霍頓房屋 (DHI) 2017 Q1 法說會逐字稿

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  • Operator

  • Good morning and welcome to the first- quarter 2017 earnings conference call of D.R. Horton, America's Builder, the largest builder in the United States.

  • (Operator Instructions) As a reminder, this conference is being recorded.

  • I will now turn the call over to 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 first quarter of fiscal 2017.

  • 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, which is filed with the Securities and Exchange Commission.

  • This morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q in the next few days.

  • After the conclusion of the call, we will post updated supplementary data to our Investor Relations site on the presentation section under news and events for your reference.

  • The supplementary information includes current and historical supporting data on our homebuilding return on inventory, gross margins, changes in active selling communities, product mix and our mortgage operation.

  • Now I will turn the call over to David Auld, our President and CEO.

  • David Auld - 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.

  • The D.R. Horton team produced strong results in our first quarter.

  • Our consolidated pretax income increased 32% to $318 million, on a revenue increase of 20% to $2.9 billion.

  • Our pretax profit margin improved 100 basis points to 11%.

  • We experienced a 20% improvement in our absorption per community, as homes sold increased 15% compared to last year.

  • These results reflect the strength of our operational teams and diverse product offering across our broad national footprint, as well as solid market conditions.

  • Our continued strategic focus is to produce double-digit annual growth in both revenue and pretax profits, while generating annual positive cash flows and increasing returns.

  • For the 12 months -- for the trailing 12 months, our homebuilding return on inventory improved to 15.9%, up 290 basis points from 13% a year ago, and we expect to generate $300 million to $500 million of positive cash flows from operations for the year.

  • With 24,500 homes in inventory at the end of December and an ample supply of land and lots, we are well-positioned for the upcoming spring selling season and the remainder of 2017.

  • Mike?

  • Mike Murray - EVP and COO

  • Net income for the first quarter increased 31% to $207 million or $0.55 per diluted share, compared to $158 million or $0.42 per diluted share in the prior-year quarter.

  • Our consolidated pretax income increased 32% to $318 million in the first quarter versus $241 million a year ago, and homebuilding pretax income increased 28% to $294 million compared to $229 million.

  • Our backlog conversion rate for the first quarter was 82%, above the high end of the range we guided to on our fourth-quarter call.

  • As a result, our first-quarter home sales revenues increased 20% to $2.8 billion on 9,404 homes closed, up from $2.3 billion on 8,061 homes closed in the prior-year quarter.

  • Our average closing price for the quarter was $297,000, up 2% compared to last year.

  • This quarter, entry-level homes marketed under our Express Homes brand accounted for 28% of homes closed and 20% of home sales revenue.

  • Our homes for higher end move-up and luxury buyers priced greater than $500,000 were 7% of homes closed and 17% of home sales revenue.

  • Our active adult Freedom Homes brand is still in the early stages of rollout, and customer response in the eight markets we are open has been positive.

  • We still expect to have Freedom communities open in one-third of our 78 operating markets by the end of the year.

  • Bill?

  • Bill Wheat - EVP and CFO

  • The value of our net sales orders in the first quarter increased 17% from the prior- year quarter to $2.8 billion, and homes sold increased 15% to 9,241 homes on a 5% decline in our average active selling communities.

  • Our average sales price on net sales orders in the first quarter was $299,100, and the cancellation rate for the first quarter was 22%, consistent with the prior-year quarter.

  • The value of our backlog increased 7% from a year ago to $3.4 billion, with an average sales price per home of $300,900, and homes in backlog increased 6% to 11,312 homes.

  • Mike?

  • Mike Murray - EVP and COO

  • Our gross profit margin on home sales revenue in the first quarter was 19.8% compared to 19.9% in the prior-year quarter and 20.5% in the fourth quarter.

  • 60 of the 70 basis points sequential change in gross profit margin was due to higher warranty and litigation costs this quarter.

  • In the current housing market, we expect our average home sales gross margin to be around 20%, with quarterly fluctuations that may range from 19% to 21% due to product and geographic mix, as well as the relative impact of warranty, litigation and interest cost.

  • Bill?

  • Bill Wheat - EVP and CFO

  • In the first quarter, homebuilding SG&A expense as a percentage of revenue improved 70 basis points to 9.5%, compared to 10.2% in the prior-year quarter.

  • We remain focused on controlling your SG&A while ensuring that our infrastructure adequately supports current and future growth.

  • We expect our SG&A as a percentage of homebuilding revenues to be lower in 2017 than in 2016.

  • However, we expect the improvement for the full year to be less than the 70 basis point improvement we achieved this quarter.

  • Jessica?

  • Jessica Hansen - VP of IR

  • Financial services pretax income in the first quarter increased to $24.2 million from $12.4 million in the prior-year quarter, driven by growth in revenue and an improved operating margin.

  • 93% of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operation.

  • Our mortgage company handled the financing for 57% of our home buyers, up from 51% in the same quarter last year.

  • FHA and VA loans accounted for 48% of the mortgage company's volume compared to 50% in the prior-year quarter.

  • Borrowers originating loans with our mortgage company this quarter had an average FICO score of 719 and an average loan-to-value ratio of 88%.

  • First-time homebuyers represented 45% of the closings handled by our mortgage company compared to 43% in the first quarter last year.

  • David?

  • David Auld - President and CEO

  • During the quarter, our total number of homes and inventory increased by 6%, a normal seasonal trend as we approach the spring selling season.

  • We ended the first quarter with 24,500 homes in inventory, of which 1,600 were models, 13,400 of our total homes were spec homes, with 9,700 in various stages of construction and 3,700 completed.

  • Compared to a year ago, we have 14% more homes in inventory, putting us in a strong position for the spring selling season and to achieve double-digit growth in revenues in 2017.

  • Our first-quarter investment in lots, land and development totaled $847 million, of which $552 million was for finished lots and land and $295 million was for land development.

