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D R Horton Inc
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Greetings, and welcome to the First Quarter 2019 Earnings Conference Call for D.R. Horton, America's Builder, the largest builder in the United States. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Jessica Hansen, Vice President of Investor Relations for D.R. Horton. Jessica, please go ahead.
Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the first quarter of fiscal 2019.
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 Web site at investor.drhorton.com and we plan to file our 10-Q early next week.
After this call, we will post an investor presentation and supplementary data to our Investor Relations site on the Presentations section under News & Events for your reference. The supplementary data relates to 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'm pleased to be joined 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 a solid first quarter of 2019. Our consolidated revenues increased 6% to $3.5 billion. Pre-tax income was $376 million and our pre-tax profit margin was 10.7%.
For the trailing 12 months, our homebuilding return on inventory improved 230 basis points from a year ago to 19.3%. These results reflect the strength of our operational teams, our ability to leverage D.R. Horton's scale across our broad geographic footprint, and our product positioning to offer affordable homes across multiple brands.
As we discussed on our call in early November, sales prices for both new and existing homes have increased across most of our markets over the past several years, which coupled with rising interest rates has impacted affordability and resulted in some moderation of demand for homes over the last few months, particularly at higher price points.
However, we continue to see good demand and a limited supply homes at affordable prices across all of our markets. And economic fundamentals and financing availability remains solid.
Our net sales orders during the first quarter increased 3% versus the last year. As we indicated on our last call, our sales in October were down from the prior year. However our sales comparison improved in November and December was a good sales month. We are pleased with our positioning of affordable product offerings for the upcoming spring selling season, and we will adjust to future changes in market conditions as necessary.
Our strategic focus is to continue consolidating market share while growing our revenues and profits, generating strong cash flows and returns and maintaining a flexible financial position. With a conservative balance sheet that includes an ample supply of homes, lots and land to support growth, we are well positioned for the remainder of 2019 and future years.
Mike?
Net income attributable to D.R. Horton for the first quarter increased 52% to $287 million or $0.76 per diluted share compared to $189 million, or $0.49 per diluted share, in the prior year quarter. Our prior year quarter includes the impact of a higher effective tax rate primarily due to the remeasurement of the company’s deferred tax assets and liabilities as a result of the Tax Cuts and Jobs Act.
Our consolidated pre-tax income for the quarter was $376 million versus $391 million a year ago. And homebuilding pre-tax income was $354 million compared to $374 million. Our first quarter home sales revenues increased 7% to $3.4 million on 11,500 homes closed, up from $3.2 billion on 10,788 homes closed in the prior year quarter.
Our average closing price for the quarter was $296,600, essentially flat with the year ago quarter, while the average size of our homes closed was down 3% reflecting our ongoing efforts to keep our homes affordable.
Bill?
Net sales orders in the first quarter increased 3% to 11,042 homes and the value of those orders was $3.2 billion, flat with the prior year quarter. Our average number of active selling communities increased 3% from both the prior year quarter and sequentially.
Excluding the builders we acquired during the first quarter, our net sales orders increased 2% and our average number of active selling communities was flat, both sequentially and year-over-year.
Our average sales price on net sales orders in the first quarter was $292,100, down 3% from the prior year quarter. The cancellation rate for the first quarter was 24% compared to 22% in the year ago quarter.
Jessica?
Our gross profit margin on home sales revenue in the first quarter was 20%, down 80 basis points from the first quarter last year and down 160 basis points sequentially from the September quarter.
The majority of the sequential decrease in gross margins was due to cost increases, less pricing power, higher incentives and to a lesser extent purchase accounting from our recent acquisitions.
We continue to focus on achieving our targeted absorptions to maximize returns in each of our communities because we believe a consistent pace of start, sales and closings with the right product positioning drives both the highest returns and pre-tax profit margins.
Our home sales gross margin for the full year of fiscal 2019 will be determined primarily by the strength of the spring selling season. Based on today’s market conditions, we currently expect our gross margin in the second quarter to be in the range of 19% to 19.5% due primarily to less pricing power and higher incentives on our first quarter sales activity as well as the impact of purchase accounting.
Bill?
In the first quarter, homebuilding SG&A expense as a percentage of our revenues was 9.5%, flat with the prior year quarter. We remain focused on managing our SG&A efficiently while ensuring that our infrastructure adequately supports our opportunities to consolidate market share and grow over the long term.
Jessica?
Financial services pre-tax income in the first quarter increased 6% to $23.6 million from $22.2 million in the prior year quarter. Financial services pre-tax profit margin for the quarter was 27.7%, up slightly from 27.4% in the prior year.
98% of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operations and our mortgage company handled the financing for 54% of D.R. Horton homebuyers. FHA and VA loans accounted for 44% of the mortgage company's volume.
Borrowers' originating loans with DHI Mortgage this quarter had an average FICO score of 721 and an average loan-to-value ratio of 87%. First-time homebuyers represented 50% of the closings handled by our mortgage company, up from 43% in the prior year quarter, reflecting our continued focus on offering affordable homes for entry-level buyers.
