Good morning. Welcome to the fourth quarter 2017 conference call for D.R. Horton, America's builder, the largest builder in the United States. At this time, all participants are in listen only mode. An interactive question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jessica Hansen, Vice President of Investor Relations for D.R. Horton. Please go ahead.
Thank you, Kevin. Good morning. Welcome to our call to discuss our fourth quarter and fiscal 2017 financial results. 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. D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and our most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.
This morning's earnings release can be found on our website at investor.drhorton.com. We plan to file our 10-K next week. After this call, we will post updated supplementary data to our investor relations site on the presentation section under news and events for your reference. The supplementary information includes data on our homebuilding return on inventory, home sales growth 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. Good morning. In addition to Jessica, I am pleased to be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer, and Bill Wheat, our Executive Vice President and Chief Financial Officer. Our D.R. Horton team finished the year strong. Pre-tax income for the fourth quarter increased 12% to $486 million on $4.2 billion of revenue. Our pre-tax operating margin improved 10 basis points to 11.7%. For the year, we delivered results in line with or better than original guidance we shared at the start of last year. With consolidated pre-tax income increasing 18% to $1.6 billion on $14.1 billion of revenue. We closed 45,751 homes this year, an increase of 5,442 homes or 14% over last year.
Our consolidated pre-tax margin for the year improved 30 basis points to 11.4%, and our return on inventory improved 120 basis points to 16.6%. During the fourth quarter, we generated $626 million of cash from operations, bringing our total to $435 million for the year and to $1.8 billion over the past three years. These results reflect consistent strong performance across our broad geographic footprint and diverse product offerings. Our continued strategic focus is to produce double-digit annual growth in both our revenue and pre-tax profits while generating annual positive operating cash flows and improved returns. With 26,200 homes in inventory at the end of the year, positive sales trends in October, and 249,000 lots owned and controlled, we are well positioned for another strong year in 2018. Mike?
Net income for the fourth quarter increased 10% to $313 million, or $0.82 per diluted share, compared to $284 million or $0.75 per diluted share in the prior year quarter. Our consolidated pre-tax income increased 12% to $486 million in the fourth quarter compared to $433 million, and homebuilding pre-tax income increased 13% to $458 million, compared to $405 million. Our backlog conversion rate for the fourth quarter was 87%. As a result, our fourth quarter home sales revenues increased 11% to $4 billion on 13,165 homes closed, up from $3.6 billion on 12,247 homes closed in the year ago quarter.
Our average closing price for the quarter was $306,500, up 3% compared to the prior year, due to an increase in our average sales price per square foot and a higher percentage of closings in our west region this quarter as a result of the hurricane impact in other regions. In the fourth quarter, our Express Homes brand accounted for 37% of our homes sold, 34% of homes closed and 26% of home sales revenue. For the year, it accounted for 34% of homes sold, 31% of homes closed, and 24% of home sales revenue. Homes for higher end, move-up, and luxury buyers priced greater than $500,000 under both our D.R. Horton and Emerald Homes brands were 8% of our homes closed and 20% of our home sales revenue in the fourth quarter.
For the year, they accounted for 7% of homes closed and 17% of home sales revenue. Our active adult Freedom Homes brand is now being offered in 21 markets across 12 states, and customer response to these homes and communities offering a low-maintenance lifestyle at an affordable price has been positive. Freedom Homes accounted for 1% of both our homes sold and closed in the fourth quarter. Bill?
The value of our net sales orders in the fourth quarter increased 19% from the year ago quarter to $3.1 billion. Homes sold increased 18% to 10,333 homes.
Our average number of active selling communities increased 2% from the prior year quarter. Our average sales price on net sales orders increased 1% to $301,600. Our fourth quarter cancellation rate was 25%. The value of our backlog increased 8% from a year ago to $3.7 billion, with an average sales price per home of $302,200. Homes in backlog increased 7% to 12,329 homes. We are very pleased with our current sales pace, and October sales were in line with our fiscal 2018 business plan, supporting our growth expectations for the year. Jessica?
Our gross profit margin on home sales revenue in the fourth quarter was 20.3%, down 20 basis points from the prior year quarter. Up 50 basis points sequentially from the third quarter, the sequential improvement in our gross margin was primarily due to lower litigation charges in the current quarter. In today's housing market, we continue to expect our average home sales gross margin to be around 20%, with quarterly fluctuations that may range from 19%-21% due to product and geographic mix, as well as the relative impact of warranty, litigation, and interest costs. Bill?
In the fourth quarter, SG&A expense as a percentage of homebuilding revenues was 8.6%, down 20 basis points from the prior year quarter. This quarter's SG&A includes approximately $3 million of Forestar transaction costs and expenses related to the recent hurricanes. Homebuilding SG&A for the full year improved 40 basis points to 8.9%, compared to 9.3% in 2016, as our increased revenues improved the leverage of our fixed overhead costs. We remain focused on controlling our SG&A while ensuring our infrastructure adequately supports our growth. We expect to further leverage our SG&A in 2018. Jessica?
