D.R. Horton (DHI) David V. Auld on Q2 2016 Results - Earnings Call Transcript

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D.R. Horton, Inc. (NYSE:DHI)

Q2 2016 Earnings Call

April 21, 2016 10:00 am ET

Executives

Jessica Hansen - Vice President of Investor Relations

David V. Auld - President & Chief Executive Officer

Michael J. Murray - Chief Operating Officer & Executive Vice President

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Analysts

Paul Przybylski - Evercore ISI

Kenneth R. Zener - KeyBanc Capital Markets, Inc.

Alan Ratner - Zelman & Associates

Eric Bosshard - Cleveland Research Co. LLC

Nishu Sood - Deutsche Bank Securities, Inc.

Stephen S. Kim - Barclays Capital, Inc.

Robert Wetenhall - RBC Capital Markets LLC

Michael Jason Rehaut - JPMorgan Securities LLC

Jack Micenko - Susquehanna Financial Group LLLP

Susan M. Maklari - UBS Securities LLC

Will Randow - Citigroup Global Markets, Inc. (Broker)

John Lovallo - Merrill Lynch, Pierce, Fenner & Smith, Inc.

Michael G. Dahl - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Jade Rahmani - Keefe, Bruyette & Woods, Inc.

Jay McCanless - Sterne Agee

Operator

Greetings, and welcome to the Second Quarter 2016 Earnings Conference Call of D.R. Horton, America's Builder, the largest builder in the United States. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jessica Hansen, Vice President of Investor Relations for D.R. Horton. Please go ahead.

Jessica Hansen - Vice President of Investor Relations

Thank you, Kevin, and good morning. Welcome to our call to discuss our results for the second quarter of fiscal 2016. 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 can lead to material changes in performance is contained in D.R. Horton's Annual Report on Form 10-K and on most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

For your convenience, this morning's earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q next week. After the conclusion of the call, we will post updated supplementary historical data to our Investor Relations site on the Presentations section under News & Events for your reference. The supplementary information includes historical 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.

David V. Auld - President & Chief Executive Officer

Thank you, Jessica, and good morning. In addition to Jessica, I'm 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 spring selling season at D.R. Horton is in full swing and our team delivered a set – a strong second quarter. Our consolidated pre-tax income increased to $301 million on $2.8 billion of revenue, and our pre-tax profit margin improved 130 basis points to 10.9%. Our homes sold increased 10% compared to the second quarter of 2015, driven by improving absorptions. These results continue to reflect the consistent solid performance of our core D.R. Horton communities and our Emerald Homes and Express Homes brands. We are striving to be the leading builder in each of our markets and to continue to expand our industry-leading market share.

We plan to maintain broad product diversity with our three brands over the long-term. Our continued strategic focus is to produce double-digit annual growth in both our revenue and pre-tax profits while generating positive cash flows and increasing returns. During the six months ended March, we generated $27 million of cash from operations, on track to meet our target of $300 million to $500 million of positive cash flows for the year.

Our return on inventory defined as homebuilding pre-tax income divided by average inventory, improved to 13.8% for the 12 months, up from 10.7% a year ago. With a sales backlog of 13,695 homes at the end of March and a well-stocked supply of land, lots, and homes, we are well-positioned for the remainder of 2016. Mike?

Michael J. Murray - Chief Operating Officer & Executive Vice President

Net income for the second quarter increased 32% to $195 million, or $0.52 per diluted share, compared to $148 million, or $0.40 per diluted share in the year-ago quarter. Our consolidated pre-tax income increased 31% to $301 million in the second quarter, compared to $230 million in the year-ago quarter. And homebuilding pre-tax income increased 36% to $283 million, compared to $209 million in the prior year quarter.

Our second quarter home sales revenues increased 16% to $2.7 billion on 9,262 homes closed, up from $2.3 billion on 8,243 homes closed in the year-ago quarter. Our average closing price for the quarter was $290,000, up 3% compared to the prior year and flat sequentially from our first quarter.

This quarter, entry-level homes marketed under our Express Homes brand accounted for 23% of homes closed and 16% of home sales revenue. Our homes for higher-end, move-up and luxury buyers priced greater than $500,000 accounted for 7% of our homes closed and 17% of our home sales revenue. Bill?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

The value of our net sales orders in the second quarter increased 13% from the year-ago quarter to $3.6 billion, and home sold increased 10% to 12,292 homes on a relatively flat active selling community count.

Our average sales price on net sales orders in the second quarter was $290,900. The cancellation rate for the second quarter was 19%, consistent with the year-ago quarter. The value of our backlog increased 14% from a year ago to $4.1 billion, with an average sales price per home of $296,700 and homes in backlog increased 12% to 13,695 homes.

Mike?

Michael J. Murray - Chief Operating Officer & Executive Vice President

Our gross profit margin on home sales revenue in the second quarter was 19.9%, consistent with the first quarter and up 20 basis points from the second quarter of last year. The consistency in our gross margin reflects a stability of most of our markets today. We are raising prices or reducing incentives when possible in communities where we are achieving our targeted absorptions. And we're also working to control cost increases.

Our general gross margin expectations remain unchanged. In the current housing market, we continue to expect our average home sales gross margin to generally be around 20%, with quarterly fluctuations that may range from 19% to 21% due to product and geographic mix, and the relative impact of warranty and interest costs. As a reminder, our reported gross margins include all of our interest costs.

David?

David V. Auld - President & Chief Executive Officer

In the second quarter, homebuilding SG&A expense was $258 million, compared to $242 million in the prior year quarter. As a percentage of homebuilding revenue, SG&A improved 80 basis points to 9.6%, compared to 10.4% in the prior year quarter, as our revenue increase improved our leverage of fixed overhead cost.

We remain focused on controlling our SG&A, while ensuring that our infrastructure adequately supports our current and expected growth.

Jessica?