  • We plan to increase our investment in our land and lot supply this year at a rate to support our expected growth in revenues.

  • Mike?

  • Mike Murray - EVP and COO

  • At December 31, 2016, our land and lot portfolio consisted of 213,000 lots, of which 119,000 or 56% are owned, and 94,000 or 44% are controlled through option contracts.

  • 77,000 of our total lots are finished, of which 32,000 are owned and 45,000 are optioned.

  • Our option lot position increased 54% from a year ago, while our overall lot position increased 20%.

  • Our 213,000 lot portfolio is a strong competitive advantage in the current housing market, and a sufficient lot supply to support our future growth.

  • Bill?

  • Bill Wheat - EVP and CFO

  • At December 31, our homebuilding liquidity included $1.1 billion of unrestricted homebuilding cash and $888 million of available capacity on our revolving credit facility.

  • Our homebuilding leverage ratio improved 690 basis points from a year ago to 28.6%.

  • The balance of our public notes outstanding at December 31 was $2.8 billion, and we have a total of $350 million of senior notes that will mature this year in May.

  • Subsequent to quarter end, Moody's upgraded our corporate credit rating to Baa3, and we now have investment-grade ratings from all three rating agencies.

  • At December 31, our shareholders' equity was $7 billion and book value per share was $18.70, up 14% from a year ago.

  • Our priorities for cash flow utilization center around being opportunistic while remaining disciplined.

  • Our top priorities for fiscal 2017 include continuing to consolidate market share by both investing in our homebuilding business and through strategic acquisitions; paying off $350 million of our senior notes in maturity in May; and providing consistent dividends to our shareholders.

  • Jessica?

  • Jessica Hansen - VP of IR

  • Looking forward, our expectations for 2017 are consistent with what we shared on our number our November call and are based on current market conditions.

  • We still expect to generate a consolidated pretax margin of 11.2% to 11.5%.

  • We also expect consolidated revenues of between $13.4 billion and $13.8 billion and to close between 43,500 and 45,500 homes.

  • We anticipate our home sales gross margin for fiscal 2017 will be around 20%, with potential quarterly fluctuations that may range from 19% to 21%.

  • We estimate our annual homebuilding SG&A expense will be approximately 9.0%, with the second quarter of the year higher than 9% and the third and fourth quarters lower than 9%.

  • We expect our annual financial services operating margin to be around 30%.

  • We are forecasting a fiscal 2017 income tax rate of approximately 35% and an annual average diluted share count of approximately 380 million shares.

  • We also expect to generate positive cash flow from operations for the third consecutive year in a range of approximately $300 million to $500 million.

  • Our fiscal 2017 results will be significantly impacted by the strength of the spring selling season, and we will update our expectations as necessary each quarter as visibility to the spring and the full year becomes clearer.

  • For the second quarter of 2017, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 88% to 92%.

  • We anticipate our second-quarter home sales gross margin will be around 20%, and we expect our homebuilding SG&A in the second quarter to be in the range of 9.3% to 9.5% of homebuilding revenue.

  • David?

  • David Auld - President and CEO

  • In closing, our first-quarter growth in sales, closings, and profits, and the improvement in our pretax profit margin are the result of the strength of our people and operating platform.

  • We are striving to be the leading builder in each of our markets and to continue to expand our industry-leading market share.

  • We remain focused on growing both our revenues and pretax profits at a double-digit annual pace while continuing to generate annual positive operating cash flows and improved returns.

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

  • We'd like to thank the entire D.R. Horton team for their continued focus and hard work, and we look forward to continuing to grow and improve our operations in 2017.

  • This concludes the prepared remarks.

  • We will now host questions.

  • Operator

  • (Operator Instructions) Stephen East, Wells Fargo.

  • Stephen East - Analyst

  • Thank you.

  • Congratulations, guys; I'm sure you're going to hear it several times today, but great quarter.

  • Maybe we'll just start with the orders, because you're going to probably get that question 100 times, also.

  • But can you talk a little bit about the trends that you saw through the quarter?

  • Did you see any impact from the rates, from the election?

  • Product type disparity, what was going on?

  • And then whatever type of commentary you want to give post quarter, what we've seen in January so far.

  • Mike Murray - EVP and COO

  • Well, Stephen, thank you very much.

  • We were very pleased with the quarter, and we saw very strong improvement in our absorptions community by community.

  • Throughout the quarter, we continued to see a good response to our positioning.

  • We were much better positioned coming into this first quarter this year than we had been, and we were able to execute against that.

  • The market was there for us, a very solid market.

  • I wouldn't say we saw significant deviations within the quarter month-to-month; it was a pretty consistent result for us.

  • Into January, the Cowboys lost, so in this part of the world the selling season is kind of starting now.

  • So we're excited about the silver lining on that cloud for us.

  • But we continue to see good sales trends in January, very early, into spring, and we will certainly keep you updated as things progress and we get back with you in April on that one.

  • Stephen East - Analyst

  • Okay, and a follow-up.

  • The absorption, one, can you sustain it?

  • And then with the rate move that you've seen so far, I assume that you're seeing very few that are not qualifying.

  • Are you starting to see any trade-down in product, and at what rate do you think you would start to see maybe some of those Express buyers have to drop out of the market?

  • David Auld - President and CEO

  • Well, Stephen, it's always good to be, in my mind anyway, the price leader in a rising interest rate environment, because if you can't afford $300,000, then if you've got a product at $250,000 you can still convert that sale.

  • We like our positioning.

  • As far as absorption for our community, at some point, no, you're not going to be able to sustain and continue.

  • But our focus has been driving to a 20% ROI.

  • So we're going to drive absorption levels and improve ROI and at some point, we're going to max out the return we can make off a flag.

  • And at that point, we will add flags.

  • Jessica Hansen - VP of IR

  • And for fiscal 2017, we feel very comfortable that we can continue to drive further improvement in our absorption to offset any community count decline to generate the 8% to 13% increase in closings that we've guided to for the year.