Mike?
We ended the first quarter with 33,700 homes in inventory, 20,100 of our total homes were unsold with 15,200 in various stages of construction and 4,900 completed. Our increased inventory homes puts us in a great position for the spring selling season in fiscal 2019.
We manage our home starts at a community level each week and we will make adjustments to our starts as necessary throughout the spring to align our inventory levels with our sales pace in each community.
Our homebuilding investments in lots, land and development during the first quarter totaled $1.1 billion, of which $440 million was for finished lots, $200 million was for land and $450 million was for land development.
Our underwriting criteria and operational expectations for new communities remained consistent at a minimum 20% annual pre-tax return on inventory and a return of our initial cash investment within 24 months.
David?
We increased the option portion of our land and lot pipeline again this quarter. At December 31, our homebuilding lot position consisted of 309,400 lots of which 128,500 or 42% were owned and 180,900 or 58% were controlled through option contracts. 37,000 of our total owned lots are finished and 89,000 of our option lots are or will be finished when we purchase them.
We have increased our option lot position by 47,000 lots from a year ago. And we plan to increase our option lots further by expanding our relationships with lot developers across the country and continuing to support the expansion of Forestar's national lot manufacturing platform. Our balanced and well-positioned lot portfolio is a strong competitive advantage.
Mike?
Forestar, our majority-owned subsidiary is a publicly traded residential lot development company now operating in 35 markets across 16 states. At December 31, Forestar owned and controlled approximately 25,600 lots, of which 2,400 are finished. 18,800 of Forestar's lots are under contract with D.R. Horton, or subject to a right of first offer under the master supply agreement between our two companies.
Forestar’s revenues in the first quarter increased 25% to $385 million compared to the prior year quarter, $38.5 million compared to the prior year quarter. And pre-tax income increased 23% to $4.9 million. During the first quarter, Forestar delivered 518 lots and is on track to grow its annual deliveries to 4,000 lots generating $300 million to $350 million of revenue in fiscal 2019 and to approximately 10,000 lots generating $700 million to $800 million of revenue in fiscal 2020.
We expect Forestar to be consistently profitable with pre-tax profit margins of approximately 10% by fiscal 2020. These expectations are for Forestar’s stand-alone results. Forestar is also making steady progress in building its operational platform and capital structure to support its significant growth plans. Forestar's current liquidity, capital base and lot position are sufficient to support its fiscal 2019 and 2020 planned growth in lot deliveries and revenues.
Forestar’s current liquidity of $531 million and a debt to capital ratio of only 14%. Subject to market conditions, Forestar plans to access the capital markets in fiscal 2019 to provide additional capital for long-term growth. Forestar will post an updated presentation to the Events & Presentation section of their Investor Web site at investor.forestar.com at the conclusion of this call. This presentation describes Forestar’s unique business model and its significant growth and value creation opportunity. We encourage investors to review it.
Bill?
At December 31, our homebuilding liquidity included $538 million of unrestricted homebuilding cash and $901 million of available capacity on our revolving credit facility. Our homebuilding leverage ratio improved 270 basis points from a year ago to 23.2%.
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 notes maturing in March, which we plan to repay at maturity for liquidity and cash flow.
During the quarter, we paid cash dividends of $56 million and we repurchased 4.1 million shares of our common stock for $140.6 million. Our remaining stock repurchase authorization at quarter end was $234.9 million. At December 31, our stockholders’ equity was $9.1 billion and book value per share was $24.45, up 17% from a year ago.
David?
Our balanced capital approach focuses on being flexible, opportunistic and disciplined. Our balance sheet's strength, liquidity, earnings 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 continued top cash flow priorities are to consolidate market share by investing in our homebuilding business and strategic acquisitions, reduce homebuilding leverage and return capital to our shareholders through dividends and share repurchases.
We have been actively pursuing select acquisitions across the country to expand and enhance our operational platform. During the first quarter, we purchased the homebuilding operations of three private builders for approximately $321 million.
In November, we acquired Westport Homes, a top five builder by volume in Indianapolis and Columbus which are both top 50 U.S. housing markets. And in December we entered Iowa by acquiring Classic Builders, the largest builder in Des Moines and we enhanced our market position in Raleigh, North Carolina by acquiring Terramor Homes. We’ve welcomed the Westport, Classic and Terramor teams to the D.R. Horton family.
Jessica?
Looking forward, based on current market conditions, we expect our number of homes closed in the second quarter will be in the range of 12,800 to 13,300 homes. We expect our second quarter consolidated revenues to be in a range of $3.9 billion to $4.1 billion.
And as we stated earlier, we expect our home sales gross margin in the second quarter to be in the range of 19% to 19.5% resulting in a lower consolidated pre-tax profit margin in the second quarter compared to the first quarter.
Our revenues and profit margins for the full year of fiscal 2019 will be determined primarily by the strength of the upcoming spring season, so we are not providing full year revenue or margin guidance at this time.