Jessica Hansen - Vice President of Investor Relations

Financial Services pre-tax income in the second quarter was $17.4 million, compared to $21.5 million in the year-ago quarter. 94% of our mortgage company's loan originations during the quarter related to homes closed by our homebuilding operations, and our mortgage company handled the financing for 53% of our homebuyers. FHA and VA loans accounted for 48% of the mortgage company's volume compared to 45% in the year-ago quarter. Borrowers originating loans with our mortgage company this quarter had an average FICO score of 717 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 second quarter last year. Bill?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

At the end of March, we had 24,600 homes in inventory, of which 1,600 were models. 11,700 of our total homes were spec homes, with 8,400 in various stages of construction and 3,300 completed. Our construction in progress and finished homes inventory increased by $361 million during the quarter due to seasonal construction activity for the spring selling season.

Our second-quarter investments in lots, land and development totaled $500 million, of which $271 million was to replenish finished lots and land, and $229 million was for land development. We expect our investments in land and development to increase in the third and fourth quarters compared to the second quarter this year. David?

David V. Auld - President & Chief Executive Officer

At March 31, 2016, our land and lot portfolio consisted of 189,000 lots, of which 112,000 are owned and 77,000 are controlled through option contracts. 69,000 of our total lots are finished, of which 31,000 are owned and 38,000 are optioned. Our 189,000 total lots owned and controlled provide us a strong competitive advantage in the current housing market, with a sufficient lot supply to support solid growth in sales and closings in future periods.

Although our housing inventories will fluctuate as we manage each of our communities to optimize returns, we expect our land and lot inventories to remain relatively stable in 2016. We also expect to generate positive cash flows from operations for the second consecutive year through increased profitability and disciplined inventory management. During the six months ended March, we generated $27 million of operating cash, an improvement of $196 million, compared to the same period last year.

Bill?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

During the second quarter, we recorded $2.8 million in land option charges for write-offs of earnest money deposits and due diligence costs for projects that we do not intend to pursue. We also recorded a $3.2 million inventory impairment charge in our East region related to a long-held, inactive land parcel that we sold during the quarter. We will continue to evaluate our inventories for potential impairment which may result in future charges, but the timing and magnitude of these charges will fluctuate.

Our inactive land held for development of $194 million at the end of the quarter represents 10,100 lots, down 22% from a year ago. We continue to work through each of our remaining inactive land parcels to improve cash flows and returns, and we expect that our land held for development will continue to decline.

Mike?

Michael J. Murray - Chief Operating Officer & Executive Vice President

At March 31, our homebuilding liquidity included $1.2 billion unrestricted homebuilding cash and $884 million of available capacity on our revolving credit facility. Our gross homebuilding leverage ratio improved 580 basis points from a year ago to 33.6%.

The balance of our public notes outstanding at March 31 was $3.2 million. On April 15, we repaid $373 million of senior notes at their maturity and we have no debt maturities in the next 12 months. At March 31, our shareholders' equity was $6.2 billion and book value per share was $16.85, up 14% from a year ago.

Jessica?

Jessica Hansen - Vice President of Investor Relations

We are updating our expectations for our fiscal 2016 profitability based on current housing market conditions and our financial performance to date this year. As we noted in our press release this morning, we're increasing our annual guidance for consolidated pre-tax profit margin by 20 basis points to a range of 10.7% to 11.2% for fiscal 2016. We are also updating our annual guidance for homebuilding SG&A to a range of 9% to 9.2% of homebuilding revenues from the previous range of 9.2% to 9.4%.

Also as outlined in our press release this morning, we are reaffirming our previously issued guidance for fiscal 2016 as follows: Consolidated revenues of between $12 billion and $12.5 billion, homes closed between 39,500 and 41,500 homes, our home sales gross margin for the full year of 2016 in the high 19% to 20%, and annual Financial Services pre-tax profit margin of 30% to 33%, and income tax rate for the full year of between 35% and 36%, and annual diluted share count of approximately 375 million shares and $300 million to $500 million of positive cash flow from operations for fiscal 2016.

Specifically, for the third quarter of fiscal 2016, we expect our number of homes closed will approximate a beginning backlog conversion rate in a range of 76% to 80%. We anticipate our third quarter home sales gross margin will be in a high 19% to 20% consistent with the first half of the year, and we expect our homebuilding SG&A in the third quarter to be in a range of 8.9% to 9.1% of homebuilding revenues. David?

David V. Auld - President & Chief Executive Officer

In closing, our second 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 our operating platform. We remain excited and are looking forward to the opportunities ahead.

We remain focused on growing both our revenue and pre-tax profits at a double-digit annual pace, while continuing to generate positive 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 offerings across our D.R. Horton, Emerald and Express brands; attractive finished lot and land position; and most importantly, our tremendous team across the country.

We would like to thank our entire D.R. Horton team for their continued hard work, and we look forward to working together to continue growing and improving our operation. Let's keep the momentum going week-by-week, flag-by-flag throughout this year.

This concludes our prepared remarks. We will now hold questions.

Question-and-Answer Session

Operator

Thank you. Our first question today is coming from Stephen East from Evercore ISI. Please proceed with your question.

Paul Przybylski - Evercore ISI

Thank you. This is actually Paul Przybylski on for Stephen. I'm impressed with the first half cash flow generation given that's typically a period of heavy spend. What's the sustainability of that going out? I know you're looking for the $300 million to $500 million for the year. But should we expect first half cash generation in out-years?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Yeah. That's hard to say in future years, Paul. For this year, we are on track based on our current plans for fiscal 2016 to generate $300 million to $500 million for the full year. We would not be surprised that in Q3, we used cash because we are building out our backlog, building out our homes and construction. And as we stated, we do expect our land and lot investments to be higher in Q3 and Q4 than it was this quarter, but we are on track of $300 million to $500 million. And then our expectations for future year is our business model is designed to continue to generate positive cash flows from operations while growing at a double-digit pace and exactly what level that might be in each year will determine as we get better visibility into the year.

Paul Przybylski - Evercore ISI

Okay. And then for follow-up, I've heard rumblings that you're looking at expanding not so much to Express name, but the Express business model to higher price points, basically, everything is included. Do you have any color on that?

