we keep our overhead in line with where our business is and that we don't get ahead of ourselves there.

There is probably a bit of caution with adding of additional overhead that I think we are now seeing some very good leverage from as we grow our volume.

Just looking a little bit past next year, when you think about you're at 9.6% this year.

If most of the improvement is going to be driven by SG&A next year, because I believe, correct me if I'm wrong, but David, I think you pointed to an outlook, or expectation for gross margins to be flattish.

That would put you at an SG&A closer to 9%, and that is essentially the best type of level you did in Company history.

You hit it, low 9% in 2004 and 2005.

And so as you think around that 9% mark, is that something that you can actually improve from?

And what I am really getting at here, is there structural difference in how you are running the business that can allow for SG&A to get into the 8% as you progress into mid cycle?

Or just any thoughts around that?

Mike, at this point, in July, we are not going to be guiding to a 9% SG&A in fiscal 2016, as of yet.

But clearly, if we expect to improve from where we are this year, we would expect to get below 9.5% and into the low 9% next year.

And we have achieved 9%, before in the past, so it is not out of the realm of possibility.

We are focused on just continuing to incrementally improve, incrementally leverage it.

And we do believe that if we are able to continue to drive growth for multiple years beyond 2016, that we can continue to drive incremental SG&A leverage beyond that.

Could that result in us getting below 9% at some point in the future beyond 2016?

That is certainly possible.

But I think that is a little bit of a longer potential.

And our 10.5% to 11% that we guided to for 2016 was a consolidated margin.

So we could potentially have some upside on our financial services business as well.

We will see as we move throughout the year and we will have more color to share.

Okay.

So just lastly then, if I am understanding it right, a little bit of the improvement, you are expecting from gross margin expansion?

Or is it going to be closer to more stableish?

We have operated this year in the high 19%, 19.7% to 19.9% have been our first three quarters.

We consistently say we expect our margin to be around 20%.

So if we come in around 20% next year, that would be a slight improvement in our gross margin from this year.

All right.

Thanks, guys.

Thank you.

Our next question today is coming from Susan Maklari from UBS.

Please proceed with your question.

Good morning.

Good morning.

In terms of your specs, you noted that they were down about 12% during this quarter.

Can you talk a little bit about how you're thinking about that, given it is such a big part of your strategy and if there is any change there that we should be aware of?

We saw our completed specs go down by 12% during the quarter, which is a pretty seasonal movement for us through the spring selling season as we are selling those homes that we built and have inventory available for our customers.

But specs as you said, are always have been a big part of our business.

We are very comfortable building speculative homes and we think it opens up a new buyer to us that we wouldn't have if we're just building homes for the customers.

No real change in our strategy there.

We are trying to operate as efficiently as we can.

And so, our spec percentage is a little lower than perhaps you've seen at times in the past but really there is no change in strategy at all.

Okay.

Perfect.

Can you just give us an update on what you are seeing in terms of the mortgage markets?

It sounds like things are continuing to maybe incrementally improve there but what do you think?

Probably exactly what you just said, Sue.

To us, the mortgage environment is okay.

Assuming a buyer has decent credit and has a little bit of money to put down, which isn't unreasonable for somebody buying a house, buyers can get credit today.

So we are seeing plenty of traffic come in that can qualify.

Our cancellation rate has settled out into the low 20s.

And that is still the main reason people do cancel is they can't qualify for the mortgage.

But that low 20s rate is not unusually high or something we are uncomfortable with.

And we haven't seen much in the way of change but I do think you continue to just see very gradual incremental loosening that probably at least all signs point right now that will continue.

I don't think we expect any broad movements in the market to really open the flood gates again.

But just continued improvement and confidence and more buyers coming out and feeling better about their ability to qualify.

Whether the standards have actually changed or not, I think we would point to as more of a positive over the past year, than the actual mortgage standards themselves.

Thank you.

Our next question is comes from Jack Micenko from SIG.

Please proceed with your question.

Hi, good morning.

Your FHA VA mix picked up pretty significantly year to year.

Is that price cut driven or is that more some of the expansion you see in the VA side?

Just curious what is driving that?

Yes, Jack, it is not a pickup on the VA side.

Our VA was pretty much flat.

So I think what you are seeing is an impact from the pricing getting more favorable on FHA, coupled with a higher share of Express coming through our closings, which is a higher FHA percentage than our Horton and Emerald buyers.