  • So clearly, we're off to a strong start.

  • We can have some variability from quarter to quarter in how we get there for the year.

  • As you saw, our sales were outside of that up 8% to 13% range.

  • We could have a quarter where our sales are under that 8% to 13% range, but we feel very comfortable that for the full year our closings will be up at least 8% to 13%.

  • David Auld - President and CEO

  • Stephen, we wouldn't guide up double-digit if we weren't confident that we could drive that level of absorption.

  • Stephen East - Analyst

  • Fair enough, fair enough.

  • Thank you.

  • Operator

  • Stephen Kim, Evercore ISI.

  • Stephen Kim - Analyst

  • Hey, guys.

  • Well, I'm going to just add my congrats as well, because clearly while your orders were very strong and you also executed very well below the top line, also.

  • So congratulations on a good execution this quarter.

  • My first question actually revolves around cost control.

  • I know that you're always focused on leveraging your scale with your vendors, but I also hear that recently you've conducted a pretty significant rebidding process with some of your suppliers.

  • And I was wondering if you'd be willing to share what you think the overall savings opportunity might be from those conversations?

  • Mike Murray - EVP and COO

  • You know, Stephen, we are constantly rebidding our suppliers and our vendors across-the-board.

  • We've had several pushes over the last several years really in which we've pushed hard on rebidding.

  • So, yes, that's a continual effort for it, and we're continually working to mitigate certainly any cost increases and improve our costs wherever we can.

  • On a year-over-year basis, our costs -- our stick-and-brick costs per square foot were up only 2%, which is certainly more moderate than we saw a couple of years ago.

  • And so we've been able to keep our revenue growth per square foot exceeding our cost per square foot on a stick-and-brick basis, which is certainly helping us going forward.

  • We are seeing lot costs start to increase.

  • Lot costs were up 9% on a per square foot basis this quarter, so it's a very -- we're seeing very good results from our efforts to control our stick and brick, which is helping keep our margins stable.

  • Stephen Kim - Analyst

  • Got it.

  • That's fair.

  • David Auld - President and CEO

  • Stephen, we've been focusing a long time on driving a higher level of absorption on a community by community basis, and that allows us to control labor and it makes the entire process of building a house more efficient.

  • And I think we're reaping some of the benefits of that.

  • Stephen Kim - Analyst

  • Well, that's really encouraging.

  • My next question relates to deleveraging in the face of very strong demand.

  • We've seen your net debt to cap already now well below what I would consider historical norms, and they seem to be on track to trend lower this year given your strong cash flow.

  • I was wondering if you could talk to us about how you think about what the right level and the trajectory -- and what trajectory is appropriate for your leverage at this time, as we're seeing some recent demand indicators inflecting upwards.

  • Bill Wheat - EVP and CFO

  • Right.

  • Well, you know, Stephen, as we look at our balance sheet, our capital structure in our guidance for the year and where we're guiding the Company to be, to the extent that we're able to still grow at a solid pace and consistent double-digit pace over the course of a year and we're able to invest sufficiently to support that growth in 2017 and beyond and maintain a sufficient land pipeline; to the extent we're able to support that level of growth and still generate positive cash flow, from our standpoint we don't have an ideal leverage level.

  • We will take that cash flow and then do what we feel like is best in the interest of our overall Company and our shareholders for the long-term.

  • So an element of that that we've prioritized this year is to continue to delever.

  • We expect to generate $300 million to $500 million of cash flow while still supporting our growth, and we're going to use $350 million of that to pay down debt while continuing to reinvest in the business and continue to pay a strong dividend to our shareholders, which we've increased, and expect to pay about $150 million in dividends this year.

  • So there's really not an ideal -- not necessarily a target ideal leverage level.

  • It's really -- we're balancing that with supporting the growth we expect to generate in the Company.

  • David Auld - President and CEO

  • We're trying to create as much flexibility into the future as we possibly can.

  • And like Bill said, we don't have a target on debt, but right now we're generating enough cash to buy the land and lots that we need to support a double-digit growth.

  • And speculating beyond that is just not in our nature today.

  • Stephen Kim - Analyst

  • All right, guys.

  • I really appreciate it and congrats.

  • David Auld - President and CEO

  • Thank you.

  • Operator

  • Nishu Sood, Deutsche Bank.

  • Nishu Sood - Analyst

  • Thank you.

  • I wanted to ask about first, the backlog conversion ratio.

  • Very, very strong conversion ratio; I think it's the strongest in five years.

  • Just wanted to dig into that a little bit.

  • You mentioned, obviously, driving absorptions in communities.

  • That may have played a part in that.

  • But on the other hand, there are still, I think, pretty widespread concerns about labor.

  • So how should we think about that?

  • Are we getting back to normal in terms of just the ability to deliver homes?

  • So what's helping you overcome the labor concerns out there?

  • Mike Murray - EVP and COO

  • Nishu, where we feel we were coming into the first quarter much better positioned, I mentioned before, on our homes and inventory and where we are right now at December 31 with 24,500 homes in inventory.

  • That to us is a great indicator of future closings, because we're getting the houses we want out of the ground.

  • We're getting them where we want and working them through to completion, and then we're closing them.

  • That's, for us, a much better predictor of closings volume in a given quarter, perhaps, than backlog conversion is.

  • In terms of back to normal, I don't know whatever is normal in this business, but it seems like the conditions are always changing a bit year-to-year.

  • And we're building a platform that allows us to respond to those market conditions and look to position our communities in front of the market with the trades we need to build the houses when we want to get them built.

  • Nishu Sood - Analyst

  • Got it, got it.

  • Makes sense.

  • And another number very, very strong; I think it's a record for your first-quarter SG&A.

  • I think it might be your first single-digit number you've ever reported.

  • Very strong performance.

  • You mentioned that look, hey, don't expect the same level of improvement in the subsequent quarters.

