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Operator
Greetings, and welcome to the second quarter 2016 earnings conference call of D.R. Horton, America's builder, the largest builder in the United States. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation.
(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 Hansen - VP of IR
Thank you Kevin, and good morning. Welcome to our call to discuss our results for the second quarter of FY16.
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 next week.
After the conclusion of the call we will post updated supplementary historical data to our investor relations site on the presentation sections under News and Events for your reference. The supplementary information includes historical data on our homebuilding return on inventory, 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.
David Auld - President & CEO
Thank you Jessica, and good morning. In addition to Jessica, I'm pleased to be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer, and Bill Wheat, our Executive Vice President and Chief Financial Officer. The spring selling season at D.R. Horton is in full swing, and our team delivered a strong second quarter.
Our consolidated pre-tax income increased to $301 million on $2.8 billion of revenue, and our pre-tax profit margin improved 130 basis points to 10.9%. Our homes sold increased 10% compared to the second quarter of 2015, driven by improving absorptions. These results continue to reflect the consistent solid performance of our core D.R. Horton communities, and our Emerald Homes and Express Homes brands.
We are striving to be the leading builder in each of our markets and to continue to expand our industry-leading market shares. We plan to maintain broad product diversity with our three brands over the long-term. Our continued strategic focus is to produce double-digit annual growth in both our revenue and pre-tax profits while generating positive cash flows and increasing returns. During the six months ended March, we generated $27 million cash from operations. On track to meet our target of $300 million to $500 million of positive cash flows for the year. Our return on inventory, defined as homebuilding pre-tax income divided by average inventory, improved to 13.8% for the 12 months, up from 10.7% a year ago. With a sales backlog of 13,695 homes at the end of March and a well-stocked supply of land, lots, and homes, we are well-positioned for the remainder of 2016. Mike?
Mike Murray - EVP and COO
Net income for the second quarter increased 32% to $195 million, or $0.52 per diluted share compared to $148 million or $0.40 per diluted share in the year-ago quarter. Our consolidated pre-tax income increased 31% to $301 million to in the second quarter, compared to $230 million in the year-ago quarter, and homebuilding pre-tax income increased 36% to $283 million compared to $209 million in the prior year quarter. Our second quarter home sales revenues increased 16% to $2.7 billion on 9,262 homes closed, up from $2.3 billion on 8,243 homes closed in the year-ago quarter. Our average closing price for the quarter was $290,000, up 3% compared to the prior year, and flat sequentially from our first quarter.
This quarter entry-level homes marketed under our Express Homes brand accounted for 23% of homes closed and 16% of home sales revenue. Our homes for higher-end move-up and luxury buyers, priced greater than $500,000, accounted for 7% of our homes closed and 17% of our home sales revenue. Bill?
Bill Wheat - EVP, CFO
The value of our net sales orders in the second quarter increased 13% from the year-ago quarter to $3.6 billion, and homes sold increased 10% to 12,292 homes on a relatively flat, active selling community count. Our average sales price on net sales orders in the second quarter was $290,900. The cancellation rate from the second quarter was 19%, consistent with the year-ago quarter. The value of our backlog increased 14% from a year ago, to $4.1 billion, with an average sales price per home of $296,700, and homes in backlog increased 12% to 13,695 homes. Mike?
Mike Murray - EVP and COO
Our gross profit margin on home sales revenue in the second quarter was 19.9%, consistent with the first quarter and up 20 basis points from the second quarter of last year. The consistency in our gross margin reflects the stability of most of our markets today. We are raising prices or reducing incentives when possible in communities where we are achieving our targeted absorptions, and we are also working to control cost increases. Our general gross margin expectations remain unchanged.
In the current housing market we continue to expect our average home sales gross margin to generally be around 20%, with quarterly fluctuations that may range from 19% to 21% due to product and geographic mix and the relative impact of warranty and interest costs. As a reminder, our reported gross margins include all of our interest costs. David?
David Auld - President & CEO
In the second quarter, homebuilding SG&A expense was $258 million compared to $242 million in the prior-year quarter. As a percentage of homebuilding revenue, SG&A improved 80 basis points to 9.6% compared to 10.4% in the prior-year quarter as our revenue increase improved our leverage of fixed overhead cost. We remained focused on controlling our SG&A while ensuring that our infrastructure adequately supports our current and expected growth. Jessica?
Jessica Hansen - VP of IR
Financial services pre-tax income in the second quarter was $17.4 million compared to $21.5 million in the year-ago quarter. 94% 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 53% of our home buyers.
FHA and V.A. loans accounted for 48% of the mortgage Company's volume, compared to 45% in the year-ago quarter. Borrowers originating loans with our mortgage Company this quarter had an average FICO score of 717, and an average loan to value ratio of 88%. First-time home buyers represented 45% of the closings handled by our mortgage Company, compared to 43% in the second quarter last year. Bill?
Bill Wheat - EVP, CFO
At the end of March, we had 24,600 homes in inventory, of which 1,600 were models. 11,700 of our total homes were spec homes with 8,400 in various stages of construction and 3,300 completed. Our construction-in-progress and finished homes inventory increased by $361 million during the quarter, due to seasonal construction activity for the spring selling season. Our second quarter investments in lots, land, and development totaled $500 million, of which $271 million was to replenish finish lots and land, and $229 million was for land development. We expect our investments in land and development to increase in the third and fourth quarters compared to the second quarter this year. David?
