D.R. Horton, Inc. (DHI) Earnings Call Transcript & Summary

Good morning, and welcome to the Fourth Quarter 2021 Earnings Conference Call for D.R. Horton, America's Builder, the largest builder in the United States. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton.

Thank you, Tom, and good morning. Welcome to our call to discuss our fourth quarter and fiscal 2021 financial results. Before we get started, today's call includes 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 factors that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and subsequent reports on Form 10-Q, all of which are or will be filed with the Securities and Exchange Commission. This morning's earnings release can be found on our website at investors.drhorton.com, and we plan to file our 10-K towards the end of next week. As referenced in our press release, we realigned the aggregation of our homebuilding operating segments into 6 new reportable segments this quarter to better allocate our homebuilding operating segments across our geographic reporting regions. As a result, in addition to our standard updated investor and supplementary data presentations, we will also be posting to our Investor Relations site 3 years of quarterly sales, closings, backlog, homes and lock data that conforms to our new geographic region presentation. All of this can be found at investor.drhorton.com on the Presentations section under News and Events for your reference. Now I will turn the call over to David Auld, our President and CEO.

Thank you, Jessica, and good morning. I am pleased to also be joined on this call by Mike Murray, our Executive Vice President and Co-Chief Operating Officer; and Bill Wheat, our Executive Vice President and Chief Financial Officer. Today, we also have Paul Romanowski with us, who was recently promoted to Executive Vice President and Co-Chief Operating Officer. Paul has been with D.R. Horton since 1999, serving as our regional Florida -- as our Florida South Division President for 15 years, and most recently, as our Florida region President for 7 years. I'd like to take a brief moment to have Paul introduce himself before we get started. Paul?

Thank you, David, and hello, everyone. I'm excited for the opportunity to serve in my new role on the D.R. Horton management team, and I look forward to getting to know our investors and analysts in the coming year.

Thank you, Paul. Given that Paul is new to his role, he will not be an active participant today, but we are glad to have him with us and believe his extensive homebuilding experience will strengthen our executive team. D.R. Horton team finished the year with a strong fourth quarter, which included a 63% increase in consolidated pretax income to $1.7 billion and a 27% increase in revenue to $8.1 billion. Our pretax profit margin for the quarter improved 480 basis points to 21.3% and our earnings per diluted share increased 65% to $3.70. For the year, consolidated pretax income increased 80% to $5.4 billion on a $27.8 billion of revenue. Our pretax profit margin for the year improved 460 basis points to 19.3%, and our earnings per diluted share increased 78% to $11.41. We closed a record 81,965 homes this year, an increase of over 16,500 homes or 25% from last year, while also achieving a historical low homebuilding SG&A percentage of 7.3%. Our homebuilding return on inventory was 37.9% and our return on equity was 31.6%. These results reflect our experienced teams and their production capabilities. Our ability to leverage D.R. Horton scale across our broad geographic footprint and our product positioning to offer homes at affordable price points across multiple brands. Our homebuilding cash flow from operations for 2021 was $1.2 billion. Over the past 5 years, we have generated $5.9 billion of cash flow from homebuilding operations, while growing our consolidated revenues by 128% and our earnings per share by 383%. During this time, we also more than doubled our book value per share, reduced our homebuilding leverage under 20%, and increased our homebuilding liquidity by $2.8 billion, all while significantly increasing our returns on inventory and equity. Housing market conditions remain very robust, and we are focused on maximizing returns and increasing our market share further. However, there are still significant challenges in the supply chain, including shortages in certain building materials and tightness in the labor market. As a result, we continued restricting our home sales pace during the fourth quarter by selling homes later in the construction cycle to align with our production levels and better ensure certainty of home closing date for our homebuyers. We expect to work through the supply chain challenges and ultimately increase our production capacity. After starting construction on 22,400 homes this quarter, our homes in inventory increased 26% from a year ago to 47,800 homes at September 30, 2021. In October, we started more than 8,000 homes, further positioning us to achieve double-digit growth again in 2022. We believe our strong balance sheet, liquidity and low leverage position us very well to operate effectively through changing economic conditions. We plan to maintain our flexible operational and financial position by generating strong cash flows from our homebuilding operations and managing our product offerings, incentives, home pricing, sales pace and inventory levels to optimize our returns. Mike?

Diluted earnings per share for the fourth quarter of fiscal 2021 increased 65% to $3.70 per share. And for the year, diluted earnings per share increased 78% to $11.41. Net income for the quarter increased 62% to $1.3 billion. And for the year, net income increased 76% to $4.2 billion. Our fourth quarter home sales revenues increased 24% to $7.6 billion on 21,937 homes closed, up from $6.1 billion on 20,248 homes closed in the prior year. Our average closing price for the quarter was $346,100, up 14% from last year. And the average size of our homes closed was down 1%. Bill?

