霍頓房屋 (DHI) 2018 Q2 法說會逐字稿

Good morning, and welcome to the D.R. Horton, America's Builder, the largest builder in the United States, Second Quarter 2018 Earnings Conference Call.

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

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

Thank you, you may begin.

Thank you, Donna, and good morning.

Welcome to our call to discuss the results for the second quarter of fiscal 2018.

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 in our most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

This morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q by early next week.

Consistent with the first quarter, our consolidated financials present our homebuilding, Forestar land development and financial services and other operations on a combined basis.

The segment information following the consolidated financials in our press release includes detailed financial information for all of our reporting segments.

And as a reminder, after this call, we will post updated supplementary data to our Investor Relations site on the Presentations section under News and Events for your reference.

The supplementary information includes data on our homebuilding return on inventory, home sales gross margin, changes in active selling communities, product mix and our mortgage operations.

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

Thank you, Jessica, and good morning.

In addition to Jessica, I am pleased to be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer; and Bill Wheat, our Executive Vice President and Chief Financial Officer.

The D.R. Horton team delivered solid second quarter and the spring selling season is off to a strong start with our sales increasing 13% from the prior year.

In the second quarter, our consolidated pretax increased 26% to $445 million on a 17% increase in revenues to $3.8 billion.

Our pretax profit margin improved 80 basis points to 11.7%.

These results reflect the strength of our operational teams, our diverse product offerings and the leverage of both, our national and local scale across our broad geographic footprint.

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

For the trailing 12 months, our homebuilding return on inventory was 17.6%, an improvement of 160 basis points from 16% a year ago.

With 29,400 homes in inventory at the end of March and 258,000 lots owned and controlled, we are well positioned for the rest -- for the remainder of 2018 and future years.

Mike?

Net income attributable to D.R. Horton for the second quarter increased 53% to $351 million or $0.91 per diluted share compared to $229 million or $0.60 per diluted share in the prior year quarter.

Our effective tax rates for the quarter and year-to-date reflect the rate reduction from the Tax Act of 2017.

And excess tax benefit related to stock-based compensation in the February Bipartisan Budget Act of 2018, which retroactively reinstated the federal tax credit for energy-efficient homes.

The current year 6-month period also includes a onetime noncash tax charge of $108.7 million to remeasure the company's net deferred tax assets as a result of the Tax Act.

Our consolidated pretax income for the quarter increased 26% to $445 million versus $354 million a year ago.

And homebuilding pretax income increased 29% to $416 million compared to $322 million.

Our current quarter results include $30.1 million of pretax inventory and land option charges to cost of sales, of which $24.5 million related to the settlement of an outstanding dispute associated with the land transaction.

Our backlog conversion rate for the second quarter was 100%, at the high-end of our guidance range.

At a result, our second quarter home sales revenues increased 16% to $3.7 billion on 12,281 homes closed, up from $3.2 billion on 10,685 homes closed in the prior year quarter.

Our average closing price for the quarter was $299,000, up 1% from the prior year quarter.

This quarter, entry-level homes marketed under our Express Homes brand, accounted for 38% of homes closed and 30% of home sales revenue.

Our homes for higher-end move-up and luxury buyers priced greater than $500,000 were 6% of homes closed and 15% of home sales revenue.

Our active adult Freedom Homes brand is now being offered in 25 markets across 14 states and accounted for 2% of homes closed and 1.5% of home sales revenue in the second quarter.

Bill?

The value of our net sales orders in the second quarter increased 13% from the prior year quarter to $4.7 billion.

And homes sold increased 13% to 15,828 homes.

Our average number of active selling communities decreased 1% from the prior year quarter.

Our average sales price on net sales orders in the second quarter was $299,600 and the 19% cancellation rate during the quarter was consistent with the second quarter of last year.

The value of our backlog increased 9% from a year ago to $4.8 billion with an average sales price per home of $305,100, and homes in backlog increased 8% to 15,841 homes.

Jessica?

Our gross profit margin on home sales revenue in the second quarter was 20.8%, consistent with the first quarter and an improvement of 100 basis points from the prior year quarter.

50 basis points of the improvement from the prior year quarter was due to lower interest, litigation and warranty costs, and 40 basis points was due to controlling construction cost increases while also reducing incentives or raising prices in communities where we are achieving our targeted absorption.

Based on current market conditions and our results for the first half of the year, we now expect our gross margin will be in the range of 20.5% to 21% for the full fiscal year with quarterly fluctuations that may be outside of the range due to product and geographic mix as well as the relative impact of warranty, litigation and interest costs.

Bill?

In the second quarter, home building SG&A expense as a percentage of revenue was 8.8%, an improvement of 50 basis points from the prior year quarter.

We remain focused on controlling our SG&A, while ensuring that our infrastructure adequately supports our expected growth.

Jessica?

Financial services pretax income in the second quarter was $31.4 million with a pretax profit margin of 33% compared to $32.2 million of pretax income and a 37% pretax profit margin in the prior year quarter.

Financial services profit margin declined this quarter primarily from lower pricing on loan origination sales due to competitive pressures in the mortgage market.