David Auld - President & CEO
At March 31, 2016, our land and lot portfolio consisted of 189,000 lots, of which 112,000 are owned, and 77,000 are controlled through option contracts. 69,000 of our total lots are finished, of which 31,000 are owned and 38,000 are optioned. Our 189,000 total lots owned and controlled provide us a strong competitive advantage in the current housing market, with a sufficient lot supply to support solid growth at 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 in 2016. We also expect to generate positive cash flows from operations for the second consecutive year, through increased profitability and disciplined inventory management. During the six months ended March, we generated $27 million of operating cash, an improvement of $196 million compared to the same period last year. Bill?
Bill Wheat - EVP, CFO
During the second quarter, we recorded $2.8 million in land option charges for write-offs of earnest money deposits and his due-diligence costs for projects that we do not intend to pursue. We also recorded a $3.2 million inventory impairment charge in our East Region related to a long-held inactive land parcel that we sold during the quarter. We will continue to evaluate our inventories for potential impairment which may result in future charges but the timing and magnitude of these charges will fluctuate. Our inactive land held for development of $194 million at the end of the quarter represents 10,100 lots, down 22% from a year ago. We continue to work through each of our remaining inactive land parcels to improve cash flows and returns, and we expect that our land held for development will continue to decline. Mike?
Mike Murray - EVP and COO
At March 31, our homebuilding liquidity included $1.2 billion of unrestricted homebuilding cash, and $884 million of available capacity on a revolving credit facility. Our gross homebuilding leverage ratio improved 580 basis points from a year ago to 33.6%. The balance of our public notes outstanding at March 31 was $3.2 billion. On April 15, we repaid $373 million of senior notes at their maturity, and we have no debt maturities in the next 12 months. At March 31 is our shareholders' equity was $6.2 billion, and book value per share was $16.85, up 14% from a year ago. Jessica?
Jessica Hansen - VP of IR
We are updating our expectations for our FY16 profitability based on current housing market conditions and our financial performance to-date this year. As we noted in our press release this morning, we are increasing our annual guidance for consolidated pre-tax profit margins by 20 basis points to a range of 10.7% to 11.2% for FY16.
We are also updating our annual guidance for homebuilding SG&A to a range of 9% to 9.2% of homebuilding revenues from the previous range of 9.2% to 9.4%. Also as outlined in our press release this morning, we are reaffirming our previously issued outside guidance for 2016 as follows.
Consolidated revenues of between $12 million and $12.5 billion. Homes closed between 39,500 and 41,500 homes. A home sales gross margin for the full year of 2016 in the high 19%s to 20%, and annual financial services pre-tax profit margin of 30% to 33%. An income tax rate for the full year of between 35% and 36%. And annual diluted share count of approximately 375 million shares and $300 million to $500 million of positive cash flow from operations for FY16.
Specifically, for the third quarter of FY16, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 76% to 80%. We anticipate our third quarter home sales gross margin will be in the high 19%s to 20% consistent with the first half of the year, and we expect our SG&A in the third quarter to be in the range of 8.9% to 9.1% of homebuilding revenues. David?
David Auld - President & CEO
In closing, our second quarter growth in sales, closings, and profits, and the improvement in our pre-tax profit margin are the result of the strength of our people and our operating platform. We remain excited and are looking forward to the opportunities ahead. We remain focused on growing both our revenue and pre-tax profits at a double-digit annual pace, while continuing generate positive cash flows, and improved returns. We are well-positioned to do so with our solid balance sheet, industry-leading market share, broad geographic footprint, diversified product offerings across our D.R. Horton, Emerald, and Express brands, attractive finished lot and land position, and most importantly, our tremendous team across the country.
We would like to thank our entire D.R. Horton team for their continued hard work, and we look forward to working together to continue growing and improving our operation. Let's keep the momentum going week by week, flag by flag, throughout this year.
This concludes our prepared remarks. We will now hold questions.
David Auld - President & CEO
Thank you, I will be conducting your question and answer session.
(Operator Instructions)
Steven East from Evercore ISI.
Paul Przybylski - Analyst
Thank you this is actually Paul Przybylski on for Steven. You know, impressed with the first half cash flow generation given, but that is typically you know a period of heavy spend. What is the sustainability of that, going out? I know you are looking for the $300 million to $500 million for the year, but should we expect first half cash generation in out years?
Bill Wheat - EVP, CFO
You know that is hard to say in future years Paul. For this year we are on track based on our current plans for FY16 to generate $300 million to $500 million for the full year. We would not be surprised if in Q3 we used cash because we are building out our backlog, building out our homes in construction, and as we stated we do expect our land and lot inventory -- investments to be higher in Q3 and Q4 than it was in this quarter. But we are on track for $300 million to $500 million.
Our expectations for future years is, our business model is designed to continue to generate positive cash flows from operations while growing at a double-digit pace. At exactly what level that might be in each year, we'll determine as we get better visibility into the year.
Paul Przybylski - Analyst
Okay and then for follow-up. I have heard rumblings that you know, you are looking at expanding not so much the Express name but the Express business model to higher price points? You know basically, everything's included. Do you have any color on that?
