Good morning, and welcome to the Second Quarter 2017 Earnings Conference Call of D. R. Horton, America's Builder and 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.
As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Jessica Hansen, Vice President of Investor Relations. Thank you, Ms. Hansen. You may begin.
Thank you, Doug, and good morning. Welcome to our call to discuss our results for the Q2 of fiscal 2017. Before we get started, today's call may include comments that constitute forward looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D. R.
Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward looking statements are based upon information available to D. R. Horton on the date of this conference call, and D. R.
Horton does not undertake any obligation to publicly update or revise any forward looking statements. Additional information about issues that could lead to material changes in performance is contained in D. R. Horton's Annual Report on Form 10 ks, which is filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at investor.dhrorton.com, and we plan to file our 10 Q next week.
After the conclusion of the call, we will post updated supplementary data to our Investor Relations site on the Presentation section under News and Events for your reference. The supplementary information includes current and historical supporting data on our homebuilding return on inventory, home sales gross margin, changes in active selling communities, product mix and our mortgage operations. Now I will turn the call over to David Auld, our President and CEO.
Thank you, Jessica, and good morning. In addition to Jessica, I am pleased to be joined on this call by Mike Murray, our Executive Vice President and Chief Operating Officer and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D. R. Horton team produced solid second quarter results.
Our consolidated pretax income increased 18% to $354,000,000 on a 17% revenue increase to $3,300,000,000 Our pre tax profit margin was stable at 10.9%. We experienced a 16% improvement in our absorption per community as homes sold increased 40% compared to last year. These results reflect the strength of our operational teams and diverse product offerings across our broad national footprint as well as a strong spring selling season. Our continued strategic focus is to produce double digit annual growth in both revenues and pretax profits, while generating annual positive operating cash flows and increasing returns. For the trailing 12 months, our homebuilding return on inventory improved to 16%, up 220 basis points from 13.8% a year ago.
We still expect to generate $300,000,000 to $500,000,000 of positive cash flow from operations in 2017. With 27,100 homes in inventory at the end of March and 227,000 lots owned and controlled, We are well positioned for the remainder of 2017 and for future growth. Mike?
Net income for the 2nd quarter increased 17% to $229,000,000 or $0.60 per diluted share compared to $195,000,000 or $0.52 per diluted share in the prior year quarter. Our consolidated pretax income increased 18% to $354,000,000 in the 2nd quarter versus $301,000,000 a year ago, and homebuilding pretax income increased 14% to $322,000,000 compared to $282,000,000 Our backlog conversion rate for the 2nd quarter was 94%, above the high end of the range we guided to on our Q1 call. As a result, our 2nd quarter home sales revenues increased 18%
to $3,200,000,000
on 10,685 homes closed, up from $2,700,000,000 on 9,262 homes closed in the prior year quarter. Our average closing price for the quarter was $295,600 up 2% compared to last year. This quarter, entry level homes marketed under our Express Homes brand accounted for 29% of homes closed and 22% of home sales revenue. Our homes for higher end move up in luxury buyers priced greater than $500,000 were 7% of homes closed and 17% of home sales revenue. Our active adult Freedom Homes brand is currently being offered in 10 markets across 8 states.
Customer response to these affordable homes and communities offering a low maintenance lifestyle has been positive. Bill?
The value of our net sales orders in the 2nd quarter increased 17% from the prior year quarter to $4,200,000,000 and homes sold increased 14% to 13,991 homes. Our average number of active selling communities was 2% lower than the prior year quarter, but increased 2% sequentially from our Q1. Our average sales price on net sales orders in the Q2 was $299,400 and the cancellation rate for the Q2 was 20%, consistent with the prior year quarter. The value of our backlog increased 9% from a year ago to $4,400,000,000 with an average sales price per home of $303,400 and homes in backlog increased 7% to 14,618 homes.
Our gross profit margin on home sales revenue in the 2nd quarter was 19.8%, consistent with our expectation in our Q1. In the current housing market, we continue to expect our average home sales gross margin to be around 20% with quarterly fluctuations that may range from 19% to 21% due to product and geographic mix as well as the relative impact of warranty, litigation and interest costs. Bill?
In the Q2, homebuilding SG and A expense as a percentage of revenues improved 20 basis points from the prior year quarter to 9.3% at the low end of our guidance range. For the 6 months ended March 31, homebuilding SG and A was 9.4%, an improvement of 50 basis points compared to the same period last year. We remain focused on controlling our SG and A while ensuring that our infrastructure adequately supports current and future growth. Jessica?
Financial Services pretax income in the 2nd quarter increased to $31,500,000 from $18,600,000 in the prior year quarter, driven by growth in revenue and an improved operating margin. 96 percent of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operations. Our mortgage company handled the financing for 57% of our homebuyers, up from 53% in the same quarter last year. FHA and VA loans accounted for 47% of the mortgage company's volume. Borrowers originating loans with our mortgage company this quarter had an average FICO score of 720 and an average loan to value ratio of 89%.
First time homebuyers represented 46% of the closings handled by our mortgage company consistent with the prior year quarter. David?