We expect our quarterly income tax rate to be approximately 25% for the remainder of this year. We also continue to expect our homebuilding segment to generate cash flow from operations of at least $1 billion in fiscal 2019. And we expect our outstanding share count to remain relatively flat with the current level for the remainder of the year.
David?
In closing, my results reflect the strength of our long-tenured and well-established operating platforms across the country. We are striving to be the leading builder in America in each of our markets and to expand our industry leading market share.
We are focused on consolidating market share while growing our revenues and profits generating strong cash flows and returns and maintaining a flexible financial position.
We are well positioned to do so with our conservative balance sheet, broad geographic footprint, affordable product offering across multiple brands, attractive finished lot and land position, and most importantly our outstanding experienced team across the country.
We thank the entire D.R. Horton team for their continued focus and hard work. We look forward to working together to continue growing and improving our operations throughout 2019.
This concludes our prepared remarks. We will now host questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question today is coming from John Lovallo from Bank of America Merrill Lynch. Your line is now live.
Hi, guys. Thank you for taking my questions. First question, Dave, are your comments on November kind of sales pace improving and December being a pretty solid environment was clearly encouraging. Have you seen improving traffic and overall business trends kind of continuing to January particularly given the rate pullback?
John, we have. We’re feeling better and better as we progress into the spring selling season. Week-to-week we’re seeing a little better sales, little better traffic. And really the last couple of weeks we’ve been happy.
Okay. That’s exactly what I wanted to hear. It looks like you’ve bought back more stock in the first quarter than you guys did in all of 2018 and it seems like the blended price was around 34 and change, which is obviously very well timed. Should we read this as you’re expressing confidence not only in your business and in strategy, but perhaps in the fact that the first quarter was kind of the market bottom here and things are looking potentially to improve?
Yes, John, this is Bill. I think it’s just a continuation of our strategy. We’re remaining flexible and staying in a flexible position. And repurchases is part of our capital allocation strategy. I expect we want to be consistent over the long term in our program but when opportunities exists when our valuation is down in the stock, we’re going to maintain flexibility to be opportunistic. And I would view the level this quarter as clearly an opportunistic buy, but we do expect to be a consistent buyer going forward. But the levels will fluctuate from quarter-to-quarter depending on what the valuation of the stock is.
John, just to build on that a little bit, we are very confident. The job growth numbers, the overall economy comes down to positioning and having the right house in front of the people that are out there trying to buy. So we’re working very hard on that. And we do not believe that this is a great demise of housing. We believe that it’s going to be a good year.
Good stuff, guys. Thank you.
Thank you. Our next question today is coming from Stephen East from Wells Fargo. Your line is now live.
Thank you and good morning, everybody. Maybe just following on that first question a little bit, David. As you look at what’s happening, what’s going on, getting a little bit better, a little bit better, how much of that is in your mind incremental incentives and you all or your peers meeting the market more versus the buyer behavior really stepping in and you all not needing to ramp incentives, say, in January or even December and January?
Steve, I feel like there was more pressure on the incentive side to try to get the pace reestablished in November than it was in December and even less so in January. It really – to me it comes down to taking advantage of the traffic that coming in the door. And as more traffic comes in, you got to be a little less aggressive to hit the targets. Because we’ve been planning a long time, but we really do look at it subdivision by subdivision, market by market against a plan that incorporates sale starts and closings to maximize some kind of return.
We did guide to the lower gross margin particularly related to the choppiness in Q1, so the 19 to 19.5 for Q2 is because of what we saw in the market in Q1. But we are optimistic that we’ll find a good pace in the spring and begin to see some level of margin stability as we move forward throughout the year.
I can tell you we haven’t seen – I don’t know if we’ve seen a month-over-month or year-over-year down number in a long time.
Okay, all right, got you.
It was a tough --
And in the end that was the only one, okay. We’ve been hearing of layoffs with several of your public competitors. One, I guess, are you all seeing that out in the market? And are you seeing them take a different stance on going to market and say you all are doing – being aggressive with the same incentives and moving on pace? Are you seeing them try to go to market differently and are you seeing them back off land deals at all?
I would say that we’ve heard of the same – some of the same layoffs. And we’re looking to meet the market and the market’s defined by the buyer behavior and it’s defined by other competitor behaviors as well. I don’t think anybody is as well positioned as our teams have got us into both in terms of product affordability, the communities we have that are now open and the inventory position we have coming in right now. So hard to generalize where we see it, but we empower our local teams to make market decisions every day and to drive their neighborhoods to the right pace to improve the returns on them. And the last part of your question I think was dealing with the land deals. We probably have seen a couple – anecdotally you hear of a couple of land deals coming back around. Maybe it’s a little more than normal. It’s hard to exactly gauge that. It’s not something that’s measured very rigorously. But we do see some opportunity that come back around a bit.
Okay. Thank you.
Thank you. Our next question is coming from Stephen Kim from Evercore ISI. Your line is now live.