  • I just wanted to dig into that a little bit.

  • What drove the strong performance that might reverse in the subsequent quarters?

  • Obviously, you've got the corporate relocation coming up; that might be a factor.

  • But why would it reverse after such a strong performance in the first quarter?

  • Bill Wheat - EVP and CFO

  • Nishu, our costs that we had in the first quarter were normal; there wasn't anything unusual there in the costs at all.

  • It was really driven by the revenue line.

  • We had guided to or we exceeded the guidance that we provided for our backlog conversion in the first quarter, back to your first question.

  • So our revenues were higher than that guidance range and so then, therefore, that generated really strong leverage on our SG&A costs in the quarter.

  • As we look forward to the rest of the year, our annual guidance for revenues are still in the 10% to 14% range, units 8 to 13, dollars $10 to $14.

  • So we do expect solid leverage on our SG&A, but we don't expect it to continue to be at 70 basis points.

  • But we're very pleased with the start to the year.

  • We're very pleased with our positioning in our inventory as well as in our SG&A expenses and our infrastructure, and looking forward to continuing to leverage that throughout the rest of the year.

  • Mike Murray - EVP and COO

  • Nishu, thank you for noticing that.

  • That is something we work very hard at.

  • Nishu Sood - Analyst

  • Right.

  • Thanks for the thoughts.

  • Operator

  • Alan Ratner, Zelman & Associates.

  • Alan Ratner - Analyst

  • Hey, guys.

  • Good morning, and I echo my congrats on a very strong quarter.

  • David, maybe this question is for you, or anybody can chime in.

  • But I think everybody is trying to read the tea leaves on what impact, if any, higher rates might have on demand.

  • And I think you certainly have a very balanced outlook there and seems like there was no impact this quarter, certainly.

  • I was curious if you were to go back in time in prior periods where we've seen similar rate moves, and 2013 is the most recent instance, but certainly there have been others.

  • And if I look at your 2013 results, you and everybody else saw pretty big deceleration in orders in that period, and we generally have seen that in prior periods as well.

  • So it might be too early to figure out what exactly is going to happen this go-around, but I was curious back then when you were out there in the field visiting your communities, what type of signs did you see that might have kind of foretell that slowdown?

  • And compare and contrast that maybe to what you're hearing from your people in the field today with that move we've seen in rates over the last 8 weeks or so.

  • Thank you.

  • David Auld - President and CEO

  • Well, 2013, I don't know that it was necessarily the rate increase as the rapidity of the rate increase that kind of shocked the market.

  • And you saw a, I would say, a deceleration of traffic, less consumer confidence feel from our sales agents.

  • We fought through it; I think we ended up with a pretty good 2013, but it did have a significant impact.

  • Right now, kind of the over optimism that seems to be out there in the market -- I just traveled through Florida and I tell you, Florida feels like it's as good a market as I've seen in a long time.

  • Our sales agents are very excited, and we have inventory that right now we're in the best competitive position we've ever been in as far as direct competition, price point competition, model against model.

  • It is as low as I've seen it for us.

  • We're very bullish today on positioning inventory in front of what we think is going to be a pretty strong sales season.

  • Mike Murray - EVP and COO

  • Alan, I think we're seeing -- if we see interest rates trend up gradually over time, today in connection with job growth, income growth and overall consumer confidence, I think those are very positive.

  • Because we'll see good household formations, we'll see good confidence by the consumer, and able to adjust to a gradual rate rise that seems to be telegraphed.

  • I think in 2013, what was different is that rates spiked up very quickly for no reason that was really tied to what people felt on the ground at the time.

  • It was just -- it happened in a vacuum and it had a very negative impact.

  • Today I don't think those things are happening in a vacuum.

  • I think there's, as David mentioned, there's confidence, there is good traffic in the sales offices.

  • There is very good confidence level across our platform of 1,600 model homes.

  • Our sales agents feel very good about the traffic they are seeing and they feel really good about the indicators they are getting.

  • Our inventory positioning is strong going into the spring, so we're very encouraged.

  • Jessica Hansen - VP of IR

  • And as David already mentioned --.

  • Ivy Zelman - Analyst

  • I'm sorry; it's Ivy.

  • Sorry, Jessica.

  • I was just going to ask you guys -- sorry, Alan, for jumping in.

  • One of the questions we get a lot from our clients, especially because of your strength and leadership in entry level, and recognizing that you are ahead of the curve and certainly pioneers in many markets that others are following suit, that the entry-level customer is likely to be the most impacted on a rise in rates.

  • And frankly, what we've heard is that it might even be more, per se, to the buyer who is stretching to maybe get to a move-up.

  • So maybe sensitivity within the portfolio, maybe you could talk about the experience.

  • Do they just buy a little less house, a little less options?

  • If, in fact, you do see if rates continue to rise and you do in the future see some impact, can you give us some of your perspective around the price sensitivity within the portfolio of different price points that might be helpful?

  • Sorry, Alan.

  • David Auld - President and CEO

  • Well, what we are seeing is increasing demand.

  • And I think, like Mike said, as long as the jobs are there, nominal increases over a period of time, people are going to adjust to them.

  • Now, the position we're in is that we have a pretty broad product line in the Express and entry-level Horton that we can flex down in price to meet a lower demand price, a lower price.

  • Jessica Hansen - VP of IR

  • And as David mentioned earlier in the call, Ivy, that is why we believe our results are what they are, is we've been focused on offering an affordable product and we're going to continue to, specifically with our Express Homes and our new Freedom Homes brand for the active adults.

  • And we believe right now, that's why we haven't seen any sort of impact from the rate rise, is that we are positioned where we want to be and we will continue to adjust as necessary to continue to offer an affordable product, regardless of the rate environment we're in.

  • Ivy Zelman - Analyst

  • Great.

  • Thanks, guys.

  • Sorry, Alan.

  • Alan Ratner - Analyst

  • Thank you very much.