Okay.

And then just looking back, I guess the last couple of months, has the 97 GSE return had any impact on demand in your view?

No.

Okay, great.

Thank you.

Thank you.

Our next question today is coming from Jade Rahmani from KBW.

Please proceed with your question.

Thanks for taking my question.

I wanted to first see if you could provide a comment on the land market, what you are seeing overall and where there is still good opportunities to invest?

I would say, yes, we are still seeing good opportunities overall.

I mean even replacing what we have just -- just replacing what we use, we are going to spend $2 billion plus this year.

We are disciplined.

We are basically underwriting it to a two year cash back program.

Generating a certain level of return, that 20% return.

And if we can fit it in that box, then it is a buy for us.

I can tell you, we are seeing deals, we are getting them done.

No shortage of deals out there available.

Okay.

And then just regarding the SG&A outlook, in terms of employee retention and sustaining the growth rate and top line, what do you see as the risk of having to reaccelerate the amount of dollars in SG&A spend?

The SG&A savings are being driven by revenue increases and efficiencies gained in the operation.

This is not a cut employee program.

In fact, some of our highest paid people are in some of our lowest SG&A divisions and it is because of the revenue driven and the efficiencies they operate with.

It really comes down to driving sales per flag per month.

And if you look at our 8,000 additional closings this year on a relatively flat community count at 290,000 per ASP, per average sales price, that is grabbing a tremendous amount of revenue out of the same store sells.

This is not a -- this model is protecting employees, not putting them at risk.

Thanks.

Appreciate the color.

Thank you.

Our next question today is coming from Will Randow from Citigroup.

Please proceed with your question.

Good morning and thanks for taking my question.

Thank you.

Just kind of thinking about, in the past, you have talked about return on inventory.

Your lot supply is down.

I will call it close to a little under 4 years supply looking forward to the fourth quarter.

And it looks like inventory growth is slowing down, especially with land held for development coming off the balance sheet.

What are the opportunities to improve returns on assets, as well as how do you think about leverage in that context for ROE?

Will, this is Bill.

Return is clearly the focus of our end charge strategy.

It's balancing our inventory investments and trying to get the right balance of volume and absorptions compared to pricing and margins profitability to drive the best return on each one of our inventory investments.

And we have been saying for a while, we felt like our land supply was at a sufficient level, our owned land supply was efficient.

So we are maintaining that at around the same level.

We own about 120,000 lots today and we have been essentially in the range of 120,000 to 125,000 or so for two years.

That is still a sufficient level for our current volume and we expect it will support continued strong double digit growth through the remainder of 2015 and into 2016.

And with that growth and improvement in profitability with a more stable land supply, that is improving our returns.

And we expect to continue to drive some more from that.

If you look at our home building ROI on our trailing 12 months, it is actually up 100 basis points as compared to FY14, and we would expect to continue to make further progress on that in Q4 in FY16.

And I guess as a followup, is the land banking markup their excuse to run 50/50, I will call it controlled versus owned, in order to improve ROI?

And also on the leverage front, do you think about, you should be running closer to a group medium leverage to hit a group arc total a little bit better ROE?

With regard to your first question on the optioning of land and lots, we are working continually to increase our controlled lot position and trying to get back more to the 50/50 balance.

That is exactly where we have been in the past and that's where we're striving to get to today.

That helps us greatly with the return on our invested inventory.

With regard to the ROE, as Bill mentioned before, our initial uses of cash that we are looking for in 2016 are handling over the $540 million of debt maturities that we have next year, as well as continual opportunistic investments in the business.

Whether that is land and lots deal by deal or whether that is continued acquisitions as we look to consolidate markets and open up new products and new customers to us.

We've got great opportunities in front of us with the cash flow and we are always monitoring the leverage ratio and looking at what we feel is appropriate for where we are in the given cycle and the opportunities that are there.

Thanks, guys and congrats on the quarter.

Thanks.

The next question today is coming from Mark Weintraub from Buckingham Research.

Please proceed with your question.

Thank you.

A bit of a bigger picture question I guess.

And that is we have seen multifamily as a bigger percentage of total starts for awhile now and I am curious whether you see that as secular or cyclical?

How is it all it might be impacting you in some of your markets even if indirectly presumably and whether it informs at all any of your medium to longer-term decision making?

Multifamily is something that we look at where the demand is in each market and we build some multifamily.

