Good morning, and welcome to the first quarter 2017 earnings conference call of D.R. Horton, America's builder, the largest builder in the United States. At this time, all participants are in listen-only mode. A 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. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton. Please go ahead.
Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the first quarter of fiscal 2017. Before we get started, today's call may include comments that constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K, which is filed with the Securities and Exchange Commission.
This morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q in the next few days. After the conclusion of the call, we will post updated supplementary data to our investor relations site on the presentations section under news and events for your reference. The supplementary information includes current and historical supporting data on our homebuilding return on inventory, gross margins, changes in active selling communities, product mix, and our mortgage 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 strong results in our first quarter. Our consolidated pre-tax income increased 32% to $318 million on a revenue increase of 20% to $2.9 billion. Our pre-tax profit margin improved 100 basis points to 11%. We experienced a 20% improvement in our absorption per community as homes sold increased 15% compared to last year. These results reflect the strength of our operational teams and diverse product offering across our broad national footprint, as well as solid market conditions. Our continued strategic focus is to produce double-digit annual growth in both revenue and pre-tax profits while generating annual positive cash flows and increasing returns.
For the trailing 12 months, our homebuilding return on inventory improved to 15.9%, up 290 basis points from 13% a year ago. We expect to generate $300 million-$500 million of positive cash flows from operations for the year. With 24,500 homes in inventory at the end of December and an ample supply of land and lots, we are well positioned for the upcoming spring selling season and the remainder of 2017. Mike?
Net income for the first quarter increased 31% to $207 million, or $0.55 per diluted share, compared to $158 million or $0.42 per diluted share in the prior year quarter. Our consolidated pre-tax income increased 32% to $318 million in the first quarter versus $241 million a year ago. Homebuilding pre-tax income increased 28% to $294 million compared to $229 million. Our backlog conversion rate for the first quarter was 82%, above the high end of the range we guided to on our fourth-quarter call. As a result, our first quarter home sales revenues increased 20% to $2.8 billion on 9,404 homes closed, up from $2.3 billion on 8,061 homes closed in the prior year quarter. Our average closing price for the quarter was $297,000, up 2% compared to last year.
This quarter, entry-level homes marketed under our Express Homes brand accounted for 28% of homes closed and 20% of home sales revenue. Our homes for higher-end move-up and luxury buyers priced greater than $500,000 were 7% of homes closed and 17% of home sales revenue. Our active adult Freedom Homes brand is still in the early stages of rollout. Customer response in the eight markets we are open has been positive. We still expect to have Freedom Communities open in a third of our 78 operating markets by the end of the year. Bill?
The value of our net sales orders in the first quarter increased 17% from the prior year quarter to $2.8 billion. Homes sold increased 15% to 9,241 homes on a 5% decline in our average active selling communities. Our average sales price on net sales orders in the first quarter was $299,100. The cancellation rate for the first quarter was 22%, consistent with the prior year's quarter. The value of our backlog increased 7% from a year ago to $3.4 billion, with an average sales price per home of $300,900. Homes in backlog increased 6% to 11,312 homes. Mike?
Our gross profit margin on home sales revenue in the first quarter was 19.8%, compared to 19.9% in the prior year quarter and 20.5% in the fourth quarter. 60 of the 70 basis point sequential change in gross profit margin was due to higher warranty and litigation costs this quarter. In the current housing market, we expect our average home sales gross margin to be around 20%, with quarterly fluctuations that may range from 19%-21% due to product and geographic mix, as well as the relative impact of warranty, litigation, and interest costs. Bill?
In the first quarter, homebuilding SG&A expense as a percentage of revenue improved 70 basis points to 9.5%, compared to 10.2% in the prior year quarter. We remain focused on controlling our SG&A while ensuring that our infrastructure adequately supports current and future growth. We expect our SG&A as a percentage of homebuilding revenues to be lower in 2017 than in 2016. We expect the improvement for the full year to be less than the 70 basis point improvement we achieved this quarter. Jessica?
Financial services pre-tax income in the first quarter increased to $24.2 million from $12.4 million in the prior year quarter, driven by growth in revenue and an improved operating margin. 93% of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operation. Our mortgage company handled the financing for 57% of our home buyers, up from 51% in the same quarter last year. FHA and VA loans accounted for 48% of the mortgage company's volume, compared to 50% in the prior year quarter. Borrowers originating loans with our mortgage company this quarter had an average FICO score of 719 and an average loan-to-value ratio of 88%. First-time homebuyers represented 45% of the closings handled by our mortgage company, compared to 43% in the first quarter last year. David?
During the quarter, our total number of homes in inventory increased by 6%, a normal seasonal trend as we approach the spring selling season. We ended the first quarter with 24,500 homes in inventory , of which 1,600 were models, 13,400 of our total homes were spec homes, with 9,700 in various stages of construction and 3,700 completed. Compared to a year ago, we have 14% more homes in inventory, putting us in a strong position for the spring selling season and to achieve double-digit growth in revenues in 2017. Our first quarter investment in lots, land, and development totaled $847 million, of which $552 million was for finished lots and land, and $295 million was for land development. We plan to increase our investment in our land and lot supply this year at a rate to support our expected growth in revenues. Mike?