Thanks very much, guys. I appreciate it. Again because I know this is what everybody is really focused on, I wanted to delve a little bit if I could into the tone of the market and your stance towards that strategically and also the impact on margins. So to frame it a little bit, David, when we met up a month or so ago I think, maybe a little bit over a month ago, you had indicated that you weren’t as a firm looking to get particularly aggressive on incentives until you had had January sort of under your belt. January’s not quite under your belt but your commentary suggest that things have improved to the point where perhaps the level of incentives that you had contemplated you might need to do in the fourth quarter or your first quarter, the fourth calendar quarter, is not what you’re expecting you’re going to need to be able to do. So I just want to make sure first of all that you have sort of held back in terms of some of the incentives that you were thinking you might have had to do relative to what you had previously thought. And then also if you could remind us where various incentives show up on the income statement? So like some of those actions you do like, whether it’d be rate buy downs or whether it be closing costs or things like that, landscaping, just which ones show up in the gross margin and which ones may show up elsewhere?
To start with the latter and then I’m sure David will also chime in on incentives and margins and his commentary on that, Steve, but any incentive we offer essentially shows up in our home sales gross margins. So whether it be a price reduction, which would impact revenue or any of the myriad of things you just looked at, those would all flow through cost of sales.
Excellent. Okay. Thank you.
And I can tell you, Stephen, the market is performing I would say pretty much as we expected, maybe a little better given the first quarter. So it is – you got to get on budget, you got to keep the community on plan. When you get on budget, it’s easier to maintain it than it is to create it. Creating momentum is always more difficult than maintaining it. So it’s my expectation that it’s going to be a little easier to get people on contract through this spring if it continues. The big debate is a lot of things happen in the market as far as politically, as far as internationally. We take the rates rising in conjunction with cost rising created affordability issues. And coming out of a higher fiscal 2018 and it’s kind of the combination of two people paused or became choppier, whatever term you want to call it. They weren’t buying houses. So we’ve seen the market come back. If you talk to Don Horton he’d tell you it’s better than he thought it was going to be. I can tell you it’s pretty much what I expected. But I’m always been more optimistic than Don Horton. I don’t know if that helps or not.
The very short answer is the very early signs, because it is still early, the very early signs for spring are good.
Sound great. Thank you. And then second question I had relates to the political environment to some degree. The shutdown obviously has been lingering on for a while now. There’s been some thought that some delayed paychecks might have caused some folks who on the margin would have been looking to get into their first home might make it difficult for them to do that and that maybe once this thing is resolved and you get some back pay hitting and maybe also with some tax refunds hitting as well that later in the spring where the spring starts to take shape you might actually have a little bit of boost. So I was wondering if you could comment a little bit on what you see from a cash flow perspective hitting some of these affected people as well as the tax refunds, whether or not you think it’s reasonable to think that it might be a little bit of a boost a little later on in the year?
I think that might be a reasonable take but it’s not something we’re counting on or really have expectations for as it relates to the current government shutdown. Fortunately that’s been relatively minimal on our business and we’re keeping a close eye on the guidance day-to-day. But really it’s impacted USDA which for us is a very low-single digit percentage of our business, it’s less than 2% generally of what we’ve been running including this quarter. So our mortgage company is doing a great job of managing our backlog accordingly. But other than USDA and as you mentioned government employees who aren’t getting a paycheck today, there’s still ways to work around that from an income verification and the different types of things you have to do. Could it be a modest help down the road? Maybe, but not something we’re really worried about right now or relying on being a big uptick.
I will say, Stephen, government’s a huge part of the economy now and the shutdown is going to have ripple effects throughout all the industries. And yes, you just look at consumer confidence and when you have lack of ability to work together at that level, you see confidence coming down which is a big part of our – that’s a big part of our business. People got to be confident to buy a home. Again, it just adds to the kind of uncertainty about committing to a number out there in the future today. But if it gets settled, I think it will be a very positive impact or when it gets settled.
All right, great. Thanks very much, guys.
Thank you. Our next question is coming from Carl Reichardt from BTIG. Your line is now live.
Good morning, guys. I wondered – you guys are in 80 plus markets now I think. Could you talk a little bit maybe about the two or three markets that produced the most positive surprise or strength this last quarter from an orders perspective and maybe two or three that were softer than what you thought? And I’d just be curious as to whether or not you feel like across your product mix the trends are effectively the same to the quarter in terms of the improvement?
Yes. Carl, as far as markets go, we’re still very, very happy. We have the concentration assets in Texas, Florida and the Carolinas. Those have been solid markets. They continue to be solid markets. And don’t see any change in the future really. Upside surprise, markets have seemed to be performing better from our standpoint. I’ll tell you the Utah market has been somewhat of a pleasant surprise. We’ve spent a lot of time positioning there. We’ve got a long term with the company, very focused operator running that market and he has positioned us incredibly well. So very happy with that. It’s probably going to be a record year for us in Utah this year. California continues to be soft. Chicago continues to be soft. I do think we are very well positioned in both California and in Chicago with the markets we got. And our operators there I think are doing are better job than at any time I’ve ever seen in this company. So again, it’s people, product and price and you get them aligned and you can have good markets, you can have bad markets. Our goal is to outperform any market. So that’s what we focus on. That’s what we get up every day trying to do.