97% of our mortgage company's loan origination during the quarter related homes closed by our homebuilding operations, and our mortgage company handled the financing for 57% of D.R. Horton home buyers.

FHA and VA loans accounted for 43% of the mortgage company's volume.

Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 722 and an average loan-to-value ratio of 88%.

First-time home buyers represented 45% of the closings handled by our mortgage company, consistent with the prior year quarter.

Mike?

We ended the second quarter with 29,400 homes in inventory, 14,200 of our total homes were unsold with 10,400 in various stages of construction and 3,800 completed.

Compared to a year ago, we have (technical difficulty) more homes in inventory, which positions us well for the remainder of the spring selling seasons and fiscal 2018.

David?

Our homebuilding investment in lots, land and development during the second quarter totaled $862 million, of which $504 million was for finished lots and land acquisition, and $358 million was for land development.

Our underwriting criteria and operational expectations for new communities remain consistent at a minimum 20% annual pretax return on inventory and a return of our initial cash investment within 24 months.

We expect our homebuilding operations to invest approximately $4 billion in lots, land and development in 2018.

Bill?

At March 31, our homebuilding land and lot portfolio consisted of 258,000 lots, of which 124,000 or 48% were owned, and 134,000 or 52% were controlled through option contracts.

103,000 of our total homebuilding lots were finished, of which 35,000 were owned and 68,000 were optioned.

8,700 of our option lots at March 31 were owned or controlled by Forestar.

We have increased our option-lot position 23% from a year ago, and we believe we can increase the option portion of our total land and lot pipeline to 60% over the next few years, while keeping our number of owned lots near the current level.

We plan to continue expanding our relationships with land developers across the country as well as growing our majority-owned Forestar land development operations.

Our 258,000 homebuilding lot portfolio is a strong competitive advantage in the current housing market and sufficient to support our expected growth.

Mike?

As most of you know, Forestar Group became a majority-owned subsidiary of D.R. Horton in October 2017.

Forestar is a publicly traded land development company with operations in 18 markets and 10 states.

D.R. Horton's alignment with Forestar advances our strategy of expanding relationships with land developers across the country to increase our access to optioned land and lot positions and enhance operational efficiency and returns.

The interactions between D.R. Horton and Forestar continue to be extremely productive, and we are excited about the value this relationship will create over the long term for both D.R. Horton and Forestar shareholders.

Forestar's operating results for the 3-month period ended March 31, and from the date of acquisition, are fully consolidated in our financial segments, with the 25% interest D.R. Horton does not own, reported as noncontrolling interest.

The segment information tables provided in our press release represent Forestar's financials on its historical cost basis while the impact of purchase accounting and interest segment profit eliminations are presented separately.

During the quarter, Forestar sold a portion of its assets for $232 million.

This strategic asset sale included projects owned both directly and indirectly through joint ventures and consisted of approximately 750 developed and underdevelopment lots, 4,000 undeveloped lots, 730 unentitled acres, a multifamily development site and an interest in 1 multifamily property.

This sale provided capital for future growth while also streamlined Forestar's operations.

Both D.R. Horton and Forestar continue to identify land development opportunities to expand Forestar's platform.

Since the acquisition closed in October, Forestar has been evaluating 38 opportunities, primarily sourced by D.R. Horton, and Forestar had closed on 21 of those opportunities as of March 31.

All of the projects are located in high-demand markets that D.R. Horton currently serves.

These 38 communities are expected to yield approximately 15,000 finished lots, the majority of which may be sold to D.R. Horton in accordance with the master supply agreement between the 2 companies.

Jessica?

Looking forward, we continue to expect Forestar to invest approximately $400 million in land acquisition and development this year and to obtain a bank credit facility by the end of the fiscal year to help fund its working capital needs.

In fiscal 2018, we also expect Forestar to deliver approximately 1,200 lots and generate $90 million in revenue.

In fiscal physical 2019, we expect Forestar to deliver approximately 4,000 lots, generate $300 million to $350 million in revenue and access the public markets for additional growth capital if conditions permit.

In fiscal 2020, we expect Forestar to deliver approximately 10,000 lots and generate $700 million to $800 million in revenue.

Over the next 3 years, we anticipate Forestar's stabilized pretax operating margin will be in the range of 10% to 12%, and Forestar is targeting a net debt to capital ratio of 40%.

The expectations I just outlined are for Forestar's standalone results.

Due to the impact of intersegment profit eliminations, we do not expect Forestar to have material impact on D.R. Horton's fiscal 2018 earnings.

Bill?

At March 31, our homebuilding liquidity included $529 million of unrestricted homebuilding cash and $1 billion of available capacity on our revolving credit facility.

Our homebuilding leverage ratio improved 380 basis points from a year ago to 24.2%.

The balance of our homebuilding public notes outstanding at the end of the quarter was $2.4 billion, and we have $500 million of senior note maturities in the next 12 months.

During the first 6 months of fiscal 2018, our homebuilding segment generated $90.7 million of operating cash flows and our consolidated cash used in operations was $98.8 million.

Excluding Forestar, we generated $59.5 million of cash from operations for the current year 6-month period.