David Auld - President & CEO
Well you know, we are learning a lot with the Express rollout, that efficiency and value is a big-time driver in sales. And yes, I mean, as we create operational efficiencies in Express that translate into the D.R. Horton, we are moving that way.
Now we will always be a locally controlled business. We are decentralized. Our operators in the field will respond to the market. And if it is a value-based market, they are going to have to drive more efficient homes. If it is a - you know, a custom-based price point, then we are going to continue to modify plans and introduce plans at the local level.
Paul Przybylski - Analyst
Thank you. Appreciate it.
Operator
Next question is coming from Ken Zener with Keybanc.
Kenneth Zener - Analyst
Good morning. I wonder, not to get too specific in particular markets, but it is useful to the Express home where I think you guys have opened up five or six new Express communities. Can you talk about the kind of trends you are seeing in Denver? As the existing home sales tighten up there either due to lack of supply, I mean you guys seem to be growing whereas others are not seeing that type of acceleration. Could you give us a little market dynamic on how that product in that market is working?
Mike Murray - EVP and COO
I think we opened up Express in Denver over the past year. The team up there has done a great job getting that online. It shows that there is a real need for affordable housing in that market, and we are delivering a value product to the market, and it's being absorbed and people are very happy with it. We are very happy we can do it and looking forward to try to do more of it.
David Auld - President & CEO
And Ken, it is kind of consistent with what we've seen in other markets. A lot of pent-up demand when we open. Absorptions have come up higher than we expected. It is a powerful tool in what we are accomplishing.
Jessica Hansen - VP of IR
(Multiple speakers) Sorry Ken. We are in 51 markets and 17 states today. We are continuing to see that expansion as we move throughout the year.
Kenneth Zener - Analyst
Right, and then I guess relative to the idea of pace. The idea of pace and price, I'm not a big fan of that notion. But are you constraining your pace? Or are you really accepting as many sales as will walk in the door? Can you describe that dynamic, broadly speaking? Thank you.
David Auld - President & CEO
You know Ken, we have been trying and successfully setting absorption targets on communities based upon what we think is a sustainable demand in that sub-market. And we are building and selling to that pace.
Operator
Alan Ratner from Zelman & Associates.
Alan Ratner - Analyst
Good morning, congratulations on another strong quarter. David, you know, I guess on the price point conversation obviously you guys have done a great job with the Express and I think that at least in the investment community there is this perception that entry level is accelerating nicely whereas maybe the higher-end luxury segment is seeing some softness. You guys have been expanding Emerald as well. I don't think it is as much of a topic of conversation, but I was wondering if you could give some updated color on the luxury and how that compares to the -- obviously the strength you have been seeing in Express and how you think about allocating dollars going forward between the segments?
David Auld - President & CEO
Well from an allocation of dollars, you know, it is a market by market program. The markets where the upper end is continuing to stay strong, we will be putting more money in it. But what's really driving the growth right now, and the improvement in returns, is the lower end, either Express or the lower Horton price points.
Alan Ratner - Analyst
And would that be true on the margin side as well? Obviously I think you probably go into it thinking that Express is going to generate a lower margin, but seems like the pricing power has been stronger there. What does the spread look like between the Emerald and the Express brands right now?
Bill Wheat - EVP, CFO
Right now it is in a pretty tight range. Both are very near our Company average. Obviously with the pent-up demand in Express and really not enough supply out there, we've seen better margins that we originally underwrote the deals to. Right now it is in a pretty tight range.
Alan Ratner - Analyst
Great thanks a lot. If I could sneak in one more on the land supply, a pretty big spike in option lots this quarter, if I heard that number correctly, and I think you are looking at over 40% control lots are optioned right now. Curious what you are seeing in the land market, if that is allowing you to pursue that strategy? Obviously it ties into your focus on cash generation. Is that a function of more AD&C capital available to the developers or something else you have been focusing on to drive that number higher?
Mike Murray - EVP and COO
I think we have been focusing heavily on developer relationships and working with them where we can. There is also a little bit of a timing functionality to that, in that it can be very high in the middle of a quarter, come down a little bit as you are buying land or lots through the quarter and at this quarter end we had a little bit more than we might have at prior quarter ends. But it has been a focus for us. We are pleased with the results we are getting in being able to control more of our future lot supply with options, and with developers. We are going to continue to focus on that. You are right, it is a key part of our cash generation strategy, and we are very excited about the results we have seen.
David Auld - President & CEO
But, no, we are not really seeing the A&D environment with the banks improve much. This is really the result of taking the very best of the best developers and trying to improve our relationships with them.
Alan Ratner - Analyst
Got it. Thanks a lot and good luck.
Operator
Thank you. Eric Bosshard, Cleveland Research Company.
Eric Bosshard - Analyst
Curious about the strategy moving forward of growing community counts, and then also looking at your growth relative to the market in total. Last year you grew faster than the market, really rolling out Express. But as you look at where demand is and where trends are in the market, just curious about how you think about investing in growing communities and accelerating growth, how you are feeling about that?
David Auld - President & CEO
Well, you know, we are in 51 markets right now with express. So we have, I think, runway there. We are relatively new with the Express brand in another 15, 20 markets that we think we can certainly gain market share in those markets. I mean, we're pretty much tracking job growth, and where the economy is supporting housing, that's where we're looking to expand our investments.
