D.R. Horton Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
November 9, 2022

There are 14 speakers on the call.

Operator

Morning, and welcome to the Q4 2022 Earnings Conference Call for D. R. Horton, America's builder, the largest builder in the United States. At this time, all participants have been placed on a listen only mode, and we will open the floor for your questions and comments after the presentation. On your telephone keypad to enter the queue.

Operator

I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D. R. Horton. Jessica, the floor is yours.

Speaker 1

Thank you, Tom, and good morning. Welcome to our call to discuss our Q4 fiscal 2022 financial results. Before we get started, today's call includes forward looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Speaker 2

Although D.

Speaker 1

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.

Speaker 1

R. Horton does not undertake any obligation to publicly update or revise any forward looking statements. Additional information about factors that could lead to material changes in performance is contained in D. R. Horton's annual report on Form 10 ks and subsequent reports on Form 10 Q, all of which are filed with the Securities and Exchange Commission.

Speaker 1

This morning's earnings release can be found on our Web site at investor. Drhorton.com and we plan to file our 10 ks towards the end of next week. After this call, we will post updated investor and supplementary

Speaker 2

Thank you, Jessica, and good morning. We are also joined on this call by Mike Murray and Paul Romanowski, our Executive Vice Presidents and Co Chief Operating Officers and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D. R. Horton team finished the year with a solid 4th quarter, which included a 20% increase in consolidated pretax income to $2,100,000,000 and a 19% increase in revenues to $9,600,000,000 Our pre tax profit margin for the quarter improved 10 basis points to 21.4% and our earnings per diluted share increased 26% to $4.67 For the year, consolidated pretax income increased 42% to $7,600,000,000 on $33,500,000,000 of revenue, which increased 21%.

Speaker 2

Our pre tax profit margin for the year improved 3 50 basis points to 22.8 percent and our earnings per diluted share increased 45% to $16.51 We closed a record 83,500 18 homes this year in our homebuilding and single family rental operations and our homebuilding SG and A as a percentage of revenues of 6.8% was an all time low. Our homebody return on inventory for the year was 42.8% and our consolidated return on equity was 34.5%. Our strong financial performance during the year of significant challenges and volatility reflects the strength of our experienced teams, industry leading market share, broad geographic footprint and diverse product offerings. Our homebuilding cash flow from operations for 2022 was $1,900,000,000 Over the past 5 years, we have generated $7,500,000,000 cash flow from homebuilding operations, while growing our consolidated revenues by 138 And our earnings per share by 503%. During this time, we also more than doubled our book value per share, Consistently kept our homebuilding leverage under 20% and increased our homebuilding liquidity by $1,800,000,000 all while significantly increasing our returns on inventory and effort.

Speaker 2

During most of the year, demand for our homes was strong. In June, we began to see a moderation in housing demand that has continued and accelerated through today. The rapid rise in mortgage rates coupled with high inflation and general economic uncertainty have made many buyers pause in their home buying decision or choose to not move forward with their home purchase. However, the supply of both new and resale homes at affordable price points remains limited and the demographics supporting housing demand remain favorable. The uncertainty of this market transition may persists for some time and could get more challenging if mortgage rates continue increasing.

Speaker 2

However, we are well positioned to meet Changing market conditions with our experienced teams, affordable product offerings, flexible supply and great trade and supplier relationships. Our strong balance sheet, liquidity and low leverage provide us financial flexibility. We will continue to focus on turning our inventory and managing our product incentives, home pricing, sales pace and inventory levels to beat the market, optimize returns, increase market share and generate increased cash flow from our homebuilding operations. Mike?

Speaker 3

Diluted earnings per share for the Q4 of fiscal 20 percent to $4.67 per share and for the year earnings per share increased 45% to $16.51 Net income for the quarter increased 22 percent to $1,600,000,000 and for the year, net income increased 40% to $5,900,000,000 Our 4th quarter home sales revenues increased 23 percent to $9,400,000,000 on 23,212 homes closed, up from $7,600,000,000 on 21,937 homes closed in the prior year. Our average closing price for the quarter was 400 $3,700 up 17% from last year and up 3% sequentially. We closed fewer homes than we expected during the Q4 due to a slower sales pace, increased cancellations and continued construction delays. In addition, we estimate that approximately 730 home closings in Florida and South Carolina were delayed from September due to Hurricane EM. Paul?

Speaker 4

During the quarter, we continued to sell homes later in the construction cycle to better ensure the certainty of the home close date and mortgage rate for our homebuyers with almost no sales occurring prior to start of home construction. Our net sales orders in the 4th quarter decreased 15% to 13,582 homes and our net sales order value was down 10% from the prior year to $5,400,000,000 Our cancellation rate during the Q4 was 32% compared to 19% in the prior year quarter and 24% in the Q3. Our average number of active selling communities increased 8% from the prior year and was flat sequentially. The average sales price on net sales orders in the 4th quarter was $399,600 up 6% from the prior year, but down 4% sequentially from the June quarter. In October, as mortgage rates continued to increase, our net sales orders were below prior year levels and our cancellation rate remains elevated.