At December 31st, 2016, our land and lot portfolio consisted of 213,000 lots, of which 119,000 or 56% are owned and 94,000 or 44% are controlled through option contracts. 77,000 of our total lots are finished, of which 32,000 are owned and 45,000 are options. Our option lot position increased 54% from a year ago, while our overall lot position increased 20%. Our 213,000-lot portfolio is a strong competitive advantage in the current housing market and a sufficient lot supply to support our future growth. Bill?
At December 31st, our homebuilding liquidity included $1.1 billion of unrestricted homebuilding cash and $888 million of available capacity on our revolving credit facility. Our homebuilding leverage ratio improved 690 basis points from a year ago to 28.6%. The balance of our public notes outstanding at December 31st was $2.8 billion, and we have a total of $350 million of senior notes that will mature this year in May. Subsequent to quarter end, Moody's upgraded our corporate credit rating to Baa3, and we now have investment-grade ratings from all three rating agencies. At December 31st, our shareholders' equity was $7 billion, and book value per share was $18.70, up 14% from a year ago. Our priorities for cash flow utilization center around being opportunistic while remaining disciplined.
Our top priorities for fiscal 2017 include continuing to consolidate market share by both investing in our homebuilding business and through strategic acquisitions, paying off $350 million of our senior notes at maturity in May, and providing consistent dividends to our shareholders. Jessica?
Looking forward, our expectations for 2017 are consistent with what we shared on our November call and are based on current market conditions. We still expect to generate a consolidated pre-tax margin of 11.2%-11.5%. We also expect consolidated revenues of between $13.4 billion and $13.8 billion and to close between 43,500 and 45,500 homes. We anticipate our home sales gross margin for fiscal 2017 will be around 20%, with potential quarterly fluctuations that may range from 19%-21%. We estimate our annual homebuilding SG&A expense will be approximately 9.0%, with the second quarter of the year higher than 9% and the third and fourth quarters lower than 9%. We expect our annual financial services operating margin to be around 30%. We are forecasting a fiscal 2017 income tax rate of approximately 35% and an annual average diluted share count of approximately 380 million shares.
We also expect to generate positive cash flow from operations for the third consecutive year in a range of approximately $300 million-$500 million. Our fiscal 2017 results will be significantly impacted by the strength of the spring selling season, and we will update our expectations as necessary each quarter as visibility to the spring and the full year becomes clearer. For the second quarter of 2017, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 88%-92%. We anticipate our second quarter home sales gross margin will be around 20%, and we expect our homebuilding SG&A in the second quarter to be in the range of 9.3%-9.5% of homebuilding revenue. David?
In closing, our first quarter growth in sales, closings, and profits, and the improvement in our pre-tax profit margin are the result of the strength of our people and operating platform. We are striving to be the leading builder in each of our markets and to continue to expand our industry-leading market share. We remain focused on growing both our revenues and pre-tax profits at a double-digit annual pace while continuing to generate annual positive operating cash flows and improve returns. We are well-positioned to do so with our solid balance sheet, industry-leading market share, broad geographic footprint, diversified product offering across our D.R. Horton, Emerald, Express, and Freedom brands, attractive finished lot and land position, and most importantly, our tremendous team across the country. We'd like to thank the entire D.R. Horton.
Horton team for their continued focus and hard work. We look forward to continuing to grow and improve our operations in 2017. This concludes the prepared remarks. We will now hold questions.
Thank you. We'll now be conducting a question-and-answer session. We ask that you please limit yourselves to one question and one follow-up. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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 key. Once again, that's star one to ask a question, and we ask that you please limit yourselves to one question and one follow-up. Our first question today is coming from Stephen East from Wells Fargo. Please proceed with your question.
Thank you. Congratulations, guys. I'm sure you're going to hear it several times today, great quarter. Maybe we'll just start with the orders, because you're going to probably get that question 100 times also, can you talk a little bit about the trends that you saw through the quarter? Did you see any impact from the rates, from the election, product type disparity, what was going on? Whatever type of commentary you want to give post-quarter, what we've seen in January so far.
Well, Stephen, thank you very much. We were very pleased with the quarter, we saw very strong improvement in our absorptions community by community. Throughout the quarter, we continued to see a good response to our positioning. We were much better positioned coming into this first quarter this year than we had been, we were able to execute against that. The market was there for us, a very solid market. I wouldn't say we saw significant deviations within the quarter month to month. It was a pretty consistent result for us into January. The Dallas Cowboys lost, in this part of the world, the selling season's kind of starting now. We're excited about the silver lining on that cloud for us.
We continue to see good sales trends in January, very early into spring, we'll certainly keep you updated as things progress, we get back with you in April on that one.