Okay. Thanks, David. And then since I asked two in one, I’ll just repeat the second one which is I’m just curious when you’re looking across your mix set and you have expressed you’ve got the other brands, the traditional Horton and then maybe especially Emerald brand. Is the traffic performance in orders as you work through the quarter you called out weakness at the higher end and I’m just curious if you could expand on that if the strength that you’ve seen is really coming out of the most affordable stuff which is certainly what we’d expect?
We did see good traffic. I think some of the rate spike that we saw in our first quarter did affect some of the entry level buyers. So like 50% of our deliveries were to entry-level buyers, but I think there was a bit of an adjustment period for those buyers with that rate change. And then certainly the moderation was helpful there. I think a lot of our – over the past years we’ve been focused on even in our Horton brand positioning that product to make it very affordable relative to the alternatives in the marketplace and provide efficiencies to the buyer with that. And so we saw probably a good performance in the Horton brand relative to Express.
Great. Thanks a lot, guys.
Thank you, Carl.
Thank you. Our next question is coming from Alan Ratner from Zelman and Associates. Your line is now live.
Hi, guys. Good morning. Nice job taking share in the choppy demand environment. I guess a question on the margin. I think last quarter, Jessica, you kind of implied that for margins to get down to this 20% level would be a pretty dramatic move I think is the word you used based on where you were running previously. And you got there and now it sounds like the next quarter might be a bit below that. So I guess you sound very positive on January which I think is encouraging. But if you wanted to take the flipside to that where maybe this is a bit of a temporary bump from the rate pullback, as you think about that price versus pace dynamic, how low are you willing to take that margin in order to hit the desired absorption pace that you target in your communities?
We continue to focus first on returns, so we’re going to continue to make adjustments community-by-community to drive the best possible return and the margin really is just what that drives based on hitting the best return on a community-by-community level. So we do still think of maintaining our consistent production and sales pace is going to drive not only the best returns but the best margins and particularly pre-tax margins. So we did end up at the low end of our range. I would tell you that October and November and December even though November and December got better, still were weaker than we expected. And so we did give up some margins to find that sales pace again, as David indicated. But typically once you can get back to a consistent sales pace that’s the best way to find stability in your gross margin.
Alan, I’d also like to point out that typically roughly a third to better of our closings in any one quarter were sales in that quarter. So we’re very quickly reacting with pricing to the marketplace to maintain our pace and our return focus at every community level. In our first calendar quarter, we probably had a large percentage of the homes closed were started late spring or early summer when lumber was just some of the highest prices we ever seen. So those cost pressures we’re cycling through against a time when we were kind of marking our homes to real-time market to maintain a pace. And those two things were a fair bit of headwind to margin. And so we did see a rather dramatic move. But because so much of our deliveries in any one quarter are reflective of market conditions in that quarter, sales market conditions, we will see as we talked about in the past volatility in margins that can move rather quickly. So we expect going forward we’re going to see some of that cost headwind fall away. We’ll have more of our closings being delivered from starts at a time when lumber was less expensive. So that coupled with the sales trends and the pacing that we’re looking at it in every community now week-to-week, we’re cautiously optimistic we should see some stabilization in the margins.
Understood. I appreciate that and I think it definitely is a benefit of the sales strategy in the model. Second question when I look at your land portfolio and obviously the mix shift towards more option has benefits on the balance sheet, but also in a softer demand environment I guess at some point it does give you the ability to go back to the landowners and attempt to renegotiate some of those contracts. So are you at the level in any markets or any communities at this point? And if so, how have those conversations being going?
I will say we are at the level every quarter of every year irrespective of whatever the market is. Our goal is to enhance the value of our shares for our shareholders and we do that by making money and being very conscious of the fact that capital is a precious commodity.
So from that standpoint then, David, I guess the question is are you seeing land sellers, I don’t know if capitulate is the right word, but are you seeing them a bit more receptive given the – it seem like a softer fourth quarter for sure or calendar fourth quarter to renegotiate or are they still pretty set in their pricing?
The guys that probably are most vulnerable to that are the people that put contracted land to our competitors and our competitors are not in a position to take close it. We are – I’m not going to say we’re punitive to somebody coming back with a deal they didn’t sell us the first time, but we are punitive to sellers coming back with – really didn’t sell us work on.
Got it.
I can tell you it’s a choppy – this is not a market where you’re going to see huge revaluations. It’s choppy. I think the way we positioned our focus on operations over the last – since the downturn, started coming out of the downturn has put us at a position to operate pretty well, outperform the industry in pretty much any market. And I’m not going to tell you we’re excited about a market that could be correcting, but we’re certainly not scared of it. So we’re going to continue to build, close houses and drive returns across the country.
All right. Good luck, guys.
Thank you.
Thanks.
Thank you. Our next question today is coming from Eric Bosshard from Cleveland Research Company. Your line is now live.