Speaker 4

As a result, we currently expect our Q1 net sales orders to be down approximately 25 to 35% year over year. Bill? Our gross profit margin on home sales revenue in the 4th quarter was 28.3%, up 140 basis points from the prior year quarter, but down 180 basis points sequentially from the June quarter. On a per square foot basis, our revenues were up 4% sequentially, while our stick and brick cost per square foot increased 8% and our lot cost increased 3%. The decrease in our gross margin from the 3rd to 4th quarter reflects the increase in our stick and brick cost and increased incentives provided to homebuyers to ensure the closings of our homes and backlog during the rapid rise in mortgage interest rates.

Speaker 4

We are offering mortgage interest rate locks and buy downs and other sales incentives to address affordability concerns and to drive traffic sales traffic to our communities. As we adjust to market conditions and focus on turning our inventory to maximize returns, our incentive levels have continued to increase and we are adjusting base home prices where necessary. We expect our average sales price and home sales gross margin to decrease from current levels in fiscal 2023. As a result, we are working with our trade partners and suppliers to reduce our construction costs on new home starts and are pleased with our early progress. Jessica?

Speaker 1

In the Q4, homebuilding SG and A expense as a percentage of revenues was 6.7%, down 20 basis points from 6.9% in the prior year quarter. For the year, Humboldtings SG and A expense was 6.8%, down 50 basis points from 7.3% in 2021. Our annual homebuilding SG and A expense as a percentage of revenues is at its lowest point in our history and we will continue to control our SG and A while ensuring that our platform adequately supports our business. In fiscal 2023, our homebuilding SG and A as a percentage of revenues will likely increase from current levels. Paul?

Speaker 4

We started fewer homes this quarter as we work to position our inventory with an appropriate number of homes relative to market conditions. We started 13,100 homes during the quarter in our homebuilding operations as we began negotiations to lower our construction costs on future new home starts. We ended the year with 46,400 homes in inventory, down 3% from a year ago and down 18% sequentially. 27,200 of our total homes at September 30 were unsold, of which 4,400 were completed. For homes we closed this quarter, our construction cycle time increased by a week compared to the 3rd quarter, which reflects continued lingering supply chain issues.

Speaker 4

However, we are beginning to see some stabilization in cycle times on homes we have recently started and we expect our cycle time to improve in fiscal 2023. We expect our starts pace in the Q1 of fiscal 2023 to increase versus our 4th quarter pace and we will adjust our starts in homes and inventory to meet the level of demand in the market. Mike?

Speaker 3

At September 30, our homebuilding lot position consisted of approximately 573,000 lots, of which 23% were owned and 77% were controlled through purchase contracts. Our total homebuilding lot position decreased by 25,000 lots from June to September. 29% of our total owned lots are finished and 50% of our controlled lots are or will be finished when we purchase Our capital efficient and flexible lot portfolio is a key to our strong competitive position. We continually underwrite all of our lot and land purchases based on current and expected home prices and costs. We are actively managing our lot and land pipeline and our investments in lots, Land and Development to meet our needs during this transition in the housing market.

Speaker 3

During the quarter, our Homebuilding segment wrote off $34,000,000 of option deposits and due diligence costs related to land and lot option contracts we terminated or expect to terminate in the future. We expect our level of option cost write outs to remain elevated in fiscal 2023 as we manage our lot portfolio. Our homebuilding segment had no inventory impairments during the quarter or the year. Our 4th quarter homebuilding investments in lots, Land and Development totaled $1,500,000,000 down 19% from the prior year quarter and down 15% sequentially. Our current quarter investments consisted of $780,000,000 for finished lots, dollars 560,000,000 for land development and $150,000,000 to acquire land.

Speaker 3

Paul?

Speaker 4

For the Q4, Forestar, our majority owned residential lot development company reported total revenues of $381,400,000 on 3,914 lots sold and pre tax income of $66,400,000 For the full year, Forestar delivered 17,691 lots, generating $1,500,000,000 of revenues with a pre tax profit margin of 15.5%. At September 30, Forestar's owned and controlled lot position was 90,100 lots. 59% of Forestar's own lots are under contract with D. R. Horton or subject to a right of first offer.

Speaker 4

$250,000,000 of D. R. Horton's lot purchases in the 4th quarter were from Forestar. Forestar is separately capitalized from D. R.

Speaker 4

Horton and had approximately $620,000,000 of liquidity at year end with a net debt to capital ratio of 26.9%. Forestar is well positioned to meet changing market conditions with a strong capitalization, lot supply and relationship with D. R. Horton. Bill?

Speaker 4

Financial Services pretax income in the Q4 was $2,400,000 on $134,000,000 of revenue with a pre tax profit margin of 1.8%. As expected, our Financial Services pre tax profit margin decreased this quarter, primarily due to a significant pull forward of revenue from rate lock commitments in the Q3 as we discussed on last quarter's call. Also during the Q4, there were increased competitive pressures in the mortgage market and increased costs of rate locks provided to customers due to rising rates. For the year, Financial Services pretax income was $291,000,000 on $795,000,000 of representing a 36.6 percent pre tax profit margin. We expect our Financial Services pre tax profit margin for fiscal 2023 to be higher than the Q4, but below the full year of fiscal 2022.

