DR Horton Management Discusses Q2 2014 Results - Earnings Call Transcript

Apr.24.14 | About: D. R. (DHI)

DR Horton (NYSE:DHI)

Q2 2014 Earnings Call

April 24, 2014 10:00 am ET

Executives

Donald J. Tomnitz - Vice Chairman, Chief Executive Officer, President and Member of Executive Committee

Jessica Hansen - Vice President of Communications

Bill W. Wheat - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Michael Murray

David V. Auld - Chief Operating Officer and Executive Vice President

Analysts

David Goldberg - UBS Investment Bank, Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Michael A. Roxland - BofA Merrill Lynch, Research Division

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Nishu Sood - Deutsche Bank AG, Research Division

Daniel Mark Oppenheim - Crédit Suisse AG, Research Division

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Stephen F. East - ISI Group Inc., Research Division

Stephen S. Kim - Barclays Capital, Research Division

Jack Micenko - Susquehanna Financial Group, LLLP, Research Division

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

James McCanless - Sterne Agee & Leach Inc., Research Division

James Krapfel - Morningstar Inc., Research Division

Alex Barrón - Housing Research Center, LLC

Operator

Greetings, and welcome to the D.R. Horton, America's Builder, the largest builder in the United States, Second Quarter 2014 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Don Tomnitz, President and CEO, D.R. Horton. Mr. Tomnitz, you may begin.

Donald J. Tomnitz

Thank you, Kevin, and good morning. Joining me this morning are David Auld, Executive Vice President and Chief Operating Officer; Bill Wheat, Executive Vice President and Chief Financial Officer; Mike Murray, Senior Vice President of Business Development; and Jessica Hansen, Vice President of Communications.

Before we get started, Jessica?

Jessica Hansen

Some comments made on this call may 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 upon reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K, and our most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission. Don?

Donald J. Tomnitz

Thank you, Jessica. The spring selling season is well underway. Our net sales orders in the March quarter were up 57% sequentially in the December quarter and at 9% from the second quarter of last year. Our average sales price increased by 10% year-over-year to $278,900, driving a 20% increase in the value of our net sales. Our solid sales performance resulted in an 18% increase in our backlog value compared to the prior year quarter, putting us in a strong position for increased revenue and profitability in the second half of fiscal 2014.

Our team of operators across the country also delivered outstanding profitability this quarter, with $201.9 million of pretax income on $1.7 billion of revenues, resulting in a pretax operating margin of 11.6%.

Housing market conditions remained favorable and continue to improve in a manner consistent with our long-stated expectations for the housing recovery. As expected, we are seeing the pace and the strength of the recovery vary significantly across our local operating markets, mostly tied to improvement in each markets economy is measured by growth in jobs, household incomes, household formations and increases in consumer confidence.

D.R. Horton is well-known for operating homes for the first-time and first-time move-up buyer, with 56% of our homes closing at an average sales price of $250,000 or less this quarter. We are experiencing solid demand and profitability in the heart of our business in our D.R. Horton communities.

Our high-end, Emerald brand continues to grow and is currently being offered in 27 markets across 10 states. This growth is evident as 6% of our homes closed this quarter were priced higher than $500,000, accounting for 16% of our home sales revenue, up from 3% on homes closed and 9% on revenues in the same quarter the prior year.

We believe that the true entry-level buyer is underserved in the current market, especially after the significant increases in home prices in the last 2 years. Therefore, we recently introduced a new brand, Express Homes, targeted at the true entry-level buyer that is focused first and foremost on affordability. Our rollout of Express is in the very early stages, just getting off the ground in 13 markets and 4 states. The price points of an Express Home will vary from market to market, but will consistently focus on providing an affordable entry-level home.

We look forward to growing all 3 of our brands and product offerings to gain market share across all price points as the recovery continues. We are positioned to grow revenues at a double-digit pace with strong operating margins for generating increasing returns. Bill?

Bill W. Wheat

Our consolidated pretax income increased 42% to $201.9 million in the second quarter from $142.1 million in the year-ago quarter. Our pretax income as a percentage of consolidated revenue was 11.6%, an increase of 170 basis points from 9.9% in the year-ago quarter.

Homebuilding pretax income increased 50% to $191.7 million from $127.4 million, and financial services pretax income was $10.2 million compared to $14.7 million. Net income for the second quarter increased 18% to $131 million or $0.38 per diluted share, compared to $111 million or $0.32 per diluted share in the year-ago quarter. Mike?

Michael Murray

Our second quarter home sales revenues increased 23% to $1.7 billion on 6,194 homes closed, up from $1.4 billion on 5,643 homes closed in the year-ago quarter. Our average closing price for the quarter was $271,200, up 12% compared to the prior year, driven by pricing power and an increased mix of larger move-up homes. David?

David V. Auld

The value of our net sales orders in the second quarter increased 20% from the year-ago quarter to $2.4 billion. Homes closed -- homes sold increased 9% to 8,569 homes, on an 11% increase in active selling communities. Our average sales price increased 10% to $278,900. The cancellation rate for the second quarter was 19%, consistent with the year-ago quarter. The value of our backlog increased 18% from a year ago to $2.8 billion, with an average sales price per home of $280,700. And homes in backlog increased 5% to 10,059 homes. Our backlog conversion rate for the quarter exceeded our expectations at 81%. We expect our third quarter backlog conversion rate to be around 75%, consistent with our long-term average rate. Bill?

Bill W. Wheat

Our gross profit margin on home sales revenue in the second quarter was 22.5%, up 210 basis points from the year-ago quarter. 160 basis points of the margin increase was due to improved market conditions resulting in higher selling prices in excess of cost increases; 30 basis points was due to lower amortize interest in property taxes as a percentage of home sales revenue; and the remaining 20 basis points was due to lower relative cost for warranty and construction defect claims.