Thank you. Would love to hear you expand a little bit more on the moving parts in gross margin, specifically the optimism about what you’ve seen recently and the 2Q gross margin year-over-year contraction I think is worse than in this current quarter. I know there’s obviously some timing of what’s going on in the business, but if you’ll just expand within the moving parts in gross margin and how we should think about that into 2Q and then into the second half of the year?
Sure and some of this information will be in our supplementary data that we’ll post as well. But if you look at the first line of that margin analysis that you see there, that is kind of what we would call our core gross margin. Sequentially from the September quarter to the December quarter, that was down 140 basis points. So that was the lion share of the change in the quarter. On a year-over-year basis that was down 90 basis points. And then as you kind of move through the pieces, interest and property taxes sequentially was actually an improvement of 10 basis points, year-over-year was 20. Warranty and litigation sequentially was flat, year-over-year was an improvement of 10 basis points. And then purchase accounting is the final piece of that. Sequentially that was a 30 basis point negative impact on our margin with the acquisitions we did during the quarter; year-over-year that was a 20 basis point negative impact. So it’s still mainly in the core business related to the sales activity in Q1 as we work to meet the market and get ourselves paced back on track. And then that’s really what’s – the Q1 sales activity in our current backlog that’s a result of that is really what’s driving our guide for Q2 to be down a bit further from Q1. But then our recent sales activity I’d say in December and then what we’ve seen thus far in January would indicate that we’re much better back on track. And if we can continue that momentum, we do see signs that we should be able to see some stabilization in our margins and we certainly have some costs tailwinds that will start to kick in as well late in our fiscal Q2 and into Q3 that gives us some cautious optimism that we’ll see stability and hopefully some opportunity to start regaining some of the margin that we’ve given late in the last quarter or two.
And then secondly, I know that you’re continuing to defer a bit on full year guidance, but is it up 10 year [ph] of delivery still in the making here?
We wouldn’t rule it out. We’re not providing guidance yet because it’s too early. Until we get into the spring, sales in February, March, April will be a big driver of it. But we’re guiding to 4% to 8% closings growth in Q2. And so if we see good momentum in sales and we certainly have the inventory to go deliver as well, we wouldn’t rule that out.
Eric, we’re positioned to accomplish that.
Great. Thank you.
Thank you. Our next question today is coming from Nishu Sood from Deutsche Bank. You line is now live.
Thank you. I wanted to come back to the share buybacks. Obviously there was a nice pickup, an opportunistic pickup in your December quarter. But thinking back on how you had been framing your share buyback strategy, you had said earlier that your plan is to just offset dilution and if I look at the activity in the fourth quarter I can look at it as just offsetting dilution even though it was a pick up. But from your comments earlier it sounds like you’re willing to go beyond just offsetting dilution. So I just wanted to kind of come back to that. Are you now saying that you will be willing to on a continual basis here go past just offsetting dilution or is that still your kind of main way you’re going to approach it?
Nishu, our base plan for the longer term is to continue to offset dilution. However, we are keeping the flexibility to remain opportunistic. And so with the buy in the first quarter, that’s certainly brought our share count down slightly as we will see further dilution in future quarters and we want to continue to be consistent in our repurchases to offset that. But the comment we made around remaining flat with the December share count level would keep us flat from this point going forward.
Got you, okay. And on Forestar, obviously continued nice pickup in the spread of operations out of Forestar; a number of states and markets that you’re operating in there. How does this choppiness in demand affect your approach there? Does it give you the opportunity to – since you still feel good about the market for '19 to maybe be a little bit more aggressive, there are probably more opportunities out there or does it give you some pause in what kind of portfolio you’ll build out of there? And also on the capital raising side, how does it affect your plans there?
I think from the market perspective we’re not seeing any of the sales choppiness we experienced earlier in our fourth quarter and our first quarter, the calendar fourth quarter, impacting any of the operating decisions at Forestar. Our underwriting guidelines for each of our communities and each of our investments whether it’s on the Forestar side or the Horton side are reflective of current market conditions. So to the extent that that’s impacting valuation or term discussions, that’s just going to be incorporated in as normal course of business. But if there is extended choppiness and it creates other folks pulling back in their opportunities, then it may create some ability for Forestar to participate more broadly in more deals. But we’re not seeing that broadly yet nor are we counting on that in the growth. We still feel really good about Forestar’s ability to create its growth – obtain its growth objectives in the current market conditions what we’re seeing out there every day. With regard to the capital raise, it’s somewhat market condition dependent. We feel good about the capital position Forestar is in today. It has adequate capital to support its growth plans for '19 and '20. And the market conditions will dictate largely when we access the market for longer term growth capital.
Okay, great. Thank you.
Thank you. Our next question is coming from Ken Zener from KeyBanc Capital Markets. Your line is now live.
Good morning, everybody.
Good morning, Ken.