Net sales orders in the fourth quarter decreased 33% to 15,949 homes, and the value of those orders was $6 billion, down 17% from $7.3 billion in the prior year. A year ago, our fourth quarter net sales orders were up 81% due to the surge in housing demand during the first year of the pandemic when we had significantly more completed homes available to sell and prior to the supply chain challenges that arose in 2021. Our average number of active selling communities decreased 5% from the prior year and was down 3% sequentially. Our average sales price on net sales orders in the fourth quarter was $378,300, up 23% from the prior year. The cancellation rate for the fourth quarter was 19%, flat with the prior year quarter. As David described, new home demand remains very strong, and our local teams are continuing to restrict our sales order pace where necessary on a community-by-community basis based on the number of homes in inventory, construction times, production capacity and lot position. They also continue to adjust sales prices to market while staying focused on providing value to our buyers. We are still restricting the pace of our sales orders during our first fiscal quarter, but to a lesser extent than during our fourth quarter. As a result, we expect our first quarter net sales orders to be approximately equal to or slightly higher than our 20,418 sales orders in the first quarter last year. Our October net sales order volume was in line with our plans, and we remain confident that we are well positioned to deliver double-digit volume growth in fiscal 2022 with 26,200 homes in backlog, 47,000 homes in inventory, a robust lot supply and strong trade and supplier relationships. Jessica?

Our gross profit margin on home sales revenue in the fourth quarter was 26.9%, up 100 basis points sequentially from the June quarter. The increase in our gross margin from June to September reflects the broad strength of the housing market, and benefited from the better alignment of our sales order pace to our construction schedules. The strong demand for a limited supply of homes has allowed us to continue to raise prices or lower the level of sales incentives in most of our communities. On a per square foot basis, our revenues were up 7% sequentially, while our stick and brick cost per square foot increased 7.5% and our lot cost increased 2%. We expect both our construction and lot costs will continue to increase. However, with the strength of today's market conditions, we expect to offset any cost pressures with price increases. We currently expect our home sales gross margin in the first quarter to be similar to the fourth quarter. We remain focused on managing the pricing, incentives and sales pace in each of our communities to optimize the return on our inventory investments and adjust to local market conditions and new home demand. Bill?

In the fourth quarter, homebuilding SG&A expense as a percentage of revenues was 6.9% down 70 basis points from 7.6% in the prior year quarter. For the year, homebuilding SG&A expense was 7.3%, down 80 basis points from 8.1% in 2020. Our homebuilding SG&A expense as a percentage of revenues is at its lowest point for a quarter and for a year in our history, and we are focused on continuing to control our SG&A while ensuring that our infrastructure adequately supports our business. David?

We have increased our housing inventory in response to the strength of demand and are focused on expanding our production capabilities further. We started 22,400 homes during the fourth quarter and 91,500 homes during fiscal 2021, which is an increase of 21% compared to fiscal 2020. We ended the year with 47,800 homes in inventory, up 26% from a year ago. 21,700 of our total homes at September 30 were unsold, of which 900 were completed. Although we have not seen significant improvement in the supply chain yet, and we expect the current constraints to ultimately moderate at some point in 2022. Mike?

At September 30, our homebuilding lot position consisted of approximately 530,000 lots, of which 24% were owned and 76% were controlled through purchase contracts. 24% of our total owned lots are finished, and at least 47% of our controlled lots are or will be finished when we purchase them. Our growing and capital-efficient lock portfolio is key to our strong competitive position, and will support our efforts to increase our production volume to meet homebuyer demand. Our fourth quarter homebuilding investments in lots, land and development totaled $1.8 billion of which $1 billion was for finished lots, $330 million was for land and $440 million was for land development. Bill?

Forestar, our majority-owned subsidiary, is a publicly traded, well-capitalized residential lot manufacturer operating in 56 markets across 23 states. Forestar continues to execute extremely well on its high-growth plan as they increased their lots sold by 53% to 15,915 lots during fiscal 2021 compared to the prior year. Forestar's pretax profit margin for the year improved 400 basis points to 12.4% excluding an $18.1 million loss on extinguishment of debt. At September 30, Forestar's owned and controlled lot position increased 60% from a year ago to 97,000 lots. 61% of Forestar's owned lots are under contract with D.R. Horton or subject to a right of first offer under our master supply agreement. $370 million of D.R. Horton's land and lot purchases in the fourth quarter were from Forestar. Forestar is separately capitalized from D.R. Horton and had approximately $500 million of liquidity at year-end with a net debt to capital ratio of 35.2%. With its current capitalization, strong lot supply and relationship with D.R. Horton, Forestar plans to continue profitably growing their business. Jessica?

Financial services pretax income in the fourth quarter was $103 million on $223 million of revenues with a pretax profit margin of 46.1%. For the year, financial services pretax income was $365 million on $824 million of revenues, representing a 44.3% pretax profit margin. For the quarter, 98% of our mortgage company's loan originations related to homes closed by our homebuilding operations and our mortgage company handled the financing for 66% of our homebuyers. FHA and VA loans accounted for 45% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 722 and an average loan-to-value ratio of 89%. First-time homebuyers represented 59% of the closings handled by our mortgage company this quarter. Mike?

Our multifamily and single-family rental operations generated a combined pretax income of $74.3 million in the fourth quarter and $86.5 million in fiscal 2021. Our total rental property inventory at September 30 was $841 million compared to $316 million a year ago. We sold 3 multifamily properties totaling 960 units during fiscal 2021 for $191.9 million, all of which were sold in the fourth quarter compared to 2 properties totaling 540 units sold in fiscal 2020. We sold 3 single-family rental communities totaling 260 homes during fiscal 2021 for $75.9 million, including 1 sale of 64 homes during the fourth quarter for $21 million in revenue. In fiscal 2022, we expect our rental operations to generate more than $700 million in revenues from rental property sales. We also expect to grow the total inventory investment in our rental platforms by more than $1 billion in fiscal 2022 based on our current rental projects in development and our significant pipeline of future single and multifamily rental projects. We are positioning our rental operations to be a significant contributor to our revenues, profits and returns in future years. Bill?