Financial services pre-tax income in the fourth quarter was $27.7 million. For the year, financial services pre-tax income increased 27% to $113 million on $350 million of revenues, representing a 32% pre-tax operating margin. 96% 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 55% of our home buyers. FHA and VA loans accounted for 46% 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 88%. First-time homebuyers represented 44% of the closings handled by our mortgage company, consistent with the prior year quarter. Mike?
We ended the year with 26,200 homes in inventory. 13,800 of our total homes were unsold, with 9,700 in various stages of construction and 4,100 completed. Compared to a year ago, we have 13% more homes in inventory, putting us in a very strong position to start 2018. Our fourth quarter investments in lots, land, and development totaled $771 million, of which $424 million was to replenish finished lots and land, and $347 million was for land development. For the year, we invested $3.5 billion in lots, land, and development. We are planning to replenish our owned land and lot supply in 2018 at a rate to support our expected growth in revenues. David?
This year, we achieved our previously stated goal of a 50% owned, 50% optioned land and lot pipeline. We believe we can increase the optioned portion of our pipeline to 60% over the next few years while maintaining our number of owned lots relatively flat with the current level. At September 30th, our land and lot portfolio consisted of 249,000 lots, of which 125,000 are owned and 124,000 are controlled through option contracts. 91,000 of our total lots are finished, of which 33,000 are owned and 58,000 are optioned. We have increased our option lot position 35% from a year ago. We plan to continue expanding our relationships with land developers across our national footprint to further increase the optioned portion of our land supply.
Our 249,000 total lot portfolio is a strong competitive advantage in the current housing market and a sufficient lot supply to support our targeted growth. Mike?
On October 5th, we acquired 75% of the outstanding shares of Forestar Group, a publicly traded residential real estate company, for approximately $560 million in cash. D.R. Horton's alignment with Forestar advances our strategy of expanding relationships with land developers across the country and increasing our optioned land and lot pipeline to enhance operational efficiency and returns. At the acquisition date, Forestar had operations in 14 markets in 10 states, where it owned, directly or through joint ventures, interests in 44 residential and mixed-use projects. Both companies are currently identifying land development opportunities to expand Forestar's platform. Since the closing a month ago, Forestar has been evaluating approximately 15 D.R. Horton-sourced opportunities located primarily in Texas, Florida, Georgia, and the Carolinas, two of which Forestar has already closed.
These 15 communities will yield approximately 8,000 finished lots, the majority of which could be sold to D.R. Horton in accordance with the master supply agreement between the two companies. Forestar's aggregate peak inventory investment for this portfolio of projects is expected to be approximately $200 million, and we expect Forestar to commit at least $400 million of capital, primarily to D.R. Horton-sourced projects during 2018. We are also actively working with Forestar on plans for their existing projects and are in discussions for D.R. Horton to potentially purchase approximately 3,000 lots from Forestar's current portfolio. The post-merger interactions between the D.R. Horton and Forestar teams have been very productive, and we are pleased with the progress we are making on the integration. We are confident that Forestar's growth is likely to exceed the original projections outlined in our slide deck from June.
We continue to be excited about the value that this relationship will create over the long term for both D.R. Horton and Forestar shareholders. As a public company, Forestar will continue to file quarterly and annual reports, as well as any other required public information, but they will not host quarterly conference calls. D.R. Horton will be handling Forestar's investor relations to allow the Forestar team to focus solely on integration and operations during the coming months. Forestar operates on a calendar year-end and will file its 2017 annual report by mid-March of 2018. We do not expect Forestar to have a material impact on our fiscal 2018 earnings.
We plan to outline the purchase accounting for the transaction and presentation of our consolidated results, including Forestar in our first quarter earnings release and conference call in January, and we will provide an update on our integration progress at that time. We expect to provide initial Forestar guidance for 2018 in January. We then expect to provide additional 2018 guidance for Forestar on our second quarter call in April, following Forestar's calendar year-end reporting. Bill.
During the fourth quarter, we generated $626 million of cash flow from operations. For the full year, our cash flow from operations was $435 million, in line with our original guidance. Our cash flow generation exceeded our updated guidance due to better-than-expected closings in late September and a greater than anticipated impact from the hurricanes on land development and construction activity. At September 30th, our home building liquidity consisted of $973 million of unrestricted home building cash and $1.2 billion of available capacity on our revolving credit facility. Our home building leverage improved 520 basis points from a year ago to 24%. The balance of our public notes outstanding at September 30th was $2.4 billion, and we have a total of $400 million of senior notes that mature in fiscal 2018, which we will likely refinance in the next few months.
We ended the year with a shareholders' equity balance of $7.7 billion, and book value per common share of $20.66, up 13% from a year ago. Based on our financial metrics and positive outlook for fiscal 2018, our board of directors increased our quarterly cash dividend by 25% to $0.125 per share. We currently expect to pay dividends of approximately $190 million to our shareholder in fiscal 2018. We repurchased 1.85 million shares of our common stock for $60.6 million during fiscal 2017, and currently have a $200 million share repurchase authorization outstanding effective through July 2018. David?