Eric Bosshard - Analyst
In terms of the pace of the overall growth, are you satisfied with what you are seeing? Is there a desire to invest more to grow faster? Or is this kind of what you are targeting and what you would like to sustain?
David Auld - President & CEO
You know, we think a solid, consistent double-digit growth both top-line, bottom-line, will continue to create separation from other builders in the industry. And today we are very happy with that strategy.
Jessica Hansen - VP of IR
And we believe our current lot position is sufficient to support that double-digit growth pace.
Eric Bosshard - Analyst
Okay. Perfect, thank you.
Operator
Nishu Sood from Deutsche Bank.
Nishu Sood - Analyst
Thank you. This quarter you had a terrific SG&A performance, and so just a market improvement, just on trend, and over last year. Your gross margins have also been very consistent. You are only taking up your pre-tax range by about 20 basis points, so just wanted to make sure I understood that. Does that mean that there were some temporary factors that may have depressed SG&A? What -- why would you expect seemingly terrific performance to reverse? Or is it something on gross margin side for the rest of the year?
Bill Wheat - EVP, CFO
Nishu, we didn't see anything unusual this quarter. We did deliver a strong backlog conversion. We delivered a little bit above our guidance range on out closings this quarter and that helped leverage our SG&A a bit further. But we were very pleased with the leverage we saw on SG&A.
We are tracking to a better pace, a better ratio for the year than we had originally guided to. We were guiding to some improvement in SG&A. Now we've simply -- showing better improvement on that. And certainly as we get further into the year, and depending on what our deliveries are later in the year, there is potential, we could leverage it a bit better than what we have guided to here. If we were to be at the high-end of our volume range, then perhaps we have a chance of beating the low end of our leverage range, our SG&A leverage range.
But right now we are comfortable with the range we guided to. Nothing unusual, no declining or degradation in our SG&A performance is expected.
Nishu Sood - Analyst
Got it. Got it. And kind of following up on Allen's question from earlier, you folks, as well as many of the other builders, have been scaling back land purchases. Allen discussed obviously the increased use of options. I was just wondering with the step back that many of the builders, including yourselves, have taken, have you seen pricing ease? You know, the options would argue that it is a little bit easier to get you know, terms -- like option take-downs. But what are you seeing in terms of the availability and pricing of deals as the stepping back of the public ease the land price pressures that have been discussed so much in the last couple of years?
Mike Murray - EVP and COO
Nishu, we are looking to continue our land investment. In fact, we'll be increasing our investment this year from what we did last year, just to replenish lots and then probably a little more. To bring it up a little bit. We did see an increase in our option lot position in the control pipeline. Some of that will be land we will purchase. That's represented as option lots today, that's land that is controlled under contracts that we will purchase as land and do the development ourselves.
Other contracts within that portfolio would be where we will be acquiring finished lots, or super pads if you will, in some cases, from third party developers. But we feel that there are still very good opportunities out there for land acquisition for well-capitalized builders and for well-capitalized developers to work through. It is hard to quantitatively look and say what's happening with land pricing globally. I would tell that it seems like we are getting anecdotally a second look at a few more deals, some things seem to come back around, which is good for us. We like that.
Nishu Sood - Analyst
Great thanks. Appreciate the color.
Operator
Thank you. Stephen Kim from Barclays.
Stephen Kim - Analyst
Thanks very much, guys. Let me add my congratulations on a strong quarter, and just a remark that your SG&A, if you actually do do a little better in your range, I think if I'm not mistaken, that's an all-time record for the Company, so that is pretty encouraging.
I guess my first question relates to M&A and the opportunity for it. You know, obviously there's been, and there still is, a pretty big disparity in valuations between the large and the small builders, and you all are pretty much leading the pack. I guess my question is, do you see this kind of disparity mirrored in the private market? And you know, particularly where some of the smaller cap publics are trading at book value or below. Are you seeing that kind of valuation mirrored in the private market in expectations? And can you talk about whether or not you think this generally is the right time, or you would be amenable to acquiring assets in that kind of way, M&A? Given the fact your strategic focus is on reducing your land investment relative to your revenues right now? Thanks.
Mike Murray - EVP and COO
We are, you are correct Steven. We do have a strategic focus to improve our ratio of revenues to our land investment today. Always looking to do that, that makes us a better steward of the capital we are entrusted with.
We do look at M&A as an opportunity to acquire lots, acquire assets, and acquire people in operating platforms and teams, and we do look at several opportunities. They can be very good if buyer and seller expectations are aligned and something can work that's accretive to both. So we will always be looking at M&A opportunities to grow the business. But there's a lot of expectation gaps sometimes between what some people think what their flat form should fetch and what the buyers are willing to actually transact for. So there's not been as many transactions, I think, as some people expected to occur.
David Auld - President & CEO
Steven, this is David. I'll also add, we are going to look at a lot. You know, anybody out there, we are going to take a look at. And try to see if they fit, culturally. Strategically, within our Company. But it's got to be a very good Company for it to make sense to us. We are -- we like where we are, we like what we are accomplishing, and we really don't want to jump out there and do anything that's going to break that focus.
Stephen Kim - Analyst
Okay fair enough. Yes. Good luck finding another Company as strong as you guys are though.