Sequentially, our gross margin improved 20 basis points from the first quarter, primarily due to lower relative costs for warranty and construction defect claims, with little impact from market conditions. We expect that further improvements from this quarter's 22.5% in gross margin will be challenging. As long as market conditions remain stable, we expect to maintain strong gross margins generally in the range of our last 4 quarters, with quarterly fluctuations due to product and geographic mix.

We are positioned to grow revenues at a double-digit pace with strong operating margins while generating increasing returns. We expect revenue growth to be a stronger driver of our earnings growth going forward rather than margin expansion. David?

David V. Auld

Ongoing SG&A for the quarter was $187,900,000, or $187.9 million compared to $155.1 million in the prior year quarter. As a percentage of homebuilding revenue, SG&A improved 10 basis points to 11.1% from 11.2%. While we continue to build our sales and production capabilities where necessary, we expect to see modest improvement in our annual SG&A percentage as we continue to work to our target of 10%. For our third and fourth quarters this year, we expect our SG&A as a percentage of homebuilding revenues to decrease sequentially on higher expected revenues.

The improvement in our gross profit and SG&A percentages expanded our homebuilding pretax margin to 11.3% in the current quarter, an increase of 210 basis points from 9.2% in the year-ago quarter. Jessica?

Jessica Hansen

Financial services pretax income for the quarter was $10.2 million, compared to $14.7 million in the year-ago quarter. This quarter continued to reflect the more competitive pricing environment, whereas the year-ago quarter benefited from unusually favorable market conditions which produced higher-than-normal gains on sale of mortgages. 90% of our mortgage companies loan originations during the quarter related to homes closed by our homebuilding operations.

FHA and VA loans accounted for 43% of our mortgage companies volume this quarter, down from 49% in the year-ago quarter. Borrowers originating loans with our mortgage company during the quarter had an average FICO score of 716 and an average loan-to-value ratio of 89%. First-time homebuyers represented 42% of the closings handled by mortgage company this quarter compared to 50% in the year-ago quarter. Mike?

Michael Murray

Our construction in progress and finished homes inventory increased by approximately $142 million since December. We had 17,600 homes in inventory at the end of March, of which 1,400 were models, 8,600 were speculative homes and 3,000 of the specs were completed. In our second fiscal quarter, our investments in lots, land and development totaled $560 million, of which $376 million was to purchase finished lots and land and $184 million was for land development.

At March 31, 2014, we owned 125,000 lots and controlled another 47,000 lots through option contracts. 60,000 of our lots are finished, of which 33,000 are owned and 27,000 are optioned. We are well-positioned to meet demand with our 172,000 total lots owned and controlled. Bill?

Bill W. Wheat

Our unrestricted homebuilding cash totaled $930.8 million at quarter end. At March 31, we had available capacity on our revolving credit facility of $654.5 million and no cash borrowings outstanding. Our homebuilding leverage ratio, net of cash, was 38.4%, and our gross homebuilding leverage was 45.5%.

The balance of our public notes outstanding in March 31 was $3.6 billion. Our $500 million principal amount of convertible notes mature on May 15. Holders of these notes may convert all or any portion of their notes at their option at any time prior to the close of business on May 13. For the notes they convert, we intend to settle them with common stock. Don?

Donald J. Tomnitz

In closing, this quarter, our pretax income increased 42% to $201.9 million. The majority of our operating metrics continue to improve on a year-over-year basis this quarter, highlighted by the value of our sales, closings and backlog, increased by 20%, 23% and 18%, respectively. Our net sales orders increased 57% sequentially on a 3% increase in average active selling communities. And our pretax operating margin increased 170 basis points to 11.6%.

We are well-positioned to improve our profit and return metrics with our broad geographic footprint, diversified product offerings across our 3 brands, an attractive finished lot position and a solid balance sheet. We continue to focus on our core D.R. Horton brand, as well as striving to become the leading luxury builder with our Emerald brand. We believe the next leg of this recovery will be driven by the true entry-level buyer, and we're prepared to capture that demand with our recently introduced Express brand.

We like to personally thank all of our D.R. Horton team for another great quarter. D.R. and I request that you keep up with the good work and finish off the spring selling season strong.

This concludes our prepared remarks. We'll now host any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is coming from David Goldberg of UBS.

David Goldberg - UBS Investment Bank, Research Division

I wanted to ask, it feels like, in addition to the increased absorption pace, the better tone, it feels like you guys are differentiating your performance a little bit from some of your peers. And I was wondering if you could talk about, do you think that sales effort is it product, is it geography, is it a little bit of both? Maybe how you rank order what you think is causing some differentiation in terms of performance?

Donald J. Tomnitz

I think it's a combination of all. But I think if you remember, we had and we still have the broadest geographic footprint on the industry. And during the downturn, we kept our footprint, we consolidated our divisions within our footprint in anticipation of a housing recovery, and we're now prepared to continue to expand those markets where we kept our footprint. So clearly, we're not dependent on any one market, and there are weak markets across the country, so we're able to supplement those weak markets with stronger markets in our footprint. So clearly, I think our geographic footprint is a key to our great performance.

Bill W. Wheat

And as you know, David, we're always very focused on our execution and our operation of the business controlling our cost, and we're always focused on sales. So I think that's just been a hallmark, a consistent aspect of our approach to the business.

David Goldberg - UBS Investment Bank, Research Division

Definitely. And then I just had a follow-up question on the Express brand and the rollout, is that going to be kind of done on a market-by-market basis, because it feels like the entry-level coming back, I agree that it's the next leg of the recovery, but it's been a little bit sporadic in terms of where we seen it. Do you see it kind of rolling out nationally, or do you see it kind of a market-by-market basis kind of a slow rollout?