Our balanced capital approach focuses on being flexible, opportunistic, and disciplined. Our balance sheet strength, liquidity, consistent earnings growth, and cash flow generation are increasing our flexibility, and we plan to utilize our strong position to improve the long-term value of the company. Our top cash flow priorities are to consolidate market share by investing in our home building business and strategic acquisitions, reduce or maintain debt levels, and return capital to our shareholder through dividends and share repurchases. We expect to generate at least $500 million of cash from operations in 2018, growing to over $1 billion annually in 2020. As we generate increased cash flows, we expect to pay down debt, decrease our leverage, increase our dividends, and repurchase shares to offset dilution with a target to keep our outstanding share count flat beginning in 2020. Jessica.
Looking forward, our expectations for fiscal 2018 are consistent with what we shared on our July call, and are based on today's market conditions. They also exclude any impact from Forestar. In fiscal 2018, we expect to generate a consolidated pre-tax margin of 11.5%-11.7%. We expect to generate consolidated revenues between $15.5 billion and $16.3 billion and to close between 50,500 and 52,500 homes. We anticipate our home sales gross margin for the full year will be around 20%, with potential quarterly fluctuations that may range from 19%-21%. We estimate our annual home building SG&A expense as a percentage of home building revenues will be around 8.7%, with our SG&A percentage higher in the first half of the year and lower in the second half.
We expect our financial services operating margin for the year to be 30%-32%, with the first two quarters of the year lower and the third and fourth quarters higher. We forecast an income tax rate for 2018 of approximately 35.2%, and that our diluted share count will increase by less than 1%. We also expect to generate positive cash flow from operations of at least $500 million in 2018, excluding any impact from the consolidation of Forestar on our financial statements. Our fiscal 2018 results will be significantly impacted by the spring selling season, and we plan to update our expectations as necessary each quarter as visibility through the spring and the full year becomes clearer. We do not currently expect Forestar to have a material impact on D.R. Horton's earnings in fiscal 2018.
For the first quarter of 2018, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 83%-86%. We anticipate our first quarter home sales gross margin will be around 20%, and we expect our home building SG&A in the first quarter to be in the range of 9.5%-9.8%. David?
In closing, the strength of our team and operating platform across the country allowed us to deliver full-year results for 2017 in line with or better than guidance we provided at the start of last year. While growing our revenue and pre-tax profits at a double-digit pace again this year, we generated $435 million of positive cash flow from operations and improved our annual homebuilding return on inventory by 120 basis points to 16.6%. We remain focused on growing both our revenue and pre-tax profits at a double-digit annual pace while continuing to generate annual positive operating cash flows and improved returns. We are well-positioned to do so with our solid balance sheet, industry-leading market share, broad geographic footprint, diversified product offering across our D.R. Horton, Emerald, Express, and Freedom brands, attractive finished lot and land position, and most importantly, our outstanding team across the country.
We congratulate the entire D.R. Horton team on our 16th consecutive year as the largest builder by volume in the U.S., and we thank you for your hard work and accomplishments. We look forward to working together to continue growing and improving our operations in 2018 as we celebrate our 40th anniversary year. This concludes our prepared remarks. We will now host any questions.
Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's *1 if you'd like to ask a question. Our first question today is coming from John Lovallo from Bank of America. Your line is now live.
Hey, guys. Thank you for taking my questions. The first question is, as D.R. Horton becomes more asset-light, cash flow should improve pretty meaningfully. I think, in our view, very meaningfully. Where do you think free cash flow conversion can kind of trend over the next few years? If it is as solid as we think, at least, would you be open to more aggressively repurchasing shares?
Yeah, John, we're taking this one step at a time. We've basically stated that we expect to achieve cash flows from operations greater than $500 million this year, and we do expect that to ramp up over the next couple of years. We expect that by 2020, our cash flow from operations should be in excess of $1 billion. That's our estimate today and our guidance today. Certainly, we do have high expectations for our ability to increase our option portion of our land position. Certainly, Forestar is a part of that as well. Over the next year, as we build out Forestar's platform, and it begins to contribute a greater impact on our overall operations, I do think we do have a lot of cash flow generation capability that could potentially exceed what we're guiding to now for the next couple of years.
On share repurchase, we are starting to repurchase more shares than we have historically, our target right now is to increase those share repurchases to a point that it fully offsets our dilution, that our share count will remain flat by 2020. Certainly, to the extent that we're able to generate more cash than we're currently guiding in time, that could change as well over the longer term. Right now, in a three-year window, we're targeting to offset dilution over the next couple of years.
Okay, that's helpful. Then touching on the options, the 60% option percentage that you guys have out there now, you've been talking about that for a bit. Has the bogey changed at all given the inclusion of Forestar? Is there anything that could prevent you from reaching much higher levels, call it 70%, even 75%?