David Auld - President & CEO
Well they are there. They're there. There are some small operators, or even mid-sized operators, that are doing a great job. If you look back at the four acquisitions we've made, we have learned and become better with every one of those.
Stephen Kim - Analyst
Sure. Yes that's a fair comment.
David Auld - President & CEO
We take what they are doing and integrate it into our Company.
Stephen Kim - Analyst
Great. I guess my second question relates to the role of master planned communities, and some of the opportunities that those larger parcels provide -- could potentially provide for you. I was wondering if you could give us some handle on what percent of your business you think is coming from master planned communities today and where you think that could go to? And as a follow on to that, would you generally think that, in some of these larger parcels, you have the ability to maybe take on a little bit of multi-family construction? Or even, like, commercial opportunities longer-term?
David Auld - President & CEO
The master plans I would say is probably 10%, 15% of our business, and that's just a guess really. It is not something we have broken down. And yes, I think as we get bigger or continue to get bigger, that percentage is going to grow. It's just a lot more efficient to deliver more houses out of one location than it is multiple locations.
Jessica Hansen - VP of IR
And then, Steve, as you know, we always investigate new business lines if they could complement our business. So we have built for-rent on land we own on a limited basis when it makes business sense, and we do currently own a few large projects with parcels that are zoned multi-family that we are evaluating or are in the process of building apartments on. But we wouldn't expect that to have any financial impact on our 2016 results.
Stephen Kim - Analyst
Fair enough thanks very much guys. Good job. Thank you.
Operator
Bob Wetenhall from RBC.
Bob Wetenhall - Analyst
You guys are crushing it. Nice job.
Jessica Hansen - VP of IR
Thanks Bob.
Bob Wetenhall - Analyst
That is a technical term. Talk to me about ASP appreciation during the balance of the year. How do you think that plays out? What kind of growth rates, you know, should we be expecting? And I'm really trying to think about this in the context of not including mix. If you took like for like and blend it together, what do you see going on in the next couple quarters?
Jessica Hansen - VP of IR
We would expect to continue to see, if you are looking like for like, some ability to move price up. We've continued to see our revenues per square foot outpace our stick and brick per square foot now, once we got that back in check a couple of quarters ago. Very positive on that front and definitely still the ability to push price. In terms though of our overall ASP, we did see on our sales front that really kind of flatten out sequentially. Which isn't surprising because of the heavier mix that continues to come from Express.
Bob Wetenhall - Analyst
Got it. But you are still getting the operating leverage off that which offsets the weaker mix. But you if you had to say, on a like for like basis, would you expect low single-digit or mid-single-digit?
Jessica Hansen - VP of IR
Yes low single digits.
Bob Wetenhall - Analyst
All right, that's helpful. And then just kind of thinking about, like, Texas and California, you know, some of your major markets where you are a leader. Would you say that the trends you saw this quarter were in line with your expectations a couple of months ago? Or would you say that in your core most important markets, that demand is stronger and better than you had anticipated? I'm just trying to understand a little bit better. If you are gauging strength of demand in your most important markets, is it coming out ahead of your expectations? Thanks and good luck.
David Auld - President & CEO
Thank you Bob. Kind of a mix. Like Texas, at least in my mind, Houston has probably underperformed my expectations over the last couple of quarters. But it's been offset by an overperform in Austin, Dallas and Fort Worth, and San Antonio. The balance of the state is doing incredibly well.
David Auld - President & CEO
And overall, we expected a good spring and we are seeing a good spring. So overall I think it is in line with our expectations for a good, solid, consistent moderately growing market with variations from market to market.
Jessica Hansen - VP of IR
Our absorptions have picked up the most in the southeast and south central regions, which is what you have heard us say. Really kind of Texas across to Florida and up into the Carolinas is a big piece of our business that we expect to be very robust. And we've seen a very good level of demand in those markets and a good return on our inventory investments.
Mike Murray - EVP and COO
Bob, we do have -- you know us, we do have very high expectations at all times. And we are pleased with where the results of the spring have come out and really across the board in all of our markets.
Bob Wetenhall - Analyst
Great execution guys, you are killing it. Good luck next quarter.
David Auld - President & CEO
Thank you Bob.
Operator
Michael Rehaut from JPMorgan.
Michael Rehaut - Analyst
Thanks, good morning everyone, and I'll add my congrats on the quarter as well. First question just on the sales pace. You know, continued expansion there, we have it roughly up 8%. Just want to make sure in terms of the drivers there, seems like primarily that's due to the continued expansion of Express as part of your business. Just want to make sure that that still is the case, in effect. And you know, would you expect -- it seems like there is still more room to go. Was that something that you would expect to continue to benefit your results even into FY17?
David Auld - President & CEO
Yes. I mean, we are -- I would say fully rolled-out in Texas and the Carolinas on the Express model. Still got room to grow in all the other markets. So I think we are going to benefit from that brand and that initiative. For this year, next year, and the year after that. We are fully integrated, fully rolled out.
Michael Rehaut - Analyst
And you know, just is it fair to say that that's really the -- the let's say biggest driver of the improvement in your overall sales pace as reported this quarter?
David Auld - President & CEO
I would say it is a major contributor. The other brands are doing well also. But there's just a whole lot less competition at that entry level.