Our balanced capital approach focuses on being disciplined, flexible and opportunistic. During fiscal 2021, our cash provided by homebuilding operations was $1.2 billion, and our cumulative cash generated from homebuilding operations for the past 5 years was $5.9 billion. At September 30, we had $5 billion of homebuilding liquidity, consisting of $3 billion of unrestricted homebuilding cash and $2 billion of available capacity on our homebuilding revolving credit facility. This level of liquidity provides significant flexibility to adjust to changing market conditions. Our homebuilding leverage was 17.8% at fiscal year-end, with $3.1 billion of homebuilding public notes outstanding, of which $350 million matures in the next 12 months. At September 30, our stockholders' equity was $14.9 billion, and book value per share was $41.81, up 29% from a year ago. For the year, our return on equity was 31.6%, an improvement of 950 basis points from 22.1% a year ago. During the quarter, we paid cash dividends of $71.6 million for a total of $289.3 million of dividends paid during the year. During the quarter, we repurchased 2.3 million shares of common stock for $212.6 million, and our stock repurchases during fiscal year 2021 totaled 10.4 million shares for $874 million. Our outstanding share count is down 2% from a year ago, and our remaining share repurchase authorization at September 30 was $546.2 million. We remain committed to returning capital to our shareholders through both dividends and share repurchases on a consistent basis, and to reducing our outstanding share count each fiscal year. Based on our financial position and outlook for fiscal 2022, our Board of Directors increased our quarterly cash dividend by 13% to $0.225 per share. Jessica?

As we look forward to the first quarter of fiscal 2022, we are expecting market conditions to remain similar with strong demand from homebuyers but continuing supply chain challenges that will delay home construction, completion and closings. We expect to generate consolidated revenues in our December quarter of $6.5 billion to $6.8 billion and our homes closed by our homebuilding operations to be in a range between 17,500 and 18,500 homes. We expect our home sales gross margin in the first quarter to be 26.8% to 27%, and homebuilding SG&A as a percentage of revenues in the first quarter to be approximately 8%. We anticipate a financial services pretax profit margin in the range of 30% to 35%, and we expect our income tax rate to be approximately 24% in the first quarter. Looking further out, we currently expect to generate consolidated revenues for the full fiscal year of 2022 of $32.5 billion to $33.5 billion and to close between 90,000 and 92,000 homes. We forecast an income tax rate for fiscal 2022 of approximately 24%, subject to changes in potential future legislation that could increase the federal corporate tax rate. We also expect that our share repurchases will reduce our outstanding share count by approximately 2% at the end of fiscal 2022 compared to the end of fiscal 2021. We expect to generate positive cash flow from our homebuilding operations in fiscal 2022 after our investments in homebuilding inventories to support double-digit growth. We will then balance our cash flow utilization priorities among increasing the investment in our rental operations, maintaining conservative homebuilding leverage and strong liquidity, paying an increased dividend and consistently repurchasing shares. David?

In closing, our results reflect our experienced teams and production capabilities, industry-leading market share, broad geographic footprint, and diverse product offerings across multiple brands. Our strong balance sheet, liquidity and low leverage provide us with significant financial flexibility to capitalize on today's robust market and to effectively operate in changing economic conditions. 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. Your efforts during 2021 were remarkable. We closed the most homes in a year in our company's history, achieving 10% market share with record profits and returns, and we are incredibly well positioned to continue growing and improving our operations in 2022. This concludes our prepared remarks. We will now host questions.

[Operator Instructions] The first question is coming from Carl Reichardt from BTIG.

Welcome, Paul. I wanted to ask about your sort of internal plans for '22 for orders and perhaps talk a little bit about what you see your community count doing relative to your absorptions in which you lean on more for growth in the next fiscal year.

Well, as far as sales absorptions and community count, I think we're still believing that the community count is flat to up single digit, low single digit. And as far as our sales numbers, if we're projecting to deliver 90,000 to 92,000 homes, then we've got to have sales pace that matches that. And again, Carl, the key to us is making sure that when we sell a home, we know when it's going to see and deliver. And as -- what I believe is, as the market continues into '22 that you're going to see stabilization on the material side first. And then the labor side, we've been working on expanding our labor base for the last 10 years. And the consistent level of starts has allowed us to drive an efficiency there that has allow us to deliver more houses and we just plan on continuing to do that.

And really rather than a focus on community count, it ebbs and flows quarter-to-quarter. If we start a house, we're going to ultimately sell and close it. So we really focus on our homes and inventory and our lot position.

Both of which are in very, very good shape right now.

Yes.

Okay. I appreciate that. And then, David, I wanted to go back to something that D.R. Horton has talked about in the past that we don't hear too much from others is this idea of getting your cash out of land investments within 24 months of when you put it in. And I'm curious really on 2 fronts. One, the significant shift to options has probably allowed that to improve. But on the other hand, the delays in entitlement and approval processes and finding dirt has probably hurt that. So can you talk about that goal of getting your cash out of your land investments within 24 months and how you see that changing over time?