During the quarter, we paid cash dividends of $47.1 million, and we repurchased 500,000 shares of our common stock for $22.5 million.

Our remaining stock repurchase authorization at March 31, 2018, was $152.1 million.

At March 31, our stockholders' equity was $8.2 billion and book value per share was $21.72, up 13% from a year ago.

David?

Our balanced capital approach focuses on being flexible, opportunistic and disciplined.

Our balance sheet's strength, liquidity, earnings growth and cash flow generation are increasing our flexibility.

And we plan to utilize our strong position to enhance the long-term value of the company.

Our top cash flow priorities are to consolidate market share by investing in our homebuilding business and strategic acquisitions, reduce or maintain debt levels and return capital to our shareholders through dividend and share repurchases.

After increasing our guidance for pretax profit margin in our press release this morning, excluding Forestar, we now expect to generate at least $800 million of cash from operations in 2018, growing to over $1.25 billion annually in 20 -- 2020.

Jessica?

Looking forward, and as outlined in our press release this morning, we are updating our expectations for 2018 based on current market conditions and our results for the first half of the year.

We now expect to generate a consolidated pretax margin of 12.1% to 12.3%.

We expect consolidated revenues of between $15.9 billion and $16.3 billion and to close between 51,500 and 52,500 homes.

We anticipate our home sales gross margin for fiscal 2018 will be in the range of 20.5% to 21% with the potential for quarterly fluctuations outside of this range.

We estimate our annual homebuilding SG&A expense will be around 8.7%.

We expect our financial services operating margin for the year to be around 30%.

We are now forecasting a fiscal 2018 income tax rate of approximately 25%, excluding the onetime deferred tax asset charge we took in the first quarter, and we expect our outstanding share count to increase by less than 1% in fiscal 2018.

And as David just mentioned, we now expect to generate at least $800 million of positive cash flow from operations in fiscal 2018, excluding Forestar.

For the third quarter of 2018, we expect our number of homes closed will approximate a beginning backlog conversion rate in the range of 87% to 89%.

We anticipate our third quarter home sales gross margin will be in the range of 20.5% to 21%, and we expect our homebuilding SG&A in third quarter to be in the range of 8.2% to 8.3% of homebuilding revenues.

We expect our income tax rate in both, the third and fourth quarters to be between 25% and 26%.

Over the longer term and as we generate increased cash flows, we expect to pay down debt and decrease our leverage, increase our dividend and repurchase shares to offset dilution with a target to keep our outstanding share count flat by 2020.

David?

To conclude and reiterate, our growth in sales, closings, profits, returns and cash flow is a result of the strength of our long-tenured people and well-established operating platforms across country.

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

We remain focused on growing both, our revenue and pretax profits at a double-digit annual pace, while increasing our annual operating cash flows and improving returns in our business and to our shareholders.

We are well positioned to do so with our solid balance sheet, broad geographic footprint, diversified product offerings across our D.R. Horton, Emerald, Express and Freedom brands, attractive finished lot and land positions and most importantly, our outstanding team across the country.

We thank the entire D.R. Horton team for their continued focus and hard work.

We look forward to growing and improving our operations during our 40th-anniversary year, while preparing for great opportunities in the years to come.

This concludes our prepared remarks.

We will now host questions.

(Operator Instructions) Our first question is coming from John Lovallo of Bank of America Merrill Lynch.

First question is, Forestar's stock has held up really well, particularly, relative to the group.

And frankly, most of the investors that we speak with are aware and really very much on board with the assets like pieces and the strategy to issue equity to not only fund the business, but to dilute your steak down.

I guess the question is why not do this sooner than later?

John, thank you for the question.

I think what we're focused on Forestar first and foremost is building a great operational platform.

When we bought the company in October, just about little over 6 months ago, they had not really been focused on driving a community development business in the way we needed to build.

And so first things first is realigning the team and people that are in place there, building the interactions between D.R. Horton and Forestar and building a strong operating platform.

We think that building for the long-term will help any capital raises when we go to the markets next year.

And John, fortunately, they started with a lot of cash.

So they had $400 million of cash at the date of the transaction.

So from the standpoint of need for capital to fund that growth, there wasn't an immediate need.

They were also able to generate cash by selling some of their legacy portfolio as well.

And so we believe that focusing on operations, putting them in place to support us for the long term, which is really what will drive long-term value is most important.

And certainly then, capital raises both equity and debt down the line from Forestar will be an important part of the strategy.

But it was not necessary here in the first year.

That makes sense, okay.

And then clearly there's a lot of concern in the market about interest rates and about construction costs, I mean your orders and margins should help you some of those concerns there.

But are you guys seeing in the field any caution from buyer -- potential buyers on rates?

And maybe if you could just update us on what your stick and brick cost running year-over-year, please?

We're actually seeing more buyers come in and better qualified buyers today.

As I indicated in the prepared remarks, our FICO score this quarter was 722, which is the highest it's been in several years.

And that's with Express continuing to become a bigger piece of our business.

So we're really seeing rates have any noticeable impact on demand.

And for us, it's still -- it's all about jobs and affordability.