During the quarter, our total number of homes in inventory increased by 11% as we prepared for higher closing volumes in the 3rd and 4th quarters. We ended the 2nd quarter with 27,100 homes in inventory, 13,200 of our total homes were unsold and 9,700 in various stages of construction and 3,500 completed. Compared to a year ago, we have 10% more homes in inventory, putting us in a strong position for the remainder of the year. Our 2nd quarter investment in lots, land and development totaled $814,000,000 of which $512,000,000 were for finished lots and land and $302,000,000 was for land development. During the first half of twenty seventeen, we invested $1,700,000,000 in lots, land and development compared to $1,100,000,000 in the first half of last year.
Our underwriting criteria and operational expectations for each new community remain consistent at a minimum 20% annual net return on inventory and a return of our initial cash investment within 24 months. We plan to continue to invest in land and lots at a rate to support our expected growth in revenues. Mike?
At March 31, our land and lot portfolio consisted of 227,000 lots, of which 118,000 52% are owned and 109,000 or 48% are controlled through option contracts. 77,000 of our total lots are finished, of which 30,000 are owned and 47,000 are optioned. Our optioned lock position increased 42% from a year ago, in line with our focus on developing strong relationships with land developers across our national footprint. Our 227,000 total lot portfolio is a strong competitive advantage in the current housing market and a sufficient lot supply to support future growth. Bill?
At March 31, our homebuilding liquidity included $948,000,000 of unrestricted homebuilding cash and $900,000,000 of available capacity on our revolving credit facility. Our homebuilding leverage ratio improved 5 60 basis points from a year ago to 28%. The balance of our public notes outstanding at the end of the quarter was $2,800,000,000 At March 31, our shareholders' equity was $7,200,000 and book value per share was $19.23 up 14% from a year ago. Our balanced capital approach is centered on being flexible, opportunistic and disciplined. Our top cash flow priorities for fiscal 2017 include continuing to consolidate market share by both investing in our homebuilding business and through strategic acquisitions, paying off $350,000,000 of our senior notes at maturity in May and providing consistent dividends, which are expected to total $150,000,000 this year.
Our balance sheet strength, liquidity and continued earnings and cash flow generation are increasing our flexibility, and we plan to maintain our disciplined opportunistic position to improve the long term value of our company. Jessica?
We are updating our expectations for fiscal 2017 based on current housing market conditions and our financial performance to date this year. As we noted in our press release this morning, we are updating our annual guidance as follows. We are increasing the range of our consolidated revenues to between 13.6 $6,000,000,000 $14,000,000,000 and are increasing the range of homes closed to 44,546,000 homes. We now expect homebuilding SG and A for the full year in a range of 8.8% to 9.1 percent of homebuilding revenues and are increasing our guidance for our financial services pretax operating margin to approximately 35%. We currently forecast an income tax rate of 35.5%.
Also as outlined in our press release this morning, we are reaffirming our previously issued guidance for fiscal 2017 including a consolidated pretax profit margin of 11.2% to 11.5%, a home sales gross margin for the full year of 2017 around 20% and annual diluted share count of approximately 380,000,000 shares and $300,000,000 to $500,000,000 of positive cash flow from operations for fiscal 2017. Specifically for the Q3 of fiscal 2017, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 81% to 84%. We anticipate our 3rd quarter home sales gross margin will be around 20% and we expect our homebuilding SG and A in the 3rd quarter to be in the range of 8.6% to 8.8% of homebuilding revenue. David?
In closing, our 2nd quarter growth in sales, closings and profits is a result of the strength of our people and operating platform. We are striving to be the leading builder in each of our markets and to continue to expand our industry leading market share. We remain focused on growing both our revenue and pretax profits at a double digit annual pace while continuing to generate annual positive operating cash flows and improved returns. We are well positioned to do so with our solid balance sheet, industry leading market share, broad geographic footprint, diversified product offerings across our Doctor Horton, Emerald, Express and Freedom brands, attractive finish lot and land position and most importantly, our outstanding team across the country. We'd like to thank the entire D.
R. Horton team for their continued focus and hard work, and we look forward to continuing to grow and improve our operations together. This concludes the prepared remarks. We will now host questions.
Thank you.
You. Our first question comes from the line of Alan Ratner from Zelman and Associates. Please proceed with your question.
Hey, guys. Good morning. Congrats on another strong quarter. My question and my first question, if I could, just thinking about the pricing environment and costs, you raised the revenue guidance, held the gross margin guidance. And we've heard from some other builders lately that pricing power seems to be reemerging, especially at the entry level.
But at the same time, there's obviously some uncertainty on the cost side. Lumber is probably the biggest unknown just given the potential tariffs coming down the pike here. So I'm curious as you look at the full year gross margin and I guess just a little bit longer term, how you're thinking about those 2 offsetting factors? And I guess just as a company as a whole, if you could just give a little bit of insight how you purchase lumber and if you're doing anything differently to potentially combat the rising costs? Thank you.
Good morning, Alan. This is Mike. Thank you for the question. We are seeing some pricing power in the communities where we have achieved the absorption pace we're going to route those communities to. And so that's been very helpful in maintaining our gross margin.
At the same time, with our cost structure going forward, we're seeing an efficient building process yielding savings in our vertical construction cost. And so we've been able to offset some of the lot cost increases we've been seeing come through to protect the margins. Looking forward with regard to our cost structure, our guys are working very hard every day. We're working very hard with our national supplier partners to protect that cost structure. And I can't tell you we're doing anything radically different on buying lumber.