Speaker 4

During the Q4, 99% of our mortgage company's loan originations related to homes closed by our homebuilding operations and our mortgage company handled the financing for 73% of our homebuyers. FHA and VA loans accounted for 42% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 724 and an average loan to value ratio of 87%. First time homebuyers represented 57% of the closings handled by our mortgage company this quarter. Mike?

Speaker 3

During fiscal 2022, our rental operations generated $510,000,000 from the sale of 775 multifamily rental units and 774 single family rental homes, earning pretax income of $202,000,000 In the 4th quarter, our rental operations generated $21,000,000 of revenues from the sale of 96 single family rental homes and incurred a pre tax loss of $13,000,000 which were below our expectations going into the quarter. We had several single family rental projects in Florida totaling 5 62 homes that were scheduled to close in September, but were delayed due to Hurricane Ian. These projects closed in October and will be reflected in our Q1 results. Also, 1 multifamily project and multiple single family rental projects that were expected to be sold and closed in the Q4 were delayed due to changes in the capital markets that affected the timing of buyers financing. Our rental property inventory at September 30 was $2,600,000,000 which included approximately $900,000,000 of multifamily rental properties and $1,700,000,000 of single family rental properties.

Speaker 3

As a reminder, our multifamily and single family rental operating results are separately reported in our rental segment and are not included in our homebuilding segments, homes closed revenues or inventories. We expect our rental operations to generate significant increases in both revenues and profits in fiscal 2023 as our platform matures and expands across more markets. Bill?

Speaker 4

Our balanced capital approach focuses on being disciplined, flexible and opportunistic. We are committed to maintaining a strong balance sheet with low leverage and significant liquidity to provide a firm foundation for our operating platforms during changes in market conditions and to support our ability to provide consistent returns to our shareholders. During fiscal 2022, our cash provided by homebuilding operations was $1,900,000,000 and the cumulative cash generated from our homebuilding operations for the past 5 years was $7,500,000,000 At September 30, we had $4,000,000,000 of homebuilding liquidity consisting of $2,000,000,000 of unrestricted homebuilding cash and $2,000,000,000 of available capacity on our homebuilding revolving credit facility. Our liquidity provides significant flexibility to adjust to changing market conditions. Our homebuilding leverage was 13.2% at fiscal year end and homebuilding leverage net of cash was 4.4%.

Speaker 4

Our consolidated leverage at September 30 was 23.8% and consolidated leverage net of cash was 15.4%. We repaid $350,000,000 of senior notes at maturity this quarter and we have $700,000,000 of senior notes that mature during fiscal 20 23. At September 30, our stockholders' equity was $19,400,000,000 and book value per share was $56.39 up 35% from a year ago. For the year, our return on equity was 34.5%, an improvement of 290 basis points from 31.6 percent a year ago. During the quarter, we paid cash dividends of $78,200,000 for a total of $316,500,000 of dividends paid during the year.

Speaker 4

During the quarter, we repurchased 3,600,000 shares of common stock for $251,700,000 for a total of 14,000,000 shares repurchased during the year for $1,100,000,000 As a result, our outstanding share count is down 3% from a year ago. Based on our strong financial position, our Board of Directors increased our quarterly cash dividend by 11% to $0.25 per share. Jessica?

Speaker 1

As we look forward to the Q1 of fiscal 2023, we expect challenging market conditions to persist with continued uncertainty regarding mortgage rates, the capital markets and general economic conditions that may significantly impact our business. As we have already mentioned, we are utilizing more incentives in today's market and are reducing home sales prices where necessary, which will impact our average sales prices and gross margins more in the Q1 than the quarter we just completed. We are providing detailed guidance for the Q1 as is our standard practice, but due to the current uncertainty in the market, our ranges for expectations are wider than normal. We currently expect to generate consolidated revenues in our December quarter of $6,000,000,000 to $6,800,000,000 and our homes closed by our homebuilding operations to be in the range of 15,000 to 16,500 homes. We expect our home sales gross margin in the Q1 to be approximately 23% to 24% and homebuilding SG and A as a percentage of revenues in the Q1 to be approximately 8% to 8.4%.

Speaker 1

We anticipate a financial services pretax profit margin of around 20% and we expect our income tax rate to be approximately 23% in the Q1. Looking further out into fiscal 2023, we have less visibility due to the macro level uncertainties we have mentioned. It is too early to know what housing market conditions will be 3 to 6 months from now during the spring selling season, so we are not providing specific guidance for the full year yet. We will reassess each quarter and give more color on our expectations as we can. We are well positioned to aggregate market share in both our homebuilding and rental operations.

Speaker 1

Our fiscal 2023 home closings volume, Pricing and margins will be determined by future market conditions and our efforts to meet the market and improve our inventory turns, construction cycle times and costs. Our goal is to generate consolidated revenues in fiscal 2023 that are slightly higher than fiscal 2022. However, the low end of our current range of expectations includes consolidated revenues potentially down from fiscal 2022 by a mid teens percentage. We forecast an income tax rate for fiscal 2023 of approximately 23%. We expect to generate increased cash flow from our homebuilding operations in fiscal 2023 compared to fiscal 2022, and we plan to consistently repurchase shares to reduce our share count during the year with the amount of our repurchases dependent on cash flow, Liquidity, market conditions and our investment opportunities.