So I get why you’re trying to build steadily. It helps for a variety of reasons. Your total units in inventory, which I’m really glad you’re highlighting that, is up about 19% year-over-year, obviously above orders. So that’s what I want to focus on. I know you guys do a lot of spec, but if you look at your 2Q closing range, it does imply a lower percentage of your units that are construction closing. And related to that I want to ask you, some of that’s obviously coming out of backlog, some of that’s obviously spec which I think you’re being judicious around. So what is the margin differential? So I think last year historically in the 2Q you have about 40% plus of orders were actually closing. So what are we seeing right now in terms of the margin spread from backlog and spec?
From backlog and spec, so from a build job pre-order versus a spec?
Right. Sort of homes that you’re for instance usually close about 40% plus in 2Q from spec. What is – that’s not backlog by definition. So what is that kind of spread that you’re seeing right now? Because I think and it sounds like when you say meet the market, you’re talking about both backlog but more importantly homes that you’re closing into the quarter. Could you highlight if that’s a 200 basis point spread or 100 because it has to do with how many units you have under construction? Thank you.
Typically about a 200 basis point differential between call it a pre-sell or a build job versus a standing spec. Now then it also depends on the age of the spec. So the way you could see even more of a gross margin differential is if we had a completed spec that has been sitting and unsold. But the vast majority for a period of time – the vast majority of what we’re selling and closing in the same quarter is very timely and so it’s only about that 200 basis point differential.
Okay.
Ken, your comment about the closings in Q2 or our projected closings in Q2 being a lower percentage of inventory, I would say our positioning going into the spring is much stronger this year. The last several years we had really been trying to catch up with community openings, getting our starts out. And I’d say our positioning with our community openings and our starts in our homes and inventory is better this year than we’ve seen in several years. And so we’re in great position to really be able to drive sales, drive growth in the spring with our inventory position today.
But I guess because you guys don’t give community count, when you’re saying you’re better positioned if you can maybe clarify? So I see you’re adjusted for your acquisitions, your total units are up about 19% year-over-year, but you’re saying you’re happy with that despite community count you’re saying flat year-over-year sequentially. So you’ve actually intentionally increased your units – your spec per community and that’s actually where you want to be right now. You were trying to play catch up is what you’re saying. So it’s not excessive in your view?
For the last couple of years going into the spring selling season we had planned on having more houses coming out of the ground and more lots available to start houses on. This year we are better positioned to hit the plan than we have been at any point in the last four, five, six years. So I do think – when Bill talks about positioning, we are very happy with the way we’re positioned and believe that we will be able to drive absorptions and generate very high returns.
And that’s analysis community by community, homes and finished lots that can still deliver a home on this year. It’s better positioned than each of the last few years.
And if you look at our ASP, there is still a tremendous amount of demand at the price points we’re delivering homes into. And there is some competition but it is significantly less on competition at $100,000 to $150,000 higher.
Right. And I guess if I could make my one last question, it’s not as complicated but if the pricing is fine at the low end which everybody says I get it, how much do you think pricing is off at the high end? Does that have to go down like 3% or is it like 10%? Considering you’re giving us this relative demand, how much is price off at that high end? Thank you.
Let me take this. We’re all kind of looking at each other with --
Blank empty look. I think Ken let me – to look at what pricing needs to adjust for us to give a number that it needs to be X%, Y% or Z%, we just don’t know. What we see is what our sales demand is, what our net sales – our teams are able to go out to the market and meet the market with the sales to hit pace, and they’re working with customers, working with buyers and writing contracts and then delivering those homes. And we’re watching the margin that’s coming in on those sales contracts and the margin that’s coming in on the closings. And they’re meeting it. And we’re not necessarily trying to globally measure from an index price or any other price for the community. It’s what is that price house by house, what is that margin house by house and we focus on this business one home, one lot, one family at a time. And it kind of rolls up to what it is and it is – it can me a fairly dynamic number, because a large percentage of our deliveries in any quarter reflect the market conditions of that quarter. So we saw that in our first fiscal quarter, we saw a change in the base level, lot level, house margin.
Thank you.
Thank you. The next question today is coming from Michael Rehaut from JPMorgan. Your line is now live.
Hi. Good morning. Thanks for taking my questions.
Good morning, Mike.
Good morning, Dave. First, I just wanted to get a little bit more insight I guess into the November, December, January trends and I appreciate the detail there so far. I think what everyone’s trying to triangulate is your performance versus the underlying market because clearly if you go back to the last downturn, Horton was kind of a first mover. Often times as the market softened, you were typically a little bit more aggressive off the bat and it’s consistent with your approach today in terms of volume and returns and meeting the market. So I just wanted to get a sense, number one, what are you seeing there in terms of your performance versus the market vis-à -vis fair gains? Do you feel like the underlying market is a little bit softer than what you’ve been able to put together in terms of results? And secondly, when you talk about December being good and January being better, particularly on the comments of January, is that more of just the typical sequential improvement for the spring or are you talking about sales pace actually growing or accelerating on a year-over-year basis?
So, Mike, it is a sequential improvement particularly in January which is what we would normally see with traditional seasonality. But to be specific about November and December, our October sales were down on a year-over-year basis. Our November and December sales were both up on a year-over-year basis. Then as we move into January what we’ve referred to is really just traditional seasonality in terms of week to week improvement in sales. It’s too early still. We’ve got a lot of January left to give a full read on what January looks like.