David V. Auld - President & Chief Executive Officer

Well, we're learning a lot with the Express rollout that efficiency and value is a big time driver in sales, and yes, I mean as we create operational efficiencies in Express to translate into the D.R. Horton. We are moving that way. Now, we will always be a locally controlled business. I mean, we're decentralized. Our operators in the field will respond to the market. And if it is a value-based market, they're going to have to drive more efficient homes. If it is a custom-based price point, then we're going to continue to modify our plans and introduce plans at the local level.

Paul Przybylski - Evercore ISI

Okay. Thank you. Appreciate it.

Operator

Thank you. Our next question is coming from Ken Zener from KeyBanc Capital Markets. Please proceed with your question.

Kenneth R. Zener - KeyBanc Capital Markets, Inc.

Good morning.

Michael J. Murray - Chief Operating Officer & Executive Vice President

Good morning.

Jessica Hansen - Vice President of Investor Relations

Good morning, Ken.

Kenneth R. Zener - KeyBanc Capital Markets, Inc.

I wonder not to get too specific in particular markets, but it's useful to the Express Home where I think you guys have opened up five or six new Express communities. Can you talk about the kind of trends you're seeing in Denver as the existing home sales tighten up there, either due to lack of supply? I mean, you guys seem to be growing whereas others are not seeing that type of acceleration. Could you kind of give us a little market dynamic on how that product and that market is working?

Michael J. Murray - Chief Operating Officer & Executive Vice President

I think we opened up Express in Denver over the past year. The team up there has done a great job getting that online. And it shows that there is a real need for affordable housing in that market, and we're delivering a value product to the market. And it's just being absorbed, and people are very happy with it. We're very happy we can do it and looking forward to try to do more of it.

David V. Auld - President & Chief Executive Officer

And, Ken, it's not consistent with what we've seen in other markets, a lot of pent-up demand when we opened. Absorptions, they've come in higher than we expected. So, it's a powerful tool in what we're accomplishing.

Jessica Hansen - Vice President of Investor Relations

We're in 51 markets...

Michael J. Murray - Chief Operating Officer & Executive Vice President

To the extent...

Jessica Hansen - Vice President of Investor Relations

Sorry, Ken. We're in 51 markets and 17 states today, so we're continuing to see that expansion as we move throughout the year.

Kenneth R. Zener - KeyBanc Capital Markets, Inc.

Right. And then, I guess, relative to the idea of pace, the idea of pace and price, I'm not a big fan of that notion. But, I mean, are you constraining your pace? Or you're really accepting as many sales as will lock in the door? Can you describe that dynamic broadly speaking? Thank you.

David V. Auld - President & Chief Executive Officer

Ken, we've been trying and successfully setting absorption targets on communities based upon what we think is a sustainable demand in a submarket. And we are building and selling to their pace.

Operator

Thank you. Our next question is coming from Alan Ratner from Zelman & Associates. Please proceed with your question.

Alan Ratner - Zelman & Associates

Hey guys, good morning. Congrats on another strong quarter.

David V. Auld - President & Chief Executive Officer

Thank you.

Alan Ratner - Zelman & Associates

David, I guess on the price point conversation, obviously you guys have done a great job with Express and I think that at least in the investment community, there is this perception that entry-level is accelerating nicely whereas the – maybe the higher-end luxury segment is seeing some softness. And you guys have been expanding Emerald as well. I don't think it's as much of a topic of conversation. But I was wondering if you can give some updated color on the luxury and how that compares to the obviously, the strength you've been seeing in Express? And how you think about allocating dollars going forward between the segments?

David V. Auld - President & Chief Executive Officer

Well, from a – The allocation to dollars, we – it's a market-by-market program. The markets where the upper end is is continuing to stay strong. We will be putting more money on it, but what's really driving the growth right now and the improvement in returns is the lower end, either Express or the lower Horton pricing.

Alan Ratner - Zelman & Associates

And would that be true on the margin side as well because obviously, I think you probably go into it thinking that Express is going to generate a lower margin, but it seems like the pricing power has been stronger there. So, what does the spread look like between the Emerald and the Express brands right now?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Right now it's in a pretty tight range. Both are very near our company average. Obviously, with the pent-up demand in Express and really not enough supply out there, we've seen better margins than we originally underwrote the deals to. So, right now it's in a pretty tight range.

Alan Ratner - Zelman & Associates

Great. Thanks a lot. And if I could sneak in one more. Just on the land supply, a pretty big spike in option lots this quarter if I heard that number correctly. And I think you're looking at over 40% to your control lots are option right now. Just curious what you're seeing in the land market that's allowing you to pursue that strategy? Obviously, it ties into your focus on cash generation, but is that a function or there's more AD&C capital available to the developers? Or something else that you've been focusing on to drive that number higher?

Michael J. Murray - Chief Operating Officer & Executive Vice President

I think, we've been focusing heavily on developer relationships and working with them where we can. There's also a little bit of a timing functionality to that. And that – it can be very high in the middle of the quarter, come down a little bit as you're buying land or lots through the quarter. And at this quarter end, we had a little bit more than we might have been prior quarter ends. But it has been a focus for us. We're pleased with the results we're getting and being able to control more of our future lot supply with options and with developers. And we're going to continue to focus on it. You're right, it is a key part of our cash generation strategy. And we're very excited about the results we've seen.

David V. Auld - President & Chief Executive Officer

But, no, we're not really seeing the A&D environment with the banks improved much. This is really the result of taking the very best of the best developers and trying to improve our relationships with them.

Alan Ratner - Zelman & Associates

Got it. Thanks a lot and good luck.

Operator

Thank you. Our next question is coming from Eric Bosshard from Cleveland Research Company. Please proceed with your question.

Eric Bosshard - Cleveland Research Co. LLC

Curious about the strategy moving forward of growing community counts and then also looking at your growth relative to the market in total. Last year, you grew faster than the market really rolling out Express. But if you look at where demand is and where trends are in the market. Just curious about how you think about investing in growing communities and accelerating growth, how are you feeling about that?