Speaker 1

We plan to continue to balance our cash flow utilization priorities among our core homebuilding operations, our rental operations, maintaining conservative homebuilding leverage and strong liquidity, Paying an increased dividend and consistently repurchasing shares. David? In closing, our results and position reflect our experienced team's Industry leading market share, broad geographic footprint and diverse product offerings.

Speaker 2

Our strong balance sheet, liquidity and low leverage provide us with significant financial flexibility to operate effectively in changing economic conditions and continuing to aggregate market share. We plan to maintain our disciplined approach to investing capital to enhance the long term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D. R. Horton team for your focus and hard work.

Speaker 2

Your efforts during 2022 were remarkable. This was a year in which we faced Structural and operational challenges we have never faced before with periods of unsustainably high demand followed by historic rise in mortgage rates. Despite these challenges and market volatility, we closed the most homes in a year in our company's history, completing our 21st year as the largest builder in the United States with record profits and returns and we are well positioned to continue improving our operations and providing homeownership opportunities to more American families in 2023. This concludes our prepared remarks. We will now host questions.

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. We do ask today that while asking your questions, you limit yourself to one question and one follow-up. And one follow-up. Please hold a moment while we poll for questions.

Operator

And the first question today is coming from Stephen Kim from Evercore ISI. Stephen, your line is live. Please go ahead.

Speaker 5

Thanks very much, guys, and thanks for all the information. Obviously, pretty solid performance in a tough environment. I wanted to ask you specifically about your starts outlook. Can you give us a sense for how much of an increase in starts we might expect in the December quarter, maybe year over year or quarter over quarter? And maybe alternatively, how many finished Specs or total specs per community, are you expecting to have as you enter the new calendar year?

Speaker 4

Stephen, looking into the Q1, we are finishing the year with 46,000 homes in inventory and positioned for our goals as we look forward to the year and looking to maintain a similar balance as we work through the So expect that our starts will keep pace with our closings through the Q1.

Speaker 5

Got you. And then, Paul Haim?

Speaker 4

Yes. In terms of the completed specs, Steve, we're in a more normal position now With having some completed specs across more of our communities that puts us in a good position to sell in the current environment given that buyers Are concerned about what their interest rates are going to be. So if we have homes that are ready to move into quickly, they can lock the rates with confidence and close on a known schedule.

Speaker 5

So the level of completed specs you have now is you're comfortable with sort of maintaining that level, right? That's what you're saying?

Speaker 4

Yes.

Speaker 5

Okay. And then the second question relates to your comments about navigating the difficult environment or the uncertain environment by managing your product The offerings and negotiating lower costs. Certainly the negotiation of lower costs, I understand that's going to be ongoing. But The managing of your product offerings, can you give us a sense for how quickly you're able to swap out models or at least floor plans that you're offering in your communities. Is that something that we could Expect you to do in communities that are currently open or are we really looking at communities that are going to be new communities opening up.

Speaker 5

Maybe give us a sense for like what share of the communities you will have open, let's say for the spring selling season, will have a revamped product line.

Speaker 3

In most of our communities across the country, Steve, we'll be able to start back smaller homes primarily and change specification levels in those homes that we start have been starting in the most recent quarter and will be starting In the Q1, there are some communities that are a little more locked in on product and planned neighborhood phases that it may take 3 to 6 months to work through some changes in the product offerings. But by and large, most of our communities, those changes are starting today and we'll continue to see that roll out through the next 6 to 9 months.

Speaker 2

Stephen, even with the product lines that we've been offering, As a spec builder, we release certain houses every month. And so when the market is running red hot like it was First half plus of last year, you have a tendency to release the bigger houses Because your net dollars for profit per house is higher. When a price point becomes Much more important to the buyers. We made the release, they go from the 2,300 Square Foot 2 Storey Down TO the 1600 Square Foot Ranch, which drops the overall ASP and that community Without really changing the product or impacting valuations within the community.

Speaker 5

Great. That's really helpful. Thanks so much guys.

Speaker 2

We control that by which houses we release into production.

Speaker 5

Yes, Great. Thanks very much, guys.

Operator

Thank you. The next question is coming from John Lovallo from UBS. Sean, your line is live. Please go ahead.

Speaker 6

Good morning, guys. Thank you for taking my questions. First one is, the Q1 order guide implies Quarter over quarter improvement, which would sort of buck normal seasonality. Can you just help us with some of the puts and takes there?

Speaker 4

Well, really we're just looking at our plans and what we're seeing right now week to week. We're already 5 weeks into our quarter, so we've got 1 month in the books. And as we just look at our pace that we're seeing right now and that Yes, we believe that that's where we're going to wind up. Obviously, seasonality, if you look at history, has been a little bit unusual in the last Couple of years, and I think we're still in a little bit of an unusual time with what has happened with rates. But with our positioning across the board, With our community count increasing, we feel like our order position in Q1 is in line with what we've guided.

Speaker 1

And as our productions got further along as well, we felt more comfortable loosening up a lot of the sales restrictions you've heard us talk about, even though we're continuing to sell later in the process With some negligible improvement on our cycle times, but getting further along in those construction cycles, we have more homes available for sale going into Q1 than we've had.