So as long as those 2 things are good, we don't expect an impact on demand even if rates do continue to rise gradually as we move throughout the year, which I think is our expectation today.

Your question about cost, John.

Our stick and brick cost per square foot was up low single digit.

Our lot cost per square foot was up mid-single digit.

And then clearly, our revenue per square foot was enough to offset that show the steady and improving year-over-year margin.

So really more of the same in terms of revenues outpacing stick and brick costs.

And our guys have done a phenomenal job in controlling cost increases in a rising cost environment, and we've been able to offset it with price.

John, it's David.

I would say the optimism that's out there in the market today slight increase in rates that we've seen are really fueling demand and its -- prices continue to move slowly.

I see a long sustained housing market.

Our next question is coming from Stephen East of Wells Fargo.

Just on Forestar a little bit, Mike, maybe you could give us an update on the build-out for Forestar, what you all are doing.

So eventually this becomes the standalone operation other than Horton sourcing everything.

And when would you expect to start to see that occur?

Where they're sourcing more than what Horton's bringing to the table?

Where they are sourcing more than what Horton's bringing to the table?

That will be probably at some point down the road.

I think one of the things we talked about last summer when we were working on this and kind of explaining our strategy, was that we have hundreds of people across the country today that are out -- their whole focus is to identify new land and community opportunities.

And Forestar still has, I think, 35 to 40 people on the team and while there has been some new folks added, and I think we will continue to see a team build-out over the next 12 to 18, 24 months.

It's going to be a bit of time before they're able to source as many deals as we're able to source and provide opportunities for them to evaluate.

So I don't see that in the near-term, in the medium to long-term certainly.

That is a key goal for them to be able to be sustainable and independent of us in terms of their own lot supply and pipeline.

Stephen, it's David.

We had the Forestar guys up yesterday, day before, kind of just gone over operational plans.

And I think their primary focus -- their internal goals are to create independence from Horton, and they are looking at deals today that will be sourced directly by them.

But they got to have people.

The thing that makes us different is people and they've got to do.

I think in the last 90 days, they've closed on 2 deals that were independently sourced.

One, again, sort of in their process for quite a while.

One was a more recent opportunity that presented itself, they were able to take advantage.

So they are out, they are actively working it.

It's just -- in this business, it's a very large funnel, we start with a lot and you work it down over a period of time to get there.

So the larger your starting number is, the more likely you're going to be able to close some of that.

And an important part of putting them in position to be able to do that down the line is expanding their platform across the Horton footprint, leveraging the Horton structure today to give them a presence in more markets than they're in today.

And then that will then put them in position to source more land independently down the line.

But fortunately, we got the opportunity for them to show tremendous growth just to grow their operations by leveraging Horton in the short term.

Okay.

And would that mean -- one follow-up on that, would that mean -- would roll ups play a significant part in that?

And then my other question just revolved around cash flow.

As you look out, when would you start seeing your cash flow get better because of Forestar's activities?

And I didn't really hear any commentary about actively looking on the M&A side.

Is that going to play into it also?

So on the roll-up opportunities within Forestar, that is something they certainly will be evaluating as they're looking to build the team.

And with that, like on the builder side, we'll be very opportunistic.

We'll continue to look at various M&A opportunities on the builder side opportunistically where it makes sense to add people to the team, potentially new products and new markets.

And our D.R. Horton cash flow guidance already includes what we expect as a result of Forestar and moving to 60% option here over the next few years and growing that cash flow number to over $1.25 billion annually by 2020.

Our next question is coming from Alan Ratner of Salomon & Associates.

So question on price point.

Obviously you guys have been an early mover at the entry level.

We heard another builder yesterday, he's more of a move-up builder, actually mentioned the fact that they're seeing less competition now as other builders have kind of moved into your space on the entry-level side.

And I remember last quarter, I think it was you actually highlighted at some point maybe an opportunity might present itself to get more active and move up.

So I was curious kind of if you could just talk a little bit about the dynamics you're seeing across your portfolio?

Do you still feel like entry-level is a space and has a lot of runway to go based on the new entrants into that arena?

And are you starting to see more opportunities unfold and move up given, I guess, some builders leaving that space?

We haven't really seen anybody leave that space.

But I can tell you the entry-level demographics and really the delay in what used to be the 25 (inaudible) houses to 35s, that group of people is -- there's more demand than is currently being serviced.

So we're focused on returns.

The entry level's driving the best returns.

I think as time moves, we will see that shift kind of up the price curve.

But right now today, it's awfully good in that [250 to 300] range.

Got it, great.

Okay, good to hear.

And then second question, if I look at your order growth, it was remarkably consistent across the regions, but just curious if you could talk a little bit about which market you're seeing maybe the strongest pricing power relative to cost inflation?

And where you're seeing the best opportunity to drive going forward?

Taxes and Florida continued to be very, very strong markets.

Arizona has come on incredibly strong for us over the last couple of years.

A lot of stability in California at the price points we're selling.

Northwest continues to be very, very strong.

And we're getting a little better in Northeast.

So we'd like to see that consistency, that's something we strive for.

And really -- pretty proud of what our people are doing out there.