David V. Auld - President & Chief Executive Officer

Well, we're in 51 markets right now with Express. So, we have, I think, runway there. We are relatively new with the Express brand in another 15, 20 markets that we think we can certainly gain market share in those markets. We're pretty much tracking job growth, and where the economy is supporting housing, that's where we're looking to expand our investment.

Eric Bosshard - Cleveland Research Co. LLC

In terms of the pace of the overall growth, are you satisfied with what you're seeing? Is there a desire to invest more to grow faster, or is this kind of what you're targeting and what you would like to sustain?

David V. Auld - President & Chief Executive Officer

We planned a solid, consistent double-digit growth both top line, bottom line. We'll continue to create separation from other builders in the industry. And today, we're very happy with that strategy.

Jessica Hansen - Vice President of Investor Relations

And we believe our current lot position is sufficient to support that double-digit growth pace.

Eric Bosshard - Cleveland Research Co. LLC

Okay. Perfect. Thank you.

Operator

Thank you. Our next question is coming from Nishu Sood from Deutsche Bank. Please proceed with your question.

Nishu Sood - Deutsche Bank Securities, Inc.

Thank you. This quarter, you had a terrific SG&A performance. So, just market improvement, just on trend and over last year. Your gross margins have also been very consistent here, only taking up your pre-tax range by about 20 basis points. So, just wanted to make sure I understood that. Does that mean that there were some temporary factors that may have depressed SG&A? Why would you expect seemingly the terrific performance to reverse, or is it something on the gross margins side for the rest of the year?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Nishu, we didn't see anything unusual this quarter. We did deliver a strong backlog conversion. We delivered a little bit above our guidance range on our closings this quarter, and that helped leverage our SG&A a bit further, but we were very pleased with the leverage we saw on SG&A and we're tracking to a better pace, a better ratio for the year than we had originally guided to. We were guiding to some improvement in SG&A. Now, it's simply showing some better improvement on that.

And certainly, as we get further into the year and depending on what our deliveries are later in the year, there is potential we could leverage it a bit better than what we have guided to here. If we were to be at the high end of our volume range, then perhaps we have a chance of beating the low end of our leverage range, our SG&A leverage range. But right now, we're comfortable with the range we've guided to. Nothing unusual, no declining or degradation in our SG&A performance is expected.

Nishu Sood - Deutsche Bank Securities, Inc.

Got it. And kind of following-up on Alan's question from earlier. You folks as well as many of the other builders have been scaling back the land purchases; Alan discussed obviously the increased use of options. I was just wondering with the step back that many of the builders including yourselves have taken, have you seen pricing these – the options would argue that that's a little bit easier to get terms like option takedowns, but what are you seeing in terms of the availability and pricing of deals as the stepping back of the public eased, the land price pressures that have been discussed so much in the last couple of years?

Michael J. Murray - Chief Operating Officer & Executive Vice President

Nishu, we're looking to continue our land investment. In fact, we'll be increasing our investment this year over what we did last year, just to replenish lots and then probably a little more to bring it up a little bit. We did see an increase in our option lot position in the controlled pipeline. Some of that will be land we will purchase that's represented as option lots. That's land that's controlled under contracts that we will purchase as land and do the development ourselves.

Other contracts within that portfolio would be – where we will be acquiring finished lots or super pads if you will, in some cases, from third-party developers. But we feel that there are still very good opportunities out there for land acquisition, for well-capitalized builders and for well-capitalized developers to work through. It's hard to quantitatively look and say what's happening with land pricing globally. I would tell you it seems like we're getting anecdotally a second look at a few more deals and things seem to come back around, which is just good for us. We like that.

Nishu Sood - Deutsche Bank Securities, Inc.

Great. Thanks. Appreciate the color.

Operator

Thank you. Our next question today is coming from Stephen Kim from Barclays. Please proceed with your question.

Stephen S. Kim - Barclays Capital, Inc.

Thanks very much, guys. Let me add my congratulations on the strong quarter.

Michael J. Murray - Chief Operating Officer & Executive Vice President

Thank you, Steve.

Stephen S. Kim - Barclays Capital, Inc.

And just a remark that your SG&A, if you actually do do a little better than your range, that's like, I think if I'm not mistaken that's an all-time record for the company. So that's pretty encouraging.

I guess my first question relates to M&A and the opportunity for it. Obviously, there's been, and there still is, a pretty big disparity in valuations between the large and small builders and you all are pretty much leading the pack. I guess my question is, do you see this kind of disparity mirrored in the private market? And particularly where some of the smaller cap publics are trading at book value or below, I mean are you seeing that kind of valuation mirrored in the private marketing expectations? And can you talk about whether or not you think this generally is the right time where you'd be amenable to acquiring assets in that kind of way M&A, given the fact that your strategic focus is on reducing your land investment relative to your revenues right now? Thanks.

Michael J. Murray - Chief Operating Officer & Executive Vice President

We are – you're correct, Stephen, we do have a strategic focus to improve our ratio of revenue to our land investment today; always looking to do that. That makes us a better steward to the capital that we're entrusted with. We do look at M&A as an opportunity to acquire lots, acquire assets and acquire people and operating platforms and teams. And we do look at several opportunities. They can be very good if buyer and seller expectations are aligned and something can work that's accretive to both.

will always be looking at M&A opportunities to grow the business. But there's a lot of expectation gaps sometimes within what some people think what their platform should fetch and what the buyers are willing to actually to transact for. So there's not been as many transactions I think that some people expected to occur.

David V. Auld - President & Chief Executive Officer

Stephen, this is David. I'll also add, we're going to look at lot. Anybody out there we're going to take a look at and try to see if they fit culturally, strategically within our company. But it's got to be a very good company for it to make sense to us. We like where we are, we like what we're accomplishing. And we really don't want to jump out there and do anything that's going to break that focus.