Michael Rehaut - Analyst
Right.
David Auld - President & CEO
Therefore more pent-up demand, and it is easier to drive absorption.
Michael Rehaut - Analyst
Right. Certainly. Second question, just on the improved SG&A guidance that you rolled out this quarter, that helps your pre-tax by 20 BPs now you have expanded that guidance. You know, given that you still kind of have similar expectations on the units, and it seems like the ASPs, it would kind of suggest that you are not necessarily expecting better --that the improved leverage isn't coming off of improved volumes per se. And it seems like Express and your overall, again, top line seems to be coming in as expected. So are there other things in the SG&A line item that's helping here in terms kind of concrete items, around perhaps advertising or other types of SG&A controllables that are coming in better than expected? Or is this just the overall model in effect -- just the overall efficiency, just being that much better even with the same type of closings that you expected 3 months ago?
Jessica Hansen - VP of IR
Mike you know, it is really just a result of our overall focus on SG&A. It's not any one thing. It's always been a hallmark of our business and something we are very focused on. We set a 9.6% SG&A in FY15, which was the best SG&A we had had other than two years in the Company's history when we had a 9 handle as well. And we've now guided to 9.0% to 9.2%. And I would just say it is a focus, and something that all of our guys in the field are looking at, is how can we run the business more efficiently and leverage our overhead better than we have in the past?
David Auld - President & CEO
Michael, this is David. We get up every day and try to figure out how to make it a little bit easier to build a house, a little bit easier to sell a house, and a little bit easier to get the house closed. And we work on that every single day. Because that is a -- that is a sustainable competitive advantage. And that is -- that's what we try to be.
Michael Rehaut - Analyst
No, that's great and obviously it's great to see, as the recovery continues. One last, quick question if I could. Community count now flattish for about 4 quarters. Is that something you would expect to reaccelerate at some point? Maybe into the, you know, mid-single-digit or high single-digit growth into next year? Or should we just continue to expect sales pace over the next couple of years to drive the bus?
Bill Wheat - EVP, CFO
Mike. For this year, we stated we expect our community count to be in that low single digit or relatively flat this year with the improvement in sales coming from improved absorptions and certainly the Express rollout is a driver of that. I think it will continue to be a driver next year, as Express matures, if you are looking over the next year or two, you would naturally expect to grow at the double-digit pace. You would see a stronger community count growth over the longer term. We don't really have the visibility fully for 2017 yet to make any specific comments on that though.
David Auld Right now, Michael, we are replacing communities every quarter, every month. And you know, if you trade a community that's driving an absorption level of 2 or 3 for a new community that is an Express model that is driving 6 or 8, flat community count, there is a lot of efficiencies and absorption improvement. So yes, but over time, we will be expanding our community count to meet the market.
Michael Rehaut - Analyst
Great very helpful. Thanks again.
Operator
Jack Micenko from SIG.
Jack Micenko - Analyst
Good morning. Hey first question for Bill, you know you are generating a ton of cash. It sounds like that trend is going to continue in the next year and years beyond. Your leverage levels are getting to the lower end of, I think, probably optimal. You know your land strategy's changed a bit, and it sounds like you know, you are going to keep it about the same point even though the mix is going to change from an absolute level. I guess the question is, what do you do with the cash?
I know in the past there has been share repurchase, there has been debt repurchase. You know, what do we think about you know, longer term goals with the cash? Beyond sort of second-half spend, that sort of thing, around capital management?
Bill Wheat - EVP, CFO
Certainly this year, Jack, we are generating $300 million to $500 million and we are paying off over $500 million of debt this year. For FY16 it is essentially debt retirement and continuing to invest in the business. We do continue to look at M&A opportunities, we've done several deals over the last several years. To the extent that we see good deals that are a good fit for us as we described earlier, that will be a priority as well. And then beyond that, we want to stay opportunistic. We are not going to tie ourselves down to anything specific beyond this year. But right now, we are focused on, you know, debt retirement, being opportunistic, investing in the business, and then we'll assess further as we get visibility into 2017.
Jack Micenko - Analyst
Okay and my follow-up question you know, through our travels, I think one of the things that we've seen is you know, the Express-type product is appealing to a buyer group maybe beyond the entry or first-time buyer. And really we are surprised at the trade-down empty nester. Everybody thinks of the active adult as sort of maybe a mid- to upper-end product, but we are seeing a lot in the lower price points as well. Are you seeing that in a meaningful way? Has it changed the trajectory or the direction of the rollout of the Express product or maybe even location? What can you share with us about that dynamic?
David Auld - President & CEO
I wouldn't say that it's changed the direction. We have seen that take place. Especially in Florida. It surprised me as well. Where you know, when we launched Express in Florida, 40%, 45% were actually the people buying their last home, not their first home. And that's something we are taking note of. And making sure that we are in a position to accommodate those buyers.
Jack Micenko - Analyst
Okay thanks.
Operator
Susan Maklari from UBS.
Susan Maklari - Analyst
Good morning. My first question is going back to your third quarter guidance in terms of the conversion rate, I believe you said 76% to 80%. That just feels a little light, relative to where we were modeling our expectations. Would you say that you saw any pull forward in demand in the second quarter? Perhaps maybe due to the overall better weather that most of the country saw?