Donald J. Tomnitz

Well, as you know, at Horton, we like to dip our toe in the water before we jump completely in. So clearly, we're going to roll out the Express brand on a market-by-market basis, focusing perhaps more on the affordable markets than the higher end markets. And we will roll it out on a national basis, but we're going to focus first and foremost on where we feel like we have the best chance of affordability.

Operator

Our next question is coming from Adam Rudiger from Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Previously, you talked a bit about having some plans put in place in case the spring didn't materialize the way you wanted it to. I was wondering if you could just talk about the quarter and what kind of parts of those plans you actually implemented, if any, and just kind of how the quarter progressed relative to your expectations when you last spoke to us?

Donald J. Tomnitz

Well, our sales improved on a month-to-month basis sequentially each month in the quarter. And as we mentioned in the last quarter's conference call, we expected to meet -- that there was challenge in demand in any of the markets. We indicated that we are more than well-prepared with our low-cost basis and our low construction cost to be able to increase incentives as necessary. We did increase incentives some within second quarter, primarily toward the end of the quarter, but not significantly. And we'll continue to do that because one thing that we're focused on is inventory turn hitting our absorptions in each one of our respective markets.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Okay. And then moving to your specs, previously, I think, there has been discussion about specs getting higher margins than dirt sales. I was wondering if that was still the case. And if -- how your -- back to David's questions about potential differentiation, how you thought your differentiated spec strategy relative to some peers might have been impacting your quarter?

Bill W. Wheat

Yes, our spec strategy is still clearly at a very important part of our business. We're getting closer back to a more normal environment as pricing power is still there in some markets, but it's not across the board as much as it was. And so today, our spec margins are more in line with our dirt margins. And over time, we would expect that our build jobs will have slightly higher margins than our specs.

Donald J. Tomnitz

And really, we've managed our specs very, very well over the years, as you know. We look at [ph] this account for over 60% of our sales. And they have one thing in common, they like to put a buyer on almost quickly as possible, and also collect the commission quickly as possible. So we're well-prepared to meet that realtor support and demand that we have across the country. But typically, if you look at our spec percentage, it went down from 55% to 49%, our completed specs declined and our sales -- our specs greater than 6 months were pretty much stable, so we're in a very strong position spec-wise.

Operator

Our next question is coming from Mike Roxland from Bank of America.

Michael A. Roxland - BofA Merrill Lynch, Research Division

First question I had was on the incentives. And Don, I think you mentioned that you increased incentives and that was more oriented towards, I guess, the back half of your fiscal second quarter. So wanted to get a sense of how much incentive has increased, and what your approach is with respect to incentives on a go-forward basis?

Bill W. Wheat

Yes, Mike, we've taken a very targeted approach to incentives. That's community by community. Each community has their sales absorption plans and they make sure that they are meeting the market, meeting the competition to hit those plans, so they need to add some incentives, they do. In general, we saw a very slight increase in our incentives over the quarter, but we really expected to see that. Some markets increased incentives, some did not. We're still seeing many markets where we're increasing prices and incentives are still very low. So it really is in line with our overall assessment of the market is that the market is improving very differently from market to market. In some markets will see incentives, and some we will not.

Michael A. Roxland - BofA Merrill Lynch, Research Division

Just suffice to say it was at the margin in terms of the amount of incentives that you increased in aggregate?

Bill W. Wheat

For the quarter, it was a slight increase on the margin. And of course, that's coming off a very low incentive levels a year ago, abnormally low incentive levels a year ago. So really, we just view that we're coming back to a more normal level where community-by-community basis, some having incentives, some do not.

Donald J. Tomnitz

And taken into consideration the increase in ASPs and the pricing power we've had over last couple of years, I think it's only natural that incentives begin to kick in some.

Michael A. Roxland - BofA Merrill Lynch, Research Division

Got it. Appreciate that. And then my last question is, can you just provide some color around further operating leverage and the additional opportunities you have to drive that lower? Is that more of a function at this point of the double-digit increase in revenue that you're expecting? Or are there actually additional cost takeouts that you could pursue that would help drive that -- drive further operating leverage?

Bill W. Wheat

So the primary driver would be increased volumes. As you well know, our long-term target on SG&A is 10%. We're working our way there, but we're not there yet. But as volumes increase, we would expect to get there. There's always places that we can continue to get more efficient throughout our company, we continue to focus on that. But we would believe that the larger driver of those efficiencies going forward would be volume increases.

Operator

Our next question today is coming from Kenneth Zener from KeyBanc Capital Markets.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

As you guys are bringing this new product line on for first-time buyer, other builders have talked about their new product targeting this -- the new buyer being a lower margin but higher-turning product. Do you think it's kind of set to come out at the margins, that gross margins that you're now delivering?

Donald J. Tomnitz

We think that, obviously, on that first-time mover -- first-time buyer market with margins are more challenging. We're budgeting as close as we can to our current margins, but probably slightly lower. But don't forget, we're planning on turning that product line as much as 3 times per year. So basically our return on that segment of the business will be just as good, if not better, than our normal business. In fact, it will be better.

Bill W. Wheat

Yes, we will expect much higher absorptions in those communities, and so certainly in a high much higher absorption, you can take a slightly higher margin and you'll see as good or better returns in entry level community.

Donald J. Tomnitz

Slightly lower margin.

Bill W. Wheat

Slightly normal on returns.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

All right. I got that ratio. Now in terms...

Bill W. Wheat

We like to have a higher margin and higher turn, but that would be a beautiful thing.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Right. So for your orders sequentially, you kind of -- you came in a little bit above, I think, your long-term seasonal rate of just a little above 50%, kind of flattens out generally in the third quarter. Is that what you're seeing now is one question. And second, you referred to community count being up 3% sequentially. Could you refer to it year-over-year, please?