Stephen S. Kim - Barclays Capital, Inc.

Okay. Fair enough. Yeah. Good luck finding another company as strong as you guys are though.

Michael J. Murray - Chief Operating Officer & Executive Vice President

They're there.

David V. Auld - President & Chief Executive Officer

They're there. There are some small operators or even midsized operators that are doing a great job. I mean, if you look back at the four acquisitions we've made, we have learned to become better with every one of those.

Stephen S. Kim - Barclays Capital, Inc.

Sure. Yeah. That's fair comment.

David V. Auld - President & Chief Executive Officer

We take what they're doing good and integrate it into our company.

Stephen S. Kim - Barclays Capital, Inc.

Great. I guess my second question relates to the role of master planned communities and some of the opportunities that those larger parcels could potentially provide for you. I was wondering if you could give us some handle on what percent of your business you think is coming from master planned communities today, and where you think that could go to?

And as a follow-on to that, would you generally think that in some of these larger parcels, you have the ability to maybe take on a little bit of multifamily construction or even like commercial opportunities longer term?

David V. Auld - President & Chief Executive Officer

The master planned, I'd say, is probably 10%, 15% of our business, and that's just a guess, really. It's not something we've broken down. And, yes, I think as we get bigger, or continue to get bigger, that percentage is going to grow. It's just a lot more efficient to deliver more houses at one location than it is in multiple locations.

Jessica Hansen - Vice President of Investor Relations

And then, Steve, as you know we always investigate new business lines, if they could complement our business. And so, we have built for rent on land we own on a limited basis when it makes business sense. And we do currently own a few large projects with parcels that are zoned multi-family that we're evaluating or in the process of building apartments on. But we wouldn't expect that to have any financial impact on our 2016 results.

Stephen S. Kim - Barclays Capital, Inc.

Fair enough. Thanks very much, guys. Good job.

David V. Auld - President & Chief Executive Officer

Thank you.

Operator

Thank you. Our next question today comes from Bob Wetenhall from RBC. Please proceed with your question.

Robert Wetenhall - RBC Capital Markets LLC

Hey, you guys are crushing a nice job.

David V. Auld - President & Chief Executive Officer

Thanks, Bob.

Jessica Hansen - Vice President of Investor Relations

Thanks, Bob.

Michael J. Murray - Chief Operating Officer & Executive Vice President

Thank you, Bob.

Robert Wetenhall - RBC Capital Markets LLC

That's a technical term. Talk to me about ASP appreciation during the balance of the year. How do you think that plays out? What kind of growth rates should we be expecting? And I'm really think about this in the context of not including mix. If you took like-for-like and you blend it together, what do you see going on in the next couple of quarters?

Jessica Hansen - Vice President of Investor Relations

We would expect to continue to see a few, if you're looking like-for-like, some ability to move price up. We've continued to see our revenues per square foot outpaced our second brick per square foot now once we got back in track a couple of quarters ago. So, very positive on that front and definitely feel the ability to push price.

In terms of our overall ASP, we did see on our sales front that really kind of flatten out sequentially, which isn't surprising because of the heavier mix that continues to come from Express.

Robert Wetenhall - RBC Capital Markets LLC

Got it. But you're still getting the operating leverage off that which offsets the weaker mix. But if you had to stay, like, on a like-for-like basis, would you expect low-single digit or mid-single digit?

Jessica Hansen - Vice President of Investor Relations

Yes, low-single digits.

Robert Wetenhall - RBC Capital Markets LLC

All right. That's helpful. And then just kind of thinking about like Texas and California, some of your major markets where you are a leader. Would you say that the trends that you saw this quarter were in line with your expectations a couple of months ago? Or would you say that in your core most important markets that demand is stronger and better than you had anticipated? Just trying to understand a little bit better if you're gauging strength of demand in your most important markets, is it coming out ahead of your expectations? Thanks and good luck.

David V. Auld - President & Chief Executive Officer

Thank you, Bob. Kind of a mix like Texas, at least in my mind. Houston is probably underperformed my expectations over the last couple of quarters, but it's been offset by an overperform in Austin, Dallas, and Fort Worth and San Antonio. I mean, the balance of the state is doing incredibly well and...

Michael J. Murray - Chief Operating Officer & Executive Vice President

Overall we expected a good spring and we're seeing a good spring. Overall, I think it's in-line with our expectations for a good solid, consistent moderately growing market with variations from market to market.

Jessica Hansen - Vice President of Investor Relations

Our absorption to picked up the most in the South East and South Central regions, which is what you've heard us say really kind of Texas across the Florida and up into the Carolina is a big piece to our business that we expect to be very robust. And we've seen a very good level of demand in those markets and a good return on our inventory investments.

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Bob, we do have very high expectations at all time. And we are pleased with where the results of the spring have come out and really across the board and all of our markets.

Robert Wetenhall - RBC Capital Markets LLC

Great execution, guys. You're killing it. Good luck next quarter.

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Thank you.

Michael J. Murray - Chief Operating Officer & Executive Vice President

Thank you, Bob.

Operator

Thank you. Our next question is coming from Michael Rehaut from JPMorgan. Please proceed with your question.

Michael Jason Rehaut - JPMorgan Securities LLC

Thanks. Good morning, everyone, and I'll add my congrats on the quarter as well. First question, just on the sales pace, continued expansion there, we have it roughly up 8%, just want to make sure in terms of the drivers there, seems like primarily that's due to the continued expansion of Express as part of your business. I just want to make sure that, that's still is the case in effect and would you expect – it seems like there's still more room to go. Was that something that you would expect to continue to benefit your results even into fiscal 2017.

David V. Auld - President & Chief Executive Officer

Yes. I mean, I would say fully rolled out in Texas, Carolinas on the Express model, still got room to grow in all of the other markets. So, I think we got benefit from that brand and that initiative for this year, next year and the year after that, but we're fully integrated, fully rolled out.

Michael Jason Rehaut - JPMorgan Securities LLC

And just is it fair to say that that's really the, let's say, biggest driver of the improvement in your overall sales pace as reported this quarter?