It is not a big percentage of our business at all.

And we really look at that market by market.

I don't see that being a major driver of our business going forward but in certain markets, it is certainly a bigger percentage of the business.

When you think about growth for the single family business, are you of the view that we are going to catch back up to prior compositions between multi and single family, which would presumably, you have this extra engine of growth from that change in mix?

Or are you of the view that we are probably going to stay at these higher levels of multifamily for a while at a national level, recognizing that you have your own individual markets that are obviously heavy single family.

Mark, I'm not sure we really have a view.

Our focus is primarily on single family and we are not too worried about where that split is going to fall out going forward.

Our goal every day is to go out and increase our market share in each of the markets we currently operate in.

And so we are going to gain as much of the single family market as we can.

Thank you.

Our next question today is coming from Alex Barron from Housing Research Center.

Please proceed with your question.

Good morning, guys.

Good job on the quarter.

Wanted to ask about the outlook for 2016, as far as community count.

Are you guys seeing one of the brands growing more than the other?

Or are all they -- is your outlook pretty much the same across the board?

In other words, are you seeing more demand or more investment going into the Express versus the other brands or not?

No, not really pushing money toward a brand.

We are allocating money based upon the returns coming out of the markets and then coming out of the underwriting individual projects.

As we continue to open the Express brand and markets, then it is growing off a slower platform, so it is going to show percentage higher growth.

But our goal is to grow every brand, every market, every year.

Okay.

I don't know if I missed it or you didn't mention it, but you gave us the percentage of homes sold for Express.

But I don't think you gave it for Emerald.

You just said closings and revenues.

Sorry, Alex, we are looking for that.

That is going to be included in our supplementary data that we will post to the website right after this call.

Is that just for this quarter or are you going to go back a few quarters also?

Our supplementary data that is out on our Investor Relations website has trailing eight quarters from it's all of the data.

It may only have one or two shy of that for the brands just because the brands are newer than that.

But it pretty much has our entire history from a brand perspective.

Okay, great.

Thank you.

Our finale question today is coming from Buck Horne from Raymond James and Associates.

Please proceed with your question.

Thanks, guys.

I appreciate the opportunity here.

Most of my questions are answered but I want to go back to just a clarification on Pacific Ridge, the acquisition there.

Did any of the reported order totals this quarter include Pacific Ridge backlog?

And would you expect any purchase accounting drag from the acquisition this quarter?

It was a relatively small acquisition to the size of our overall closings.

I would not expect a big purchase accounting drag from Pacific Ridge at all.

It contributed -- we had 40 closings, 41 closings in the quarter from Pacific Ridge.

Largely that would have come out of the opening backlog.

And then 25 net new sales within the quarter from Pacific Ridge.

But we do not add their backlog to our reported sales for the quarter.

So our sales number for the quarter was pure Horton with our other brands inclusive of the 25 sales that Mike just mentioned.

That's perfect.

Okay.

And my last question, just going back to the Express Homes division and I think one thing we are trying to wrestle with is, what is the credit profile of that buyer today in terms of whether it is a FICO score or the average down payment they are able to put down on the home?

New home sales under that $200,000 price point are still kind of, looking at the national numbers, still the weakest of all of the categories but yet, you guys are taking an incredible amount of share there.

I am just wondering to what extent you can share either the secret sauce or how deep you think that buyer pool really is?

Sure.

In terms of the mortgages, I can give you some idea of what that looks like for those buyers that are utilizing our mortgage company and the FICO score is really quite strong as well.

It is close to 700 on average for our Express buyers.

The loan to value is not that far off from our company average.

It is slightly higher.

Which is to be expected with a higher percentage of FHA loans being used.

The debt to income is right in line with the average for our overall company.

And then obviously, the loan amount is a little bit lower just because of the lower average sales price.

I think we feel really really good about the depth in the market for that buyer and continue to prove it with the strength in the sales we're seeing across all of the places we have opened that.

Thank you very much.

Thank you.

Thanks, Buck.

Thank you.

That does conclude our question-and-answer session.

I would like to turn the floor back over to management for any further or closing comments.

Thank you, Kevin.

We just want everybody to know we appreciate your time on the call today.

I want to tell our employees that they are in fact the best in the industry.

Appreciate what you do every day.

Thank you.

Thank you.

That does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.

We thank you for your participation today.