Okay. Follow-up, the absorption one, can you sustain it? With the rate move that you've seen so far, I assume that you're seeing very few that are not qualifying. Are you starting to see any trade down in product? At what rate do you think you would start to see maybe some of those Express buyers have to drop out of the market?
Stephen, it's always good to be, in my mind anyway, the price leader in a rising interest rate environment, because if you can't afford $300, then if you've got a product at $250, you can still convert that sale. We like our positioning as far as absorption per community. At some point, no, you're not going to be able to sustain and continue. Our focus has been driving to a 20% ROI. We're going to drive absorption levels and improve ROI, and at some point, we're going to max out the return we can make off a flag, and at that point, we will add flags.
For fiscal 2017, we feel very comfortable that we can continue to drive further improvement in our absorption to offset any community count decline to generate the 8%-13% increase in closings that we've guided to for the year. Clearly, we're off to a strong start. We can have some variability from quarter to quarter in how we get there for the year. As you saw, our sales were outside of that up 8%-13% range. We could have a quarter where our sales are under that 8%-13% range, we feel very comfortable that for the full year, our closings will be up at least 8%-13%.
Stephen, we wouldn't guide up double-digit if we weren't confident that we could drive that level of absorption.
Fair enough. Thank you.
Thank you. Our next question today is coming from Stephen Kim from Evercore ISI. Please proceed with your question.
Well, I'm going to just add my congrats as well, because clearly, while your orders were very strong, and you also executed very well below the top line also. Congratulations on a good execution this quarter. My first question actually revolves around cost control. I know that you're always focused on leveraging your scale with your vendors. I also hear that recently you've conducted a pretty significant rebidding process with some of your suppliers, and I was wondering if you'd be willing to share what you think the overall savings opportunity might be from those conversations.
Stephen, we are constantly rebidding our suppliers and our vendors across the board. We've had several pushes over the last several years, really, in which we've pushed hard on rebidding. Yeah, that's a continual effort for it, and we're continually working to mitigate certainly any cost increases and improve our costs wherever we can. On a year-over-year basis, our stick and brick costs per square foot were up only 2%, which is certainly more moderate than we saw a couple of years ago. We've been able to keep our revenue growth per square foot exceeding our cost per square foot on a stick and brick basis, which is certainly helping us going forward. We're seeing lot costs start to increase. Lot costs were up 9% on a per square foot basis this quarter.
We're seeing very good results from our efforts to control our stick and brick, which is helping keep our margins stable.
Got it. That's fair.
Stephen, we've been focusing a long time on driving a higher level of absorption on a community-by-community basis. That allows us to control labor, and it makes the entire process of building a house more efficient. I think we're reaping some of the benefits of that.
Well, that's really encouraging. My next question relates to de-leveraging in the face of very strong demand. We've seen your net debt to cap already now well below what I would consider historical norms, and they seem to be on track to trend lower this year, given your strong cash flow. I was wondering if you could talk to us about how you think about what the right level and what trajectory is appropriate for your leverage at this time, as we're seeing some recent demand indicators kind of inflecting upwards.
Right. Well, Stephen, as we look at our balance sheet, our capital structure, and our guidance for the year and where we're guiding the company to be, to the extent that we're able to still grow at a solid pace and consistent double-digit pace over the course of a year, and we're able to invest sufficiently to support that growth in 2017 and beyond, and maintain a sufficient land pipeline, to the extent we're able to support that level of growth and still generate positive cash flow, from our standpoint, we don't have an ideal leverage level. We will take that cash flow and then do what we feel like is best in the interest of our overall company and our shareholders for the long term. An element of that that we've prioritized this year is to continue to de-lever.
We expect to generate $300 million-$500 million of cash flow while still supporting our growth. We're going to use $350 of that to pay down debt while continuing to reinvest in the business and continue to pay a strong dividend to our shareholders, which we've increased, and expect to pay about $150 million in dividends this year. It's really not necessarily a target ideal leverage level. We're balancing that with supporting the growth we expect to generate in the company.
We're trying to create as much flexibility into the future as we possibly can. Like Bill said, we don't have a target on debt. Right now, we're generating enough cash to buy the land and lots that we need to support a double-digit growth. Speculating beyond that, it's just not in our nature to do.
All right, guys. I really appreciate it, and congrats.
Thank you.
Thank you.
Thank you. Our next question today is coming from Nishu Sood from Deutsche Bank. Please proceed with your question.
Thank you. I wanted to ask about first the backlog conversion ratio. Very strong conversion ratio. I think the strongest in five years. Just wanted to dig into that a little bit. You mentioned, obviously, driving absorptions in communities. That may have played a part in that. On the other hand, there's still, I think, pretty widespread concerns about labor. How should we think about that? Are we getting back to normal in terms of just the ability to deliver homes? What's helping you overcome the labor concerns out there?