David V. Auld - President & Chief Executive Officer

Actually, it is a major contributor. The other brands are doing well also, but there's just a whole lot less competition at that entry level.

Michael Jason Rehaut - JPMorgan Securities LLC

Right.

David V. Auld - President & Chief Executive Officer

And therefore, more pent-up demand, and it's easier to drive absorption.

Michael Jason Rehaut - JPMorgan Securities LLC

Right. Right. Now, certainly. I guess second question just on the improved SG&A guidance that you rolled out this quarter that helps your pre-tax by 20 bps. Now, you've expanded that guidance. Given that you still kind of have similar expectations on the units and it seems like the ASPs, it would suggest that you're not necessarily expecting better – that the improved leverage has been coming off of improved volumes per se, and it seems like Express and your overall, again top line seems to be coming in as expected.

So, are there other things in the SG&A line item that's helping here in terms of kind of concrete items around perhaps advertising or other types of SG&A controllables that are coming in better than expected, or is this just the overall model. In effect, just the overall efficiency just being that much better even with the same type of closings that you expected three months ago?

Jessica Hansen - Vice President of Investor Relations

Mike, it's really just a result of our overall focus on SG&A. It's not any one thing. It's always been a hallmark of our business. It's something we're very focused on. We set a 9.6% SG&A in fiscal 2015 which was the best SG&A we've had other than two years in the company's history when we had a 9% handle as well. And we've now guided to 9.0% to 9.2%. And I'll just say, it is a focus and something that all of our guys in the field are looking at. It's how can we run the business more efficiently and leverage our overhead better than we have in the past.

David V. Auld - President & Chief Executive Officer

Michael, this is David. We get up every day and try to figure out how to make it a little bit easier to build a house, a little bit easier to sell a house, and a little bit easier to get the house closed. And we work on that every single day, because that is a sustainable, competitive advantage. And that is – that's what we try to be.

Michael Jason Rehaut - JPMorgan Securities LLC

No. That's great. And obviously it's great to see as the recovery continues. One last quick question if I could. Community count now flattish for about four quarters. Is that something that you would expect to reaccelerate at some point maybe into the mid-single digit or high-single digit growth into next year? Or should we just continue to expect sales pace over the next couple of years to drive the bus?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Mike, for this year, we stated we expect our community count to be in kind of that low-single digit or relatively flat this year with the improvement in sales coming from improved absorptions. And certainly, the Express rollout is a driver of that. I think it will continue to be a driver next year. As Express matures, if you're looking over the next year or two, you would naturally expect to grow at the double-digit pace. You would see a stronger community count growth over the longer term. We don't really have the visibility fully for 2017 yet to make any specific comments on that, though.

David V. Auld - President & Chief Executive Officer

Right now, Michael, we're replacing communities every quarter every month. And when you create a community that's driving an absorption level of two or three or a new community that's on an Express model that's driving six or eight. Flat community count. There's a lot of efficiencies and absorption improvement. So, yes, but over time, we will be expanding our community count that lead to market.

Michael Jason Rehaut - JPMorgan Securities LLC

Great. Very helpful. Thanks again.

Operator

Thank you. Our next question is coming from Jack Micenko from SIG. Please proceed with your question.

Jack Micenko - Susquehanna Financial Group LLLP

Hi. Good morning.

Jessica Hansen - Vice President of Investor Relations

Good morning, Jack.

Jack Micenko - Susquehanna Financial Group LLLP

Good morning. Hey, first question for Bill, you're generating a ton of cash. It sounds like that trend is going to continue in the next year and years beyond. Your leverage levels are getting to the lower end of, I think, probably optimal. Your land strategy has changed a bit. And it sounds like you're going to kind of keep it about the same point even though the mix is going to change from an absolute level. I guess the question is, what do you do with the cash? I know in the past, there have been share repurchase. There's been debt repurchase. What do we think about longer-term goals with the cash beyond sort of second half spend, that sort of thing around capital management?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Certainly, this year, Jack, we're generating $300 million to $500 million, and we're to paying off over $500 million of debt this year. So, for fiscal 2016, essentially, debt retirement and continuing to invest in the business. We do continue to look at M&A opportunities, we've done several deals over the last several years, and to the extent that we see good deals that are a good fit for us as we described earlier. That will be a priority as well.

And then beyond that, we want to stay opportunistic. And so, we're not going to tie ourselves down to anything specific beyond this year, but right now, we're focused on debt retirement, being opportunistic investing in the business, and then we'll assess further as we get visibility into 2017.

Jack Micenko - Susquehanna Financial Group LLLP

Okay. And then my follow-up question, through our travels, I think one of the things that we've seen is the Express-type product is appealing to a buyer group maybe beyond the entry or first-time buyer. Really, we're surprised that the trade down empty-nester, everybody think of the active adult is maybe at mid to upper-end product, but we're seeing a lot in the lower price points as well.

Are you seeing that a meaningful way? Has it changed the trajectory or the direction of the rollout of the Express product, or maybe even location? What can you share with us about that dynamic?

David V. Auld - President & Chief Executive Officer

I wouldn't say that it's changed the direction. We have seen that take place especially on Florida, it surprised me as well, or when we launched Express in Florida, 40%, 45% were actually the people buying their last home, not their first home. And that's something we're taking note of, and making sure that we're in a position to accommodate those buyers.

Jack Micenko - Susquehanna Financial Group LLLP

Okay. Thanks.

Operator

Thank you. Our next question is coming from Susan Maklari from UBS. Please proceed with your question.

Susan M. Maklari - UBS Securities LLC

Thank you. Good morning.

David V. Auld - President & Chief Executive Officer

Good morning.

Susan M. Maklari - UBS Securities LLC

My first question is just going back to your third quarter guidance in terms of the conversion rate, I believe you said 76% to 80%. That just feels a little light relative to where we were modeling our expectations. Would you say that you saw any pull-forward in demand in the second quarter, perhaps maybe due to the overall better weather that most of the country saw?