It's something we look at market by market, looking at the commodity market and trying to lock in pricing when we feel it's a good time, again, market by market in the lumber.
And I'll just add that the supply demand equation is, I think, allowing us to offset the cost that we've seen that vary commodity by commodity. So land goes up, price of the house goes up. It ultimately comes down to positioning and efficiency, and we get up every day working on those two things.
So we do feel very confident about our forward margin guidance that it's going to remain consistent as it has for the past few years.
Got it. I appreciate that. And on the cost side, I might have missed it, but do you have, however you look at it, price per square foot, what your material and labor costs are on a year over year basis? And just curious within the lumber component specifically, have you already seen that inflation hit your P and L or with the price increases, is that going to be more on a go forward basis?
Sure, Allen. This is Jessica. Year over year, we saw our revenues per square foot up 3% and our stick and brick costs were only up 1%. What was offsetting that was we do continue to see slightly higher land prices flowing through our P and L on a per square foot basis. And sequentially, our revenues per square foot and our stick and brick was really right in line.
They were both up just a very low single digit percentage. In terms of lumber, specifically, we haven't seen any noticeable impact from lumber. Generally, when I talk to our purchasing team, they say whatever that market price is doing, we're generally taking some lesser price increase, when we're out there locking in our prices for
Our next question comes from the line of Carl Reichardt from BTIG. Please proceed with your question.
Good morning, everybody. I wanted to ask about community count. I know we've talked about it being flat to a little bit down for the balance of the year. When do you guys think it's likely to inflect and begin to track up as you look forward?
Carl, this is Bill again. As we've talked about it, we have visibility to exactly where the community count is pretty good for a quarter or 2, but beyond that, it gets a little murky just given the timing of communities roll off. So as we look the next couple of quarters, we continue to believe we're going to stay relatively stable, plus or minus flat within a couple of percentage points. But we do believe that over the long term as we get into 2018 and beyond as we continue to expect to grow at a 10% to 15% pace on the top line that that will require some community count growth. And so as we make those investments to prepare for that growth, we would expect we get into 2018 for our community accounts to start to rise at a modest pace.
We still expect to continue to improve our absorptions and are very focused community by community on executing as well as we can to continue to drive some of our growth through absorption improvement as well.
Okay. Thanks, Bill. And then if I can ask about Freedom and the rollout. When we've gone and looked at the product, I'm curious about whether or not you are concerned about cannibalization of the Express product. We've talked about Express.
One of the reasons it's been successful is because you saw a larger percentage of customers in that product who were effectively moved down buyers. And so, I think the thinking is, well, if you're opening Freedom near Express, you may see some level of cannibalization. So how do you think about it and balance that? And has there been any impact to Express absorptions because of Nearby Freedom product?
Carl, this is David. We haven't seen any negative impact to Express. The concept of Freedom is to capture and expand the offering to include the people that just don't want to live next door to a 2 store with a bunch of kids and those buyers are out there. So it's we're trying to set these communities up as kind of a lock and leave opportunity, something that they don't have to be there every day to maintain. And that was a buyer segment that, to be honest with you, we were not actively pursuing at the level we are now.
We think it's a huge opportunity for the company and a little more difficult to roll out and express because it is a specific type of community that we're launching Freedom in. You can't just go build it on a lot. But no, from my perception and what I'm hearing from our people, Freedom is not going to cannibalize. It's going to augment and I think support it for us.
Thanks so much, guys. I'm sorry, go ahead.
Yes. And just
as we look, it's very early, but when we look at average price points on Freedom versus Express today, they're running about 10% to 15% higher. So there's a little bit of extra cost for those homebuyers, still affordable, but certainly a step above Express. And there is an element of an HOA fee to cover the maintenance and those aspects for the community that are not in Express as well. So a little bit of a differentiation from an economic standpoint. Okay.
Thanks, Todd.
Our next question comes from the line of Stephen East with Wells Fargo. Please proceed with your question.
Thank you and good morning everybody. Your guidance in the for revenue for the full year suggests you're slowing down in the second half And your backlog today your growth in your backlog today is not a whole lot different than your growth in the Q4 of last year. So I'm trying to understand, is it just conservatism? Are you all seeing something out there that will take longer to deliver on the homes? What's driving that reduced growth rate in the second half?
Well, Stephen, as
you know, we got off to a really good start at the start of the year and the spring helps drive where we're going to be for the end of the year. We are raising our guidance for the year to a higher annual growth rate. And as we get a little bit closer, if we see that we need to raise it a bit more, we certainly will do that. I wouldn't try to imply necessarily anything as far as a moderating growth rate at all. We're right in line, right in the range of what we've been investing for and planning for the year.
Okay. I appreciate that. And then you talked about your allocation, your capital allocation, which I appreciate. And You talked about M and A sort of a couple of part question here. When you talked about M and A, there are a lot of non traditional buyers out there right now.
And I'm wondering, is it disrupting the market? You don't have the strategic buyers we're not seeing be that active. And just wondering why the strategic buyers aren't as active or the nontraditional guys pushing pricing too far, etcetera, and just how you all are thinking about it? And then, no conversation of share repurchase in your capital allocation. And while I'm not a huge repo guy, when I look at the impact it can have on your returns, your ROEs, it can make a big difference.
So just your thoughts there.