Nishu, where we feel we were coming into the first quarter, much better position, I mentioned before, on our homes and inventory, and where we are right now at December 31st with 24,500 homes in inventory. That, to us, is a great indicator of future closings because we're getting the houses we want out of the ground, we're getting them where we want, and working them through to completion, and then we're closing them. That's, for us, a much better predictor of closings volume in a given quarter, perhaps, than backlog conversion is. In terms of back to normal, I don't know whatever is normal in this business.
It seems like the conditions are always changing a bit year to year, we're building a platform that allows us to respond to those market conditions and look to position our communities in front of the market with the trades we need to build the houses when we want to get them built.
Got it. Makes sense. Another number, very, very strong. I think it's a record for your first quarter SG&A. I think it might be your first single-digit number you've ever reported. Very strong performance. You mentioned that, "Look, hey, don't expect the same level of improvement in the subsequent quarters." Just wanted to dig into that a little bit. What drove the strong performance that might reverse in the subsequent quarters? Obviously, you've got the corporate relocation coming up. That might be a factor, why would it reverse after such a strong performance in the first quarter?
Initially, our costs that we had in the first quarter were normal. There wasn't anything unusual there in the costs at all. It was really driven by the revenue line. We exceeded the guidance that we provided for our backlog conversion in the first quarter, back to your first question. Therefore, that generated a really strong leverage on our SG&A costs in the quarter. As we look forward to the rest of the year, our annual guidance for revenues are still in the 10%-14% range. Units, 8%-13%, dollars, 10%-14%. We do expect solid leverage on our SG&A, we don't expect it to continue to be at 70 basis points. We're very pleased with the start to the year.
We're very pleased with our positioning and our inventory, as well as in our SG&A expenses and our infrastructure, looking forward to continuing to leverage that throughout the rest of the year. Nishu, thank you for noticing that. That is something we work very hard at.
Right. Thanks for the thought.
Thank you. Our next question today is coming from Alan Ratner from Zelman & Associates. Please proceed with your question.
Hey, guys. Good morning. I echo my congrats on a very strong quarter. David, maybe this question's for you, or anybody can chime in. I think everybody's trying to read the tea leaves on what impact, if any, higher rates might have on demand. I think you certainly have a very balanced outlook there. Seems like there was no impact this quarter, certainly. I was curious if you were to go back in time in prior periods where we've seen similar rate moves. 2013's the most recent instance, certainly there have been others. If I look at your 2013 results, you and everybody else saw a pretty big deceleration in orders in that period. We generally have seen that in prior periods as well.
It might be too early to figure out what exactly is going to happen this go around. I was curious, back then, when you were out there in the field visiting your communities, what type of signs did you see that might have foretold that slowdown? Compare and contrast that maybe to what you're hearing from your people in the field today with that move we've seen rates over the last eight weeks or so. Thank you.
2013, I don't know that it was necessarily the rate increase as the rapidity of the rate increase that kind of shocked the market. You saw, I would say, a deceleration of traffic, less consumer confidence feel from our sales agents. We fought through it. I think we ended up with a pretty good 2013, but it did have a significant impact. Right now, the over-optimism that seems to be out there in the market. I just traveled through Florida, and I tell you, Florida feels like it's as good a market as I've seen in a long time. Our sales agents are very excited. We have inventory that right now, we're in the best competitive position we've ever been in. As far as direct competition, price point competition, model against model, it is as low as I've seen it for us.
We're very bullish today on positioning inventory in front of what we think is going to be a pretty strong sales season.
Alan, I think if we see interest rates trend up gradually over time, today, in connection with job growth, income growth, and overall consumer confidence, I think those are very positive because we'll see good household formations, we'll see good confidence by the consumer, and able to adjust to a gradual rate rise that seems to be telegraphed. I think in 2013, what was different is that rates spiked up very quickly for no reason that was really tied to what people felt on the ground at the time. It happened in a vacuum, and it had a very negative impact. Today, I don't think those things are happening in a vacuum. I think, as David mentioned, there's confidence, there's good traffic in the sales offices, there's very good confidence level across our platform of 1,600 model homes.
Our sales agents feel very good about the traffic they're seeing, and they feel really good about the indicators they're getting. Our inventory positioning is strong going into the spring. We're very encouraged.
as David already.
I'm sorry, it's Ivy. Sorry, Jessica. I was just going to ask you guys, sorry, Alan, for jumping in. One of the questions we get a lot from our clients, especially because of your strength in leadership in entry level, and recognizing that you are ahead of the curve and certainly pioneers in many markets that others are following suit, that the entry-level customer is likely to be the most impacted on a rise in rates. Frankly, what we've heard is that it might even be more per se to the buyer who's stretching to maybe get to a move up. Maybe sensitivity within the portfolio, maybe you could talk about the experience. Do they just buy a little less house, a little less options?
If rates continue to rise, and you do in the future see some impact, can you give us some of your perspective around the price sensitivity within the portfolio of different price points? That might be helpful. Sorry, Alan.
Well, what we are seeing is increasing demand. I think, like Mike said, as long as the jobs are there, nominal increases over a period of time, people are going to adjust them. Now, the position we're in is that we have a pretty broad product line in the Express and entry-level Horton that we can flex down in price to meet a lower demand price, a lower price.