Well, I would say it's more of a requirement, not a goal, Carl. That's something that we put in place coming out of the downturn that we have not wavered off of. And that is probably the toughest underwriting hurdle that our divisions had to face. But it's a nonnegotiable program because we saw what's going wrong on owning long positions in land does to your balance sheet and your risk level and what -- or unforeseen events that may happen in the future. So the 24-month cash back is still a part of every deal we underwrite. And has been a primary factor, I think, in driving our optional acquisition because it's -- we have to find partners. We have to control the lots we want to control. So we've got to be good partners with these guys. And that's been a focus through this entire cycle. And I think a major factor in that is the -- just the unrelenting underwriting requirement that you got to get your cash off the table in 24 months.

And Carl, to your point about extending delays and things like that, that applies when we do own our land and we're self-developing. It doesn't necessarily affect our cash return when we're working with a third party and buying lots because we're not buying a lot until we're ready to start homes and those approvals are in place. I would say more recently, one thing that is impacting our turns and our ability to actually return our cash in 24 months is the extension of our construction times with the supply chain delays. We have seen further elongation of our construction times, I believe, on a year-over-year basis. Our closings this quarter were -- the construction times were longer by about 7 weeks, which is a bit longer than we would have reported last quarter. And so that is a factor that is causing a bit of friction in our inventory turns right now. But hopefully, as we achieve some stabilization on the materials side over the coming year, we'll see that stabilize and hopefully will be able to contract again.

And your next question is coming from Stephen Kim from Evercore ISI.

I guess my first question relates to your company's comments about affordability. I guess, first, am I right to think that you're driving affordability primarily through construction and bot design efficiencies? Or should we think that this effort is going to imply a lower gross margin, all things held constant? And then related to your margin, I imagine you got peak lumber coming to your December quarter. So if lumber stays where it is right now, I mean would it be reasonable to think that the December quarter margins is maybe likely to be the low point for the fiscal '22 year?

Well, in terms of lumber costs, they are still rising. They rose further in our fiscal Q4. We've seen them rise further into October. So we do believe that we are seeing the peak of lumber costs. However, other costs are increasing as well. We're seeing costs really increasing across the board. So even when we see perhaps some relief from lumber, as we move further into fiscal '22, I think that will be offset by other cost increases. As far as the net effect on gross margin, ultimately, that will depend on the strength of the demand environment as we move into the spring season. And our ability to continue to offset costs with prices. Right now, our short-term view is that we should be able to offset cost with price and maintain our margins at or around the level that we just reported in the fourth quarter. But truly, as we move through fiscal '22, it will depend on the strength of the demand environment.

And our ability to continue to achieve affordability is really across a multitude of things. It's not any one thing we would point to. Clearly, our size and our scale and the construction efficiencies that we've been very focused on, particularly in our Express Homes brand, limiting floor plans, limiting options being able to control a trade at our job site all day long, house to house to house, repetitively doing the same thing over and over and over again has been a benefit in that regard. And then to a lesser extent, we have also continued to see our average square footage come down, and that's the way we can focus on affordability as well is building more of our smaller floor plans.

Stephen, we're constantly trying to drive a more affordable total occupancy cost for our buyers. And that effort is never going to stop.

Right. I think the gist of my question was that none of that implies a necessarily a lower gross margin, all else held constant, right?

No, I don't -- we're not seeing that.

All right. That's what I wanted to clarify. Okay. And then secondly, regarding sales restrictions. Again, I think, obviously, really encouraging, we do an analysis of your starts and your inventory. And it certainly -- we agree, we saw a really big positive inflection in your production metrics that we can see externally. And so I wanted to ask you about your comment about sales restrictions because a lay person or somebody listening from the outside could hear you say, "Hey, we're reducing our sales restrictions" and think to themselves, well, yes, that's because demand has weakened. And so therefore, there aren't as many people on waiting list and things like that. And so I was wondering if you could clarify with maybe a little more detail. Are you -- these sales restrictions, which are starting to get alleviated or being relaxed. Is that a sign of slowing demand or increasing supply? And assuming it's not a weakening of demand, I just wanted to go back to what you said in March, I think, Jessica, that you did a stress test on your backlog. I thought that gave a lot of comfort about affordability. I was wondering if you did that recently.

So the last question, yes, we did update the stress testing. We look at that every quarter in our backlog and found no real change. In fact, there may be a slight improvement from the March quarter to what we saw in September quarter backlog. And the sales restrictions is certainly a function of supply. We're seeing that we have been able to pull more homes through the production process to points where we are able to give that buyer a more confident delivery date and give them a better experience in the process. I don't think in any way it's -- sales have been reflective of the demand environment. We have consciously chosen not to push our sales contracts and take advantage of that demand until we can meet those customer expectations properly. So we've seen that our completed homes in inventory that are unsold are still below 1,000 homes, and that's scattered across the country. So it's not like we're seeing any pile up of available inventory. It's when we're releasing homes, we're able to sell those homes in the normal course of business.