Jessica Hansen - Vice President of Investor Relations

You know, Sue, not necessarily that we're attributing it to better weather. But our operators did convert their backlog at a higher rate than we anticipated and then what we've told you for Q2. When we look at our business plan for Q3, which we're expecting to deliver on, it's right in the heart of that 76% to 80% range that we've guided to for Q3.

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Yeah. The timing of the deliveries through the year is a function of really the roll up of all of our communities and the timing of when communities come online and when housing starts gets started. And right now, the way it's rolling up division-by-division points to that range, but still for the year points to the same range we gave at the start of the year.

Jessica Hansen - Vice President of Investor Relations

And historically, we typically do see a tick down in our conversion rate from Q2 to Q3. That's a normal seasonal trend for us.

Susan M. Maklari - UBS Securities LLC

Okay. And then looking at your spec levels, it seems like those are continuing to sort of trend down over time. Can you just talk a little bit about what's contributing to that and what should we make of that?

Michael J. Murray - Chief Operating Officer & Executive Vice President

I think we can contribute that there's a very strong demand in the marketplace right now. And that we are starting specs and getting them out there and getting them sold early in the construction process. And its – you've got to start more houses. And then, so you get those started and you get those sold. In addition, we're starting some houses to-be-built jobs as well. So our overall mix of build versus spec is staying the same, we're just seeing very strong demand in the marketplace. More efficient with turning of our homes is one of the key drivers of our cash flow generation. Doing more revenue, more closings with the same number of homes under construction at any point in time, a key part of our focus.

Susan M. Maklari - UBS Securities LLC

Okay. Thank you.

Operator

Thank you. Our next question is coming from Will Randow from Citigroup. Please proceed with your question.

Will Randow - Citigroup Global Markets, Inc. (Broker)

Hey. Good morning and congrats on the quarter.

David V. Auld - President & Chief Executive Officer

Thank you.

Will Randow - Citigroup Global Markets, Inc. (Broker)

Just going back to Susan's question. When you look at your current percentage of closings that are spec, could you talk about that? And how you feel going into, kind of, the peak construction period in regards to potential labor inflation and or delays?

Jessica Hansen - Vice President of Investor Relations

And so, in terms of our specs that we closed in the quarter, it was in our normal range, which is every quarter, 70% to 80% of what we're closing is a spec. And so, when you look at our reported gross margin, you're essentially seeing our spec gross margin. In terms of labor...?

Michael J. Murray - Chief Operating Officer & Executive Vice President

We're not seeing a tremendous amount of labor inflation. In fact, we've been able to stay ahead of the cost increases we've seen on stick and brick, which any cost increase that have come through have been more labor oriented versus the materials and the commodities today. But we haven't seen a tremendous amount of pressure. And in terms of shortages affecting delays, our cycle times have remained very consistent, and we've not had, as evidenced by our backlog conversion rate last quarter, we have not had a real labor constraint widespread that's affected closings.

David V. Auld - President & Chief Executive Officer

Again, as you drive higher absorption in a community-by-community basis, you take a lot of pressure off the trade base, because a lot of their time is just going from community to community. And if we can get them into the community and keep them there, they can make more money, a lot less pressure on pricing.

Will Randow - Citigroup Global Markets, Inc. (Broker)

And just as a follow-up, you mentioned your stick and brick costs are fairly stable. Is there any way you can parse down on the categories in terms of the movements, for example, lumber and how you think about that going through the year?

Jessica Hansen - Vice President of Investor Relations

In terms of overall, our revenue per square foot year-over-year was up about 4% and our stick and brick was up about 2.5%. Sequentially, it was closer to both being up about 1%. The majority of the cost inflation, as Mike mentioned, we continue to see is on the labor side not the material side. And so lumber specifically, I wouldn't say we've seen anything unusual in lumber prices. They tend to follow a seasonal trend, and we haven't seen anything unusual this year.

Will Randow - Citigroup Global Markets, Inc. (Broker)

Thank you, and congrats again.

David V. Auld - President & Chief Executive Officer

Thank you.

Michael J. Murray - Chief Operating Officer & Executive Vice President

Thank you.

Operator

Thank you. Our next question today is coming from John Lovallo from Merrill Lynch. Please proceed with your question.

John Lovallo - Merrill Lynch, Pierce, Fenner & Smith, Inc.

Thank you for taking the call, guys. First question, last quarter, I believe you mentioned not heavily reinvesting in Houston at this point, but kind of taking more of a replenishing strategy. Was that the case in the second quarter? And did anything happen in the quarter where you might have – might change that strategy going forward?

David V. Auld - President & Chief Executive Officer

No, that would still be the case in the second quarter. It may change in the future as we are positioned to take advantage of opportunistic buys. And as stress gets put on a market, sometimes that creates an opportunity for us.

John Lovallo - Merrill Lynch, Pierce, Fenner & Smith, Inc.

Okay. That's helpful. And then in terms of the cash flow guide, $300 million to $500 million, it's a fairly wide range. Can you just remind us what kind of drive the upper end of the range versus the lower end?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

It really comes down to our overall revenue volume, our closings volume. It would be – is the main driver. We expect that predominance of that cash flow to come in our fourth quarter when we have our largest closings quarter. And essentially then, the wide range is attributable to a little bit unpredictability on the timing of when land purchases will close. And so, as we get a little closer to the end of the year, we might be able to tighten that a bit. But, there is some unpredictability in the timing of when the land deals will close.

John Lovallo - Merrill Lynch, Pierce, Fenner & Smith, Inc.

Okay. Great. If I could sneak one housekeeping in here. The flat community count that you guys talked about, was that year-over-year or is that sequentially?

Jessica Hansen - Vice President of Investor Relations

Yeah. We mentioned that our year-over-year community count was essentially flat, and it was actually down slightly. And really when we look at that going forward, we would expect no more than a low single-digit movement. Either way, it could be up or down in a low single-digit percentage here over the next couple of quarters.