I think nothing's really changed with regard to the 60% target with Forestar. That's part of our strategy to achieve that. Over time, once we achieve that goal, we will continue to set higher goals for ourselves, but it's one developer, one contract, one project at a time that we make these relationships work.
Okay. Thanks very much, guys.
Thanks, John.
Thank you. Our next question today is coming from Alan Ratner from Zelman & Associates. Please proceed with your question.
Hey, guys. Good morning. Congrats on a great year and the progress on Forestar. Exciting to see that moving forward. First question on Forestar. You mentioned a few markets where you've already sourced and optioned some deals from them. I think those are all existing Forestar markets if I remember correctly. I'm just curious, as you're ramping up the personnel within Forestar, have you looked into bringing that operation into some of your more higher-cost markets like California, Pacific Northwest, where obviously the land investment is going to be a much greater percentage of the home value? It would certainly tie up a lot more capital there. Any thoughts on really the viability of optioning a meaningful percentage of lots out in those higher-cost markets?
To your first point, Forestar has acquired a project in Florida, which has not been a market they've been operating in. We're looking to, as we've talked about, kind of bootstrap our way in, leverage the growth of Forestar into new markets, leveraging the Horton platform existing in those markets. With regard to sort of higher land basis markets, we have identified a couple of projects to take a look at up in the Pacific Northwest. Because they are more capital-intensive, they may be a little slower to grow their ramp there.
Got it. Okay, thanks for that. Second question, on M&A in general, obviously a big deal here in this space over the last couple of weeks. I want to make sure I'm thinking about this correctly. On one hand, you're definitely looking to shift the business towards more asset light, which clearly the market is rewarding and seems to like. On the other hand, I know you guys have always been very focused on scale in both local as well as national, and take a lot of pride in being the largest builder in the country, and certainly there's advantages that go along with that.
Just curious now as you think about the allocation of capital, would it be inconsistent for you to continue to look towards M&A opportunities on the traditional home building side of the business, even if that means temporarily lengthening the land book, if it comes with the benefit of increased scale?
Alan, we look at deals every day, and we'll continue to do that. We're looking for a fit. We're looking for something that is additive that we can grow. We look at them from the same standpoint we look at a piece of land. It's got to be a fit culturally for us, for the people. From a capital outlay standpoint, we want to return the cash over the asset base within 2 years. That makes it difficult to look at the great big deals. We've had a lot of success integrating small private companies in over the last 4 or 5 years. Like what that does for our company. Like the fact that you get the return of the cash pretty quick, so.
Got it.
Are we looking at them? Yeah. If we're going to look at them, we're going to continue to look at them. It's a tough hurdle to get over.
All right. Good luck.
Thank you, Alan.
Thank you. Our next question is coming from Stephen East from Wells Fargo. Your line is now live.
Thank you. Good morning, guys. Just quickly to follow on Alan's M&A question. I know Forestar is not a big deal for you all, but it's a big change in the way you all operate. Is your appetite for M&A changed at all temporarily?
No. I think what we're trying to do is look at things on a consistent basis with a lot of discipline, and does it make us better over the long term?
Fair enough.
Kind of what we talked about before is what we're going to continue to do and continue to talk about.
Fair enough. All right. Here comes my compound question here. Forestar. Several things. I sort of call it the first 100 days plan. Maybe give a little bit more detail about what you all were talking about there, as you look maybe over the next year or two, how that evolves. Did I hear you right that you expected they would commit $400 million of capital in 2018? If so, just wanting to understand, on your land and development, the $3.5 million you did this year, does that change with Forestar spending $400 million or so in 2018?
Sure, Stephen, I know we gave a lot of detail on the call. We've actually got a timeline included in the presentation that we'll post that will outline kind of over the next year what we're planning on giving you further on Forestar. It also includes some of those numbers we talked about. You did hear us correctly that we're planning to commit at least $400 million of capital, primarily to D.R. Horton source projects during 2018. That doesn't mean we're only going to use $400 million for Forestar this year. We're looking at other capital sources. Primarily in the near term, we'll likely put together a revolving credit facility. We'll also be recycling through some of their assets and bringing that cash back in the door as well.
Stephen, in terms of our land spend at D.R. Horton, we're in year one of Forestar, and as they build out their portfolio, we will still be replenishing our lot supply in 2018 at D.R. Horton. We expect to keep our own lot supply relatively flat while we grow our option position with other land developers and as Forestar grows their platform as well. Our land spend in order to replenish lots and land at D.R. Horton in fiscal 2018 will continue to be at or above the same level that we did this past year. Certainly over the long term, there's potential for that to not have to grow at the same pace, and not have to replenish as much. We've got to build out the Forestar platform as well as our third-party developer platforms further.
Consistent with what you've seen each of the last few years, though, we would expect our inventories to grow at a slower rate than our revenues, which will drive that continued improvement in returns.
Got you. All right. Great answers. Thank you.