Stephen, this is Mike. On the M and A question, we are continuing to be very active in looking at
a lot of opportunities.
And the most important things for us are finding a good homebuilder, a good operation that fits with us culturally and lot wise. And equally as important is a reasonable seller and reasonable seller expectations. And there have been a there has been a little bit of dislocation in that, but I would say that seems to have died down a bit. And we might see the bid ask spread narrow a little bit coming going forward.
Stephen, this is
I'll pass on to the rest of the question. And in terms of our overall allocations, acquisitions are part of that, but we are going to remain disciplined. And so we're going to we certainly have the room to make large investment there if we find the right deal that fits our return strategy. In terms of share repurchase, we have an outstanding authorization from our Board of $100,000,000 which we have not used as of yet. And when we talk about our top priorities, our most significant priorities for this year, we've laid those out.
But that is something and we've talked about this previously that as we look further and as we generate cash flow for our 3rd consecutive year over the longer term, we would expect there to be some level of share repurchase in our overall allocation. But as of yet, we have not purchased any shares back.
All right. Fair enough. Thanks a lot, guys.
Thank you.
Our next question comes from the line of Nishu Sood from Deutsche Bank. Please proceed with your question.
Thanks. So this focus on absorption growth versus raw community comp growth, obviously, you've been Current pace puts you at about 46,000, 47,000 orders for fiscal 2017. How much upside is there as you think about getting all of your communities to their optimal absorption rate? I mean, does that take us to 55,000, 60,000 on the current footprint? And I understand you mentioned community counts might begin to rise again in 2018.
Just trying to think about how much upside there is left on this absorption push?
Nishu, we're just focused every day, every community, getting incrementally a little bit better. If you'd asked us 3 years ago if we'd be exactly where we were today, I'm not sure our answer would have been because we're just trying to get better every day. And but what I'll tell you is that as our operators are in the field and our division presidents are out there working hard every day, they're finding ways to get better every day. And so we do believe there's continued upside, there's continued opportunities to continue to get better. We've got certain markets that can get significantly better.
We've got others that may be getting closer to that potential. We're going to keep trying to work to improve it. And we do believe that in this year and into next year, we will continue to find ways to improve our absorption. Exactly what that full potential is, what the ceiling is, not sure there is ever a ceiling. We're just going to keep working to get better.
Nishu, it's never going to be good enough with our Chairman and active shareholder we have here. So we're just going to keep growing.
Got it. Got it. Okay. So it sounds like still some runway left there. The Southwest division had some pretty good looking metrics this quarter in terms of the orders and the pricing, etcetera.
Can you dig down into that? Obviously, the closings were up nicely as well. Can you just dig down into that and walk us through the drivers of that, please?
Go ahead, Mike.
Sorry. Thank you for noticing. The Southwest market is had been a little bit of a smaller area for us, and we have been repositioning that group, making some investments in opportunities in Phoenix primarily. And that team has done a great job of taking advantage of those opportunities in a market that's kind of been rebounding a bit. So very happy with the positioning that our team has done and their execution against that position.
And so that's really simply is what it is right there.
Nishu, we spend a lot of time talking about people, people, people. We've got an operational focus and a leader in that division today that we can support with capital. And she is doing a tremendous job of turning that into growth and profitability. So kudos for her. Great.
Thank you.
Our next question comes from the line of Ken Zener from KeyBanc. Please proceed with your question.
Good morning, all.
Good morning, Ken.
I'm thinking Toy Story Infinity and Beyond for your order pace. Absolutely, Ken. Yes. So looking at some operational metrics, your orders were basically seasonal in 2Q, that's quarter over quarter pace. You guys did very well in 1Q, so it's good you maintain that.
But when I think about your guidance, which is related to closings, I think about homes that are totally built, which includes all your specs, so your units under construction, Your guidance went from, I think, 8% to 13% to like 10% to 14% for year over year now and it's up a little bit. But your units under construction was 14% growth in 1Q, now we're down to 10%. Can you talk about the decisions that are being made to have that lower growth? Was it warmer weather that enabled you to put more units in the ground and you're really targeting 10 because the delta shows that you're decelerating your units that are which obviously build up into your closing. So can you kind of talk about that actual capital allocation if we use units under construction, year over year is the indicator for your forward best spinoff year over year as the indicator for your forward best speedometer?
Sure, Ken. We've talked quite a bit about the fact that we were starting this year much stronger in position back in October 1 and then January 1 with our units under construction to prepare ourselves for the spring. And so we had a stronger year over year comparison in those first couple of quarters. I wouldn't say that we're decelerating at all or versus our expectations there. We just simply got an earlier start.
And so now we're into a good mode of just replacing homes and maintaining them at a level that we believe will support the growth that we're expecting and position us start to position ourselves then for next year as well. So, wouldn't read too much into just this quarter end positioning on a year over year basis. We're in a good position with our homes and construction.
Go ahead, David.
We are focused on a community by community process and market shifts and starts and planned targeted closings. We're trying to be disciplined, we're trying to be smart and we're trying to maximize every flag. So again, we set annual targets. We operate quarter to quarter and we adjust. But don't read anything negative into that number.
And as you look at as our community accounts do start to get back to close to flat year over year and rising into 2017. Obviously, there's some homes that go along with those flags as well that I would expect to be coming into the picture as well.