Donald J. Tomnitz

Our community count was up about 11% year-over-year, and I think we'd expect to see that community count continue to grow year-over-year, albeit at a slower pace than 11%, probably single digits -- high single digits for the balance of the year.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

And the seasonality of orders you're seeing so far?

Jessica Hansen

Yes. So in terms of what we're seeing today, we're only 3 weeks into April, so we really don't have a whole lot to share, but we would expect our strongest sales quarters to be our fiscal second and third quarters of the year. So with our positioning, we would expect to have a strong Q3.

Donald J. Tomnitz

Especially after having overcome the tough comp that we had in the second quarter.

Operator

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

Nishu Sood - Deutsche Bank AG, Research Division

First question, I wanted to ask about Emerald and Express and how to think about those longer-term in the context of your strategy. This recovery in downturn has been choppy. First, there was first-time buyer, then it's been entry-level -- I'm sorry, then it's been the move-up buyer. So should we think about Emerald and Express as kind of medium-term plays to -- that you might put more capital into depending on where we are in the cycle, or is this a longer-term shift to a more multi-brand strategy?

Donald J. Tomnitz

So longer-term shift to a multi-brand strategy. We believe, from our perspective, that we have underserved that luxury buyer, and that was the reason we started focusing on the Emerald brand. It also helps us gain entry to some of the master-plan communities, where there are no or very few custom builders because of a lack of financing for those. And so we're able to backfill the space left by them because banks are still not lending to that small custom builder and provides us a great entry with a great capital position and a great balance sheet to become a major player on that higher end market, especially in master-plan communities. So we're focused on truly becoming the leading luxury builder with that brand over the next 3 to 4 years. On the Express side, there's no question that with the price increases that we've experienced in our industry over the last couple or 3 years with all the pricing power we have had, we've really depleted that pool of affordable buyers. And so as a result, by going down into the price range where we think we'll be in a typical market somewhere between 120 and 150 on the price point, but that truly is going to create for us a whole new pool of affordable buyers that let us expand our footprint and our revenues.

Nishu Sood - Deutsche Bank AG, Research Division

Got it. That makes a lot of sense at the lower end of the market, especially that comes back. But in a rising interest rate environment, affordability will be stretched and the amount that a dollar of mortgage payment buys will be stretched across all price segments. So are -- will there be, or are you planning to, or are you in the stages of implementing reactions to add across your D.R. Horton brand as well, or is that something more you're going to think about as interest rates rise?

Donald J. Tomnitz

Clearly, as interest rates rise, I think that the Express brand is even going to put us in a stronger position, because as buyers have more difficulty qualifying, just as we saw 6, 9 months ago as the 30-year mortgage moved up, then we had higher cancellation rate during that time period and was primarily because of the fact that lack of affordability. So key, I think, to expanding our business on a go-forward basis in a rising interest rate environment is to be able to offer a lower-priced but competitive, well-built house.

Operator

Our next question today is coming from Dan Oppenheim of Crédit Suisse.

Daniel Mark Oppenheim - Crédit Suisse AG, Research Division

I was just wondering if you can talk a bit about Express in terms of just how different it's going to be from what you're doing currently in some markets. And then if we look at Mobile and some other places you're currently building at that price point, is it going to be -- so is some of it based on the success you've had there in terms of selling homes at that price point? Is it going to be continuing in terms of the -- just what something along those lines? How should we think about it overall in terms of just doing something different in terms of construction at a lower price point and such?

Donald J. Tomnitz

Certainly, on the express side, we believe we're going to be able to turn that inventory a lot faster because the cycle time on the construction side of the business is going to be significantly less and we are focusing on that -- those cycle times on Express, but also across the other price points. But if you take a look at Express in general, we are going to be offering essentially a product that's not going to require options, not going to require upgrades. It's going to be basically a turn-key operation. When those people show up, they basically are going to be able to not have to go to the design center and purchase a lot of upgrades and options because they have difficulty qualifying, so basically, it's going to be pretty much a turn-key product.

Daniel Mark Oppenheim - Crédit Suisse AG, Research Division

Great, okay. Sounds like it will definitely meet a segment market that will work well there. And the second question, wondering, you talked about slight increase incentives at the end of the quarter, and how have you seen that in terms of as it's gone into April and how are you thinking about the environment here?

Jessica Hansen

We're continuing to do what we would do on a day-to-day basis, which is meet the market on a community-by-community basis and do what we need to do to hit our targeted absorption.

Donald J. Tomnitz

Dan, we're in an extraordinarily strong position, because as we've talked about on other conference calls, we've accumulated a very attractive land and lot position over the last couple of years. We're glad we're not on the market having to be aggressive on the land side today, because we've got built in gross margin in our existing land supply. So as a result, we assigned certain absorption level for each community, and we're going to move forward with our low cost structure, our land side and our construction side in order to meet our target.

Operator

Our next question today is coming from Michael Rehaut from JPMorgan.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

First question was on the Express brands, and I think it's a great idea and I do believe that the first-time buyer is definitely -- there are different reasons why I believe that buyer hasn't come back to the market. Certainly, affordability is at the top of the list, but I also think there is a lack of product out there as well, so I think it's a great idea. On that rollout, you said you typically kind of initially dip your toe in the water and go from there. Is -- how should we think about that in terms of timing? I mean, would 2014 be more of kind of the initial stages, and would we expect to see a more aggressive rollout in '15 if the expectations are met? And also from the land side, you mentioned a faster turn business. Is that going to be all kind of finished lot option take downs, are there going to be any land banking perhaps? Or would any of this be developed through your own development machine?