Thank you. Our next question today is coming from Bob Wetenhall from RBC Capital Markets. Please proceed with your question.
Hey, good morning. Thanks for all the color, and congrats on a good year. I want to go in the time machine back to 2006 when you delivered 53,000 homes, and I think that's the peak deliveries for Horton since it's been a public company. You're talking about $1 billion of free cash flow by 2020, which is a remarkable number. I was just trying to figure out, if between 2016 and 2017, you added about 5,000 homes, and it looks like you're going to add 6,000 homes in 2018, what's the growth profile that you're kind of underwriting to get that $1 billion of free cash flow by 2020?
Bob, we plan on double-digit growth the next three years. That's how we're setting up the operations of this company. We're going to get a little better building each house and feel like the market has got some legs, and it's the double-digit growth year over year over year. You generate a lot of that.
Just to be technical about it, you're jacked up about the outlook, it sounds like.
That's a technical term, yes, Bob. 10%-15% growth over the next three years, continuing to get more efficient and generate stronger returns, which would mean inventory will grow at a slower pace than revenues.
It's specifically a revenue target. This year, you'll see in our fiscal 2018 guidance, we're expecting it mainly to come from closings growth. As we go over the next couple of years, we'll give more specifics. The target is for double-digit revenue growth.
I will tell you, Bob, the market feels really good. The positioning of this company with its people and its communities, never been better. Yeah, we're pretty jacked up.
That sounds good. Just one other question. Obviously, you have a very positive view of the marketplace. I wanted to get your view, if the Fed hikes next year, say three or four times, does that put a damper on your ability to grow by reducing affordability? Do you just think where Horton's positioned in the market and renters becoming buyers, that's really not an issue, and instead the Fed's tightening because the economy's good and they need to do it. There's job growth, that just means you're going to see more buyers. Thanks and good luck. Congrats on a great year.
Thank you, Bob. We're going to adjust to the market if affordability continues to drive. We're going to meet the market where we need to. The best thing that can happen for home building is a strong economy and job creation. Given those two things, we'll figure out a way to sell houses, I can guarantee it.
A lot of confidence. Thanks again. Good luck.
Thank you. Our next question today is coming from Carl Reichardt from BTIG. Please proceed with your question.
Morning, guys.
Morning.
I wanted to talk a little bit about store count for next year. You were, I think, relatively flat on community count this year, but absorptions were up particularly well back half. As you look out to next year, do you expect to increase that store count a little bit more, and that be more of a driver of order growth to support delivery volume? Or will it continue to be absorption?
Sure, Carl. One of the hardest things for us to project, and as I remind everyone, I think every quarter, it's why we don't give specific guidance regarding community count. Our community count was up 2% year-over-year to finish the year out. It was actually down 1% sequentially. As we look and move through fiscal 2018, we really expect it to be flat to no more than slightly up. A continued story of absorptions, maybe with a little bit of community count growth to drive that 10%-15% increase in units this year.
Okay. Thanks, Jessica. Bill, just a clarification question on cash flow for fourth quarter, better than you expected, and you said part of that was due to a lack of an ability to develop, so not spend due to hurricanes, and then also some additional closings. Can you sort of parse out for me the dollars associated with each of those two elements in terms of what came in better versus what didn't happen and would go into Q1 or later quarters? Thanks.
I don't have the specific dollars in front of me, Karl, here. The delta on the closing side, we provided revised guidance in mid-September of about 85% backlog conversion. Our operators were able to over-deliver on that in late September, and we delivered 87%. That 2% change in conversion rate would be the delta on the closing side. The remainder would be less spending on inventory, primarily in the land development side, probably a little bit of land acq as well. Primarily in the areas affected by the hurricane, there was certainly a slowdown and some disruption in activity there, and that was a little bit greater than we anticipated. The remainder of that cash flow delta would come from our land activity. We would have expected our annual land spend and development spend to be a bit higher than it was.
Clearly that's a timing thing that does slide into 2018. Even with that, we still expect to exceed $500 million of cash flow from operations in 2018.
All right. Thanks, Bill. Great job, guys.
Thank you.
Thank you. Our next question today is coming from Mike Rehaut from JPMorgan. Please proceed with your question.
Thanks. Good morning, everyone, and congrats again on the Forestar completing that transaction. A couple questions around that is, obviously, that's kind of been the primary focus of investors and how that kind of reshapes your company over the next few years or perhaps continues on your current path of more optioning and better returns. When you talk about the operating cash flow outlook for 2018 of $500 million, which I think is up from your prior guidance of $300 million-$500 million, it seems like part of that is due to the Forestar shift, if I'm thinking about it right, with the $400 million of capital expected to be of Forestar to use for D.R. Horton sourced deals. Just trying to get a sense of maybe what the operating cash flow would look like if you netted out the Forestar investment.
Is it as simple as 500 minus 400? I know you talked about some recycling of cash as well from Forestar. I guess that's my first question.