Speaker 6

Makes sense. Okay, great. And then the ASP in the 4th quarter down about 4% sequentially, How much of that was like for like pricing versus mix?

Speaker 4

Yes. At this point, it's like for like. I mean, we're as we said, we're increasing incentives And then where necessary community by community we're adjusting prices. And so I don't believe there's necessarily been a big change in mix yet. And so it's more likely from like for like.

Speaker 6

Got it. Thank you, guys.

Operator

Thank you. The next question today is coming from Carl Reichardt from BTIG. Carl, your line is live. Please go ahead.

Speaker 7

Thanks. Good morning, buddy. You talked about cutting base prices where necessary. Can you give me a sense of How often it's been necessary that maybe percentage of communities or percentage of orders this quarter where base prices were cut and what level of cuts are creating some elasticity in unit demand?

Speaker 4

Carl, I don't know that we can get specific on terms of communities or by area. We are finding the market community by community and market by market. Those cuts on base have not been significant to this point. We have That focused on financial incentives and interest rate and where needed to we've been able to adjust price and find the market to drive additional traffic and sales.

Speaker 1

And a lot of our guide is coming from what we know we're going to put into the market In terms of when we are opening new communities or new phases, we can reset our base pricing that way. And so we do expect our ASP to shift down throughout the year. But as Paul mentioned to date it's been more heavily incentivized than it has been base price cuts.

Speaker 7

Okay. Thank you, Jess. Thanks, Paul. And then, on cycle times, Starting to see a little bit of easing and working with the trades and suppliers. Would your guess be that your cycle times could get to sort of normal pre pandemic levels in fiscal 2023 or is that too much to hope for at this point?

Speaker 3

Anecdotally, I was talking to a builder last week. He said he started a house in late August and he's going to close it in December. So he was pretty excited about that. That's one story, one house out of a lot of houses.

Speaker 1

And builder equals construction superintendent, our employee. Yes.

Speaker 3

And he was really excited about that. So I think we're making the right progress. We're starting to see a little bit of progress pick up in the numbers of October completions. We got a little bit of time back there. Getting all the way back to where we want to be pre pandemic levels, it might be by the end of the year for the starts that we have later in the year that we're pushing it through, but we're going to make that progress this year.

Speaker 2

Carl, just we've talked about it, I think, for a while, but just the discipline in the industry today has translated into across the board slowdown in starts. And I think it will allow the trade base material suppliers to kind of get the feet under them. I've been accused of being overly optimistic at times, but I do think 2023, If the industry stays disciplined, we will get back into a situation where we can sell a house, know what it's going to cost and when we're going to be able to deliver And that will be a good thing.

Speaker 7

Well, it starts with 1 house. So I appreciate the color guys. Thanks so much.

Speaker 1

Thanks, Karl.

Operator

Thank you. Your next question is coming from Mike Rehaut from JPMorgan. Mike, your line is live. Please go ahead.

Speaker 8

Great. Thanks very much. I appreciate you taking my questions. First off, just wanted to get a sense of the cadence in progression of incentives as it works through your fiscal Q4 and into October and perhaps even into November. Obviously, a lot of that I would presume is being reflected in the Q1 gross margin guidance.

Speaker 8

But what I'm trying to get a sense is just the degree of magnitude of the change in trend and how we should be thinking about perhaps where incentives are today versus where they were 3 or 4 months ago?

Speaker 4

I think it start with just looking taking a step back and looking at where interest rates were. At the end of the last quarter mortgage rates We're still in the low to mid fives and by the end of the quarter they were in the high sixes and subsequent to the end of the quarter they've now stepped into the sevens. And so we have been adjusting to reflect that. A lot of our incentives have been on the financing side with interest rate locks and buy downs to try to address the payment shock there from the interest rates and that has increased sequentially through the quarter and has continued into October. So The levels have continued to increase.

Speaker 4

We were focused on ensuring that we could close our backlog, because we did have a lot of homes scheduled to close in September. And so I believe we did hold off on some price adjustments to ensure that we could close that backlog. And so price adjustments has started to fold in a little more commonly as we've stepped into Q1. So it's been a sequential increase along the way. And then what it will be going forward will depend largely on what happens with rates in the market and then our efforts to meet the market.

Speaker 4

We are looking D. R. Horton:] Community by community to make adjustments in order to hit our sales pace and turn our inventory and maximize our returns. And so, we're Looking to find the market and find that pace community by community.

Speaker 8

Okay. So I guess I appreciate that answer. I know obviously projecting gross margins beyond the Q1 is somewhat difficult, but it would seem like given the trends that we're not yet at a point of stabilization. I guess my second question and If you have any thoughts on that, that would be great. But second question, just on the SG and A guide for the Q1.

Speaker 8

With Consolidated revenue being a little bit below, obviously, it's not a surprise to see the SG and A come up. I'm also wondering if there's anything in that number around increased broker commissions to the market as part of encouraging the broker community in a softer environment and how we should be thinking about that line item within SG and A over the next year?