Okay. And in terms of the fair gain question as you kind of see it over the last two or three months, any sense for how you performed versus the underlying markets?
Mike, we would expect that we performed better than the underlying markets. That’s our goal every day and that’s been kind of our performance over the past several years is to continue to grow market share. And for our teams they’re very competitive and they like to win.
Great.
But we don’t have any empirical data to that today.
We’ll see as everyone reports, just like you do over the coming weeks.
Right. And just lastly on the gross margin front, you had talked about hoping to see some stabilization there with the potential tailwind in perhaps the back half of the year for lower lumber. At the same time obviously you’ve been buying land over the last two, three years. I would suspect that there’s still somewhat of a rising cost basis from a land perspective in your inventory books. So when we talk about stabilization, are we to think of the upcoming second quarter low 19 range as something where all else equal given that sales pace has come a little bit back in response to the incentives. That’s kind of the new base and even – I guess the real question is stabilization at those levels and would a lower lumber kind of just offset higher land cost in the back half.
Mike, as we sit here today and based on the recent sales trends we’ve seen, we’re hopeful – we’re cautiously optimistic that we are going to see some stability in our margin and the cost relief we’ll get on the lumber ruling for our closings in the latter half of the year should be a part of that. In terms of the land cost, we’ve actually seen our finished lot cost as a percentage of our overall revenues stay relatively consistent over the last year or two. So I would say to think we have any headwinds coming in terms of our lot cost as a percentage of revenues. I think part of that reflects the fact that we’re buying more and more of our lots on a finished lot basis in the current market and so that’s adjusting community by community based on market conditions.
Okay. But just to be clear the stabilization we’re talking about is coming off of 2Q levels. Is that fair?
Yes. I think that’s where we would start. And in terms of some cost relief coming and stability in sales pace, it should provide stability in margins. It starts with stability. And if we see good momentum, hopefully we would have the opportunity to improve on it.
Mike, as we’ve gone through all these numbers and I keep going back and looking at the first quarter that our people put on the books, first quarter SG&A is 9.5% on operating margin at 10.7%. Those are historically incredibly strong numbers. I got to tell you I’m pretty proud of our people.
Yes, we are focused first on returns and returns don’t happen with us selling and closing houses. And so that’s what we’re going to do. We’re going to meet the market. And margin is what we solve for, but then obviously improving margins improves returns as well. So it’s always a balanced community by community to drive the volume, hit the sales pace, generate the best returns we can get at the best margins we can get.
I appreciate it. Like I said, you’re definitely at the Vanguard in the last downturn and it looks like you continue to be here, so congrats.
Thanks, Mike.
Thank you. Our next question today is coming from Susan Maklari from Credit Suisse. Your line is now live.
Thank you. Good morning.
Good morning, Susan.
My first question is with the choppiness that we have seen in the market, has that changed the appetite of some of the M&A opportunities that you see out there? Are sellers maybe a bit more willing to sort of get out before things perhaps get a little softer?
I think we’ll probably see a fair bit of that and people are engaging where they are in their markets and where they are in their horizons and think it may not get a whole lot better going forward potentially, and so they might want to take a little off the table. And it may affect bringing some of the bid/ask spreads a little bit.
Okay. And then my second question is just in terms of some of the raw materials, the inputs for labor, have you seen any changes there? How should we think certainly about the lumber prices coming down as we move through the year and anything else that’s in there?
Nothing real noticeable other than the lumber cost that we have already talked about that will still be a headwind in Q2 but then should be more of a tailwind going forward. You typically hear us talk about our stick and brick costs on a per square footage basis. So on a year-over-year basis, our stick and brick costs were up just a little over 4% and our revenues were just slightly behind that, which was some of our margin issue. Sequentially, our revenues per square foot were essentially flat and our stick and brick costs were up about 2%.
Okay. Thank you.
Thank you. Our final question today is coming from Jade Rahmani from KBW. Your line is now live.
Thanks very much. Any change in investor purchases of homes in your communities, any opportunistic purchases as a result of the moderation in sales?
No. We track that very closely as it’s something that did cause a big impact last cycle that we’re very cognizant of. So we have limited sales to investors that are essentially one-off. In individual communities, we don’t do any big bulk sales transactions to investors. We really want to focus on the for-sale, live-in-the-house part of the business and to keep our communities in good shape.
And can you give the percentage of closings that came from spec?
Almost 80% this quarter I believe. It traditionally runs right in the 70% to 80% range very tightly. There’s some seasonality to it.
Thanks very much.
Thank you. I’d like to turn the floor back over to management for any further or closing comments.
Thanks, Kevin. We appreciate everyone’s time on the call today. I look forward to speaking to you again in April to share our second quarter results. And to the D.R. Horton team, thank you for a solid first quarter and a strong start to 2019. It’s your focus and hard work that has put us where we are. We appreciate it, we thank you for it and expect it to continue. Thank you.
Thank you. That does conclude today’s teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.