Mike, I think in looking at the $400 million we expect Forestar to commit in 2018, not all of that will be spent in 2018. That's a commitment to those projects, as they develop and execute over time, some of that will be spent in 2018, some of it in 2019. It's not all $400 million is going to go out when you start a project. The other part of it is that Forestar does have a current portfolio of projects, a lot of lots under contracts to builders to sell over the next 12 months, that they'll be continuing to deliver lots to those builders, which will free up more capital to continue developing some of their existing projects, as well as invest in net new projects for the Forestar program.
We're still working out the exact capital needs Forestar's going to have and expect to get more of that information back to you in 2018.
Okay. No, I appreciate that. Obviously, looking forward to that. I guess secondly, you also mentioned that even after the first month or so, that it looks like you could exceed some of the projections for Forestar that you originally filed, you had in your June presentation. Looking at that presentation, just for example, if you take a 2020 snapshot of those slides where you said, for Forestar could have lot deliveries of a little over 7,000 versus maybe around 1,000 in 2018. Just trying to get a sense for what that upside might be. You've already noted that you've provided 15 source deals to Forestar, of which two have already closed. In the assumption set from the presentation, I think it was slide 10, you said that the assumption there would be eight projects for Forestar in the first year.
I assume obviously we're not talking about a doubling of the projections, but just trying to get a sense perhaps of what the upside might be.
We're still working with the Forestar guys to figure out exactly what those projections ought to look like. We are optimistic about the numbers we put out in that June deck, that we're seeing a greater deal flow that'll give us an ability to exceed these numbers. It's hard to sit here today and quantify that exactly, but what we are seeing a deal flow that we expect will be greater than what we anticipated for these projections. A doubling, probably a little too aggressive to say it's going to double at this point, but we're working hard to find every opportunity that makes sense and hits the return hurdles for Forestar.
Great. Thank you.
Thanks, Mike.
Thank you. Our next question today is coming from Ken Zener from KeyBanc Capital Markets. Your line is now live.
Good morning, everybody.
Morning, Ken.
Morning.
One of the things that we always talk about is the pace that you talked about, your community count. What I like to focus on is your units under construction in your 4Q, so your September, and how you've made the choice to not cycle down as much often as other builders do seasonally, which really gives you just a higher entry point into 2Q. Is there any particular reason? I think that's what's really different about your business model versus other builders, is you do build all this spec. Looking at this year, you're up 13%, I believe, year-over-year versus last year at 17%. Community count seems to be flat in both cases.
Is there something happening that this year versus last year in terms of construction or your regional mix that's kind of keeping that 26,000 and change number at a lower growth rate than you had last year?
No, Ken, I wouldn't say there's anything different than what we've done. We're just positioning to grow the company. I do think that you get to a certain size, the positioning takes a little bit longer. We purposefully put more inventory out, started more inventory late in the fourth quarter to be positioned for what we think is going to be a very good spring selling market.
Ken, two years ago, I think we entered fiscal 2016 probably a little lighter than we would've liked to have been in housing inventory for the market that we saw in front of us. As we grew our year-over-year, year-end inventory position 2015 to 2016 pretty aggressively, and we're glad we did because we were able to take advantage of that into 2016. The growth from 2016 to 2017's moderated a little bit from that prior year growth because we were better positioned to start 2016. We were better positioned, excuse me, to start 2017 than we were 2016, that gave us less need to add inventory, but we still feel with the units we have on hand right now, 26,300, we feel great about that positioning going into 2018.
Just for reference, that's our overall housing inventory that's up the 13%. Our spec count's actually up 17% going into the year, which we feel very good about.
Okay. If I could use that segue to hinge on spring selling, which we approach this seasonally, where over the last few years, your pace, if you look back over the long term, it appears the pace usually fell 15%-18% in the December quarter. In the last few years, it's been either up or down single digit, which is a big change, and that provides a lot greater pace momentum. Can you talk about what your base outlook is for spring selling? Realizing you don't know the exact numbers, but just from a seasonal basis, what do you expect that to be historically? Or what would you expect it to be?
It goes in line with what we're trying to drive from a closings perspective, which is the only number we actually guide to. If you look at it, generally speaking, we typically see a very sharp increase from December to March, although September to December is relatively flat, slightly up to slightly down. Typically, December to March, we would expect to see at least, call it, a 50% increase in our sales to feel good about where the spring's headed.
Okay. December to March.
A lot of it has to do with how you're positioned, too. Where the houses are, what communities, what sub-markets. I can tell you, right now, we feel very good about our positioning this year. I think it's the best we've done positioning for a fiscal year out of the last three, so
Houses and finished lots.
Yes.
Thank you.
Thank you. Our next question today is coming from Buck Horne from Raymond James. Your line is now live.
Hey, thanks. Good morning. I was curious about the option land market at this point. Not all options, I guess, are structured the same. I guess I'm curious in terms of what are the typical terms you're able to negotiate in today's market, whether it's percentage cash down, take down commitments, length of time you're able to get these locked up. Just wondering how far out on the time horizon you're able to control land in this current environment.