  • Operator

  • Eric Bosshard, Cleveland Research Company.

  • Eric Bosshard - Analyst

  • Thanks.

  • The progress on absorption is obviously impressive.

  • I'm curious as you think about the growth path forward, the plans in terms of community count growth, the success you're having, does it encourage you to be more aggressive in opening new communities over the next 12 months?

  • Just curious if your thinking on that has evolved.

  • Bill Wheat - EVP and CFO

  • Sure, Eric.

  • Really, our outlook on community count is the same as it was last quarter.

  • We expect community count from where we are today to still remain relatively flat over the next few quarters.

  • At some point we would expect it to increase, but right now our community opening schedule would indicate that it's going to stay relatively flat.

  • So sequentially, relatively flat, which would still indicate a year-over-year decrease.

  • This quarter community count was down 5%, but with the 20% absorption improvement our sales were up 15%.

  • So in the short to medium term, still relatively flat.

  • Mike Murray - EVP and COO

  • That's exactly right.

  • Eric, I think also what we're seeing is the impact of some of the communities we're opening now are frankly more productive communities than some that are closing off.

  • We've been focusing on a return base model for the past several years, and the fruit of that is coming through.

  • We're seeing our return on homebuilding inventory jump up almost 300 basis points on a trailing 12-month basis over where it was a year ago.

  • And our discipline around living within our means inventory wise and being very focused on the balance sheet has encouraged our field teams to be very selective in the communities they are bringing online and where they are deploying their capital, as to where they're going to get the most turn out of that capital.

  • So that's where we're seeing, I think, some good pickup in our absorption on a flag-by-flag basis.

  • Eric Bosshard - Analyst

  • Second question -- and that's helpful -- the second question is in terms of the runway with Express, both from a competitive standpoint and a cost standpoint and a customer standpoint, wondering how you view that and if you view that any different; if the runway and the opportunity is even greater than you had thought?

  • Just wonder where we are in the cycle of sustaining the success or even accelerating the success with what you've done with Express.

  • David Auld - President and CEO

  • Well, I will say the demand for the product and the returns we've been able to generate were a surprise to me.

  • It was a much deeper and higher demand market than I thought it was going to be when we rolled it out.

  • As far as sustainable, I think that's the biggest part of the pyramid; that's where most of the buyers are.

  • We are very well positioned in there, and we certainly feel like we can compete effectively and sustain and grow.

  • We're just rolling out in the West and just actually rolling out in Phoenix; kind of early in the stages in Denver.

  • It's got a -- we feel like we've got quite a bit of runway there.

  • And we are equally excited about Freedom, which is our age-targeted, age-designed product that we think is going to fit very nicely with Express and offer something that doesn't exist in the market today.

  • Eric Bosshard - Analyst

  • That's helpful.

  • Thank you.

  • Operator

  • Ken Zener, KeyBanc Capital Markets.

  • Ken Zener - Analyst

  • Good morning, all.

  • So I'm trying to understand, given the orders and your units under construction conversion, why you're thinking with that broad range.

  • Because your closings as a percent of units under construction 1Q was kind of normal, so it didn't seem like that's constrained.

  • Orders have been following the seasonality of the last few years.

  • Your under construction is up 14%.

  • So how does that translate to 10% unit delivery for the midpoint for the year?

  • What are we missing there, or is it just a natural conservatism on your part?

  • Bill Wheat - EVP and CFO

  • Well, Ken, our guidance is not 10% on units; it's 8% to 13%, so there is a range there.

  • So we could certainly be 10% and still be in our guidance range.

  • Ken Zener - Analyst

  • Yes, yes.

  • Bill Wheat - EVP and CFO

  • And as you well know, the entire year is driven really largely by the spring selling season.

  • And if we're on the front edge of that, and we certainly feel optimistic about it and we're positive about it and we really feel like our positioning is very strong for that, but it hasn't happened yet.

  • So we will evaluate the spring as we get into it.

  • We will certainly evaluate our guidance, and we will update that as we feel like we need to once we have visibility into the spring, and it's still too early to do that at this point.

  • Ken Zener - Analyst

  • Understood, but we've had normal seasonal trends, so you don't need anything stellar to actually hit the high end of your unit is my --.

  • Bill Wheat - EVP and CFO

  • Correct.

  • Ken Zener - Analyst

  • -- I guess statement to you.

  • Jessica Hansen - VP of IR

  • It's January 24.

  • Ken Zener - Analyst

  • I know, seasonal trends are pretty consistent.

  • Bill Wheat - EVP and CFO

  • That's all we really want to say; we are well-positioned.

  • Ken Zener - Analyst

  • Yes, yes, understood.

  • Just for perspective here, so not necessarily about the quarter but your lot cost increases and your stick- and-brick increases; you talked about what it was in 1Q.

  • Could you just give us -- just have a little broader trend, if you will, and hopefully you have this available to you, what the lot and separate stick-and-brick costs were inflation wise for FY16 and FY15, just so we can have that context?

  • Thank you.

  • Jessica Hansen - VP of IR

  • Sure, Ken.

  • I'll talk about it very generally, and I'm happy to follow-up on the specifics that we've given on most of our calls over the last couple of years.

  • In fiscal 2015 is really where we started to see the sharpest increase in both -- well, really primarily labor, and to some extent materials.

  • So for a couple of quarters, we did experience a high single-digit percentage increase in our stick-and-brick cost per square foot, which wasn't outpacing our -- which was outpacing our revenues at that point in time.

  • As we moved through the end of 2015 and into 2016, we were able to get that closer to, call, it a mid- single-digit percentage and our revenues started catching up with that stick-and-brick cost, which is where you saw our gross margin really start to stabilize and become very consistent for the last, call it, six to eight quarters now.

  • And as we've kicked off 2017 and really the end of 2016, we're in a low single-digit cost inflation environment.

  • This is all stick and brick that I've been talking about.