Yes. And I don't it wasn't
set up as a derogatory comment. It's just that I think people misunderstand that number or don't apply it enough. And as you start moving into right from 2Q to 3Q to 4Q, 4Q is actually just multiply that number times 2 and usually your forward volume. So I'm just trying to think about not only the execution that you're doing this year, but how you're setting up conceptually '18, right, from your capital allocation as we think about that. And it seems as though labor is not an issue.
Your closings as a percent of units under construction is exactly what it was last year. You're obviously labor is not an issue for you. So it's just determining how many units you want to have in for spec. So I can tell you,
we're very focused on 'eighteen and 'nineteen to be honest with
Thank you.
Our next question comes from the line of Bob Wettenhall from RBC Capital Markets. Please proceed with your question.
Hey, good morning. And no surprise, another great quarter from Horne. Just wanted to understand your gross margin target a little bit better. It looks like you're increasing your Financial Services operating margin by a pretty healthy amount, but at the same time you're reiterating your full year gross margin guidance. And I just want to understand kind of what the offset was and it sounds like cost pressures are actually rather benign.
Could you help us think through that a little bit?
Sure, Ken. Bob, sorry, this is Mike. What we have is financial services are not a component of our gross margin. That's down in our other area, operating margin. It is it's part of operating margin overall, but we're seeing gross margin to be consistent with where it's been.
Financial services is improving a bit, and we'll probably get some more SG and A leverage in the second half of the year. And we're providing Right.
So with that, it's sorry, I missedpoke. I meant to say you reiterated your full year operating margin for the company of 11.2% to 11.5%. It seems like you got a very positive trend there on the financial services side with the consistent gross margin. So you're also getting the SG and A leverage. So I was just trying to understand, at some point does the operating margin inflect higher just because of what's going on?
It will depend on what happens with gross margin in the back half of the year. But if you look at the 1st 6 months of the year, we're only running 19.8%. So our margin probably will lose and it was around 20%. I'm curious talk a lot about 19% to 21% as the broader range. So as if we move into Q3 Q4 and we do see that margin tick up over 20%, that could allow us to have some upside or at least hit the high end of our operating margin guidance.
But because we're only running 19.8% for the 6 months 1st 6 months of the year, we don't feel like it makes sense to move that operating margin range up from where it is today.
That makes perfect sense. Thank you. And that's very helpful. And also too, just a follow-up question, if I may. What should we expect about the conversion rate going forward to backlog?
Do you think it would just be consistent with last year? Or do you expect any change to the pace?
We're focused on improving that on a year over year basis. So we are projecting a lower conversion rate sequentially, but that's a typical seasonality for us. But in terms of a year over year, we would hope to see some improvement, although let's see. Yes, we guided to 81% to 84% and that compares to last year's Q3 conversion rate of 78%.
Very impressed.
Just trying to get better every day, Bob.
That sounds good. Good progress. Congrats on a great quarter.
Thank you.
Our next question comes from the line of Stephen Kim from Evercore. Please proceed with your
I wanted to ask a
question if I could about the difference in the way you approach implementing price increases in communities which are perhaps lower price point, maybe more volume oriented versus more of your semi custom or move up product. In general, we're hearing that there's strength across the board, but probably more concentrated at the lower end, lower price points. And I was curious if you could give us a sense for if your strategy or the pace of implementation of price increases varies or is different when the strength you see is more in those lower price communities?
Stephen, we try to be consistent in our operation and absorption in these communities. So based upon the season and timing within the year, but the best practice we found is small incremental based on the number of units that are being sold. If it's a 300 lot community and we want to sell 10 a month, then we would have a nominal increase every 10 houses. So if there is a consistency to the pricing, there's a set urgency to get people off the fence and they buy now or they pay a little more next month. So and that's proven to be very effective.
It's not only creates urgency, but it improves margin.
Got it. That's helpful. Thanks for that. And then the second question I had relates to kind of a more general question. I think one of the things that we're seeing that's really fascinating about the industry and the stocks right now is this sort of blend between things that are early cycle and later cycle.
The valuations that we're seeing in the group, the level of margins, the labor constraints you're running into and rate of land spend as a percentage of revenues. Those are all things which are more characteristic of later cycle. And yet, we I should say the not the multiples, the valuations are actually more early cycle. But we're also seeing that a growing share at the entry level and the overall level of housing starts a very early cycle. So you got some aspects to the market that are kind of early cycle ish and then you have some aspects that seem like they're more later cycle ish.
And I was curious as to as you look at where we are right now and you try to assess your strategy over the course of the next few years, let's say, where do you think we are in the housing cycle and which of these various metrics or things to look at do you think are the best gauge for determining where we are and what the right approach for your company should be from a cyclical perspective?
You know, Saba, we operate subdivision by subdivision and job growth within submarkets. And I can tell you we have submarkets that are very early cycle and then we have others where they feel more mature. It doesn't get a sense that it's a and I'm sure at some point there will be some disruptions and things may change. But right now, in the markets that are producing at the top for us, there is more demand and less options or inventory out there than at any point that I have been in this business. So I think you get too focused.
I think sometimes we can get too focused on trying to judge a cycle and miss tremendous opportunity. And so we're adjusting quarter to quarter and supporting the divisions that are improving returns. And Mike?