Speaker 1

Sure, Mike. So builders report those things separately Or differently, I should say. So broker commissions for us are actually in gross margin. So that is contemplated as one of the increased incentives in our gross margin guide And not an impact for us, particularly on SG and A.

Speaker 4

In terms of SG and A overall, with our ASPs Expected to come down with revenues down a bit. That's driving an expected increase in our SG and A as a Percentage of revenues, we're coming off of all time lows there and are still positioning ourselves to continue to gain market share. And so with essentially SG and A spend staying relatively stable with the exception of A variable SG and A that moves with revenues or with profitability, that's resulting in the expected increase From all time lows to a little bit higher level as a percentage of revenues in Q1.

Speaker 8

Great. Thanks so much.

Operator

Thank you. And the next question today is coming from Matthew Bouley from Barclays. Matthew, your line is live. Please go ahead.

Speaker 9

Good morning, everyone. Thank you for taking the questions and for all the detail. Just a follow-up on the incentive side. I think I heard you say at the top that within Financial Services you were including some I think you said rate buy downs and things like that. So in the incentive comments you just made around reaching 6 or 7, I think I heard you say, is that all in the gross margin?

Speaker 9

And is there additional incentives on Financial services side that we should look out for or is that kind of all in? Thank you.

Speaker 4

There's always some of those costs on both sides, Matt. And that can vary a bit depending on the nature of the incentives. But yes, both of our guides, the guides for financial services margins Going into Q1 as well as the guide for our gross margin on the homebuilding side reflect our anticipation for our level of incentives related to financing.

Speaker 9

Understood. Okay. Thanks for that clarification. And then, just secondly, you mentioned that you would think I heard you say you would expect the option abandonments that occurred this quarter to kind of continue to occur? I mean, should we expect the magnitude of that to increase?

Speaker 9

And then just kind of any update on actual impairment thoughts around your own land portfolio?

Speaker 3

With the option write off cost, as We evaluate projects at various decision points. We'll be working with various land sellers and developers and where we can't reach An agreement or accommodation, we're not going to move forward with a bad deal. So if it doesn't make sense and what we expect the market conditions Are or will be over the life of the project. That's the reason we have the option arrangement. So we may have an increase in those costs, but Yes, we do take a pretty accurate look at those things, very realistic expectation and we'll be very quick to move on those.

Speaker 2

And I'll just add both when the market was accelerating and now it is in a pause, We are very disciplined in how we approach every economic decision on the land side. It's all about creating optionality and efficiency of capital. And that's been our program and it's going to continue to be

Speaker 1

In terms of your impairment question, even with our guide for gross margins today, we're still projecting for Our gross margins to remain at very healthy levels, that would signify that we're a long way off from any sort of broad based impairments. We're also in a completely different financial position this cycle to prior cycles, which allows us some flexibility in terms of how we look at the land that we have on our balance What we plan to do with it going forward. That being said, we do expect there to be some impairments along the way, in weaker submarkets. But right now, don't expect anything broadly based in the near term.

Speaker 10

Makes sense. Thanks, Jessica. Thanks, everyone. Good luck.

Operator

Thank you. And the next question is coming from Eric Bossard from The Cleveland Research Company. Eric, your line is live. Please go ahead.

Speaker 10

Thanks. Context, if you could, around 2 things. First of all, the 23% to 24% gross margin in 1Q, Obviously, a component of that is what's going on with incentives and pricing. You talked today about savings on the cost side or changing the product mix. And so what I'm trying to understand is, is that a baseline, the changes that you're making to support gross margin or change mix, can that number improve?

Speaker 10

Can you just give us a little bit of sense of what's contributing to that? And in terms of the things you're doing to protect gross margin, what the path forward might look like?

Speaker 4

Yes. Eric, I think as we are out In the market with our trade partners and suppliers working to reduce costs to provide the best value we can to our homebuyers. And we provided the visibility into the Q1 with those gross margins. What we're seeing, which is Encouraging early on in that isn't going to come through in homes that close for the next 6 to 9 months towards the end of the year. So we've still got the homes that we have in the ground with that cost structure.

Speaker 4

But as we continue to find the market, we expect to See gross margins like we have guided to in the Q1.

Speaker 2

And we did Suffer through extended bill cycle times. So the houses will be closing in Q1, our houses that were started And bear the cost of high lumber costs and really Trade shortages. So you've got the double whammy of high cost and normalized ASP.

Speaker 10

And just within that is like today, can you comment is that the floor or is there both upside and downside through the rest of the year relative to the 1Q gross margin?

Speaker 2

It depends on what the capital markets and interest rates do. I mean, If we see stabilization in interest rates, I feel very optimistic about what we can do this year. If we continue to see 100 basis point increase Quarter to quarter to quarter, I think it's going to be a very challenging year.

Speaker 10

Okay. And then secondly, you've mentioned single family for rent, both of what you're doing and buyers of home of your homes from others. Just curious if you can give us a sense of how much of the business is single family for rent, what the expectation is in 2023 and if there's any risk or volatility around that buyer group?