  • In terms of lot costs, lot costs, if you go back to 2015 and 2016, pretty muted increases really until the back half of 2016, which was when we started seeing, call it, a mid-to-high single-digit increase in lot costs.

  • And this quarter is one of the higher in terms of we were up 9%, as Bill mentioned earlier, for a lot cost increase on a per square footage basis.

  • But we've been able to offset the majority of that with price and kept that gross margin very, very consistent, at least from a lot level gross margin perspective.

  • Ken Zener - Analyst

  • Thank you.

  • Operator

  • Bob Wetenhall, RBC Capital Markets.

  • Bob Wetenhall - Analyst

  • You guys are having a fantastic start to the year; congratulations.

  • I wanted to ask you how much of your outperformance in the strength in orders do you attribute to you guys taking share relative to the broader strength of the market?

  • Are you guys doing something on the ground so you're picking up share?

  • Bill Wheat - EVP and CFO

  • That's always our goal.

  • As we compete in every community and we compete to have affordable product out there, that's always our goal.

  • If you look -- really when you look at share, you have to look over a longer trend.

  • And we certainly over the longer trend have been pretty consistently gaining share, and that's certainly our goal going forward; market by market, community by community, and then rolling up to the overall company is to continue to gain share in the marketplace.

  • And we feel like we're in really good position to do that.

  • Mike Murray - EVP and COO

  • We're looking to position our communities and our homes to be the best choice for every customer in every market that we're serving.

  • So to the extent that helps us gain share, that's great.

  • To the extent it just helps us grow with the market, we're going to do that as well.

  • Jessica Hansen - VP of IR

  • And clearly, our product offering at the Express entry level affordable price point has driven an outsized increase in those efforts over the last couple of years.

  • David Auld - President and CEO

  • Bob, every one of our operators wants to be number one in their market.

  • Whether they are closing 100 houses in a 7,000 permit market or 500 houses in a 600 permit market, they want to win.

  • And that's -- we instill that, we promote it.

  • And our expectation is that they will win, and with that we will gain share.

  • Bob Wetenhall - Analyst

  • Wow, it sounds like your execution is great.

  • And my just follow-up question, you reiterated free cash flow guidance.

  • M&A is a core strategy; you guys have a great track record of that.

  • What's the pipeline like, and do you think it's a public or private type of M&A situation?

  • Is there anything out there size wise that would be a game changer that would be a good fit for the platform right now, or do you think it's just going to be kind of selective, sharpshooter M&A?

  • Great job, and thanks and good luck.

  • Mike Murray - EVP and COO

  • Thanks, Bob.

  • We continue to look at a lot of opportunities, and we evaluate them all against the track record we have.

  • So we have a very high bar for what makes sense for us to bring onboard.

  • But what we continue to look at every opportunity that's presented to us, give it a very serious look and try to learn and understand how it could be a good fit for the Company, and we will continue to do so.

  • And it's been a very active time over the past few years, and I expect it will continue to be so.

  • Bob Wetenhall - Analyst

  • If you don't find that M&A opportunity, what do you think you do with the cash, because you got a lot of cash on the balance sheet currently?

  • Bill Wheat - EVP and CFO

  • Well, over the last couple of years, we've generated a lot of cash and we've consistently still found some acquisitions to allocate capital towards.

  • So right now with the pipeline that we see, our expectation is that we will still find some acquisitions that fit.

  • So right now, it's -- we will certainly think about if, if we don't find some acquisitions that fit.

  • David Auld - President and CEO

  • There's a great big old vault underneath that new Horton building, and Don wants to be able to put it -- spread it out down there and play in it.

  • Bob Wetenhall - Analyst

  • All right.

  • Thanks again.

  • Operator

  • Michael Rehaut, JPMorgan.

  • Michael Rehaut - Analyst

  • Thanks.

  • Good morning, everyone.

  • Also, obviously, nice results on the orders, nice to see the rebound from the prior quarter.

  • First question, I was hoping to dig into the Freedom Homes rollout a little bit.

  • You're still on track, it appears, and expecting to be in one-third of your markets by fiscal 2017 end.

  • I was wondering if you could give us a sense of, and maybe remind us if we talked about this last quarter, but how does that Freedom brands product differ from your corporate average in terms of ASPs and sales pace?

  • And given that it would appear that this is a market share gain opportunity, if this is something that is just getting revved up in this current year; is this something that you can further, perhaps, take share in your given markets over the next two or three years?

  • Jessica Hansen - VP of IR

  • Sure, Mike.

  • We definitely agree with the latter part of your statement in terms of this helping us continue to capture additional share.

  • As David mentioned earlier in the call, this is a product that we don't think really is out there today in terms of a lower price, affordable, active-adult community, smaller community size; limited amenities but good locations, kind of a lock-and-leave approach.

  • So gated where we can and some pools and small clubhouses in markets like Florida.

  • In terms of a price point, very early stages, so we'll adjust as we continue to roll it out.

  • But we would currently anticipate it to run about 10% to 15% higher than a like Express product.

  • And we do have plans, as we mentioned at the beginning, to be in at least one-third of our markets by the end of 2017.

  • So not a huge driver of our 2017 results; probably more of a driver in 2018, but definitely something that's going to help us continue to consolidate share and kind of rounds out our product offerings for the one place we weren't really playing before.

  • David Auld - President and CEO

  • Super large demographics, favor that brand.

  • And as interest rates stick up, these buyers are less mortgage sensitive.

  • So we're -- it's kind of a hedge against a little higher rate as well.

  • Michael Rehaut - Analyst

  • That's helpful.

  • And part of my -- let me just make sure I also get as part of that first question the sales pace, how that compares to the rest of the group.

  • And then my second question is, on SG&A, obviously continues to be a hallmark of the Company.

  • It was interesting, I was looking back at the past cycle and this -- in 2004 when you did a similar amount of homes closed that you are guiding for this year, you actually also had an SG&A of about 9.1%, it looks like, in that year.