Donald J. Tomnitz

Well, clearly, on the Express side, we have our targets. And 2015, it will be a much greater growth rate than what it is in 2014. I can tell you that D.R. has given us guidance in terms of where he wants to be with Express in 2015, and our goal is to hit this aggressive targets. On the land side, we're focusing right now on finished lot deals. And in terms of having to develop land for Express, we may very well have to do that. But I will remind you of our strict underlying guidelines, and we're adhering to those as we move forward even into Express. And that is our goal is when we buy piece of land, that we get our initial land expense back within 24 months, and Express will adhere to those guidelines.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Great. On the gross margins, appreciate the color there, and I believe what was stated earlier on the call was that further improvement will be more difficult and that you'd expect gross margins to be in the range in the last 4 quarters or so. That would seem to imply that the number that you did in this most recent quarter being at the high end of that range, are you kind of saying in a way that there's a little bit of expectations for the back half of the year to be lower than the first half of the year, albeit modestly?

Donald J. Tomnitz

I don't -- go ahead.

Bill W. Wheat

No, no, we're not really saying that we expect margins to go down. What we're saying is we expect any further significant increases to be challenging. We really don't expect significant increases or really any significant decreases in margins, but we feel like they'll operate in a range similar to where we've been the last few quarters, including this quarter. Obviously, there is a number of -- there are number of factors that could push margins up or compress margins on an individual quarter. We expect some fluctuation from quarter-to-quarter. But in general, we expect to stay in the same range we are right now.

Donald J. Tomnitz

Mike, we've had tremendous, as you know, pricing power over the last couple of years, and that's one of the things I think that's depleting the pool of buyers out there. So clearly, with our Express brand, we're going to try to increase that pool. But yet, at the same time, we don't see major pricing power opportunities in as many markets as what we've had in the last 2 years.

Bill W. Wheat

We are focused first and foremost on returns. We have achieved a lot of pricing power, a lot of operating margin, improvement over the last couple of years. Now we're focusing on maintaining that, improving our volumes to drive stronger returns. So continuing to increase to strengthen our returns versus where we've been.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

And then just one last quick one, SG&A, down 10 bps year-over-year, I think in the first quarter it was down 30. Should we expect a similar type of kind of just modest year-over-year improvement? I know longer term, you're still trying to go for the 10%. But in terms of the back half, should we kind of expect a similar type of 10, 20 bp improvement?

Donald J. Tomnitz

Clearly, with most of -- with approximately 60% of our annual closing is coming in the second half of the year, we are anticipating stronger SG&A performance in terms of decreasing our SG&A as a percentage of revenues in the second half of the year. So we would not be happy with a 20 bp decrease.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

No, I'm referring to year-over-year. So I certainly would expect it to be materially lower back half versus first half, but just as you look at on a year-over-year basis.

Donald J. Tomnitz

With our expectation that it would decrease by even more in the second half than you would infer for the year, it will also decrease by even more than the 20 basis points we've been showing.

Operator

Is coming from Bob Wetenhall from RBC Capital Markets.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

I just wanted to ask about DT's comments regarding the first-time home buyer potentially returning. We've heard from a lot of people, Texas is strong and benefiting from sustained investment in oil and gas. What's your kind of expectation for other geographies that don't have that tailwind? And what do you think the timing is for something like that where we see this category open up?

Donald J. Tomnitz

Well, clearly, I think if we gain job growth in this country, which I think ultimately, we're going to experience and I think, clearly, that's where a lot of those first-time home buyers are going to come from. But I also believe strongly that as we move into this recovery, first-time home buyer is not participating at the level that a lot of our political leaders would like for them to be participating. And I think that they will see some encouragement from the government in terms of trying to get more and more people into entry level homes. So my focus is really the affordable buyer, job creation, as well as a little help in the politics.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Got it. So you need some things to come together for that to work out in the relative near term.

Bill W. Wheat

I think that was a take-away close there.

Donald J. Tomnitz

I'm supposed to do the take-away close.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Go ahead. Tell me.

Donald J. Tomnitz

I'm supposed to do the take-away close. We wouldn't be getting into the Express brand, if we didn't feel like that, that was the next segment of the business to recover. And clearly, I do see more favorable job growth, and I think a lot of that job growth is more on entry-level jobs and that's going to translate into entry-level buyers. So improved job growth in the country, as well as I think that we start looking at the underwriting guidelines and moving forward to try to get more people qualified, I think that we're going to get some help on the qualification side. And I think you're seeing that with several lenders today.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Got it. Very helpful. Switching gears a little bit. Average order price on new homes in the quarter was up 10% against a very tough comp from last year. Do think you can sustain that kind of price appreciation during the balance of the year? How should we think about that? Should it tail off in the second half? Or do you think kind of a mid-single-digit full year price increase is achievable?

Bill W. Wheat

It's hard to make it a call quarter-to-quarters. But in a specific discrete time because of mix changes and things like that. But we said consistently that we do expect -- we still expect further price increases, but we expect it to moderate down into the single-digits. Whether that will occur in Q3 or Q4 or sometime in fiscal '15, we can't tell you. But we do expect it to moderate back to the single-digits.

Operator

Our next question is coming from Stephen East from ISI Group.

Stephen F. East - ISI Group Inc., Research Division

I know you haven't talked about Express at all this call. But I will ask you a couple of questions on the first-time buyer. I mean, in our field research, we're definitely seeing a comeback and we're seeing some of that credit availability that you just mentioned. Are you seeing a meaningful change? Your sales to first-time buyers were down year-over-year. But have you already reached the inflection point? And is that turning as far as you all are seeing in traffic, in demand, et cetera? And are you starting to see that drive to qualify type of activity going on?

Donald J. Tomnitz

I think the biggest thing that we're seeing is the lack of affordable buyers out there. And as we increased our prices, new pricing power over the last couple of years, as I say, we depleted that pool of the first-time homebuyer. And our goal is to have a more competitively priced product with Express. And as I said, we are focusing on, in a typical affordable market, somewhere between $120,000 and $150,000 as an average sales price. So we have not had product offerings in that price point. So I think it's more of us trying to bring those people into the market as opposed to those people being out there and being underserved and driving to qualify. I just think it's a function of there's just not the product out there for those people to qualify. And if we can get that product price point down, then I believe there are people out there who truly will buy just simply because they've been priced out of the market.