Jessica Hansen - VP of IR
You know, Sue, not necessarily that we are attributing it to better weather. But our operators did convert their backlog at a higher rate than we anticipated and than what we told you for Q2. When we look at our business plan for Q3, which we are expecting to deliver on, it is right in that heart of that 76% to 86% range we have guided to for Q3.
Bill Wheat - EVP, CFO
The timing of deliveries through the year is a function of really the roll-up of all of our communities and the timing of when communities come online and when housing starts get started, and right now the way it is rolling up, division by division, points to that range. But still for the year, points to the same range we gave at the start of the year.
Jessica Hansen - VP of IR
Historically, we typically do see a tick down in our conversion rate from Q2 to Q3. That is a normal seasonal trend for us.
Susan Maklari - Analyst
Okay. And then looking at your spec levels, seems like those are continuing to sort of trend down over time. Can you just talk a little bit about what's contributing to that? And what should we make of that?
Mike Murray - EVP and COO
I think we can attribute it to a very strong demand in the marketplace right now. And that we are starting specs and getting them out there and getting them sold early in the construction process. You have to start more houses, so you get those started and you get those sold. In addition, we are starting some houses to be billed jobs as well. Our overall mix of build versus spec is staying the same, we are just seeing strong demand in the marketplace. More efficient with the turning of our homes is one of the key drivers of our cash flow generation. Doing more revenue, more closings, with the same number of homes under construction at any point in time: -- key part of our focus.
Susan Maklari - Analyst
Okay thank you.
Operator
Will Randow from Citigroup.
Will Randow - Analyst
Good morning and congrats on the quarter.
Jessica Hansen - VP of IR
Thank you.
Will Randow - Analyst
Back to Susan's question. When you look at your current percentage of closings, that are spec, could you talk about that? And how you feel going into kind of the peak construction period in regards to potential labor inflation and/or delays?
Jessica Hansen - VP of IR
So in terms of our specs that we closed in the quarter, it was in our normal range, which is every quarter is 70% to 80% of what we are closing is a spec. And so when you look at our reported gross margin you are essentially seeing our spec gross margin, in terms of labor.
Mike Murray - EVP and COO
We are not seeing a tremendous amount of labor inflation. In fact, we have been able to stay ahead of the cost increases we have seen on stick and brick, which, any cost increases that have come through have been more labor-oriented versus the materials and the commodities today, but we haven't seen a tremendous amount of pressure. And in terms of shortages affecting delays, our cycle times have remained very consistent and we have not had, as evidenced by our backlog conversion rate last quarter, we have not had a real labor constraint widespread that has affected closings.
David Auld - President & CEO
Again, as you drive higher absorption in a community-by-community basis you take a lot of pressure off the trade base. Because it's -- a lot of their time is just going from community to community. If we can get them out to the community and keep them there they can make more money, a lot less pressure on pricing.
Will Randow - Analyst
And just as a follow-up, you mentioned your stick and brick prices are fairly stable. Any way you could parse down on the categories in terms of the movements? For example, lumber and how you think about that going through the year?
Jessica Hansen - VP of IR
In terms of overall, our revenue per square foot year-over-year was up about 4% and our stick and brick was up about 2.5%. Sequentially it was closer to both being up about 1%. The majority of the cost inflation, as Mike mentioned, we continue to see is on the labor side, not the materials side. And to lumber specifically, I wouldn't say we've seen anything unusual in lumber prices. They tend to follow a seasonal trend, and we haven't seen anything unusual this year.
Will Randow - Analyst
Thank you and congrats again.
David Auld - President & CEO
Thank you.
Operator
Thank you. John Lovallo from Merrill Lynch.
John Lovallo - Analyst
Thank you for taking the call, guys. First question, last quarter I believe you mentioned not heavily reinvesting in Houston at this point, but kind of taking more of a replenishing strategy. Was that the case in the second quarter? And did anything happen in the quarter where you might have, might change that strategy going forward?
David Auld - President & CEO
That would still be the case in the second quarter. It may change in the future, as you know, we've -- we are positioned to take advantage of opportunistic buys. And as stress gets put on a market, sometimes that creates an opportunity for us.
John Lovallo - Analyst
Okay that's helpful. Then in terms of the cash flow guide, $300 million to $500 million, it is a fairly wide range. Can you just remind us what would kind of drive the upper end of the range versus the lower end?
Bill Wheat - EVP, CFO
It really comes down to our overall revenue volume, our closings volume. The main driver we expect the predominance of that cash flow to come in our fourth quarter. When we have our largest closings quarter. Then it is essentially -- then the wide range is attributable a little bit the unpredictability on the timing of when land purchases will close. As we get a little closer to the end of the year we might be able to tighten that a bit. But there is some unpredictability in the timing of when land deals will close.
John Lovallo - Analyst
Okay great. If I could stick one housekeeping in here, the flat community count you guys talked about, was that year-over-year or was that sequentially?
Jessica Hansen - VP of IR
Yes we mentioned that our year-over-year community count was essentially flat. It was actually down slightly, and really when we look at that going forward we would expect, you know, no more than a low single-digit movement. Either way. It could be up or down in the low single digit percentage here over the next couple of quarters.
John Lovallo - Analyst
Great. Thanks very much.
Operator
Mike Dahl from Credit Suisse.