  • And what it struck to me is that there are many builders today talking about maybe having a lower cost structure this cycle versus last, either through digital marketing which is something that you guys talk about as well.

  • But I was -- just the similar amount of closings and similar SG&A would suggest a similar cost structure.

  • And I was wondering if there are some pluses and minuses to your business model from a cost standpoint.

  • Certainly what comes to mind is you have your three or four brands today, which might require a little bit more SG&A relative to your singular approach last cycle.

  • But I was curious about some of the pluses and minuses on the SG&A front because on a top-down level, looks like the same cost structure.

  • Jessica Hansen - VP of IR

  • Mike, I think Bill will touch on the SG&A question.

  • In terms of going back to your follow-up Freedom and absorption, once again, very, very early stages for that brand.

  • But we would likely anticipate it being faster than a typical Horton community, but probably not quite as fast turning as an Express community.

  • Bill Wheat - EVP and CFO

  • And then, Mike, compared to the historical, we've looked at those historical comparisons as well.

  • And you're right, as far as where we were on SG&A as a percentage for the entire year in 2004 at similar closings was at a 9.1%.

  • The difference between then and now is we were seeing significant price appreciation in our homes in 2004.

  • In the data that I'm looking at, it was a high single-digit ASP increase then, which obviously creates a lot of SG&A leverage.

  • So today we're achieving this with a much more modest ASP appreciation.

  • And we're not really quite up to our peak volume yet, and with what we're on track for right now our expectations -- we're guiding to 9%.

  • We certainly feel very confident that we can hit the 9%, but if we continue to see the improvements and the efficiencies in our business, we expect to push beyond that before we get fully to peak volumes again.

  • You asked about costs and where there might be some changes.

  • Certainly in terms of efficiencies from technology -- and you mentioned the marketing, certainly efficiencies there.

  • Those are things that have been positives over the last cycle, over the last decade that are certainly helping to contribute.

  • On the cost side, frankly, the costs of regulations and running our business throughout our business, in all respects of our business, are significantly higher today at the local level and really all the way up through our business, which is something that we've had to absorb as well as everyone else in the industry, and it's well-publicized.

  • So I would say that's probably one of the more significant offsets to the other efficiencies we've seen.

  • Jessica Hansen - VP of IR

  • The other big difference, Mike, between 2004, 2005 and 2006, and our business model today is we had extremely pretty aggressive growth targets in place that we were actually adding headcount and building infrastructure out for.

  • Today, we are growing.

  • We have a stated target of double-digit revenue growth, and we're making sure we're incurring and adding SG&A to be able to handle that.

  • But we don't have to add at the same rate today as we would've had to back then to go after that.

  • Michael Rehaut - Analyst

  • Great.

  • Thanks, everyone.

  • Operator

  • John Lovallo, Bank of America.

  • John Lovallo - Analyst

  • Good morning, guys.

  • Thanks for taking the call.

  • The first question is the orders in the West region seemed a little bit lighter than we had expected, and to underperform some of the other regions.

  • Was this community-count driven, or maybe with the rollout of Express into California?

  • What were the factors there?

  • Bill Wheat - EVP and CFO

  • Hey, John, in the West as we've talked about, we have not been investing as heavily in the West.

  • We've been maintaining our position.

  • And relative to our other regions, we've been making larger investments in other regions.

  • So I think it's a reflection of just a little bit lower growth expectation there in our West region, which does reflect itself in community counts.

  • David Auld - President and CEO

  • And we did get -- because we don't have the number of communities there that we have in some these other regions, the delays in getting a couple of significant communities online can impact a quarter-over-quarter number.

  • Mike Murray - EVP and COO

  • And we're in the very early stages of Express roll out there, so it's not -- the West is not seeing as much benefit in absorption improvement and efficiencies yet that we have seen in other areas of the country.

  • David Auld - President and CEO

  • We are getting those communities open and there is certainly a market out there.

  • John Lovallo - Analyst

  • Okay, that's helpful.

  • And then given some of Trump's rhetoric around bringing jobs back, particularly in the auto industry, is there any appetite on your part for expansion into the Midwest, call it Michigan, Wisconsin, Ohio?

  • Have you guys considered that?

  • Mike Murray - EVP and COO

  • We continually evaluate opportunities to enter various markets, and we have looked at a few opportunities.

  • When one makes sense for us, we do think that those markets may have been a bit underserved in the past and we will evaluate those.

  • But we do like our conscious positioning of where we focus the most of our energies, the most of our capital, into a lot of the southern markets.

  • And even where a lot of -- there's been a lot of auto manufacturers open production facilities across the South and Southeast that have been good drivers for us and sources of good business in the Carolinas and Alabama.

  • John Lovallo - Analyst

  • Okay.

  • Thank you, guys.

  • Operator

  • Jack Micenko, SIG.

  • Jack Micenko - Analyst

  • Hey, good morning.

  • The pickup of an absorption pace, I think, was one of the biggest things out of the quarter.

  • I'm wondering if you could give us or if you have the absorption pace improvement year-over-year for each of the brands; so Express, Horton and Emerald.

  • Can I get a sense of the relative mix, and do you have that number?

  • Mike Murray - EVP and COO

  • No, we don't by brand.

  • We've got it here by region, but we don't have it here by brand in front of us.

  • That's something we could look at and follow-up with later on, but that's not something we have right here in front of us.

  • Jack Micenko - Analyst

  • Okay.

  • And then your capture rate mortgage had a nice improvement year-over-year.

  • What was driving that?

  • Mike Murray - EVP and COO

  • I think a lot of what's driving the capture rate improvement has been a renewed focus by the mortgage company on improving their utilization; that's shown up in a lot of their operating metrics.

  • Their operating margin is improving as they are getting better overhead leverage.

  • As our volumes increase and we're serving more of the Express homebuyers, the first- time homebuyers, it's very helpful to our homebuilding operating divisions to have that customer managed through the mortgage qualification process into the backlog so that when the home is ready, they are ready with the mortgage to close.