And when you see our supplemental data here in a little while, Alan, after the call, you'll see the -- really our absorptions were up strongly across the board in all of our regions.

Any markets that jump out on the other side where maybe pricing seeing a bit of a wall or absorption growth is a bit more challenging?

I've got to tell you, we're not seeing that right now.

Even what has been our weaker markets have stabilized, and we're seeing, if not significant absorption gains, we're seeing margin moving up a little bit.

So market is very good right now.

It's -- there are a lot of people out there that don't want a house, but they want to figure out how to get in one.

And they feel good enough to take the risk the decide a mortgage and close.

So job growth is strong, consumer optimism is way up, consumer confidence is way up.

A lot of good things are happening in the country right now.

Our next question is coming from Carl Reichardt of BTIG.

I'm going to ask about -- I wanted to ask about [lot] count, which I think was flat or a little bit down.

When you expect that you might see a sort of reacceleration in the growth in the number of communities year-on-year especially given that the lot count is kind of building now behind the store count?

Carl, we do still expect to see growth over time in our community count.

We've seen periods where we were slightly up.

This quarter we were down 1% year-over-year.

Over the medium to longer term, we expect to see modest growth there.

Predicting exactly when that inflection point hit by quarter is a little bit difficult for us.

But we've been seeing continued improving absorptions as we continue to improve our execution, and how we're meeting the markets across our markets.

And that's been able to drive steady double-digit growth now for several years with very modest community count growth.

But we do expect that to inflect, but predicting exactly when, it's a little bit hard.

Okay.

And then I wanted to ask about (inaudible)] costs.

I know for a long time you've looked at buyers brokers as a really important set of partners for you.

And you've worked with them closely over a long period of time.

How are you thinking about those relationships on sort of a longer-term basis?

Are those kinds of cost that you have to pay out, something that you could work to lower over time?

I'm just kind of interested in how you think about that sort of strategically and tactically?

Strategically, we think of them as partners.

And we're going to continue to work with that community at a level that really is unique in the industry.

Now over time, will their economics change?

Will they have to become more efficient and more competitive?

Yes.

But at least in my mind, they're going to be -- the resale market is so much bigger than the new home market.

And whether it's online, whether it's some other type, that in reaction with people at point-of-sale, I think it's still going to be a part of how you get a transaction closed.

So we love rotors, we're going to continue to support rotors and to me there is a bigger part of the cost of the house as a necessary part of the house as concrete and lumber, because they drive the industry.

Our next question is coming from Michael Rehaut of JPMorgan.

First question, wanted to go back to the shift to lot optioning and obviously you've had a lot of success there.

And with the most recent -- this most recent quarter at 52%, you continue to make a very consistent solid move towards that 60%.

If you extrapolate 2% a quarter, not that 1 quarter is indicative of a trend, it could suggest that maybe you're going to get to that 60%, not in a couple of years, but perhaps, on a shorter time frame.

I was curious if that's a possibility to get to a 60% type of mark over the next 12, 18 months instead of the next 2 to 3 years?

And what might -- and what impact that might have from a return perspective, return on equity, return on capital?

Michael, that's -- that has been a consistent driver of our improving returns on our investments.

And as we look from where we were 6 months ago, we've picked up 2% in that mix.

And so we're going to continue to push that business so that we're buying lots on an option basis and engaging with developers and looking for ways to work with them on an optioning basis.

I don't know that we won't get there in 18 months, but it might also take us 30 months to get there.

It's a little bit of a snapshot point in time the quarter end that we're measuring that.

And land and lots are purchased and contracted on a dynamic basis throughout the year.

So we're consistently looking to move metric up and consistently looking to improve our returns.

So it's a big part of our regional presidents, division presidents, compensation plan is to be focused on returns.

So they are the ones that make this happen and they do it deal by deal and market by market.

Our goal is not only consistency, but sustainability.

And we've talked in the past about achieving something if you can't grow it and maintain it really is kind of a false achievement.

So everything we're doing is set up to execute quarter-to-quarter a little better and sustain it off down the road into the future.

Quarter-to-quarter, 52%, 53%, 54%, that's really not in our minds or anything that we spend a lot of time thinking about.

Right, I appreciate that.

No, I understand.

I think second question, I just wanted to focus a little bit on the margin side and the kind of a 2 part here.

You were able to raise your gross margin guidance for the year.

And I was just thinking about over the next year or 2, is this 20.5% to 21% range that you see a sustainable?

Or do you see a little bit of possible upside to that as you continue to lever some of the fixed costs or some -- get more efficiencies?

Conversely, on the SG&A, just any thoughts around the fact that you reiterated the full year SG&A guidance ratio despite raising the revenues?

Typically you'd see a little bit of leverage -- incremental leverage if you were to raise revenues all else equal.

And how do you think about SG&A over the next 2 or 3 years?

Mike, I'll kind of start at the bottom line, and then I'll go and go back to the pieces.

We're first and foremost focused on improving our returns.

And there's a lot of levers that allow us to achieve that.

Certainly, as we've already touched on managing our inventory investments and our options as part of that.

But we're very focused on improving our P&L metrics there as well to drive continued and improving returns.