As David mentioned earlier in the call, Ivy, that is why we believe our results are what they are, is we've been focused on offering an affordable product, and we're going to continue to, specifically with our Express Homes and our new Freedom Homes brand for the active adult. We believe, right now, that's why we haven't seen any sort of impact from the rate rise, is that we are positioned where we want to be, and we'll continue to adjust as necessary to continue to offer an affordable product regardless of the rate environment we're in.
Great. Thanks, guys. Sorry, Alan.
Thank you very much.
Thank you. Our next question today is coming from Eric Bosshard from Cleveland Research Company. Please proceed with your question.
Thanks. The progress on absorption's obviously impressive. I'm curious as you think about the growth path forward, the plans in terms of community count growth, the success you're having, does it encourage you to be more aggressive in opening new communities over the next 12 months? Just curious if your thinking on that has evolved.
Sure. Eric, really our outlook on community count is the same as it was last quarter. We expect community count, from where we are today, to still remain relatively flat over the next few quarters. At some point, we would expect it to increase, but right now, our community opening schedule would indicate that it's going to stay relatively flat. Sequentially, relatively flat, which would still indicate a year-over-year decrease. This quarter, community count was down 5%, but with the 20% absorption improvement, our sales were up 15%. In the short to medium term, still relatively flat.
That's exactly right. Eric, I think also what we're seeing is the impact of some of the communities we're opening now are frankly more productive communities than some that are closing off. We've been focusing on a return-based model for the past several years, and the fruit of that's coming through. We're seeing our return on homebuilding inventory jump up almost 300 basis points on a trailing 12-month basis over where it was a year ago. Our discipline around living within our means inventory-wise and being very focused on the balance sheet has encouraged our field teams to be very selective in the communities they're bringing online and where they're deploying their capital as to where they're going to get the most return out of that capital. That's where we're seeing, I think, some good pickup in our absorption on a flag-by-flag basis.
Second question. That's helpful. The second question is, in terms of the runway with Express, both from a competitive standpoint and a cost standpoint, a customer standpoint, I'm wondering how you view that and if you view that any different if the runway and the opportunity is even greater than you had thought. I just wonder where we are in the cycle of sustaining the success or even accelerating the success with what you've done with Express.
I will say the demand for the product and the returns from that have been able to generate were a surprise to me. It was a much deeper and higher demand market than I thought it was going to be when we rolled it out. As far as sustainable, I think that's the biggest part of the pyramid. That's where most of the buyers are. We are very well-positioned in there. We certainly feel like we can compete effectively and sustain and grow. We're just rolling out in the West and just actually rolling out in Phoenix, kind of early in the stages in Denver. We feel like we've got quite a bit of runway there.
We're equally excited about Freedom, which is our age-targeted, age-designed product that we think is going to fit very nicely with Express and offer something that doesn't exist in the market today.
That's helpful. Thank you.
Thank you. Our next question today is coming from Ken Zener from KeyBanc Capital Markets. Please proceed with your question.
Good morning, all.
Good morning.
I'm trying to understand, given the orders and your units under construction conversion, why you're sticking with that broad range. Your closings as % of units under construction 1Q was kind of normal, it doesn't seem like that's constrained. Orders have been following the seasonality of the last few years. Your under construction's up 14%, how does that translate to 10% unit delivery for the midpoint for the year? What are we kind of missing there, or is it just a natural conservatism on your part?
Ken, our guidance is not 10% on units, it's 8%-13%. There is a range there. We could certainly beat 10% and still be in our guidance range.
Yeah.
As you well know, the entire year is driven really largely by the spring selling season. We're on the front edge of that. We certainly feel optimistic about it. We're positive about it. We really feel like our positioning is very strong for that. It hasn't happened yet. We will evaluate the spring as we get into it. We will certainly evaluate our guidance. We'll update that as we feel like we need to once we have the visibility into the spring. It's still too early to do that at this point.
Understood. We've had normal seasonal trends, you don't need anything stellar to actually hit the high end of your unit.
Correct
statement.
We've-
It's January 24th.
I know. Seasonal trends are pretty consistent. The other question is.
We said we're well-positioned.
Yeah. Understood. Just for perspective here, not necessarily about the quarter, but your lot cost increases and your stick and brick increases. You kind of talked about what it was in 1Q. Could you just give us, just to have a little broader trend, if you will, and hopefully you have this available to you. What the lot and separate stick and brick costs were inflation-wise for FY 2016 and FY 2015, just so we can kind of have that context. Thank you.
Sure can. I'll talk about it very generally, and I'm happy to follow up on the specifics that we've given on most of our calls over the last couple of years. In fiscal 2015 is really where we started to see the sharpest increase in both, well, really primarily labor, and to some extent, materials. For a couple of quarters, we did experience a high single-digit % increase in our stick and brick cost per square foot, which was outpacing our revenues at that point in time.