And as a reminder, for those that may not have heard the stress test commentary last quarter and just to quantify that, the stress test that we've done on our backlog is if interest rates were to rise 100 basis points, what that at-risk buyer would look like. And it's generally mid- to high single-digit percentage of potential at risk with a full 100 basis point move. And that's really just at risk. We would not expect a total fallout in that regard. We look to document additional income, look to put those buyers in additional -- in different mortgage products than they're currently anticipating. So we feel pretty comfortable still with the ability of our buyers from an affordability perspective.

Your next question is coming from Matthew Bouley from Barclays.

Congrats on the results here in a pretty tough environment. So on the order outlook, Bill, you spoke to the Q1 uptick, I think, suggesting basically 28% higher sequentially versus Q4, which is certainly well above historical norms. And not surprising as you release those sales restrictions and the inventory homes are there. Does this kind of a typical uptick get you back to equilibrium for lack of a better term? Or should we understand that just given your inventory position ahead of the spring that we can perhaps see yet another, I guess, I'd call it an unusual uptick as you kind of release those continue to lessen the sales restrictions?

Yes. Thanks, Matt. I think we're still in an unusual environment. The prior year trends really don't apply to where we are today. Our sales order pace, the sequential pace of our sales orders is really driven by supply. By the homes that we have started, that we have in production, that reached the stage that we're ready to release them for sales. And so our sales volumes are really governed by or constrained by our homes and inventory and where they stand. So right now, with the visibility that we have to Q1, we believe we're in a position where we will deliver sales that are equal to or maybe slightly better than last year's level, which is an unusual sequential pattern versus where we were in Q4 when we were restricting sales. And then as we move into the year, I think pattern will still be governed by our inventory levels.

Well, I think what you're going to see in our forward expectation on sales, it's kind of aligning with our growth in starts that we've had over the past few quarters. And as Bill said, as those homes come through production, and reach production stages that we're confident in the delivery date, then we're able to release those to the marketplace for sales.

That's great. Secondly, on ASPs, I think the revenue guide from doing the math right, implies maybe mid- to high single digit increases in ASPs in fiscal year '22, give or take. Obviously, your order ASPs have been north of that for 2 consecutive quarters, if not, well north of that here in Q4. Are there any assumptions around geographic or product mix that we should be aware of that might temper closing ASPs into next year?

Well, I think -- we're looking at the year as a whole, and what our ASP will be for the year will ultimately be dependent on the spring selling season. And so the assumption that prices for the year will be up mid- to high single digit. I think that's fair. We're not going to assume that prices will continue to increase as fast as they have. And so our base assumption will be there will be some moderation in sales prices. We're going to continue to be focused on affordability from an intentional perspective for our business. And so for our initial guide going into the year prior to seeing what the spring will look like, prior to seeing what the supply chain challenges will continue to be and what that will do to us over the course of the year, we've set our ASP target as you've seen.

Your next question is coming from Mike Rehaut of JPMorgan.

First question, I was hoping to get a little bit of sense of how you're thinking about gross margins, at least perhaps directionally through fiscal '22 and even longer term. Understanding, obviously, a lot's in flux, but as you look through the rest of the year, obviously, a lot of people are focusing on the reduction of lumber costs as a tailwind. At the same time, you have some other headwinds in terms of additional cost inflation. And I guess, assuming incentives and discounts are steady, just trying to get a sense of how you think at this point between lumber and other areas of cost inflation and the current pricing that you have in place, how things might progress throughout the rest of '22?

Mike, we really don't have much visibility to our gross margin past a quarter or two. So you heard our specific gross margin guide for fiscal Q1, which was essentially relatively in line with Q4. As Bill mentioned, continued lumber headwinds in that December quarter. Some of that does back off as we move throughout next year. But ultimately, the gross margin that we achieved for fiscal 2022 as a whole is going to be dependent on the strength of the spring selling season, which we're pretty far out on. But I think we do feel with the strength in today's market, we should be in a very good position to continue to hopefully at least maintain gross margins from here. But we'll update if necessary as we move throughout the year and see how the spring unfolds and some of the supply chain pressures that are continuing to drive some cost increases.

Right. I appreciate that. I guess also just longer term, you're kind of in a new state of play here in terms of plus or minus around 27%. Just 3 years ago, you were at closer to 20% and -- versus the last cycle, I think your peak was around 25.5% in 2005. So over the next 2, 3, 4 years, as you're underwriting deals today and just kind of curious, obviously, you kind of underwrite them for returns. But there is a gross margin component in that. How should we think about "normal" or even a new normal, again, assuming that we don't have this over the next 12, 18 months, like, a complete mean reversion to a, let's say, a fuller incentive type backdrop or whatnot?

Appreciate that, and it's a great point. One, we do focus, first and foremost, on returns and not just the margin. You're right, it is a component of the return equation. And 3 years ago, as you mentioned, we were around 20%. And if we had said at the time, we think 3 years from now, we'll be at 27%, I don't think we'd have gotten a lot of credibility for that prediction. So it's really hard, as Jessica mentioned before, to really give us any great degree of confidence in predicting accurately what margins will be several periods out. I do think in our forward underwriting is that we are encouraged by what we see and what we'll be able to achieve in margins going forward. And ultimately, it's the return and the cash back that's driving our investment decisions today.