Buck, that's a deal by deal situation. On average, we've got about a 5% deposit up for remaining purchase price. Some of the projects, we control 18 months, 24 months supply. Others, we control three to five years' worth of supply in a given project. It varies. There are certainly some we put up more than 5%, others less than 5% to arrive at that average. We work very hard at developing those relationships with the developer community. Key business partners for us in all of our markets. Our division presidents, our land acquisition professionals work very hard to understand their developers and their market and who they need to partner with to get lots put on the ground and then be a good partner to those developers.
Okay. Just in terms of hard cost increases or inflation rates, just what are the trends you're seeing in terms of materials, lumber, concrete, and the like, in terms of cost increases going into 2018? The labor situation, any comments you have on skilled labor availability and wage rates you're seeing into the markets right now?
In terms of our cost up per square foot that we typically talk about, our revenues, once again, outpaced our stick and brick costs on a year-over-year basis. We did see a slightly higher increase in both our revenues per square foot and our stick and brick per square foot than the first three quarters of the year. That really was just driven by the closings mix shift that Mike mentioned in our scripted comments, because we had a higher percentage of our closings coming from the West. I'd say really, we're just seeing more of the same if you take out the closings mix. We're seeing a very minor increase in our revenues, just enough to cover our stick and brick increase.
The reason you're not seeing that flow through to an increased gross margin is we continue to have a little bit higher land costs flowing through as well.
Okay. Thanks, guys. Congrats.
Thank you.
Thanks.
Thank you. Our next question today is coming from Stephen Kim from Evercore ISI. Your line is now live.
Yeah. Thanks very much, guys. Congratulations on a really strong quarter and a good end to the year. My first question relates to economies of scale. Because certainly, it is apparent from your results over the last few years, if not longer, that there is a substantive difference in terms of how you're able to translate a given level of demand on the ground up to shareholder value. It seems that there are economies of scale that maybe weren't really fully realized or realizable 10 years ago or 15 years ago.
I was curious if you could just talk about what kinds of things have changed at the corporate level in the way you're managing your business to extract and drive these economies of scale, and if all of them are at the local level, or if you've been able to achieve meaningful ones at the national level.
Stephen, during the downturn, we all had to get a lot better, look at everything we were doing and try to figure out how we could do it with a little less people, a little more efficiently, and a little better, or a lot better. The key operators in this company went through that downturn. Very painful experience. Don't want to go through it again. We strive every day to get a little better everything we do. I think that has helped, and has created a different operating mindset today than we had in 2006.
Steven, I'd add to that, just kind of overall, part of the ability to approach the business differently does come to our balance sheet structure. We are operating at a significantly lower leverage level than we did the last time that we were at this scale. That's important. It does reduce our cost structure. It reduces the risk profile significantly. Our approach to land, where we're being more efficient there, moving more towards option and having a lower risk land strategy, but also more efficient, higher return strategy that allows us to still generate cash flow while growing, is a significantly different position than we were at the last time that we were at this scale. We like our position, but we still see, obviously, plenty of opportunities to continue to improve on it from where we are.
Got it. Okay. Second question is on the M&A landscape. I think you said two things that I found particularly interesting. I think, David, you said that you look at acquisitions pretty much the same as you look at a piece of land, and I think you also mentioned that you preferred smaller tuck-in deals. I just wanted to ask a couple of questions regarding those two points. One is regarding looking at acquisitions as a piece of land. Generally speaking, we've thought that companies such as yourself typically don't like to pay a lot above book value for the acquisitions you look at. Similar to the way you look at a piece of land, that's where most of the opportunities it would seem arise from, is the land holding.
Could you talk about what characteristics in an acquisition would encourage you to pay substantially above book value? Then regarding the smaller tuck-in deals, why smaller ones? Is there something about the difficulty to integrate a large deal that concerns you? I would think the competition for the smaller deals would be greater than for the larger deals, particularly with the Asian companies recently on the hunt, it would seem valuations for the smaller deals are kind of getting pushed up. Can you just sort of describe your preference for these smaller deals and what the pipeline looks like compared to last year or the year before?
I would say, to start with the end, I'd say the pipeline is probably a little longer today than it was a year ago. What we're looking for is not necessarily small or bigger, but something that is additive to our company, that we can take and grow or integrate some of the things they're doing or the people that they have that make us better. First thing we look at at any acquisition is culture of the company. If the culture is not aligned, the people aren't going to be aligned, it's typically not a great deal for us. Next thing we look about is what kind of premium we got to pay and can we earn that premium back in two years? If we can't, the deal structure's probably not right for us. Go ahead, Mike.
With the current platform we have, we're not motivated to pay a big premium for anything that we couldn't otherwise do ourself. As David said before, if it's not something that's going to make our company better, it's probably something that we're better off to spend our time and effort focused in a different area. I guess the only thing that would motivate us to want to pay a significant premium over book value would be to end my career at Horton. That would pretty much do it, I think.