Stephen F. East - ISI Group Inc., Research Division

Okay. And are you having to -- for the Express product, are you able to utilize some of that land that you already got on your books? Or is this primarily going to be new purchase-type of land base?

Bill W. Wheat

It will be both, Stephen. There are some properties we have that we can bring out. And it will be a good fit for Express. But then there's also finished lots out there in areas that have been underserved that because there hasn't been anybody out there building this kind of product that are available to us as well. So we will look at all sources. But yes, it will help us a little bit on our land held piece, too.

Stephen F. East - ISI Group Inc., Research Division

Okay. And just quickly one last question to follow on what Bob was asking about, other regions. I mean, this definitely -- your performance this quarter turn from Texas to a lot of other regions at least from the order perspective. And we haven't necessarily seen that from all the other builders. What do you all think is going on in your markets that's allowed you to start to see that meaningful improvement?

Donald J. Tomnitz

Well, I think clearly if you take a look at our West. Our West had better sales and better closings. And that's a function of us over the last year and 2 years, taking good land positions in California and just now bringing those to fruition with model grand openings. So I think that clearly helped a lot. If you look at the East, the East performed well for us. And that's because David Auld was the previous regional president for the East. And the only reason he's sitting across on this conference call table is because of his performance in the East. But we entered into a lot of rolling option and a lot of good land deals in the East during his tenure. And they were penetrating those markets deeper. And we expect to continue to do that. The South, on the other hand, it's been strong all during the downturn, and it continues to be strong. But it's being -- to our credit, the South is being outpaced, as we always said, by the East and the West. And we said that will be a great position for this company to be in because the South region held us up and supported us during the downturn. And as Rick Horton said, the best thing that could ever happen to him is for the East and West to take the pressure off of him. So they are doing that today. And we're in a great position.

Operator

Our next question is coming from Stephen Kim from Barclays.

Stephen S. Kim - Barclays Capital, Research Division

I just wanted to just mention that I totally agree with your strategy to go after the entry level. I mean, as I recalled last month, I think this is really where the puck is going. And I really congratulate you guys on really being unique and sort of skating to where the puck is going, so good job with that. And I'm looking forward to learning a little bit more about the timing of how you roll out Express. I know there was already a question asked on it. I wanted to sort of roll something -- run something by you though. When we look at the job growth figures that have been coming across, generally speaking, the numbers in raw units or raw numbers of jobs have actually been pretty good for a while, and yet household information has been very depressed. We have our view on why you haven't seen that translate into household information. I'm curious as to what you are seeing in your markets. Are you hearing that your entry -- that the entry-level buyers, who are coming out, are saying to you, "It's been really tough to get to this point where we can actually buy a home because we haven't been able to -- it took us a lot to get jobs?" Or are you hearing that it's the type of jobs that they have been having that have required them to take longer to accrue the savings to buy the homes?

Donald J. Tomnitz

Well, I think most of the jobs being created in this country, Steve, are entry-level jobs. And as a result, just by definition, I think they're having to save a lot longer. I think the other thing that I was talking about earlier, the help from the political side, is with the high student loan debt that these people get, these college kids are graduating, young adults are graduating. And there's work on the political side that would help relieve them of some of that burden with the college debt. So as a result, even though they are graduating from college, many of them have had difficulty finding higher-paying jobs. And secondly, they're burdened with typically $26,000 with the student debt. So a function of getting them that entry-level job, which is pretty much a lot of them having to go into at perhaps a lower salary than what they expected, and some relief on the student loan debt, I think, that pool begins to grow.

Stephen S. Kim - Barclays Capital, Research Division

We've looked into the student loan issue. And what we've seen mostly has been an initiative in Washington to sort of prevent predatory servicing, I guess, you could say, but not necessarily in terms of forbearance or forgiveness so much. Have you been hearing something more specific to forbearance or forgiveness of current outstanding student loan balances?

Donald J. Tomnitz

As I'd like to say, I watch too much Fox News. But on Fox Business News yesterday, there was a discussion on that. And I just caught the headline as I was walking by the conference room. So I don't know specifically about that, but there was a discussion yesterday on that in terms of how they can work with the people who have the college debt. I don't know whether that's forgiveness, forbearance or whatever. But I think you're going to have some relief.

Bill W. Wheat

I think that there's recognition that it's an issue and it is holding back economic growth, I think there's a general sentiment that there will be some improvement or help along the way.

Donald J. Tomnitz

We're helping everyone else, we might as well help the college students.

Stephen S. Kim - Barclays Capital, Research Division

Yes. Well, that actually would have to be very encouraging. Your land spend figures that you gave this quarter suggest that you spend about 22% of your revs on land spend. It's about the lowest we've seen since the downturn. I was curious as to whether you anticipate maintaining this very strict control on land spend for the rest of the year, and in particular, whether it is -- you would expect to spend maybe a little more on land suitable for your Express or if you think you really got enough there, just like you do in the rest of your business.

Michael Murray

I think we made a lot of early investments in the cycle that have allowed us to be very selective at this point and focus, as Bill said before, on the returns. So I think we're seeing some -- a lot of replacement of lot costs that's coming through. Bringing some of our land held back into production will help support some further growth. But I don't see a huge expansion, Stephen, in the push on land at this point. I think we're going to stay pretty focused and disciplined at this point moving forward. The Express model, we're going to prefer the finished lot deals, as DT said, but where necessary, make disciplined investments on projects that meet our return hurdles.

Bill W. Wheat

That owned and controlled position of 170,000 lots, that will support much higher revenues than what we're generating today. So we believe that we can increase our revenues on the lot supply we have. And then if we need to augment it -- so at some point down the line, we will. But today, we feel like we're in good position.