  • And the service levels provided by our mortgage company to the homebuilder are very high in that regard.

  • I mean we're still out there -- the mortgage company is competing for the business customer by customer in a very competitive mortgage market, but they are able to deliver a higher service level to that customer because of the integration we have with the builder in a lot of cases.

  • Jessica Hansen - VP of IR

  • Jack, to go back to your question, we were able to get our hands on the change in absorption by brand, and really it was consistently strong across all three brands, a strong double-digit increase in absorption.

  • Jack Micenko - Analyst

  • Okay, okay.

  • Thank you very much.

  • Operator

  • Mike Dahl, Barclays.

  • Mike Dahl - Analyst

  • Hi, thanks for taking my questions and all of the color so far.

  • Forgive, my voice is a bit raspy.

  • I wanted to ask about your owned option mix, and you've been one of the few builders that's successfully pushed pretty meaningfully back towards optioned.

  • And this quarter seem to stabilize a bit; recognize that it's not going to be so linear, but over time you can continue to mix that higher.

  • Curious to hear if there is anything regionally you can speak to in terms of either incremental successes or challenges that you've found in striking new option deals?

  • Mike Murray - EVP and COO

  • Mike, we're still not to our goal of a 50-50 balance in our total portfolio of option and controlled.

  • Very happy with the relationships we've been able to expand upon with developers across the country.

  • Key trade partners for us, frankly, in supplying the first raw material input to our business is land or lots.

  • And we're very pleased with the increase of finished lots we've been able to tie up and partner with others to develop for us.

  • That's probably driving a bit of our lot cost increase as a percentage of revenue or per square foot that we're seeing in our current deliveries.

  • It's a reflection of our strategy to try to have more lots provided for the Company finished, rather than us self-developing as much.

  • And we're seeing a big benefit of that in our focus on our improved returns; and we're seeing our returns come up as a result of that.

  • So there is no magic bullet to that.

  • It's building relationships, partnering with the right people market by market, having the experience with them and the confidence to get projects on the ground and work through them together.

  • Mike Dahl - Analyst

  • And is part of the lower investment in the West a function of just really that still being more of a cash market, and given your focus on shifting towards this balance, it's kind of an intentional mix away from the West?

  • David Auld - President and CEO

  • Well, we're not decreasing our investment in the West.

  • The balance of it -- we like the West; we've made a lot of money in the West, but we're just going to be disciplined.

  • And we have underwriting guidelines for everything we do, and whether it's in Texas or California, it's got to meet the same underwriting guideline which, by definition, is a capital limiter.

  • But, no, we're not reducing our investment in California.

  • We're actually doing very well in the West, very happy with our performance and the returns that we're driving.

  • Bill Wheat - EVP and CFO

  • And just continuing to work, just like everywhere else, to improve our returns in the West.

  • Even though it is a more capital-intensive area, it's still an area we want to improve our returns in.

  • Mike Dahl - Analyst

  • Okay, thank you.

  • One housekeeping then as a follow-up.

  • On the warranty and litigation this quarter, is there any color you can provide -- just as you -- this function of just as you've expanded, expanded in markets just normal course of business, or is there anything regional or more one-time in nature?

  • Bill Wheat - EVP and CFO

  • No.

  • I mean, inherently, the warranty and litigation area is a bit volatile, a bit lumpy from quarter to quarter, and that's one of the reasons why we give the range we give for our margin guidance.

  • That's just an element that you can have some variability from quarter to quarter.

  • So the variability we had this quarter is not outside our normal range.

  • A little bit bigger than it has been recently, but nothing highly unusual at all.

  • Mike Dahl - Analyst

  • Okay, thanks, and good luck this spring.

  • Operator

  • Jade Rahmani, KBW.

  • Ryan Tomasello - Analyst

  • Good morning; this is actually Ryan on for Jade.

  • Thanks for taking my question.

  • It seems that other real estate sectors are going through a period of price discovery as markets digest the economic outlook and the trajectory of rates.

  • So can you say if you've seen any adjustments in pricing or bid-ask spreads or demand in the land markets that you are currently purchasing in?

  • Mike Murray - EVP and COO

  • We haven't seen any kind of an adjustment in land pricing at this point.

  • Anecdotally, we're maybe getting another bite at a project that might've gotten by once.

  • So some things may be falling out, but that's just anecdotally.

  • It would be hard to put a trend to that or to see anything else happening on a harder quantitative basis at a global scale for us.

  • David Auld - President and CEO

  • I will say, Ryan, we closed some deals in our first quarter that were as good as any lot buy we made in the last four or five years.

  • So there are opportunities out there, and you've just got to be out there looking for them.

  • Ryan Tomasello - Analyst

  • Thanks.

  • And then my second question is a bit more nuanced.

  • Have you seen any changes in the levels of competition in any of your markets from either single-family rentals or multifamily apartments?

  • Mike Murray - EVP and COO

  • We've not seen -- it's an alternative housing choice for a customer, but typically those sources of housing stock are great feeders for us into our business.

  • As people see changes in their rentals and the opportunity to have an ownership position and lock in their housing cost, very attractive alternatives.

  • So we have not seen a significant change in our markets relative to those at this point.

  • But we do help a lot of people get into their first owned home out of a rental situation, whether it was single-family rental or a more traditional multifamily rental.

  • Ryan Tomasello - Analyst

  • Great.

  • Thanks for taking my questions.

  • Operator

  • Thank you.

  • We've reached the end of our question-and-answer session.

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

  • David Auld - President and CEO

  • Thank you, Kevin.

  • We appreciate everyone's time on the call today and look forward to speaking with you again in April as we share our second-quarter results.

  • And to the entire D.R. Horton team, outstanding first quarter.

  • You are truly the best of the best.

  • Let's go tear them up in 2017.

  • Operator

  • 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.