John Lovallo - Merrill Lynch, Pierce, Fenner & Smith, Inc.

Great. Thanks very much.

Operator

Thank you. Our next question today is coming from Mike Dahl from Credit Suisse. Please proceed with your question.

Michael G. Dahl - Credit Suisse Securities (USA) LLC (Broker)

Hi. Thanks for taking my questions and nice quarter.

David V. Auld - President & Chief Executive Officer

Thank you.

Michael G. Dahl - Credit Suisse Securities (USA) LLC (Broker)

Wanted to go back to some of the comments and obviously, a lot of questions and remarks about the Express side, but just from a – made a comment about just seeing a lot less competition there. And clearly, you've had a period of – number of quarters of success, competitors have taken notice. Feels like the market in general there's a more positive tone on the entry-level and some acknowledgement that it seems like that demand is pushing outward. And so, I'm just curious to hear your take on – we've kind of heard that some other builders are starting to explore similar things, maybe not quite the same. But as you're looking at new land deals, are you running up against more competition than you would have seen kind of 6, 9, 12 months ago? And how do you think they're positioned? Or what's the – what do you think that they're doing differently?

Michael J. Murray - Chief Operating Officer & Executive Vice President

We tend to focus a lot on what we're doing, and we do see some competition on the land front. It's constant out there, and it's market-by-market and it varies. What other things they do with their entry level, entrants, I've heard of others coming to market. There's some of it out there, but broadly we're not seeing widespread, heavy competition today with us flag-by-flag.

Certainly, in our pockets but there's more competition. But generally, we're not seeing it. How others tend to approach that market? That will be up to them. We're focused on providing a great value for the home buyer, and so our customer can be in their house. They can be in there at a good price they can afford and a place for their family.

But as entry level grows, we do expect more competition to come. And we're certainly prepared to deal with that is as it comes.

Michael G. Dahl - Credit Suisse Securities (USA) LLC (Broker)

Okay. Great. Thank you.

Operator

Thank you. Our next question today is coming from Jade Rahmani from KBW. Please proceed with your question.

Jade Rahmani - Keefe, Bruyette & Woods, Inc.

Yes. Hi. Thanks for taking my question. Just wanted to ask regarding leverage. At this point in the cycle, is your plan to retire near-term debt maturities as was indicated in the press release to reduce leverage? Or do you plan to eventually replace those maturities with similar-sized debt offerings?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

We always look at the debt markets, and we'll remain opportunistic there. There are certainly – it's a favorable market right now. But where we sit today with our cash position with our expectations for cash flows, we right now do not expect to be in the debt market in the short term. We have already paid off the $373 million that came due on April 15. We paid that out of cash. And we believe our cash position, our liquidity available on the revolver and our cash flows are sufficient for the remainder of the year as we sit here today.

Jade Rahmani - Keefe, Bruyette & Woods, Inc.

And just regarding other income, can you comment on what drove the spike in the second quarter?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Yeah. We did have – we sold an investment that we had in debt securities. It's been – You can look back in our 10-Qs, there's been a disclosure around that investment. We had some debt securities that we had acquired a while back that gave us access to some lands that we have now acquired the land and are actively developing it. And we were able to restructure those debt securities and resell them in the market. So, we had a gain on that sale of $4.5 million, which was an improvement in our other income line this quarter.

Jade Rahmani - Keefe, Bruyette & Woods, Inc.

Thanks. And just lastly, the capital markets uncertainty and spread widening that we've seen this year, you may have alluded to it on the land side, the second look you referred to, but have you noticed any impact on either the land market or sales trends due to the volatility? Thanks a lot.

Michael J. Murray - Chief Operating Officer & Executive Vice President

It's hard to attribute it to any one factor. Just the competitive environment, deal-by-deal is different. We are seeing a few more second looks, so that's been very positive for us.

Jade Rahmani - Keefe, Bruyette & Woods, Inc.

Thanks.

Bill W. Wheat - Chief Financial Officer & Executive Vice President

Thank you, Jade.

Operator

Thank you. Our next question today is coming from Jay McCanless from Sterne Agee. Please proceed with your question.

Jay McCanless - Sterne Agee

Good morning, everyone. First question, I know Houston is a smaller market for you, guys, but if you could update us on what's happening on the ground there? And what you think you're going to see in terms of delays for either labor or materials to get homes finished.

Jessica Hansen - Vice President of Investor Relations

Jay, it's business as usual. We're – we feel for the people and what they're going through in Houston right now with the horrendous flooding. But our operations are fine, and we don't expect any noticeable impact on our business in Houston. Clearly, the market has just softened due to the lower oil prices, but we continue to see very consistent, steady demand at price points below $300,000.

David V. Auld - President & Chief Executive Officer

We like the Houston market, big believers in that long term. And if it becomes – if we see an opportunity to buy something at a very advantageous price, we're going to be all over it.

Jay McCanless - Sterne Agee

Got it. The second question I had, there was a small order decline in the East geography this quarter. Could you talk about what's going on in that market?

Bill W. Wheat - Chief Financial Officer & Executive Vice President

The East for us is the Carolinas and North, so it's really more Northeast for us. And, yeah, we were down, I believe, 2% in sales units. Our community count in that region was actually down. So, our absorptions were actually up mid-single digits there. So really just reflects probably fewer investments over the last few years, manifesting itself with your communities.

David V. Auld - President & Chief Executive Officer

We're kind of going through a reset up in the Northeast. We like where we're headed. But it's not going to be a stellar performance this year.

Jay McCanless - Sterne Agee

Great. Thank you.

Operator

Thank you. We've reached the end of our question-and-answer session. I like to turn the floor back over to management for any further or closing comments.

David V. Auld - President & Chief Executive Officer

Thank you, Kevin. We appreciate everyone's time on the call today and look forward to speaking with you again in July to share our third quarter. But I'd also like to once again thank the entire D.R. Horton team. You are truly the best in the industry and your quarter-to-quarter consistent performance proves that out. Thank you.

Operator

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

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