As we moved through the end of 2015 and into 2016, we were able to get that closer to, call it, a mid-single digit %, our revenues started catching up with that stick and brick cost, which is where you saw our gross margin really start to stabilize and become very consistent for the last, call it, six to eight quarters now. As we've kicked off 2017 and really the end of 2016, we're in a low single-digit cost inflation environment. This is all stick and brick that I've been talking about. In terms of lot cost, if you go back to 2015 and 2016, pretty muted increases, really until the back half of 2016, which was when we started seeing, call it, a mid to high single-digit increase in lot cost.
This quarter is one of the higher in terms of we were up 9%, as Bill mentioned earlier, for a lot cost increase on a per square footage basis. We've been able to offset the majority of that with price, and kept that gross margin very consistent, at least from a lot level gross margin perspective.
Thank you.
Great. Our next question today is coming from Bob Wetenhall from RBC Capital Markets. Please proceed with your question.
You guys are having a fantastic start to the year. Congratulations. I wanted to ask you, how much of your outperformance and the strength in orders do you attribute to you guys taking share relative to the broader strength of the market? Are you guys doing something on the ground so you're picking up share?
That's always our goal. As we compete in every community, and we compete to have an affordable product out there, that's always our goal. When you look at share, you have to look over a longer trend, and we certainly, over the longer trend, have been pretty consistently gaining share, and that's certainly our goal going forward, market by market, community by community, and then rolling up to the overall company, is to continue to gain share in the marketplace, and we feel like we're in a really good position to do that.
We're looking to position our communities and our homes to be the best choice for every customer in every market that we're serving. To the extent that helps us gain share, that's great. To the extent it just helps us grow with the market, we're going to do that as well.
Clearly, our product offering at the Express, entry-level, affordable price point has driven an outsized increase in those efforts over the last couple of years.
Got it.
Bob.
Go ahead, Dave.
Every one of our operators wants to be number one in their market. Whether they're closing 100 houses in a 7,000 permit market or 500 houses in a 600 permit market, they want to win. We instill that, we promote it, and our expectation is that they will win. With that, we will gain share.
Well, it sounds like your execution's great. My just follow-up question, you reiterated free cash flow guidance. M&A is a core strategy. You guys have a great track record of that. What's the pipeline like, and do you think it's a public or private type of M&A situation? Is there anything out there size-wise that would be a game changer, that would be a good fit for the platform right now, or do you think it's just going to be kind of selective sharpshooter M&A? Great job, and thanks, and good luck.
Thanks, Bob. We continue to look at a lot of opportunities, and we evaluate them all against kind of the track record we have, and so we have a very high bar for what makes sense for us to bring on board. We continue to look at every opportunity that's presented to us, give it a very serious look, and try to learn and understand how it could be a good fit for the company. We will continue to do so. It's been a very active time over the past few years, and I expect it will continue to be so.
If you don't find that M&A opportunity, what do you think you do with the cash? You got a lot of cash on the balance sheet currently.
Over the last couple of years, we've generated a lot of cash, and we've consistently still found some acquisitions to allocate capital towards. Right now, with the pipeline that we see, our expectation is that we will still find some acquisitions that fit. Right now, we'll certainly think about if we don't find some acquisitions that fit.
There's a great big old vault underneath the new Horton building, and Don wants to be able to spread it out down there and play in it. All right. Thanks again.
Thank you. Our next question today is coming from Michael Rehaut from JPMorgan. Please proceed with your question.
Thanks. Good morning, everyone. Also, obviously, nice results on the orders. Nice to see the rebound from the prior quarter. First question, I was hoping to dig into the Freedom Homes rollout a little bit. Still on track, it appears, and expecting to be in a third of your markets by fiscal 2017 end. I was wondering if you could give us a sense of, and maybe remind us if we talked about this last quarter, but how does that Freedom brand product differ from your corporate average in terms of ASPs and sales pace? Given that it would appear that this is a market share gain opportunity, if this is something that is just getting revved up in this current year, is this something that you can further perhaps take share in your given markets over the next two or three years?
Sure, Mike. We definitely agree with the latter part of your statement in terms of this helping us continue to capture additional share. As David mentioned earlier in the call, this is a product that we don't think really is out there today in terms of a lower-priced, affordable active-adult community, smaller community size, limited amenities, but good locations, kind of a lock and leave approach. Gated where we can and some pools and small clubhouses in markets like Florida. In terms of a price point, very early stages, so we'll adjust as we continue to roll it out, but we would currently anticipate it to run about 10%-15% higher than a like Express product. We do have plans, as you mentioned at the beginning, to be in at least a third of our markets by the end of 2017.
Not a huge driver of our 2017 results, probably more of a driver in 2018, but definitely something that's going to help us continue to consolidate share and kind of rounds out our product offerings for the one place we weren't really playing before.
Super large demographics favor that brand. As interest rates tick up, these buyers are less mortgage-sensitive. It's kind of a hedge against a little higher rate as well.