Donald J. Tomnitz

We are clearly focused on one thing on the land side, I assure you. And that is how do we get our initial investment on our land back within a 24-month period. And that's going to apply to all 3 brands.

Bill W. Wheat

But even just to replenish our lot supply, there's still a significant spend. They're still on pace of a $2 billion year in terms of land act and land development, just to replenish and keep our lot supply where it is. And so this is not that we're not investing, we're just not necessarily growing our investment from the current level right now.

Stephen S. Kim - Barclays Capital, Research Division

Yes. Well, I remember about a year ago, you made this comment, DT, that you wanted to limit your land spend to things that you could get your money back in, in 24 months. And I hand it to you, that was good timing because that was at a time when the market was feeling really ebullient.

Operator

Our next question is coming from Jack Micenko from SIG Capital.

Jack Micenko - Susquehanna Financial Group, LLLP, Research Division

Most of my questions have been answered. But I wanted to just get your take on Texas specifically, obviously your home market, knocking on almost 40 years there. It seems like a lot of the competition has been carving out Texas commentary this quarter, job growth, taxation, whether it maybe reading a lot about population addition numbers pretty encouraging. Are you seeing more builders come in? Is it more competitive than it was maybe a year or 2 ago? Are there more builders? Is your lot supply adequate there? Is land pricing disproportionately rising in Texas versus other markets? Just some color you can give us on the state overall.

Donald J. Tomnitz

Well, obviously, D.R. started in Texas in 1978. And I will tell you, you can go to almost any community and turn the corner, and there are multiple builder signs on every corner, 20 to 30. So Texas is one of the most competitive markets, but it also has few barriers to entry. And that's one of the things that makes it so attractive, and that is that land prices are still competitively priced, so we can deliver a competitive lot. And there's ease of entry in terms of not having to go through, as we do in a number of markets, a 2- to 3-year entitlement period. Most of our land, we can get entitled and plotted within a period of 6 months or less. And there are adequate general contractors to develop lots down here. So in general, we think Texas has been a strong market. It's a very competitive market. We continue to lead every market in Texas. One of the things we're most proud of recently is that we're on our way to being #1 in the Houston market. We've been in the Dallas/Fort Worth market #1. And we're focusing on San Antonio and Austin. And I'll tell you that all of those markets are very, very strong for us and we're very competitive in those markets.

Jack Micenko - Susquehanna Financial Group, LLLP, Research Division

So it sounds like it's always -- it's sort of a status quo, I mean, always been a good housing market and it doesn't [indiscernible] the others...

Donald J. Tomnitz

Well, I think it's a good housing market because of the strong economy and as well as it's a great place to live with the people coming in and being able to buy a nice house that's affordable. And land prices are competitive. So there's no income tax in the state of Texas, so there are a lot of attractive reasons and the weather is great here. So I don't know why. There aren't many states that are as centrally-located with as many attributes as the state of Texas has. I mean, we've been a leader in Texas, and we'll continue to be the leader in Texas as we move forward.

Jack Micenko - Susquehanna Financial Group, LLLP, Research Division

Okay. And then just, I mean, how do you think about Emerald in terms of size and mix? I know it's a tough thing to answer with numerator, denominator mix and that sort of thing moving around. But how big could Emerald be? I know you rattled off some numbers early on. I missed some of those. But I think you said 6%, I believe. I mean, how do think that number could play out over time?

Donald J. Tomnitz

Well, I think we said it all when we said we are focusing on being the leading luxury builder in the U.S. And we anticipate that, that's a good growth segment for us and very profitable growth segment for us. But we're expanding it where it makes sense. And just like we said on the Express side, we started slow, dipping our toe in the water. And we found a great success in that market, great demand for our product out there. And the product line that we're offering is extraordinary in terms of finish out and quality of homes. So we expect Emerald to continue to be a bigger and bigger portion of our business. And as I said, our focus is how do we become the leading luxury builder in the U.S.

Operator

Our next question is coming from Jade Rahmani from KBW.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

I wanted to ask if you could clarify your comments on backlog conversion and how you would expect that to trend in the balance of the year. Do you think 4Q levels could reach what was achieved this quarter? And longer term, do you think normal backlog conversion should be below 70% or something in the 70% to 75% range normal?

Jessica Hansen

Yes. There definitely is seasonality, Jade, to our backlog conversion rate. As we said earlier, we'd expect it to be around 75% in our third quarter, which really is our historical average at this point, if you look over the last 10 years. And then traditionally, our fourth quarter would be a higher backlog conversion rate than our third quarter. With as many homes that we sell and close in the same quarter, it's hard for us to give you guidance much further out than the next quarter. But yes, I think we'd expect our backlog conversion rate to increase somewhat in the fourth quarter from whatever we end up doing in the third quarter.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then as far as a normal conversion rate, do you think something in the 70% to 75% range is a normalized level?

Jessica Hansen

I think in the back half of the year, yes. And in the first half of the year, seasonally, it's usually a little bit lighter.

Donald J. Tomnitz

And we thought it was abnormal that we had an 80% backlog conversion in the second quarter. But usually, second quarter is slower or lower backlog conversion than the first quarter. So I guess, our builders out there just decided to close a lot more homes in the second quarter than we anticipated.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Great. On financial services, the operating margin increased sequentially, which accounted to some of the mortgage banking trends we have been seeing. Do you expect the margin to moderate in coming quarters? Or do you think the current level has absorbed most of the competitive pressures?

Bill W. Wheat

We think we've absorbed most of it, thus far. Obviously, we don't -- we can't tell what the future holds. But we certainly are encouraged when our volume is going up. And typically, in the quarters, when we have higher volume in our financial services segment, we'll see a better operating margin. And so Q3 and Q4 typically will show a better margin than we do in Q1 and Q2.