We're certainly seeing a good healthy housing market, which is allowing us to see good stability and some lift in our margins, which has driven the adjustments in our guide on margin as well.

And then with our volume, we're going to get leverage on SG&A as well.

And we would expect to -- so we continue to do that work to improve that line item as well, all with the driver of improving our returns.

And as we've been working to improve returns, velocity of capital absorption pace within a given community is critical to achieving the returns.

So we're very pleased that executing on that strategy, maintaining the discipline absorption and starts plans that we have in place community by community, we're able to see improving margins in today's environment.

I guess just being a little more specific though on SG&A, was there any type of reason why you weren't able to get a little bit more leverage off of a higher revenue base all else equal?

I mean, the question might is more above the round, are we kind of reaching a point where SG&A is at a natural level?

Or is there incremental leverage there?

(technical difficulty)

Ladies and gentlemen, please standby.

Your conference will resume momentarily.

Thank you, please resume.

Our sincere apologies for the interruption.

Mike, Bill's going to answer your question now.

Sorry about that, Mike.

You were asking about our SG&A, our annual guidance.

Yes, I mean we're certainly pleased with where we are year-to-date on our SG&A.

Our annual guidance from a revenue standpoint, we have increased the bottom end of our revenue range, our top end of the revenue range is still in place.

And so from an annual standpoint, we feel like our annual guidance will still realistic and reasonable relative to that annual revenue guide.

But certainly, we're focused on achieving that and hopefully beating it.

But at this point in time, we feel like the annual guidance was still at a reasonable level.

Next question is coming from Jack Micenko of Susquehanna.

This is actually Soham Bhonsle on for Jack this morning.

So just getting back to rates and the impact on your buyers.

The concern is obviously around sensitivity to rates and given your entry-level mix is higher there.

But can you maybe speak to some of the tools that you guys have under your belt to offset some of that pressure for that buyer going forward?

And we've heard of point by downs in some cases in the longer rate locks.

We're not seeing those kind of products with any kind of widespread use right now.

We're -- as Jessica mentioned before, we're seeing kind of an increasing pool of better qualified buyers.

Even with our larger exposure to the entry level and Express.

Our mortgage company FICA score is the highest it's been in years this last quarter on current originations.

And while interest rates are going up, I do think they're going up for the reasons we hoped is that strengthen the economy, and we're seeing people with more jobs and better incomes, which are 2 of the primary drivers for household formations and home-purchase decisions.

And what we would typically do first as buyers become more challenged if rates do continue to rise to a level that impacts affordability to any large extent, is just a shift down in size of the home they're going to buy.

So we have multiple floor plans in our communities and right now our average square footage in an Express community maybe 2,000 square feet.

But we've got a 1,500 or 1,600 square foot plan available that we're just not selling as many of.

And as rates rise and affordability becomes more of a challenge, people still need to buy homes.

They may just buy a little less home, but rather than the larger home.

We're not seeing that today, as Mike indicated.

But that would typically be the first shift, and we can flex very quickly to do that.

Right, that's helpful.

And then switching to Forestar, as I look at the SG&A expense line, it's down 40% sequentially.

So was that you guys just rightsizing the business this quarter?

And when you expect to get to that normalized 10% to 12% pretax margin by?

Jack, the first quarter for them -- the prior quarter included a lot of their transaction costs.

So they had a lot of unusual costs associated with the transaction, both costs associated with it as well as change of control type payments to employees.

So this quarter its closer to a normalized SG&A rate for them.

We would expect over time for their SG&A to need to grow obviously as they build out their platform.

And then as they get to a normalized pace where they're delivering really the new profile of deals, the faster-turning deals that they'll be delivering to D.R. Horton in 2019 and really by 2022 then their pretax operating margin of 10% to 12% would be our expectation at the current time.

Okay.

So you expect it by next year at some point?

I think there will be in that ballpark.

They're still working through the legacy assets, some of which are higher margin, but lower turn.

Newer assets will be a faster turn.

And so I'd say by late '19 and into '20, you should start to see their profile get closer to that stabilized level that we described.

Our next question is coming from Ken Zener of KeyBanc Capital Markets.

I'd like you to comment on units under construction to improve investors' understanding of your business with closings at 100% of backlog.

I think that's less insightful than 40 -- closings 44% a prior quarter's units under construction.

So my one question has 3 parts.

Please explain why you carry a spec unit for each unit in backlog?

How you locally manager your construction cycles without a top down infrastructure?

And then how does this help your asset velocity and lower your land risk, which is 2.5 years' supply?

First part of the question.

Why do we carry specs and what ratio is appropriate?

I mean, we manage the spec levels community by community, looking at construction cycle times, looking at sales demand in that sales market and what the planned absorption is for that community.

And we will start a number of homes that are unsold to meet the expected delivery demand that we're going to see in that.

And our operating process is start the home and sell into that production cycle.

But that's done at community-by-community level, and we will adjust those starts and that inventory level up or down depending upon market reaction and how our sales efforts are going, yes.

I'm not exactly sure what -- the second part of your question was about managing the construction cycle.

Such top down, because we certainly don't.