Speaker 3

So our approach to the single family rent toll business is to build communities of traditional single family homes, Rent those up in stabilization and then sell them to typically institutional owners of that sort of residential asset class. It's about $1,700,000,000 I think is our current investment in the single family rental platform. We expect that's going to grow during 2023 Yes, depending upon market conditions, probably not more growth than we had from the end of 2021 to the end of 2022, but we do expect growth in 2023. And we still see that when we complete the homes and they go to market to lease, there's still good demand and people are needing a place to live and they're choosing to live in these communities.

Operator

Okay. Thank you. Thank you. The next question is coming from Alan Ratner from Zelman and Associates. Alan, your line is live.

Operator

Please go ahead.

Speaker 11

Hey guys, good morning. Thanks for all the great detail in a difficult market to forecast out here. So we appreciate it. I guess first question, just trying to triangulate all the comments you made about the margin outlook, the goals as far as revenue are concerned in 2023. So

Speaker 2

if I

Speaker 11

look at your 1Q margin guide, it's down about 600 to 700 basis points from the peak a couple of quarters ago, and I think that's largely consistent with kind of the net price adjustments we've seen across the industry. As you think about that versus your goal to grow revenues for the or even maybe the low end of that range, what's the price sensitivity to achieving that goal? How low are you willing to take that margin in the near term, recognizing that maybe longer term you have some potential cost relief coming or other things that could be offsets. But in order to hit your 2023 target there, how low could that margin go before you kind of hold back and say, you know what, we're just going to slow the start pace. We're not going to chase that revenue growth because the price environment is too difficult.

Speaker 4

Yes, Alan, there's always a balance. We're always balancing what we're doing on pricing and incentives and what that results in margin versus pace and turning inventory to generate the best return. And so we'll be trying to strike that balance across all our communities throughout the year. It's too early and too uncertain to know what the year may bring in terms of the macro environment, in terms of rates, in terms of the general economy to know exactly what those decisions may need to be. And so that's why we're trying to provide as much color as we can around how we're looking at things.

Speaker 4

But In reality, we don't have really any specificity or visibility to what those conditions may be into the spring and into 2023. So In terms of where the line is on where margin or pricing might need to go or what we are willing to do to Push pace, I think remains to be seen. We're going to be making those decisions day to day, week to week as we march forward here.

Speaker 1

And as you know, we don't push or dictate that From a high level, it really is managed community by community, market by market, so we can make sure we're maximizing our returns at the local level and then blended overall.

Speaker 11

Okay. I appreciate the thoughts there. I guess on the rental segment, so I hear the delays in Florida, but I thought I also heard maybe a couple of projects that you thought would close this quarter that got pushed out because of presumably the higher borrowing costs that your counterparties are experiencing and how that impacts Underwriting. So I guess I'm just thinking out loud here, you do expect growth in that segment and certainly the inventory has been building. But How concerned or not concerned are you about what's going on with borrowing costs for those investors.

Speaker 11

I mean, we're hearing that there's a bit of a stalemate, if you will, or at least a widening bid ask spread on the rental side as well, given the difficulty underwriting to the new borrowing costs. So what's the sensitivity for you to achieve that growth? Is there any risk to that if borrowing costs remain elevated?

Speaker 4

Alan, we have certainly seen from that Buyer base in the credit markets and their ability to borrow soften, but there's still plenty of buyers out there. Like our buyers on the homebuyer side, they're taking a bit of a pause in some cases just to evaluate the market. But we've got about 7,400 homes In production on the single family for rent side and that's from beginning to those that are complete. We still expect to see people in that market. Not everyone needs to be in the credit markets or borrowing to purchase.

Speaker 4

And our single family rental communities tend to be on the lower end side relative to apartment sizes. And so we still feel good about that business, but we certainly did see communities that we expected to be sold and closed in the Q4 push into the Q2.

Speaker 11

And when you look at your deals that are under construction or completed or close to complete and if you underwrite those deals as if you're a buyer Today, you're still seeing those penciling? In other words, you can make the math work, and assume that a buyer theoretically can as well?

Speaker 4

Yes. And we have been very conservative on our underwriting. We are really looking at each of those communities as we would on the for sale side. And so The performance we saw on the ones that we sold in the market a year ago and through the last year were Far outperformed our underwriting and so we still feel good about the position in the active communities that we have and we will adjust as the market adjusts in terms of that business on a go forward.

Speaker 3

And more of the issue, I think, Alan, related to a change in that buyer, they were Just to say they were very excited would be an understatement to get their hands on the communities early in fiscal 2022. We experienced some of the same construction delays in those products that we did in our single family for sale business and we had Expectations and buyer indications of interest willing to close on the projects prior to completion and prior to full stabilization. The markets Come back and more normalized now and their expectation is that we get to a stabilized point before there We're going to get a good valuation.

Speaker 11

If I could just sneak in one last one and I apologize, but it's relevant to this topic here. In the environment where the capital markets remain tough and the borrowing costs continue to rise here, but you're Still seeing good fundamentals at the community level, good occupancy, good rents. Are you willing to kind of shift the strategy in the near term and kind of hold on More of these assets on your balance sheet and wait for the transaction environment to improve? Or is the goal here really to turn the capital and you're not looking to necessarily to grow a portfolio of stabilized assets?