Operator

Our next question is coming from Jay McCanless from Sterne Agee.

James McCanless - Sterne Agee & Leach Inc., Research Division

First question on Express. Is the initial crop of neighborhoods there going to be repurposed D.R. Horton neighborhoods? Or is that something you might be pulling out of mothball? If you could just talk about that.

Donald J. Tomnitz

I think it's a combination of both with a lot of them are new option lot deals that we entered into. And typically, it's in a market clearly where we've already been building the D.R. Horton brand and we're trying to increase our affordable buyer pool in that market because we have seen people coming into our model homes in the D.R. Horton brand, who can't qualify because of the pricing power that we had over the last couple of years. So primarily, it's expanding and supplementing our existing markets.

James McCanless - Sterne Agee & Leach Inc., Research Division

Okay. And then I was going to ask if we could dig in to the financing questions because while I would guess you're waiting on Washington to decide it wants to get back into the entry-level housing market, have you been hearing from bankers that they're willing to buy higher FICO paper -- excuse me, lower FICO paper, a little bit more risky paper on the average Express buyer even with mortgage rates sitting where they are now?

Donald J. Tomnitz

Actually, we've heard the same thing you've heard on the media over the course over the last 60 to 90 days. We, from our mortgage company perspective, don't see a lot of institutions willing to buy that kind of paper. So as a result, it's limited from that perspective.

James McCanless - Sterne Agee & Leach Inc., Research Division

Okay. And if I could sneak one more in. When you were talking about the luxury builders, private luxury builders not getting a lot of financing from the banks, could you -- what are you seeing on the land development side? Are the banks willing to do development lending now? Or is that still a very small or closed business?

Donald J. Tomnitz

Very, very limited. And thank goodness for our strong balance sheet because, frankly, as we've worked through that supply of finished lots that were generated in '07, '08 and '09, we've had to begin developing obviously. It takes a strong balance sheet to be able to do that. Clearly, that small builder, small developer, not back in the business because of lack of capital.

Operator

Our next question is coming from Jim Krapfel from Morningstar.

James Krapfel - Morningstar Inc., Research Division

To what extent did weather push out closings, negatively impact orders or lead to incremental cost in the quarter? It appears that there wasn't much effect in the closing side.

Donald J. Tomnitz

Well, we have a policy at D.R. Horton. And it's a sincere policy. And that is we don't want our division presidents to give us a weather report. And so we're not really -- we work with our broad geographic footprint to the extent that we did have weather-related issues is really a nonevent.

James Krapfel - Morningstar Inc., Research Division

Okay. And what were the cost ASPs per square foot in your closings this quarter?

Bill W. Wheat

On a year-over-year basis, our revenues per square foot were up 9%. We usually talk about our vertical costs, our vertical's stick and brick costs during the quarter on a per square basis were up 10%. So essentially, our costs and our revenues increased at about the same rate on a per square foot basis. Now in aggregate per unit, revenue still exceeded our cost increases.

James Krapfel - Morningstar Inc., Research Division

Okay. And then on the cost side, where do you see that trending going forward? You said you see some moderation in that inflation.

Donald J. Tomnitz

I think costs are going to continue to increase. We are fortunate that we have a lot of volume in most of our markets so that we can be more competitive with our subcontractors on the cost side. But clearly, labor is one of the cost components that's going up. And lumber, I don't think is going to come down nearly as much as what it did last year. It seems like it's going to hang high at where it is currently right now. But it's a day-to-day process for our purchasing managers to work with our vendors and our suppliers and our trades out there to get the benefit of the volume that we can offer our vendors and our trades.

Operator

Our final question today is coming from Alex Barrón from Housing Research Center.

Alex Barrón - Housing Research Center, LLC

I wanted to ask on the Express homes. Are you guys going about your marketing strategy in a different way, meaning are you trying to target those entry level -- those renters more directly? Or are you kind of going the traditional way of just kind of waiting for them to show up at the communities?

Donald J. Tomnitz

Well, I think it's a different type of marketing. I know that as you clearly are trying to attract the entry-level buyer, a lot of them living in apartments. And so we try to do a special marketing with the apartment complexes that are near us. And another potential pool are the people living with their -- the college graduates and others that are living with their parents. And I think we do that primarily through realtors. I also believe that our Express brand, that it's going to be easier for perhaps parents to help their children get into homes because they could help them a lot easier with a lower price point, as we have, with the Express brand than they can in a standard price that's with D.R. Horton. So I look at both those avenues as trying to get with the realtors to make sure that the parents or the kids who are living at home, we can attract them with a lower price point as well as focusing on those apartments.

Alex Barrón - Housing Research Center, LLC

And also wondering if you guys have considered doing a stock buyback, given how cheap your stock is this year?

Donald J. Tomnitz

Well, we don't -- I don't really want to comment on the stock buyback. I do know one thing on our business that's pretty general. And that is our focus is how do we get to a free cash flow position. And I think, Alex, if we adhere to our business plan that David is helping us implement, I think that we'll clearly get to a free cash flow position. And when we get to a free cash flow position, we're going to be in a position to do a lot of things. And one of them will be perhaps buying back our stock. But the key is how do we get to that free cash flow.

Operator

We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management at this time.

Donald J. Tomnitz

Thank you. And thank you for joining this call. D.R. and I and David want to thank everybody in the field because we had one heck of a quarter, as you know, and we turned in a sterling performance in the month of March, and we appreciate that. The key is how do we go forward, execute the business plan in Q3 and Q4 and deliver a very, very outstanding year for us in 2014. We're welcomed to have David onboard. He's a good addition to the 38th floor up here. And we've got a great team of people here as well as in the field. So thank you very much. And as I say, execute the competition and don't take any prisoners.

Operator

Thank you. That does concludes today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.

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