Two of the things that we can point to. A lot of the questions have been about are there structural changes in the business that could lead to maintaining a higher gross margin over the long term than what we've historically seen. They're not enough to keep us at 27%, but 2 things we would point to that we believe we can maintain are the scale advantages. We would expect to maintain some level of improved growth in our margin from that, but then also less interest in our cost of sales. With what we've done with our balance sheet in terms of reducing our leverage, we will be flowing through less cost of sales consistently going forward.

And in the entire industry that's consolidated. It's a maturing industry. So my anticipation is you're going to see more stability than typically as one associated around prior cycles. I think that there's a consistency of discipline in the industry today that never existed.

One last quick one, if I could sneak it in. How should we think about community count and sales pace in '22 versus '21 in terms of I think over -- in terms of just growth from both aspects?

It's going to continue to be mainly driven by absorption rather than community count. We would expect for the full year to have a modest increase in our community count. But I think as I referenced to Carl at the outset of the call, if we have the houses and lots, we're going to ultimately sell and close the house. And so that's generally the better indicator of where our business is going than just what our absolute community count is doing.

Your next question is coming from Deepa Raghavan.

Nice quarter. My first one is on your start space in October, 8,000 or higher homes that suggests a pretty solid rate. Perhaps there's some timing benefit here. But can you walk us through some of the puts and takes to a normalized start pace near term? Or is this a good run rate for 2023 deliveries would perhaps upside when supply chain improves?

I think the run rate that we're targeting is pretty well established for the first 4 to 6 months of this year. So that's a consistent run rate we're targeting. I think that we're basing our guidance and everything and what we're projecting for the year on the way the supply chain exists today. And we have to carry more houses and inventory that supports that double-digit growth than we typically have had to do in the past. So we're positioning for it. We'll see what the spring brings, and we'll see what the material and labor supply issues either resolve, mitigate or get worse.

It's a lot easier to slow down our start pace than it is to speed it up. So we consistently adjust our starts based on what our forward outlook is.

What we control is our liquidity and our process and our targets. And we're very focused on the liquidity because it's a risk mitigator and it allows us to be more flexible in what we target and how we operate.

We've already talked on this call about we're in an unusual time in terms of how our sales pace looks. We're also in an unusual time in terms of historical measures of our homes and inventory relative to what we can close with extended construction times and all the disruptions, as David said. We have to hold more homes and inventory to deliver the same number of closings today versus a few years ago.

The offset to that will be a lot of land in terms of year supply. So we're still driving very impressive returns.

Well, again, we're very focused on liquidity and maintaining the flexibility. That is a -- that's a great key competitive advantage, I think, for whatever happens in the market.

All fair comments. My follow-up is a pretty high-level question to the extent you're just willing to discuss. How do you think the supply chain is going to play out? Do you appreciate that the visibility is not great beyond a quarter or more at best. But just given the current state, what are your thoughts on a realistic best case or worst case scenario playing out in fiscal 2022? Or even if you don't want to go all out to 2022, what are some of the scenarios as we enter spring selling season?

From a supply chain standpoint, I think you've got some of the best companies that have ever existed in the history of the world focused on that. And I think they're going to get it figured out. And the people that we do business with are the best of the best in that industry. So I'm very confident. Was it Q1, Q2, Q3? I don't know that, but I am very confident that the people that are working on it are going to get it resolved. And when that happens, I think our -- we will return to an inventory conversion rate consistent with what we've done in the past, maybe even a little better.

Your next question is coming from Anthony Pettinari from Citigroup.

This is Asher Sohnen on for Anthony. And I just want to ask, you mentioned that you need more homes in inventory now to deliver the same number of homes. I'm just -- are you able to articulate a target around maybe your normalized spec count for this kind of new normal? And then when supply chains do clear up, do you expect to reduce that spec count eventually? Or could this become like the new normal going forward?

Absolutely. When we get back to a more normalized time, we would expect our inventory turns to return back to historical norms as David said, or better. Historically, if you looked at the beginning of the year for us, you could take our homes in inventory, and you could pretty well double that, and that's what we would close the next year. Sometimes, we've done a little better than that, sometimes a little worse. In the current environment, if it remains as tough as it is right now, we will not be able to do that. Our guidance obviously would imply that. But absolutely, when we get back to a more normal time, we would expect to reduce our spec count and turn our inventory and focus on generating the best returns we possibly can. This is simply a reflection of the current environment we're in, the elongated construction times we're seeing.

Great. Great. And then as a follow-up, just understanding that the sales declines in the quarter is kind of a function of supply. But I'm just curious, have you seen any markets where maybe prices are starting to get a bit frothy or that you're concerned around affordability, maybe seeing some buyers start to walk away around the margins?

I think it's pretty clear that the market is not as white hot right now as it was in the spring, but we're still seeing very strong demand. And the homes that we're leasing for sale are still being absorbed quite well with very historical low levels of incentives in place. And so we're seeing very few homes complete construction that are not being sold part of that completion process.

And I'd also say that even though our ASP has gone up and it's not a sustainable rise quarter-to-quarter. But it is something that I think indicates the level of demand out there when you restrict on the houses you sell. It's a good time to be selling houses today.

Demand still exceeds supply.

Yes.

And I think in terms of Mike's comment, it's not as white hot as in the spring. We are seeing, I think, somewhat of a return to normal seasonality as well. We wouldn't expect the market to be as strong today as it is during the spring selling season. So we still feel very good as we move throughout fiscal '22 that the market is going to remain robust.