Speaker 4

Our base business model is to sell the assets. That still generally will generate the best return, but we're going to make sure that we stay in a position from a capital perspective to be able to Manage timing to manage a bit of a slower process if necessary due to some disruptions in the capital markets, which typically Don't last that long, but we do want to make sure we stay in a flexible position to be able to manage timing when necessary.

Speaker 11

Okay, perfect. Thanks for all the time guys. I appreciate it.

Operator

Thank you. Your next question is coming from Buck Horne from Raymond James. Buck, your line is live. Please go ahead.

Speaker 12

Yes. Thank you. Appreciate that. I was wondering if you could I think you mentioned the cancellation rate in October remained elevated. I was just wondering if directionally you could indicate whether that was the cancellation rate was higher or lower than what happened in the Q4

Speaker 4

in October?

Speaker 1

Yes, we typically have volatility month to month in our Can rate throughout the quarter, so we don't give it specifically for the month. But anything for us above the call it low 20s, High teens to low 20s is elevated, and we certainly did not see any market improvement in October as compared to Q4.

Speaker 12

Okay. Appreciate that. And can we talk about any just regional differences in terms of how buyer traffic and interest levels have behaved as the progression of interest rates kind of March higher either during the quarter through October. Just kind of walk us through the map and just kind of where things are how buyers are behaving in different geographies?

Speaker 3

We've seen Still see a lot of traffic in our models. We still see people coming in looking to get into a home, a little more challenging with the affordability sometimes to get them qualified. But as we see stabilization in rates and when we see periods when rates have stabilized and that demand is there, we're able to meet it. We do see in our sales process is that we're selling the large majority of our homes past a certain stage of construction, not just from our restriction of that sale, but from the buyer wanting certainty of what that interest rate payment can be within the lock window that can be afforded to them. And so That's been important for us to accelerate the cycle times, have more inventory later in the production process that we can deliver within the interest rate lock window.

Speaker 12

Right. I'm just curious, are there pockets of strength kind of geographically?

Speaker 2

Just from geographically. It's the same markets that are experienced inflow of buyers. I mean, I think our Relocate for San Diego relocation buyers picked up last quarter again. There is a it's the market is, I think evolving maybe is the best word. There is still a migration out of urban or out of Urban into the suburbs and there is still housing formation taking place That exceeds the supply of homes.

Speaker 2

It's easy to get caught up in the short term. Our goal Here is to stay focused on the long term. And I can tell you our efforts are in positioning for Now Q2, Q3, Q4 and 2024 and 2025. And so we're trying to stay out of the Short term reaction, but where do we want to be as this platform continues to develop,

Operator

Thank you. And the next question is coming from Susan Maklari from Goldman Sachs. Susan, your line is live. Please go ahead.

Speaker 13

Thank you. Good morning, everyone. My first question is going back to the land market a bit. Can you talk about what you're hearing from the sellers? And how are the renegotiations of some of those option contracts coming together?

Speaker 13

What is the pushback that you're getting if there is any? And how is that progressing and changing as the market is changing?

Speaker 4

Yes, Susan. We have They're very proactive with our land sellers and development partners and realistic in terms of expectations with the market as it moves. So Largely they have been understanding and working with us to keep those deals alive where we can. To the extent that it just the underwriting doesn't make sense, Then we're having to make the decisions that we are and we will, if needs be, have to walk away from some of those options. That's why we have the option contracts in place and have made that shift with our land strategy.

Speaker 4

But by and large, they are reading the headlines like everyone else Understanding of where the market is, they ultimately want to be in a position to move through those lots, and so have been relatively well received and receptive

Speaker 2

And we treat or attempt to treat our development partners like they're a part of the family. I mean, we're very transparent with them. They understand where we're headed and what our start pace is and what our expectations for that community. And coming out of the last downturn, we built Relationships that are still existing today and our goal in every community, every division He is to be kind of the favorite nation builder and we are going to treat them better. So we really do believe And transparency and consistency and honest and direct communication.

Speaker 2

And that's how you build relationships.

Speaker 13

Yes. Okay. And then can you talk a bit about capital allocation? As the market is changing, how are you thinking about the different uses of cash and especially maybe any thoughts on Buybacks as we think about 2023?

Speaker 4

Yes. Sue, we'll continue to take a balanced approach To it all, we're in a good flexible position to be able to continue to provide returns to our shareholders both in the terms of increased dividends and share repurchases. Obviously, we'll be adjusting in our business and how much we invest into To land and to home starts and into our rental business based on market conditions. And but at a base level, we do expect to generate an increase in our homebuilding cash from operations in fiscal 2023. And with that, that gives us even more flexibility to make those relative decisions, but continue with more of the same in terms of the balance and the consistency in the approach.

Speaker 13

Okay. Thank you. Good luck.

Speaker 4

Thanks, sir.

Operator

Thank you. And that is all the time we have for questions this morning. At this time, I would like to turn the floor back to David Auld for closing remarks.

Speaker 2

Thank you, Tom. We appreciate everybody's time on the call today and look forward to speaking with you again to share our Q1 results in January. And finally, congratulations to the entire D. R. Horton family for another remarkable year.

Speaker 2

Stay humble, Stay hungry, stay focused. Go compete and win every day. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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Earnings Conference Call
D.R. Horton Q4 2022
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