No, that's helpful. Let me just make sure I also get, as part of that first question, the sales pace, how that compares to the rest of the group. My second question is on SG&A, obviously continues to be a hallmark of the company. It was interesting, I was looking back at the past cycle, and in 2004, when you did a similar amount of homes closed that you're guiding for this year, you actually also had an SG&A of about 9.1, it looks like in that year.
What struck to me was that there are many builders today talking about maybe having a lower cost structure this cycle versus last, either through digital marketing, which is something that you guys talk about as well, but just the similar amount of closings and similar SG&A would suggest a similar cost structure. I was wondering if there's some pluses and minuses to your business model from a cost standpoint. Certainly what comes to mind is you have your three or four brands today, which might require a little bit more SG&A relative to your singular approach last cycle. I was curious about some of the pluses and minuses on the SG&A front, because on a top-down level, looks like the same cost structure.
Mike, I think Bill will touch on the SG&A question. In terms of going back to your follow-up, Freedom and absorption, once again, very early stages for that brand, but we would likely anticipate it being faster than a typical Horton community, but probably not quite as fast-turning as an Express community.
Mike, compared to the historical, we've looked at those historical comparisons as well, and you're right. As far as where we were on SG&A as a percentage for the entire year in 2004 at a similar closings was at a 9.1%. The difference between then and now is we were seeing significant price appreciation in our homes. In 2004, in the data that I'm looking at, it was a high single-digit ASP increase then, which obviously creates a lot of SG&A leverage. Today, we're achieving this with a much more modest ASP appreciation. We're not really quite up to our peak volume yet, and with what we're on track for right now, our expectations, we're guiding to 9%.
We certainly feel very confident that we can hit the 9%. If we continue to see the improvements and efficiencies in our business, we expect to push beyond that before we get fully to peak volumes again. You asked about costs and where there might be some changes. Certainly, in terms of efficiencies from technology, and you mentioned the marketing. Certainly, efficiencies there. Those are things that have been positives over the last cycle, over the last decade, that are certainly helping to contribute. On the cost side, frankly, the cost of regulations and running our business throughout our business, in all respects of our business, are significantly higher today at the local level and really all the way up through our business, which is something that we've had to absorb as well as everyone else in the industry, and it's well-publicized.
I would say that's probably one of the more significant offsets to the other efficiencies we've seen.
The other big difference, Mike, between 2004, 2005, and 2006 and our business model today is we had extremely pretty aggressive growth targets in place that we were actually adding headcount and building infrastructure out for. Today, we have a stated target of double-digit revenue growth, and we're making sure we're incurring and adding SG&A to be able to handle that. We don't have to add at the same rate today as we would have had to back then to go after that.
Great. Thanks, everyone.
Thank you.
Thank you. Our next question today is coming from John Lovallo from Bank of America. Please proceed with your question.
Good morning, guys. Thanks for taking the call. First question is, the orders in the West region seemed a little bit lighter than we had expected and to underperform some of the other regions. Was this community count-driven or maybe with the rollout of Express into California? What were the factors there?
Hey, John. In the West, as we talked about, we have not been investing as heavily in the West. We've been maintaining our position. Relative to our other regions, we've been making larger investments in other regions. I think it's a reflection of just a little bit of a lower growth expectation there in our West region, which does reflect itself in community counts.
Because we don't have the number of communities there that we have in some of these other regions, the delays in getting a couple of significant communities online can impact the quarter-over-quarter numbers.
We're in the very early stages of Express rollout there. The West is not seeing as much benefit in absorption improvements and efficiencies yet that we have seen in other areas of the country.
We are getting those communities open, and there is certainly a market out there.
Okay, that's helpful. Given some of Trump's rhetoric around bringing jobs back, particularly in the auto industry, is there any appetite on your part for kind of expansion into the Midwest? Call it Michigan, Wisconsin, Ohio. Have you guys considered that?
We continually evaluate opportunities to enter various markets, and we have looked at a few opportunities. When one makes sense for us, we do think that those markets may have been a bit underserved in the past, and we'll evaluate those. We do like our conscious positioning of where we focus the most of our energies, the most of our capital into a lot of the Southern markets. Even where there's been a lot of auto manufacturers, open production facilities across the South and Southeast that have been good drivers for us and sources of good business in the Carolinas and Alabama.
Okay. Thank you, guys.
Thank you. Our next question today is coming from Jack Micenko from SIG. Please proceed with your question.
Hey, good morning. The pickup of an absorption pace, I think, was one of the biggest things out of the quarter. I'm wondering if you could give us, or if you have, the absorption pace improvement year-over-year for each of the brands, so Express, Horton, and Emerald, to kind of get a sense of the relative mix. Do you have that number?
No, we don't by brand. We've got it here by region, we don't have it here by brand in front of us. That's something we could look at and follow up with later on. That's not something we have right here in front of us.
Okay. Your capture rate in mortgage had a nice improvement year-over-year. What was driving that?