Right. Of those 900 homes we have that are completed and unsold less than 100 have been completed for an extended period of time, out of almost 50,000 homes.

Your next question is coming from Jade Rahmani from KBW.

On the land side, you said that sequentially, lot costs were up 2% quarter-over-quarter. How much do you think they're up year-over-year?

Give me one second, Jade. I have it. I just -- they're up about a mid-single-digit percentage, which has been pretty consistent now for the last year or 2 on a year-over-year basis.

Okay. That's somewhat surprising because I think historically, land usually appreciates in line with appreciation or perhaps at a faster clip. Do you expect log costs to begin accelerating as the moderate pace of growth reflective of the timing at which you acquired these lots?

That's got a lot to do with it, Jade. It's -- the homes we're delivering this quarter are delivered on a large variety of vintages of lot acquisitions of one we contracted for the land and contracted for the lots. And so you're seeing a big blend come through. So generally, we are seeing cost inflation in our lot costs and what we're currently buying. But it takes -- it's a muted impact in the near term, and it takes several years for those costs to be fully reflected through into our closings.

And this is one of the strengths of our long lot pipeline and our controlled lot position because we've got land and lots controlled generally at fixed prices or at known prices. And so we reap the benefit of that by having a strong controlled lot position.

Your next question is coming from Truman Patterson from Wolfe Research.

Paul, congratulations on the promotion. Just wanted to follow up on a prior question. Your '22 closings expectations, up about 11% year-over-year at the midpoint. You all mentioned material shortages and multiple products currently. But David, you've made a couple of comments that you expect improvement in 2022. I'm just trying to understand what are your suppliers telegraphing you with respect to 2022 capacity? Are they adding employees, lines, et cetera? Just what sort of level of growth do they think they can support?

We've got commitments from all of our major material guys that they're going to support us. They know our numbers. They know what we're trying to accomplish. They see our start base for the last 6 months and the next 6 months. So -- and they are really good companies. I mean it's -- I'm not going to throw out a bunch of names because I forget about half of them. A CEO of one of them came in with Don Horton, myself and the entire executive team. It's a level of partnership and commitment to each other, I think, that just hadn't existed in the past. And I think as a result of the consolidation of the industry and the significant 10% market share in new home housing is a real number.

And in our conversations, they are hiring, they are opening new lines. Unemployment benefit going away is expected to have some impact. I think some of the extended impact from the Texas freeze is also expected to be worked through as we move into calendar 2022. So as David said, I mean, these things are taking a while to work through, but they are doing what they need to do to help support our business. And as always, we expect them to support D.R. Horton's business first. And for a lot of those pressures to be sell with smaller builders versus us.

Having scale, significant scale, in these markets is a huge benefit for us and I think really gives us more access and better service than some of the smaller, less -- people with less scale.

Having a forward lot pipeline of over 0.5 million lots makes it pretty powerful as a conversation piece in talking with the large suppliers.

Okay. Okay. Fair enough. And in your capital allocation priorities, I don't believe that I heard anything about M&A. Could you just discuss any -- the level in your pipeline that you're seeing or valuation stretched at this point? Then just a second question. I'm sure it's well deserved, but could you all just run through the decision behind creating the co-COO chair?

Sure. I'll take the first question, and I'll let David handle the second question. The M&A landscape is pretty similar to where it's been in the past few quarters. It's anecdotal. We're not looking for any major transformational M&A opportunities. It would be hard for us to accomplish one of those at the scale we're at today. But we are looking at tuck-in acquisitions to add great platforms and people to the team across the country where we maybe looking for growth. And it's an ongoing conversation with people in that process. But don't look for any major use of capital on that front today.

And on the co-COO program, in looking at our platform, we basically have doubled in the last 5 years. And trying to -- during COVID, trying to get places being not only from an executive officer standpoint, but from a regional president standpoint. We were asking guys to get on planes and really became less and less comfortable with that. So I think on the last call, I made a statement about infrastructure and then immediately had to quit talking about it. Because the infrastructure I was talking about was our platform, which was dual COO roles and then doubling our reach count. And it -- so that we're continuing to scale up our platform to make -- to coincide with the scale up in market share that we're gaining. And we've got great people that have performed at exceptional levels. But as you move up that next step, the role changes and the skill set changes. So you've got to get young guys in a position, in my mind anyway, and what we've talked about up here. You've got to get the younger guy into a position, a regional role, where he's working through divisions instead of on top of divisions, and it's a training process. And so while we've got a great market, while we're scaling up in absorptions, we need to scale up in people. And Paul gives us the ability to touch the regional guys more consistently and to be in the market more consistently, as he travels, Mike travels, I travel. And by increasing the number of regions we were then able to elevate people within divisions to leadership roles. And it's just kind of a consistency stair step where we get more people access to that role and give them a chance to learn that job before something happens and you were forced to make a change. So it's a part of continuing to scale for our next 5 years in a row. And it's -- we've got great people, and we've got an incredibly strong management team. And that's something that, to be honest with you, I think about all the time, is the quality of our people at the division level and region level compared to when I started to the company or compared to when we went public or even compared to the last cycle, what I call super-cycle. So it's -- the company is in an incredibly good position with incredibly good people. And Paul is going to help us make it even better.

Your next question is coming from Eric Bosshard from Cleveland Research.