Stephen, I think you touched on it, not just geography, as David mentioned, and individual submarkets, but within markets, different customer segments have been coming into the housing equation at different times. I think coming out of the last downturn, we saw more of the move up buyers, pent up demand being satisfied in that rush. And now I think we're seeing more of the entry level first time buyers coming into the marketplace now that there's some supply out there that is attainable for those folks. So we're, as David said, community by community being responsive to what we see in the market in front of us. And rather than looking at broad trends, we're focusing at a very micro level with our capital.
Steve, we made a decision to push into the entry level opportunities that we see out in California. And I can tell you that certainly isn't late cycle because those opportunities haven't existed for the buyers out there. And Don Horton traveled the West region over the last 30 days and he's not an exuberant type guy, but he came back feeling better about what he saw in the West and specifically the opportunities in California than I have seen him in a long, long time. And I traveled Texas, Louisiana and Arizona in the last couple of months. And I can tell you, I think I said 2 or 3 years ago, Dallas was the best housing have ever seen.
Still an incredibly strong market, but we're seeing strength in Houston and opportunity in Houston that compressed oil industry had kind of put on hold. Austin is red hot. Phoenix we are opening a price point in Phoenix that didn't exist. So to say that Phoenix is at some point in the cycle, I'd tell you from an affordable housing standpoint, it is at the very front end of the site. So it's just market by market and where people want to live and where there's no houses.
We found the ability to sell houses.
Well, for a company that doesn't focus on the cycle, you guys have certainly been doing a lot of things that look pretty prescient from a cyclical perspective, I have to say over the last several years. Just to put a fine point or to make sure I understood what you said, you don't manage as to a cycle per se, but you don't mean to suggest that when we go into the next down cycle or downturn in the economy that you think that the markets across the country will some markets will be completely immune to that. Do you I mean, the market is going to
have a
cycle, right? No, I was around in 'eight, 'nine and 'ten. We're not immune from market.
Not at all. But the only way to respond, you can't respond at a global level effectively. You still have to respond on the ground in a subdivision what's the right decision day to day and operating that community and what's going on around it. And that's the way our operations set up. That's what our all of our operators in the field are focused on
every single day. And over the backdrop of the past several years, the balance sheet strength we have garnered is going to give us greater flexibility through whatever the next cycle holds or the next stages of the cycle to make those best decisions community by community.
Our next question comes from the line of John Lovallo from Bank of America. Please proceed with your question.
Hey, guys. Thanks for taking my call. The first question here and I don't want
to beat a dead horse, but
I just want to be clear because I do believe this is why the stock is under pressure today. If we look at the first half revenue growth year over year, it's about 18.8%. If we take the high end of your total revenue range of $14,000,000,000 that's going to imply a 15% growth for the full year. At 13.6%, it's about 12% growth. So there it does appear like there's a deceleration and the market's looking for any reason to say that that growth is slowing.
So
what are you guys seeing? Is this
is really kind of just that you got off to a stronger start? I mean, are you seeing any indications that demand is slackening? Did orders trail off through the quarter? Or are things looking a lot better than the market is actually giving you credit for today?
Well, John, I think one element here is if we're looking at simply a year over year trend, one part of that component is the prior year numbers. We had a slow start last year, honestly, and we've talked about that. We were trying to play catch up all year long with our homes and inventory and getting communities open. And we got a lot of our growth last year in achieving our 10% to 15% growth in the second half of the year. We've worked really hard to position ourselves to start this year in better position.
And so when we performed in Q1 and Q2 versus a slower Q1 and Q2 last year, we've seen a higher annual growth rate. The year is still right in line with what we've expected. It's not a deceleration of growth. It's really more of a function of the comparison to the prior year on a quarter to quarter basis. We invest in this business on multi year cycles.
We plan our years out and we try to put ourselves and each of our communities in the best position possible to execute as well and give our chance to sell us an opportunity to do better. And we believe we're in good position this year to do it. We're feeling really good about the rest of the year. We're feeling really good of our ability to position ourselves to grow double digit again in fiscal 2018. And we certainly don't feel like we're decelerating here.
It feels like we're in position to do exactly what we're planning to do.
Okay. Yes, that's really helpful. And then if we think about just kind of the traffic that's been coming through your communities, interest rates have bounced around a bit. I know last quarter you mentioned that you didn't see any real notable impact. But how is traffic, how are folks feeling in general?
Is there any continued chatter about interest rates that you guys are hearing?
Not a lot of chatter about interest rates. I can tell you the salespeople in our company today feel as good about the market as they have ever. Traffic numbers are up. We're selling houses. We're well positioned against competition where we have competition.
And it's I mean, it's just a good time to be in the business.
Okay. That's really helpful, guys. Thank you.
Our next question comes from the line of Jack Micenko from SIG. Please proceed with your question.
Hey, good morning. I wanted to talk a bit more about Freedom. I know in the past you've talked about it being a growth opportunity next year. I think you said 10 markets, 8 states today. Is it possible for you to size what that looks like a year from now, 4 or 5 quarters from now?
And if it is growing and the community count numbers are still flattish, what do the Freedom Communities displace? Or will that be the growth in community count?
I think this is David. I think Freedom will be a growth in our community count. We're certainly not looking to displace any of our other brands. So it is kind of a unique product and offering, and it's not going to roll out at the same speed that Express did. So but yes, I think in 2018, 2019, it will be a big part of the growth story.