That is a very local submarket by submarket with the teams in place that know their market the best, know their trades the best, with the trades are capable of doing and how to maximize the efficiency with those trades to get the best labor pricing.

On a national basis, what we're able to do on the pricing side is, work for a lot of our national trade partners on leveraging our scale and purchasing power to keep our input cost as low as possible.

And then you mentioned the asset velocity, and really what our local operators are doing where they're managing this community by community.

When they open a community, they have a plan -- business plan that is designed to strike the best balance between pace and price margin to generate best return.

And so they are executing to that plan.

And clearly, asset turn, asset velocity monthly absorption is an important part of that.

And then that's what they guide their business to.

If they start a little high and there's still little bit more, they're more likely to moderate their pace to hit their absorption pace and push price and margin.

If they're starting a little slow, they will push their absorption to make sure they stick to their absorption plan and make sure they do that to optimize their returns.

So it's really governed by optimizing that balance to generate the best returns community by community.

And that driving the return off of the land or lot investment does derisk that land or lot investment, because we're going to move through that capital in the time frame that we expected to at the output of the project, thereby we pull that capital back in the company and we're able to redeploy to current market.

And the spec strategy is a key part of that in order to turn the land inventory and to keep that consistent pace going, having that inventory specs in place to anticipate what we want to sell, what our absorption plans are for each months in that community is a vital part of it.

And having inadequate supply of specs in every community makes this a viable alternative to the existing home sales that are out there, which as David mentioned before, is a much larger market than the new home sales.

Our next question is coming from Jay McCanless of Wedbush Securities.

The first one I had by my count Horton's the fourth builder this week to raise their full year gross margin targets.

Can you talk about what's changed versus the last conference call?

And maybe what you guys in the industry are seeing that gives you more confidence on that line item?

Yes, Jay, I would day, 3 more months to the spring is really -- as we're seeing that the environment is good, we're seeing that we're hitting our absorption pace, we're seeing that we continue to have the ability to offset cost with price community by community has given us that confidence level.

And so we're pleased to be able to do that.

And what we see today is continued stability, continued healthy market that we think in the latter half of the year should support that higher guidance.

Okay.

That's great.

And I also wanted to touch on -- you guys with Freedom, you're one of the first movers on this empty-nester trend that seems to be gaining steam.

Are you guys tracking anything in the field for your other product lines in terms of how many more empty-nesters or 55-plus buyers are coming in maybe versus this time in the last year or few years ago?

Not really.

I wouldn't say we're tracking.

As we establish our Freedom flags in the markets, we're seeing better and better success.

And the Express communities have absorbed a lot of that 55, I call them blue-collar retiree, because it's just a lower cost lifestyle.

That's -- from a demographic standpoint, it's a huge trend.

And it also dovetails into the migration from high-tax states to low-tax states.

So it's -- we believe it's a long-term trend that we're going to see a lot of demand for roughly foreseeable future.

Great.

And (inaudible) just what are the long-term targets?

Or how many Freedom flags you want out there?

Yes, we're in [certainly] markets.

Some markets are significantly bigger than others, but our goal is to get them rolled out, kind of like our Express program to a level in each market that the market will absorb.

So it's going to be a big part of our growth over the next 5 to 7 years.

Our next question is coming from Stephen Kim of Evercore ISI.

Mike first question actually relates to production efficiency.

Obviously, you guys with the rollout of Express way before the competition really got a jump on that and it's been a huge part of the success of the company over the last few years.

I was curious about what you've thought about the opportunity to, maybe, take the next step in terms of productivity with the use of -- or the partnering with companies that do penalizations or factory construction for the sake of simplicity, I'll call them like e-builders.

And so my question is basically 2 parts.

One, what percent of the homes that you built today are using some extensive use of penalization and is this an area you're really focused on?

And 2, do you think the productivity gains, that you might get, will continue to be through low-tech strategies?

Or do you think the integration of things like robotics or BIM modeling, logistic software et cetera, along the factory production holds a real promise?

So first question, we do use apparently penalization in various markets and its market by market where those capabilities exist in the market and can provide a timely and cost-effective solution for our local building operations.

We are very happy using penalization, and we look to expand that and work with a trust plant in a given market to expand to see if they're capable of moving to the next step in penalization.

So we do that.

I don't have a percentage for you of what the breakdown is across the country.

But it is something that we do monitor and measure and continually challenge our existing assumptions about what the most efficient way is to deliver a home to a customer.

In terms of the higher tax, I would say broadly, yes, Stephen.

I think there will be production efficiencies to be gained in our industry through this.

Do I know which one it is yet?

No I don't.

But we are evaluating those, and we are watching those and we're very interested in paying attention to what's happening there.

I think there's some really interesting things happening.

And I think -- we're excited to be -- to play a part of that.

Yes, that makes sense.

I just want to follow up on that, if I could, Michael.

You mentioned that it depends -- your use depends a little bit on if the local market can support your use of that.

And I was curious if you -- that seems to suggest there may be some sort of a bottleneck in certain markets.

And I was curious if that supply issue or bottleneck had to do with an availability of capital?

And if that's so, if you would be interested in partnering with some of these kind of initiatives to sort of get them jump started to get to the kind of scale where they can actually support somebody of your size?