Two things. First of all, in terms of the spring selling season, I know that you don't have visibility to it. And so there's, by definition, some degree of uncertainty. But as you look at your position and what you're seeing in the market now, could you identify -- these are the areas of notable uncertainty that you just won't know until you get to the spring?

That's sort of the unknown-unknown. Always a great question. It's one of the things we're always trying to ponder and peer around the quarter and figure out what's going to happen. But one of the big unknowns going into the year is not from a demand side, but from a production capacity side. As David said before, is it going to get better, stay the same or get worse. I mean, it may -- different parts of it may do all 3 over the next 6 to 9 months. And being prepared to handle those challenges is what we deal with every day. As we say when people want to and can buy homes, we can solve the rest of the problems. That's our job. Still see good demand trends out there, still see very good traffic this fall in the models, quality of traffic, interest of traffic and our realtor participation has been really strong starting the fall. So that -- for us, that would be a good sign for continuing what happens.

What we can control, Eric, is the inventory and how we position it to be in front of the spring market and that we feel very good about. So we can -- that is where we can have targets, we can have a plan. We can execute that plan, and then we'll respond to the market as it comes.

Okay. That's helpful. And then secondly, a lot of talk about affordability earlier in the call, and I know there's a lot of components of affordability. But ultimately, for your customer, it's them paying the price for the house. And the order ASP, I think coming out of 4Q, is now $380,000, which is certainly different than it was 2 or 3 years ago for the company. I'm just curious how you think about that if -- especially how you think about it relative to the different products that you have and relative to markets how you think consumers respond to that, customers respond to that and the path forward?

It's something we talk about and try to stay focused on providing more affordable homes and being the relative affordable choice in a given marketplace. We look at our mortgage company statistics, and we can see that almost 60% of our buyers this quarter were first-time homebuyers. And almost 60% of our buyers had a combined household income, reported income for the mortgage purpose at least of $90,000 or less. And so we still think that provides a good target market for us to continue to look to serve. And while we have seen pricing come up and average loan size come up, the debt-to-income ratios that we're seeing across the loans we're underwriting has not really budged. It's been pretty consistent.

And the industry as a whole has continued to increase sales prices, relatively speaking, we still do have the lowest average sales price generally than almost all the large public builders.

The final question we have time for today is coming from Alan Ratner from Zelman & Associates.

So I'd love to drill in a little bit on the rental operations. Obviously breaking it out this quarter and certainly, I think, over $700 million of revenue, clearly got some aggressive growth plans there. So I guess focusing first on the single-family rental side, I'd love to hear your thoughts kind of on the rollout there and maybe what you've been surprised on or maybe what's reaffirmed your views up to this point as you start leasing up communities and selling them. Are you seeing any interesting trends on who these renters are? Are they longer-term renters, they're choosing to rent? Are they people waiting for a new home to be built? Any kind of either anecdotal or data you could provide there. And I guess, longer term, how big of a piece of the business do you want to target this at?

I would say the renters are not terribly different than first-time homebuyers. People moving into areas, they're looking for housing. They're looking for a better lifestyle, things that probably have surprised us, level of demand and the lag up not only from a rental standpoint, but from what I consider institutional-type investor base that has bought the 3 that we've sold. It may not be a white-hot for-sale business this year compared to last year. But it is a white-hot build-to-rent business, especially the way we're positioning these projects as kind of on the affordable end, self-contained, not intermix for sale housing.

Got it. So on that note, David, with as strong as demand has been, I guess, first off, is the 35% margin that you guys generated in that business, is that a realistic kind of intermediate-term margin on that $700-plus million of revenue? And is the plan still to do the merchant build approach? You mentioned the institutional capital, a lot of your peers have either partnered up with some of those investors and established joint ventures or some ongoing investment there. It seems like you're kind of choosing more of the merchant build approach. So profitability and longer term? And any reason why maybe the strategy changes there?

We've got a small sample size thus far on those that we've closed. We've been very pleased with the profit levels we have seen. I expect we will still see some projects that will generate those level of profits. But as we grow the platform and as we build the infrastructure in place to support a larger volume across the country. We wouldn't necessarily expect to continue to generate the same margin that we've shown in these first few. But do expect pretax profit margins to be higher on the rental business than on our for-sale business. And to generate an accretive return, it needs to be a little bit higher because the assets are held a little bit longer. So do still expect to see very attractive profit levels on the rental business, but the current sample size is still a little bit small.

And as we've said before, as we learn the business, then we'd make our capitalization decisions about how to go about capitalizing the business. And we're still evaluating that, looking at options there.

I will say that everything we work on, everything we think about, we want to do things that are sustainable and scalable. And I can tell you the rental side of this market certainly seems sustainable and with our platform is scalable. So we're pretty excited about it.

This does conclude today's question-and-answer session. I would now like to turn the floor back to David Auld for closing comments.

Thank you, Tom. We appreciate everybody's time on the call today and look forward to speaking with you again in January on our first quarter results. And finally, congratulations to the entire D.R. Horton team. You are the first homebuilder to close more than 50,000 homes. You are now the first to close greater than 80,000 homes in a year. And you are well on your way to becoming the first homebuilder to close more than 100,000 homes in a year. Stay humble, stay hungry and stay focused. You'll compete and continue to win every day. Thank you.

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.