Okay, great. And then on the financial service margin, what is driving it higher? Is that just more volume? Or are you doing more, I don't know, FHA, VA that's driving the gain on sale profitability higher? What's behind the changing guidance on the financial service side?
We're seeing better loan sale execution. So we are seeing higher gains on sale. We're also continuing to see a higher average loan amount, particularly in this quarter. So that coupled with just this doesn't affect the operating margin, but the revenue growth that we saw and our increased capture rate again, our financial services operation has done a great job of that capturing more of our homebuyers, our D. R.
Horton homebuyers and that all helps us play out to drive
Our next question comes from the line of Mike Dahl from Barclays. Please proceed with your question.
Hi. Thanks for taking my questions. David, wanted to follow-up on a comment you made about California and Doctor's tours a couple of questions ago. And just to ask specifically, is the enthusiasm coming from the Express rollout? Or is it kind of across your brands?
And then specific to the rollout of Express, can you give us a little more color on how that's going and whether or not there's been any impact from things like the rains that you've seen in parts of California?
I would say the enthusiasm was the alignment of our people out there with the opportunities in the market because he was not only in California looking at the EXPRESS program rollout, he was also along the coast looking at our infill operations and up in Seattle and Portland. So I mean, it's just strong markets with aligned teams executing very well. And the what was the California Express question? I'm sorry.
Just if you could give us any update on how that rollout is going and whether or not there's been any impact from the rain?
I have not seen a big impact on the rain because it's just everything in California takes a lot longer. We have a significant number of projects identified and or controlled, and we're launching. It's I think the impact that we're going to see probably going to be in 2018. But just the opportunity and the positioning that we've been able to accomplish, pretty exciting for us.
Got it.
But I have not seen a lot of impact from the range.
Thanks. My second question is going back to actually, I think the first question around lumber. And I appreciate that you guys have the purchasing power to negotiate much better deals than some others across the industry. But just want to make sure we understand just mechanically the right way to think about it between how you contract out on lumber and then the kind of cost allocation process that takes place as you incur essentially higher costs and then obviously your build cycle. So to the extent this most recent leg higher in lumber sticks, is that something that will impact the P and L in the second half?
Or is it more likely to be something where you'd have it impacting fiscal 2018?
Okay, Mike. So we would allocate the cost of the individual houses that we're buying the lumber for and we're looking at lumber pricing. It varies on the logs 30, 60, 90 days and some adjustments to that the buying of protecting our backlog and our planned spec starts in the near term. So as any lumber costs may come through in our purchasing production, they would show up in a house closing 4 to 6 months after that lumber was dropped on the lot or 2 to 6 months after that lumber was dropped on the lot. And so you would see that particular cost line potentially having some pressure.
But I would tell you that we would expect to see some of those things offset by other decreases and other material costs that we're seeing as well as continued greater labor efficiencies that we're getting with our production processes in our neighborhoods more with the Express and some of that Express concepts going into our other product lines.
Got it. And are there any things that you can point out specifically as far as the areas where you're seeing the decreases for the actual sticks and bricks costs?
Nothing pointed at specifically. It's just that we've been working really hard with a lot of our national trade partners to focus on our purchasing power and some of the mutual benefits we can both have in expanding their market share in a given market.
Our next question comes from the line of Michael Rehaut from JPMorgan. Please proceed with your question.
Hi, thanks very much. First question, just wanted to circle back to community count and it looks like actually there's a couple of questions earlier about maybe community count flat to slightly down and you kind of I think earlier Bill kind of talked about community count being stable for the year. But it seems like community count was actually up sequentially 3% during the quarter. And you also have, I think as you've alluded to earlier, you have a continued growth now in lock count for a few quarters, up solid double digits. And excuse me that I didn't I forgot to type in the total number for this quarter, but I believe you're still at a healthy double digit pace now for a few quarters.
So why wouldn't lock count maybe continue to drift up sequentially for the rest of the year similar to the Q2 rate?
Are you asking if our lock count is going to continue to drift up?
No, I'm sorry. For the community count, community count, excuse me.
Sequentially, our community count on average was up 2%. So it was the first time we've seen a slight tick up in that community count. And we do have the lots, for that to happen. But as Bill mentioned earlier, the timing of when communities roll off and when new ones roll on is pretty flexible and it's highly dependent on the sales absorptions we're seeing in our currently open communities and then also just our ability to bring new communities online because there's a lot of moving parts. So we could see that continue to go up, but we don't expect it to go drastically up.
Any changes in our community count, both sequentially and year over year, we would expect to be in a low single digit range.
Okay, fair enough. Also on the gross margin front, obviously still well within your guidance range, But essentially what you've had now is a couple of quarters, a touch below 20% that was preceded by the back half of twenty sixteen, a little bit above 20%. So just curious if there's anything mix driven so far in the first half of this year that resulted in it being a little touch below? It seems like your cost inflation is still very reasonable and not too much of a driver if I'm interpreting those numbers correctly. So just curious if it was a little bit more mix driven or obviously the warranties sometimes play a role?
Right. Yes, Mike, this is Bill. We've really seen incredible stability actually in our gross margin for quite some time now. At a core level, it's been very tight within 20, 30 basis points from quarter to quarter to quarter. And that's why we guide around 20 and we can see some quarterly volatility due to some of those other factors that you mentioned.