Again, it is going to be very, very much market by market where there are markets where they are very efficient labor sources that are able to stick frame a home and construct a home in the traditional fashion.

It's a difficult barrier to overcome the cost efficiencies.

It takes to bring penalization to place.

Other markets that are high-labor cost markets, we've seen more rapid adoption of penalization.

I will say, Stephen, affordability in housing is just going to become more and more difficult to maintain.

And even at our Express level, there are still a significant amount of the population is priced out of home ownership.

So we have got to get better.

And I think technology and different ways of thinking about constructing houses is going to be how that takes place.

Because I don't see labor going down, and I don't see materials going down.

And land certainly is not going to go down.

So how you build a house -- I mean that's -- to me everybody at some point in their life ought to be able to own a house.

And that's just not the case today in the United States and it's certainly not the case in the world.

That something we think about a lot.

Over time this industry and this company will put the puzzle together.

Marrying the technology, marrying the new techniques with the unique attributes of how you build out a community, every piece of real estate is different, every local market is different, but marrying those things market by market will happen and will happen for this industry and for this company.

It was a very important day to me when I was able to buy my first house.

And I can tell you, I think that helped me become the success -- whatever success I have achieved, I think that was the part of it.

So everybody ought to get experience of.

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

So I just wanted to ask about updated thoughts on share repurchases.

Obviously the cash flow outlook is very strong obviously raising the guidance for this year.

And obviously Forestar's on track to be more self-sufficient next year.

You maintained your intention to just buy back to the extent to offset dilution.

Any updated thoughts on going beyond that?

Over the longer term issue, yes, we would expect that we would do that.

But for the short run, we are getting established with being a consistent repurchase for shares each quarter.

We have not historically done that on a consistent basis.

So we are in the early stages of beginning a long-term share repurchase program.

So right now, we're starting at a level that we're comfortable with within our cash flow.

Obviously, our cash flow is used for a number of purposes this year.

We had a major acquisition early in the year.

We continue to pay a dividend at a healthy rate as well.

And so we're beginning the share repurchase at a modest level.

But we would expect it would increase over time.

First step is to offset dilution here by 2020.

And then as our share -- as our cash flow grows, as our business grows, we would expect that to grow -- to continue to grow over time as well.

Again, it's about consistent and sustainable over a long period of time.

The flat buyers in my experience don't do much for shareholders long term.

Got it.

And what do you need to see specifically to feel that the -- to conclude basically that you've been successful in creating a consistent cash flow generating machine.

I mean they're going to be over $800 million this year and this stage of the cycle in the market is going well, that's a very strong number.

And I think you've maintained the $1.25 billion target for '19, you didn't mention it.

I would love to know if your -- your real thoughts on that are different.

So coming out of 120 you've all been 3 years, averaging about $1 billion a year.

At that stage, do you say we've been successful in our goals?

And maybe we can consider a sustainable program?

What exactly are you going to use to judge that kind of metric or number-wise?

Well, it's going to be on balance with all aspects of our business.

What we see overall in our business, what we see in our opportunities to continue to invest in growing our business.

What we see on the M&A front as well as then what we just see in terms of our outlook on the market.

So what I would say is, we do believe that we have been very successful at building a cash flow generating machine.

We generated a positive cash flow for 3 straight years, this will be the fourth year.

And it gave us the confidence to begin the share repurchase program.

And so now we will just build on that quarter by quarter, year by year.

And as we continue to make progress quarter by quarter then I'd expect the share repurchase to increase alongside it.

Got you, got you.

And that...

We're going to stay optimistic.

I mean, the investment we made in Forestar, we think is going to be significantly better for our shareholders than increasing our stock buyback by $500 million this year.

So it's -- we're out there looking at the market and making what we believe are the best long-term decisions for our shareholders.

Got it.

And on Forestar, the 10,000 lot delivery goal, I think that was the third year out, so for fiscal '20.

As you've been developing the pipeline, any kind of updated thinking on what percentage of those might be delivered to D.R. Horton?

And what percentage might be external?

How D.R. Horton will link to expect the Forestar to be at that stage especially now that you have some clarity with 38 deals having been bedded so far?

The first couple of years here, '18, '19, '20, it's going to be very -- more heavily weighted towards Horton than they will be over the longer term.

Over the longer term, as David mentioned earlier, we met with the Forestar team this week and they would expect to deliver to other builders over the longer term 20% to 30% of their deliveries to other builders.

It's going to take them a bit of time to develop their sourcing capabilities, but they do have existing relationships with other builders today and are delivering lots to other builders today, but their sourcing capabilities are going to be largely driven by Horton here in the short run.

But 20% to 30% would be a good range for them for the long term for other builders.

At this time, I would like to turn the floor back over to management for any additional or closing comments.

Thank you, Donna.

We appreciate everyone's time on the call and look forward to speaking with you again in July to share our third quarter results.

And to the D.R. Horton team, another spectacular quarter.

It makes us proud to set up here and be able to represent you.

Thank you.

Ladies and gentlemen, thank you for your participation.

This concludes today's conference.

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