One other thing I will pull out, is we don't see any lack of opportunities to grow our business organically at the pace we want to grow at today. It puts us in a very strong position that there's no deal we have to go do to hit our growth targets.
All right, that's helpful. Just to translate, when you said the pipeline is a little longer than it used to be, does that mean that it is more chock-full of acquisitions that are of interest or the opposite?
There are plenty of acquisition opportunities that we're evaluating to determine interest on. It's the way it's kind of continued to be for the last several years, the longer that the cycle has performed well, the industry has performed well. More and more people have a confidence that they feel like they can price their company comfortable. In a lot of the private builder situations, the principals, the individuals running it day to day to day are three to five years older today than they were three to five years ago. Their perspective and outlook potentially may be changing.
Yeah, it's a common malady. All right, guys. Thanks very much.
It's a good one, though.
Yeah.
Alzheimer's is not very good.
Exactly. All right, guys. Congratulations, thanks very much.
Thank you.
Thanks.
Thank you.
Thank you. Our next question today is coming from John Micenko from SIG. Please proceed with your question.
Hey, good morning. First question. Looking at your Southeast operations, looks like you did a bit better, certainly than some of the peers who pointed out a lot of disruption with some of the storms. Curious what you attribute that relative outperformance to.
Great people.
Obviously. That is the platform. It is people. We've got a great position there. There was an impact. There's no doubt there was an impact. There was a disruption from hurricanes, but we've got a lot of hardworking people that worked their way through it.
Okay. Stepping back a bit, you're going to generate a ton of cash. Your land strategy is moving to be more capital efficient. Kind of called out, though, that we're not going to see outsized buybacks, at least for the next couple of years. I'm just curious, how do we think about, or how do you think about return on equity, improving return on equity? You talk about de-leveraging. What am I missing in this cash build and equity build? I think book value is up 13 or 14% year-over-year. Is there more to squeeze out of operations? Where does the ROE improvement come from with so much cash build?
There's always room to improve on operations. We'll continue to improve on that. We are focused on return on equity as well. Our primary driver right now of return on equity is to continue to drive a stronger ROI.
We do expect to continue to grow our revenues faster than our inventory growth to drive that. We're at the beginning stages of beginning to repurchase shares that will also provide an element of an improvement to return on equity over time. We're going to walk before we run. We're going to begin by taking the steps towards offsetting our dilution. When we've achieved that, we'll see where we are, and we'll take the next steps from there. Clearly, we believe there's longer term, we have significant cash flow generation opportunities that will give us a lot of flexibility down the line. For the window that we see the next two to three years, we believe we're comfortable today stating we'll offset dilution, and we'll take the next steps when we get there.
You'll see in the investor presentation that we're going to post at the end of this call, we actually have added a return on equity slide after our return on inventory, showing that our ROE, while reducing leverage pretty dramatically, has improved from 11.8% in fiscal 2014 to 14.4% in fiscal 2017. It's improving along with our ROI while we're de-levering.
We do expect it to continue to improve.
Just to speak one more. Bill, do you have a leverage target? I mean, you got the 2.4, you're going to refinance the $400 in 2018 you suggested. Is there a leverage ratio that we should think about going out to 2020?
No specific leverage ratio. We expect our leverage ratio to continue to drop from now through 2020. We expect to keep our debt level relatively flat this year by refinancing, but our leverage ratio will drop this year. Then we'd expect that ratio to continue to drop through 2020 while also then increasing our dividends and increasing our share repurchase and growing our business.
Okay. Thank you.
Balanced approach is really the approach we're taking.
Okay, thanks.
Balanced approach.
Thank you. Our final question today is coming from Dan Oppenheim from UBS. Please proceed with your question.
Thanks very much. Was wondering if you can talk a little bit more in terms of, if you think about the success that you've had with Express Homes and the Southwest. You're getting back to prior peak volumes, but the Southwest is basically 22% of that prior peak at this point, where we've seen, obviously, loan limits being a real challenge in some of those markets. As you think about the gradual easing of credits and FHA and VA loans coming down slightly relative to what it has been, do you see more potential there in terms of just a greater share of closing coming from there? How are you thinking about that in terms of future investment?
We think the Phoenix Southwest, which has really driven the Southwest region, is going to continue to outperform. We're incredibly well-positioned there. Made some very strategic acquisitions on the land lot site a couple of years ago. The operating team out there was kind of reset in conjunction with those, and right now, we got an all-star team running that division with incredibly well-positioned lots. Our expectation is you're going to see continued growth in the Southwest.
Great. Thank you.
They will get back to their peak at some point.
Okay. Thanks very much.
Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further closing comments.
Thank you, Kevin. We appreciate everyone's time on the call today, and look forward to speaking with you again in January to share our first quarter results. A special thank you to the D.R. Horton team. In a tough fourth quarter because of weather, you did an outstanding job of delivering the 2017 and an even better job of positioning for 2018. You're the best in the industry, and we thank you.
Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day.