In general, our interest costs have been ticking slightly lower as a percentage of our cost. And so that's been a slight help to our margin over the last 8 quarters or so. We see more volatility in kind of our warranty line there. And in recent quarters, we've seen a little bit more of a negative impact from that, not too significant, but a little bit more of a negative impact there in the last couple of quarters, which is one factor why we've been slightly below 20%. But overall, we would characterize our margins as very stable.
We're seeing actually less volatility from all of those factors than we have seen over the longer term history in our company. And that's why we're continuing to guide to around 20. But you will see some movement either above 20 or below 20 from quarter quarter.
And Mike, we'll post after the call our supplementary data that has home sales gross margin slide in it that shows the specific basis point impact either up and down, to what we kind of call our core gross margin. Some of those items that Bill and you have already touched on, can see the specifics after the call.
Our next question comes from the line of Will Randoll with Citigroup. Please proceed with your question.
Hey, good morning and congrats on the quarter.
Thank you. Thank you.
On Express and Freedom, the two things we noticed touring those brands on our recent field trip is your carbon costs out of those homes via not using trusses, for example, and that Freedom buyers were typically buying to live near their adult children, in, for example, an Express community. So can you discuss how much cost you carved out of Express and Freedom relative to your peer set on a dollar or percentage basis? And secondly, what quantifiable benefits are you seeing from active adult buyers buying Freedom Homes and communities near their children who possibly have bought a Horton home?
Will, your question on the cost, was that related to trusses? We couldn't quite hear you there.
Sorry. So yes, so you carved out cost on trusses in other places within a home. So that was my first one. Can you quantify the benefits? And second, what first derivative benefits are you seeing from active adults buying near their children and co located communities?
Because we heard a few of your salespeople say that on a recent tour.
That's part of our overall analysis of Freedom is that we're giving adult children or the parents an opportunity an affordable opportunity to live near their children and grandchildren. And I mean, we just feel like that's a major factor in people relocating. And I lived in Florida for 25 years, saw it every day where somebody was moving down. A job had brought the family, the children and grandchildren down and then the parents were coming in trying to find something to buy, where they would have a home close to their grandchildren. I just think that's a big driver in the market of it.
And as far as the overall cost in the design and what I mean, that's a market to market determination. What we try to do with the Freedom product is drive as much efficiency and labor savings as we possibly could. And so everything we're doing today is to drive better value to the customer and try to take labor out of houses where we can because that's going to be that has been and continues to be the constraint on a market right now. I think there's not a builder out there that could sell more houses if they can build.
And I guess as a follow-up, realizing your exposure to California is smaller than most of your public peers, There have been concerns regarding, the ever senseless state of California mandating what type of labor you choose via AB199 in a number of markets, which can add 1,000 of dollars of cost to a house and also a mandate to reduce emissions by 20% in 2017, which can add another $5,000 to $10,000 per house. We've heard AV199 is a moot point, but the emission cost is real. Can you comment on both the AB199 view you may have as well as the emissions reductions cost for you?
Well, we compete market by market and we're going to be competitive in every market we're in, as David said, looking to provide the value on the ground that we are. And the great thing about the country we have is that different parts of it can enact different rules that meet what their population wants to see happen. We have an exposure to California. Maybe it is a little smaller percentage wise than some other of our peers. But we do like our positions in California and the way we're positioned to take advantage of some affordable value plays we have there.
We have time for one last person in queue. Our last person is Buck Horne with Raymond James. Please proceed with your question.
Hey, thanks. Good morning. Just wondering if you could just maybe offer a little bit of color on the kind of month to month trends in order growth activity, just how that progressed January through March? And any comments you might be able to offer on how April is feeling right now?
Yes, Budd, through the spring, we've really seen solid, good, consistent demand out there, really good supply demand dynamics, very little supply. And so it's really just a good solid stable consistent spring and really thus far in April, we're seeing the same kind of conditions, Pretty healthy, good, strong market out there.
Sounds good. And on the just looking at your option lot position, since that's been growing so rapidly, and I know that's a determined strategy. So what opportunities are still out there to keep growing the number of lots you're controlling through options? How do you see that longer term mix of owned versus option land going? And does that impact your margins at all longer term?
Historically, we like a fifty-fifty balance. As far as the misnomer on the option lot contracts, typically they extend over a period of time. And margins on the front end of a community may be a little less. But if pricing power continues within the market, depending on times in the cycle, You can actually end up on the back half of those deals with submarket price lots and very strong margin.
But one more comment I'd make on the lot positioning and impact on margins. What we're really focused on in underwriting our communities is our return that we get community by community. And option lock positions can provide a very efficient, very high returning community, to move forward with that. So it's not just the margin, that's one component of the returns that we're looking at as a community and our underwriting, but returns are much more important to us today in generating cash flow.
Sounds good. Thanks. Good quarter, guys. Thank you.
That is all the time we have for questions. I'd like to hand the call back over to management for closing comments.
Thank you, Doug. And we appreciate everyone's time on the call today and look forward to speaking with you again in July. Again, a special thanks to the D. R. Horton team.
Outstanding quarter. You continue quarter after quarter to outperform the industry and we certainly appreciate it. Thank you.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.