Mike Dahl - Analyst
Thanks for taking my questions and nice quarter.
David Auld - President & CEO
Thank you.
Mike Dahl - Analyst
Wanted to go back to some of the comments and obviously a lot of questions and remarks about the Express side. But just from a, you know, made a comment about just seeing a lot less competition there. And clearly, you have had a period of -- a number of quarters of success, competitors have taken notice. Feels like the market, in general, there is a more positive tone on the entry level and some acknowledgement that it seems like that demand is pushing outward. So I'm just curious to hear your take on you know, we've kind of heard that some other builders are starting to explore similar things, maybe not quite the same. But as you are looking at new land deals, are you running up against more competition than you would have seen 6, 9, 12 months ago? Or how do you think you are positioned? What do you think that they are doing differently?
Mike Murray - EVP and COO
We tend to focus a lot on what we are doing, and we do see some competition on the land front. It's, you know, constant out there, and it is market by market and it varies. You know what others are going to do with their entry level entrants, I have heard of others coming to market. There is some of it out there. But broadly, we are not seeing widespread, heavy competition today, with us flag by flag. Certainly there are pockets where there is more competition, but generally, we are not seeing it. How others tend to approach that market, that will be up to them. We are focused on providing a great value for the home buyer so our customer can be in their house, they can be in there at a good price they can afford, and a place for their family.
Bill Wheat - EVP, CFO
But as entry-level grows we do expect more competition to come and we're certainly prepared to deal with that as it comes.
Mike Dahl - Analyst
Okay, great, thank you.
Operator
Jade Rahmani with KBW.
Jade Rahmani - Analyst
Yes, hi, thanks for taking my question. Just wanted to ask. Regarding leverage at this point in the cycle, is there a plan to retire near-term debt maturities as was indicated in the press release, to reduce leverage? Or do you plan to eventually replace those maturities with similar-sized debt offerings?
Bill Wheat - EVP, CFO
We'll always look at the debt markets, and we'll remain opportunistic there. There are certainly, it is a favorable market right you now. But where we sit today, with our cash position, with our expectations for cash flows, we right now do not expect to be in the debt market in the short-term. We have already paid off the $373 million that came due on April 15th, we paid that out of cash. And we believe our cash position, our liquidity available on our revolver and our cash flows are sufficient for the remainder of the year as we sit here today.
Jade Rahmani - Analyst
And just regarding other income, can you comment on what drove the spike in the second quarter?
Bill Wheat - EVP, CFO
Yes we did have, we sold an investment that we had in debt securities. You can look back in our 10-Qs, there has been a disclosure around that investment. We had some debt securities that we had acquired a while back that gave us access to some land, that we have now acquired the land and are actively developing it. And we were able to restructure those debt securities and resell them in the market and so we had a gain on that sale of $4.5 million, which was an improvement in our Other Income line this quarter.
Jade Rahmani - Analyst
Thanks, just lastly, the capital markets uncertainty and spread widening that we have seen this year, you may have alluded to it on the land side, the second look you referred to. But have you noticed any impact on either the land market or sales trends due to the volatility? Thanks a lot.
Mike Murray - EVP and COO
Hard to attribute it to any one factor. Just a competitive environment, deal by deal is different. We are seeing a few more second looks, so that's been very positive for us.
Jade Rahmani - Analyst
Thanks.
Bill Wheat - EVP, CFO
Thank you.
Operator
Thank you. Next question today is coming from Jay McCandless from Sterne Agee.
Jay McCanless - Analyst
Good morning everyone. First question, I know Houston is a smaller market for you guys. But if you could update us on what's happening on the ground there and what you think you are going to see in terms of delays for either labor or materials to get homes finished?
Jessica Hansen - VP of IR
You know Jay, it's business as usual. We feel for the people and what they are going through in Houston right now with the horrendous flooding, but our operations are fine. And we don't expect any, any noticeable impact on our business in Houston. Clearly the market has just softened due to the lower oil prices. But we continue to see very consistent, steady demand at price points below $300,000.
David Auld - President & CEO
We like the Houston market. Big believers in it, long-term. And you know, if it becomes, if we see an opportunity to buy something at a very advantageous price, we are going to be all over it.
Jay McCanless - Analyst
Got it. The second question I had, there was a small order decline in the east geography this quarter. Could you talk about what's going on, in that market?
Bill Wheat - EVP, CFO
Yes the east for us is the Carolinas and north. So it is really more Northeast, for us. We were down I believe 2% in sales units. Our community count in that region was actually down, so our absorptions were actually up mid-single-digits. Really just reflects probably a few fewer investments over the last few years manifesting itself in the communities.
David Auld - President & CEO
We are kind of going through a reset up in the Northeast. We like where we are headed. But it's not going to be a stellar performance this year.
Jay McCanless - Analyst
Great. Thank you.
Operator
Thank you. We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further comments.
David Auld - President & CEO
Thank you Kevin. We appreciate everyone's time on the call today and look forward to speaking with you again in July to share our third quarter. I would also like to, once again, thank the entire D.R. Horton team. You are truly the best in the industry, and your quarter-to-quarter consistent performance proves that out. Thank you.
Operator
Thank you, that does conclude today's teleconference. You may disconnect your line and have a wonderful day. We thank you for your participation today.