I think a lot of what's driving the capture rate improvement has been a renewed focus by the mortgage company on improving their utilization. That's shown up in a lot of their operating metrics. Their operating margin's improving as they're getting better overhead leverage. As our volumes increase and we're serving more of the Express Homes buyers, the first-time home buyers, it's very helpful to our home building operating divisions to have that customer managed through the mortgage qualification process into the backlog so that when the home is ready, they're ready with the mortgage to close. The service levels provided by our mortgage company to the home builder are very high in that regard. We're still out there.
The mortgage company is competing for the business customer by customer in a very competitive mortgage market, they're able to deliver a higher service level to that customer because of the integration we have with the builder in a lot of cases.
Jack, to go back to your question, we were able to get our hands on the change in absorption by brand, really, it was consistently strong across all three brands, a strong double-digit increase in absorption.
Okay. Thank you very much.
Thank you. Our next question today is coming from Mike from Barclays. Please proceed with your question.
All right. Thanks for taking my questions and all the callers so far. Forgive, voice is a bit raspy. Wanted to ask about your owned option mix. You've been one of the few builders that's successfully pushed pretty meaningfully back towards optioned. This quarter seemed to stabilize a bit. Recognize that it's not going to be so linear, but over time, you can continue to mix that higher. Curious to hear if there's anything regionally you can speak to in terms of either incremental successes or challenges that you've found in striking new option deals.
Mike, we're still not to our goal of a 50-50 balance in our total portfolio of option and controlled. Very happy with the relationships we've been able to expand upon with developers across the country. Key trade partners for us, frankly, in supplying the first raw material input to our business is land or lots. We're very pleased with the increase of finished lots we've been able to tie up and partner with others to develop for us. That's probably driving a bit of our lot cost increase as a percentage of revenue with or per square foot that we're seeing in our current deliveries. It's a reflection of our strategy to try to have more lots provided for the company finished rather than us self-developing as much.
We're seeing a big benefit of that in our focus on our improved returns, and we're seeing our returns come up as a result of that. There is no magic bullet to that. It's building relationships, partnering with the right people market by market, having the experience with them, and the confidence to get projects on the ground and work through them together.
Is part of the lower investment in the West a function of just really that still being more of a cash market and given your focus on shifting towards this balance, it's kind of an intentional mix away from the West?
Well, we're not decreasing our investment in the West. We like the West. We made a lot of money in the West. We're just going to be disciplined, and we have underwriting guidelines for everything we do, and whether it's in Texas or California, it's got to meet the same underwriting guidelines, which by definition is a capital limiter.
Okay.
No, we're not reducing our investment in California. We're actually doing very well in the West. Very happy with our performance and the returns that we're driving.
Yeah. Just continuing to work just like everywhere else to improve our returns in the West. Even though it is a more capital-intensive area, it's still an area we want to improve our returns in.
Okay, thank you. One housekeeping as a follow-up. On the warranty and litigation, this quarter, is there any color you can provide? Is this function of just as you've expanded in markets, just normal course of business, or is there anything regional or more one-time in nature?
No. Inherently, the warranty and litigation area is a bit volatile, a bit lumpy from quarter to quarter. That's one of the reasons why we give the range we give for our margin guidance, is that's just an element that you can have some variability from quarter to quarter. The variability we had this quarter is not outside our normal range. A little bit bigger than it has been recently, but nothing highly unusual at all.
Okay, thanks, and good luck this spring.
Thanks.
Thank you. Our final question today is coming from Jade Rahmani from KBW. Please proceed with your question.
Good morning. This is actually Ryan on for Jade. Thanks for taking my question. It seems that other real estate sectors are going through a period of price discovery as markets digest the economic outlook and the trajectory of rates. Can you say if you've seen any adjustments in pricing or bid-ask spreads or demand in the land markets that you are currently purchasing in?
We haven't seen any kind of an adjustment in land pricing at this point. Anecdotally, we're maybe getting another bite at a project that might have gotten by once. Some things may be falling out, but that's just anecdotally. It'd be hard to put a trend to that or to see anything else happening on a harder quantitative basis at a global scale for us.
I will say, Ryan, I closed some deals in our first quarter that were as good as any lot buy we made in the last four or five years. There are opportunities out there, and you just got to be out there looking for them.
Thanks. My second question is a bit more nuanced. Have you seen any changes in the levels of competition in any of your markets from either single-family rentals or multi-family apartments?
We've not seen. It's an alternative housing choice for a customer. Typically, those sources of housing stock are great feeders for us into our business as people see changes in the rentals and the opportunity to have an ownership position and lock in their housing costs, very attractive alternatives. We have not seen a significant change in our markets relative to those at this point. We do help a lot of people get into their first owned home, out of a rental situation, whether it was single-family rental or more traditional multi-family rental.
Great. Thanks for taking my questions.
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 April as we share our second quarter results. To the entire D.R. Horton team, outstanding first quarter. You are truly the best of the best. Let's go tear them up in 2017.
Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation.