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Operator
My name is Courtney and I will be your conference Operator today.
At this time I would like to welcome everyone to the DR Horton America's Builder 2009 fiscal year end conference call.
All lines have been placed on mute to prevent any background noise.
After the speakers remarks there will be a question and answer session.
(Operator Instructions) Thank you.
Mr.
Don Tomnitz, you may begin your conference.
- President and CEO
Thank you, and good morning.
Joining me this morning are Bill Wheat, Executive Vice President and CFO, and Stacey Dwyer, Executive Vice President and Treasurer.
Before we get started, Stacey?
- EVP, Treasurer
Some comments made on this call may constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.
Although DR 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 DR Horton on the date of this conference call and DR Horton does not undertake any obligations to publicly update or revise any forward-looking statements.
Additional information about issues that could lead to material changes in performance is contained in DR Horton's Annual Report on Form 10-K and the most recent Form 10-Q, both of which were filed with the Securities and Exchange Commission.
Don?
- President and CEO
Net sales orders for the fourth quarter were 5,008 homes, up 26% from the same quarter in the prior year.
Fourth quarter sales were essentially flat with our June quarter which is better than the usual seasonal trend.
Our average sales price on net sales orders in the quarter decreased approximately 4% from the year ago quarter and 1% sequentially to $205,100.
Our cancellation rate was 27%, in line with our June quarter, but improved from 47% in the year ago quarter.
Our net sales were relatively even in each month throughout the quarter, fourth quarter, and in October.
However, we have seen our sales in November slow both seasonally and in response to the original November 30th expiration date of the federal home buyer tax credit.
We expect our net sales to show a positive year-over-year comparison in our first quarter of fiscal 2010.
As I am sure you are all aware, the federal home buyer tax credit has been extended.
To qualify for the tax credit homes must be under contract by April 30, 2010 and close by June 30, 2010.
The tax credit has also been expanded with higher income limitations and a new $6,500 tax credit for existing homeowners who have been in their homes for five years or more.
Our sales backlog increased 6% from the prior year and 4% sequentially to 5,628 homes or $1.1 billion.
Our fourth quarter home sales revenues were $1.0 billion compared to $1.5 billion in the year ago quarter.
Our average closing price for the quarter decreased approximately 5% from the year ago quarter to $210,100.
Stacey?
- EVP, Treasurer
Our gross profit margin on home sales revenue in the fourth quarter before inventory impairments and land option write-offs was 12.5%, a 160 basis point increase from our home sales margin in the year ago period.
Approximately 300 basis points of the increase was due to the effects of prior inventory impairments on homes closed during the quarter, the average cost of our homes declining by more than our average sales prices and geographic mix shift.
This increase is offset by 140 basis points due to an increase in our estimated warranty and litigation accruals.
Bill?
- EVP, CFO
During our fourth quarter impairment analysis we reviewed all projects in the Company and determined that projects with a combined carrying value of $963.1 million had indicators of potential impairment.
We evaluated these projects and determined the projects with a pre-impairment carrying value of $421.3 million were impaired.
We recorded inventory impairments of $174.9 million as a charge to cost of sales to reduce the carrying value of these impaired projects.
Our West region incurred the largest portion of these charges.
We refer to our projects which were evaluated and not impaired as our watch list which represents those projects deemed to be the highest risk for future impairments.
Our watch list is currently at $541.8 million with the largest concentration in California, Texas, Illinois, Florida, and Arizona.
The size of our watch list this quarter is 50% smaller than both last quarter's balance and a year ago when it had a balance of $1.2 billion.
During our fourth quarter we also recorded $17.7 million in write-offs of earnest money deposits and pre acquisition costs related to land option contracts that we do not intend to pursue.
Don?
- President and CEO
Homebuilding SG&A expense for the quarter was $134.8 million, down $41 million or 23% from $175.8 million in the year ago quarter.
We have and will continue to actively manage our SG&A levels relative to our expected number of home closing.
We recorded $26.8 million in interest expense during the quarter.
We will continue to recognize a portion of our interest incurred as interest expense as long as our home builder net levels exceed our active inventory.
Bill?
- EVP, CFO
Financial Services pre-tax loss for the quarter was $2.9 million compared to pre-tax income of $6.9 million in the year ago quarter.
89% of our mortgage company's business was captive during the quarter.
Our Company-wide capture rate was approximately 65%.
Our average FICO score was 723 and our average combined loan to value was 93%.
Our product mix in the quarter was essentially 100% agency eligible with government loans accounting for 64% of our volume.
Stacey?
- EVP, Treasurer
At September 30th, we have a net income tax receivable of $293 million.
We received $113 million of the receivable in October of 2009.
The majority of the remaining income tax receivable is due to carry backs of losses generated in fiscal 2009 that can be carried back against fiscal 2007 taxable income.
We expect to receive an additional refund of approximately $150 million in Fiscal 2010 and the remaining amounts are federal and state items expected to be recovered in future years.
In addition to the income taxes receivable that are reflected on our balance sheet at September 30th, we expect to receive an additional tax refund related to the recent legislation which expands the NOL carryback up to five years.
We are evaluating our options because we can choose to either carryback our remaining net operating loss from fiscal 2009 or carryback any taxable losses generated in fiscal 2010.
The amount of additional refund we estimate would be generated from choosing to carryback our full 2009 NOL is approximately $200 million.
We are evaluating our business plans to determine which option will be more beneficial to us.
Our reported net loss for the quarter was $231.9 million or $j0.73 per share compared to a net loss of $799.9 million or $2.53 per share in the prior year quarter.
Bill?
- EVP, CFO
Our total inventory decreased by approximately $29 million, excluding non-cash impairment charges during the quarter.
Our homes in inventory at the end of September totaled 11,600, of which 1,100 were models.
Of our total homes in inventory, 5,800 were speculative and 2,200 of these specs were completed.
We plan to continue to manage both our total number of homes in inventory and our number of speculative homes in the coming quarters to match our demand.
Don?
- President and CEO
Our land and lot acquisition spending remains limited and we continually reevaluate our land development plans based on current sales trends.
We spent $377 million in fiscal 2009 on land and lot acquisitions and land development expenditures which was less than the $500 million guidance originally provided for the fiscal 2009.
Our spending on raw, land and development costs will continue to be at very low levels.
However we have been actively contracting for finished lots which require less capital and can supplement our existing land positions and increase our current average gross margins.
Our spending on finished lots will be largely dependent on our sales base.
Bill?
- EVP, CFO
Our supply of owned, land and lots at September 30, 2009, was approximately 89,500 lots, down 10% from a year ago.
We plan to continue to adjust our owned land and lot supply in line with our expectations for future home sales and closings.
We control an additional 26,500 lots through option contracts which includes 8,100 lots for which we do not expect to exercise our option but the contract has not yet been terminated.
Our net earnest money deposit balance is only $9.4 million at September 30th but it represents contracts that control 18,400 lots with a purchase price of $607 million.
We have no unconsolidated joint ventures and we rarely use land bank arrangements so our deposits are typically a low percentage of the purchase price.
Don?
- President and CEO
We generated approximately $39 million in operating cash flow in the quarter bringing our total for the fiscal Year 2009 to $1.1 billion.
We have generated positive operating cash flow in the past 13 consecutive quarters for a total of $5.2 billion.
We ended the quarter with approximately $1.9 billion of unrestricted homebuilding cash and $55 million of restricted cash.
Stacey?
- EVP, Treasurer
In the current quarter, we repurchased approximately $72 million of our outstanding notes for $72.4 million plus accrued interest which brings our debt repurchases for the fiscal year to approximately $380 million.
At September 30, our homebuilding leverage ratio net of cash was 36.3%, a 730 basis point improvement from a year ago and well within our target operating range of less than 45%.
Don?
- President and CEO
As we look forward to fiscal 2010, our industry continues to face many challenges.
High, although moderating, levels of both new and existing inventory, continued high levels of foreclosures, tight credit for our home buyers, continued limitations of mortgage products available, low consumer confidence, increasing unemployment, continued pricing pressure in certain markets, the expiration of both the federal home buyer tax credit and government support of purchases of mortgage backed securities which could lead to higher interest rates.
These headwinds continue to impact our business both in our sales volumes and operating margins.
However, this quarter we did see our first year-over-year increase in net sales since the March quarter of 2006.
In addition, as we mentioned earlier, our sales were essentially flat from the June quarter which is stronger than the usual seasonal trend.
Our cancellation rate of 27%, while still above our historical range, was in line with our June quarter and significantly better than 47% a year ago.
We expect the extension and expansion of the home buyer tax credit to be beneficial to our business in the near term.
DR Horton has a solid balance sheet to capitalize on the eventual housing recovery.
During the quarter we generated an additional $30 million of operating cash flow, $39 million of operating cash flow, bringing our total for the fiscal year to $1.1 billion.
We continue to reduce our inventory dollars, our number of completed specs and the percentage of our specs to total inventory.
We continue to reduce our SG&A, homebuilding down $41 million and 23% year-over-year.
We will continue to reduce our owned lot position while we focus on option lot opportunities.
Our current focus remains on targeting the entry level buyer, managing our SG&A, and continuing to negotiate lower construction costs.
As I look forward to where we are in this cycle, I believe we have already passed two major milestones.
One, our impairment charges and operating loss peaked in fiscal 2008.
Two, our closings hit a volume bottom in 2009.
We have added and will continue to add additional flags in most every market and are beginning to add employees in certain markets.
We strongly believe our closings in 2010 will be greater than in 2009 and that we will continue this growth in the upcoming years.
Our entire Company is focused on how to return to profitability in 2010 and maintain this profitability thereafter.
House by house and community by community.
We want to thank all of our DHI team members who continue to out perform all of our peers.
We're especially proud of our sales team which significantly out sold all of our competitors in the industry.
Keep up the great work.
DR Horton is leading the industry into the housing recovery.
This concludes our prepared remarks and we will host any questions.
- EVP, Treasurer
Courtney, we'll turn it back to you for questions, please.
Operator
(Operator Instructions) Your first question comes from the line of Michael Rehaut from JP Morgan.
Your line is open.
- Analyst
Hi, thanks, good morning everyone.
The first question has to do with gross margins and then I have a second question on impairments.
On the margins, you gave some breakout that there was 300 bips benefit, if I understand this right, and I apologize if I'm not repeating it correctly, 300 bips benefit from prior impairments in geographic mix shift and then 140 bips from estimated.
I think I'm not repeating it correctly.
Can you just review the differences year-over-year.
And also, given the higher gross margins in the first half of '09, was that primarily due to the larger charges that you took in '08 and how do you see gross margins going forward particularly as you look at your backlog today?
- EVP, CFO
Sure, Mike.
On the improvement in the margin in the quarter, we discussed the year-over-year improvement.
And the 300 bips improvement is essentially core margin improvement which reflects the effects of prior impairments on our inventory.
It also reflects reductions in our actual cost of construction relative to our sales price changes.
That's really what's built into the 300 basis point improvement.
Offsetting that 300 basis point improvement is 140 basis points that reflects increases in the amount of our estimated warranty and litigation costs that we record in our accruals and estimate each quarter.
Those are the primary factors on a year-over-year basis.
- EVP, Treasurer
And in terms of the margin differential in Q4 compared to the earlier quarters of 2009, if you go back and look at our average sales price in the first and second quarters on our deliveries, we ran about $217,000 and $215,000.
So from this time last year to where we currently are today we have seen some additional pressure on sales price and we've also redesigned some of our product to be more affordable.
- EVP, CFO
And as far as where we are today in our expectations for margin, as you recall, especially second quarter and third quarter this year we had some pressure on our margin as we reduced our completed spec count and our age completed spec count.
That is having a lesser effect now so that is certainly one positive impact on our core margin this quarter.
And we would expect that improvement to continue, so we would expect to see some incremental improvement in margin as each quarter moves forward.
We're not in a position to talk specific amounts but we do expect incremental improvement.
- Analyst
And just before I hit on the impairment question, the 140 bips from increased warranty litigation accruals, is that something that, I know you've talked about that in the past if I remember correctly, is that something that you expect to moderate or reach?
Was there some sort of catch up where you wouldn't necessarily have that same type of impact going forward?
- President and CEO
I believe that as our closings have continued to trend down over the past three or four years, clearly our tail on our warranty is shortening so we would anticipate that to moderate moving forward.
- EVP, CFO
Mike, there's two major components to that.
Our ongoing warranty expense typically occurs within a two to three year period after the home is closed so that tail is dramatically shorter.
Other matters which we estimate, largely based on just estimations of potential future exposure, have a longer tail and so we continue to revise those estimates just based on what we see in the marketplace.
But at some point, that tail will start to decline further, as well.
- Analyst
Great.
Just second question on the impairments and I'll get back in queue.
I think the number that came out maybe was higher than our estimate, higher than I think others.
The way I'm looking at it more is that towards the year-end and towards the back half of the last couple of years, there's been a larger impairment, and as far as I understand it, to some degree it also has to do with just perhaps a more aggressive scrubbing of the books at year-end or more aggressive review.
The increase in impairments is also a little bit different than some other builders that have reported where it's more, it had been sequentially stable, particularly given the more stabilizing price environment.
So I was wondering, was this just some certain communities that you really just tried to work through or address more finely or were there certain price declines in the quarter that triggered it, maybe give some color on the reasons for the increase.
- EVP, CFO
Sure, sure.
The first thing that I would comment on is our disclosures that we've consistently disclosed each quarter over the past two to three years regarding our watch list.
And our watch list has been our best indicator that we could provide to investors regarding forward visibility on potential impairments.
As you know, it's been very difficult to predict exact amounts but we've attempted to try to provide good visibility.
And that watch list in terms of absolute volume has remained very high.
Even last quarter that watch list remained at a level of $1.2 billion, so that was our best indication that we expected to still see some substantial impairments on a forward-looking basis through last quarter.
Clearly more impairments came through this quarter but as we discussed in our prepared statements our watch list is far lower now, September 30th, forward-looking into fiscal '10 at $541 million less than half of the previous balance.
As far as the patterns over the past years and this year in terms of having more impairments in the second half of the year, absolutely.
We have seen higher levels of impairments come through in the second half of the year and primarily that is not because our review is any different in terms of aggressiveness on a quarter to quarter basis.
What it really has to do with is our market knowledge at those points in time.
In the first half of our fiscal year, that's at the end of December and at the end of March, that's the slower time of the year.
At the end of December, we will have just reported our earnings a month earlier.
We're at the slow time of the year.
You really don't know a whole lot more about what the market really says 30 days later.
At the end of March, typically, you're very early in the selling season.
It's very hard to make definitive conclusions on what the market is doing to our projects at the end of March.
But by the time you get to June, by the time you get to September you're well into the selling season and beyond the selling season and the dust has settled, and so we know a whole lot more about the market and we also know with much more certainty what our operating plans for all of our individual projects will be going into the next fiscal year.
And so that process and that improved knowledge has I think contributed to the higher level impairments in our third quarter and our fourth quarter.
So from that standpoint, that would be our basic explanation of that pattern.
- Analyst
Great.
Appreciate it.
Thank you.
Operator
Your next question comes from the line of Kenneth Zener from Macquarie Capital.
Your line is open.
- Analyst
Good morning.
I was wondering one of the things that always comes up, other builders that have more land versus shorter land is that gross margins should be lower versus shorter landed builders.
I wonder if you could just comment on that based on their blending in land, as well as the fact -- if you could get started there.
- President and CEO
Why don't you state your question again because I'm not sure--
- Analyst
I just wanted to see about the margins, about your gross margins being lower because of the legacy land you have versus perhaps shorter landed builders which are acquiring land.
And then within that context, obviously it comes up that Horton at last quarter was an aggressive buyer of land, which we actually don't see in terms of your increasing lot count.
So, one, gross margin, and, two, what you are seeing out there in terms of land yield.
- President and CEO
Let me answer the second half and let Stacey answer the first half secondly.
We are not aggressive purchasers of land.
We are aggressive purchasers of lot option contracts and as we stated, we have over $600 million worth of option contracts with only about $9 million of earnest money.
So yes, we'd tie up the world if we could but we're not putting very much earnest money up against those future purchases.
Stacey?
- EVP, Treasurer
And we do see higher margins in the lot option contracts that we are putting into production today, and we have not seen a significant impact from that in our current margins because the mix of our closings is still heavier in terms of the legacy land we've owned.
That's one of our goals for next year.
As Don mentioned, we're actively contracting for land, we're trying to get more flags in the air and we want to continue to blend in those option contracts with our existing land, and that's part of what will contribute to the margin improvement that Bill referenced earlier.
- Analyst
Do you think it can get to 25% of your closings next year or how would you characterize that based on what business you're contracting today?
- EVP, Treasurer
It will be totally dependent on sales, Ken.
If we see continued good sales pace and we see opportunities to bring online it could approach 25%.
But if we see our sales slow down, we aren't going to be bringing as many new projects online and it wouldn't be 25% of our sales.
- Analyst
Okay, and then relative to your units under construction, which actually rose for the first time into the fourth quarter relative to the third quarter, so you guys increased it roughly 700 units, historically you guys have said that's the best indicator of your times 2, so essentially 11,000 times 2 so 22,000 units for your four year deliveries, would you still stand by that characterization?
- President and CEO
I think you can do the math.
These are unusual times.
I'll stand by what we clearly said earlier that in 2010 we will close more units than we did in 2009.
- EVP, Treasurer
One other anomaly, Ken, for this year is the expiration of the original tax credit in November of 2009.
We usually see a seasonal pattern where we have our absolute strongest closings in our September month.
This year, it's changed a little bit so we're actually a little heavier with inventory, a little heavier with backlog at September than we typically would have been because the real push for seasonal closings has moved from September now to November, so that's one of the reasons you see that inventory staying a little higher in September.
- President and CEO
And we think that we'll see the same thing in our third quarter because basically, we're going to, with the tax credit, we'll see more people pushing their closings or we'll have a bigger number of closings through June 30th.
- Analyst
Thank you.
Operator
Your next question comes from the line of Dan Oppenheim from Credit Suisse.
Your line is open.
- Analyst
Thanks very much.
In the past you guys have talked about, I think rightly so, about how you don't build homes for practice and you focus on net income.
I'm wondering about the operating cash flow and your comment just recently about how you'll see more closings in the fiscal first quarter.
Do you have any goals in terms of what you'd like for cash flow for fiscal 2010 or at least for the first quarter 2010?
- President and CEO
We're planning on having positive operating cash flow in 2010 and I think that will come from a couple of places.
One of the places which we believe it will strongly come from is from profitability so that's what we're focusing on in 2010.
- EVP, Treasurer
And then clearly we do have income tax receivables that we expect to come in.
We have already received $113 million in our first quarter and we expect approximately another $150 million which is reflected in our income tax receivable on our balance sheet.
And then as we stated with the expanded carryback of the NOL to five years, that will mean an additional $200 million.
But if you look at the current quarter and a quarter in which our inventory stayed relatively flat and we were not profitable, we still had positive operating cash flows with no tax refunds, so we are operating at or around breakeven cash flow on an operating basis now even with no profits.
- Analyst
Great, and then secondly, I was wondering, with the comments you've made about the closings pushed to November, it would seem that you probably had, 60 days from contract signing to closing, you probably had a lot of the orders for the fiscal fourth quarter coming in the month of September.
How lumpy was the quarter in terms of the timing of the orders and what's the thought in terms of how much of a pull forward from the first quarter in terms of orders occurred there?
- EVP, Treasurer
We mentioned in our conference call that we actually saw our net sales throughout the fourth quarter are relatively flat across each of the months and we saw October relatively flat with the volume that we saw in those months in the fourth quarter.
We have seen November slow down a little bit.
That probably is both seasonal and in response to the original expiration at November 30th for the tax credits.
- Analyst
Great.
Thanks very much.
Operator
Your next question comes from the line of Nishu Sood from Deutsche Bank.
Your line is open.
- Analyst
Thanks.
I also wanted to follow-up on Dan's question on cash flow.
You folks have close to $2 billion in cash.
You just mentioned that you'd like to be cash flow positive, including the tax refunds for 2010.
That obviously reflects a conservative outlook, you've got to see how things go, how they recover.
What would you need to see, and assuming that the land opportunities are out there, what would you need to see before you begin to say okay, we are sitting on a lot of cash where there's a lot of opportunities out there, let's really go out there and tie up a lot of land as you we grow back to a more normalized environment?
- President and CEO
First of all, I don't know what a lot of cash is, but I think the $2 billion in cash is not as much cash as what we would like and clearly we're continuing to focus on cash generation.
Secondly, DR and I have been together for 26 years and this is our third downturn together.
As we had our Board of Directors meeting yesterday I can assure everyone that we're focusing on a land light business model, so to the extent that we're focusing on increasing our volume, which we are, we're doing that clearly by rolling option lot option contracts.
To the extent that we buy any land, we have a very tight parameter on how quickly we want that money back from that investment, and I will assure you that it doesn't go into two and three years out.
We want to turn our land very quickly so we are not going to be doing, on a going forward basis, any projects that have sizes that are too big for us to get our money back within a year or 18 month time period.
- Analyst
Got it.
That raises a question going forward if you're going to be pursuing a land light model.
Obviously, there's a good amount of raw land or less developed land on your own balance sheet that you would need to put capital into at some stage but then what, as an operating model as DR Horton deals with the sellers of land in the market, who would you prefer to be doing that development then going forward?
Is it going to require then more partnering because you folks have obviously traditionally shied away from joint ventures and land banking arrangements, so to maintain the size of DR Horton, if someone else is going to have to be doing that development, who is going to be doing it in the future then?
- President and CEO
First of al, we are going to clearly stick with our business model of not having any joint ventures nor any partners of that sort, certainly financial partners.
Secondly, to answer your question, there are an excess number of developers out there who are available in each one of our markets to develop those lots.
Clearly, I believe that we're better off to consistently make a gross margin on homebuilding and maintain that in the good times and in the bad times, so to the extent that there are opportunities for the lot prices to be higher, we would be willing to let the developer make a little bit more money on the development and sell the lots to us on an option basis at a higher price so that we can continue to maintain our consistent homebuilding margin and not take on the risk of the land ownership.
- Analyst
Got it.
And if I could just get one little quick housekeeping question in.
The other assets balance increased quite a bit.
I was just wondering what drove that.
- EVP, CFO
This quarter, and we will be filing our 10-K within the next day or so, there is a revision in the classification of estimated insurance receivables on our balance sheet.
In the past that has been netted against other liabilities and at year-end, that has been revised to be shown as an asset on the balance sheet.
The impact of that at September 30, 2009, is $235 million.
We have revised the prior year balance and the prior year impact is $241 million, so that's essentially an increase in other assets and an increase in other liabilities.
- Analyst
Okay, thanks a lot.
Operator
Your next question comes from the line of Joel Locker at FBN Securities.
- Analyst
Hi, guys.
Just the interest expense, it declined in the last two quarters before this one and it just surprised me it jumped up a little bit.
Just wanted to see what you guys thought going forward if it was going to continue to come back down or might stay elevated for a while.
- EVP, CFO
Joel, you're talking about the homebuilding interest expense?
- Analyst
Yes, the interest expense that came through the income statement, declined $25.6 million to $23.1 million, to $20.3 million and then back up to $26.8 million.
- EVP, Treasurer
There's probably a couple of different things happening in there.
We had issued $500 million of a convertible debt in May, and it did carry a low interest coupon of 2% but that would have been incremental debt in our fourth quarter.
And then the other thing we continually evaluate is in terms of what we can capitalize we look at our active inventory compared to our notes balance and any changes in that ratio could increase or decrease our interest expense in any given quarter.
- Analyst
But your active inventory it seems like it's been holding steady.
With the buyback of the debt I would expect that to at least stay flattish or at least from maybe in the low 20s or so.
- EVP, CFO
It's been slightly declining relative to our overall debt level.
And we've been having to expense a bit more of the overall interest incurred.
- Analyst
And just a follow-up question, on your backlog conversion was actually lower in the fourth quarter than it was in the third quarter for the first time in probably over a decade, if not ever.
Do you expect that might have been an inflection point on your conversion rate where it will start declining because your backlog is actually not declining year-over-year as it was?
- EVP, Treasurer
We have seen a very high conversion rate on our backlog in the March and June quarters.
We did see that moderate a little bit in September.
I think that ties back into what we were talking about a little bit earlier with the tax credit expiration moving the urgency of the closings from our September quarter which traditionally would have one of our highest conversion rates to actually now the month of November.
In terms of the conversion rate going forward, it will truly depend on the mix of our spec business versus our to be built homes closed in any given quarter.
- President and CEO
And the new tax credit expiring in April 30 and having to close by June 30, that's going to drive closings into that third quarter.
- Analyst
Okay, thanks a lot guys.
Operator
Your next question comes from the line of David Goldberg from UBS.
Your line is open.
- Analyst
Good morning.
It's actually Susan for David.
You guys noted that you expect your closings to be up in your fiscal '10 and as you look forward, can you give us some idea of how much growth using the current liquidity can support.
Is there a way for us to think about that in terms of planned spending in working capital investments, how much maybe you could handle without having to access the capital markets?
- EVP, CFO
First, regarding our liquidity, as Don talked about with regard to our strict guidelines on any spending on land and getting our cash back more quickly, to the extent that we're able to sustain that model, that's not going to necessarily require significant additional capital.
So with our cash balance and our modest debt maturities the next couple of years, we would expect to be able to really handle any growth that the market is going to give us.
I think our growth will be dependent largely on what the market is overall and what opportunities we have to continue to add additional flags on a lot option basis.
I don't think we'll be limited by our liquidity in the next couple years.
- Analyst
Okay, and then can you give us some sense of how you think about investing in the business relative to maybe buying back more debt or the possibility of maybe easing up on that?
- EVP, CFO
We have been relatively consistent in repurchasing our debt each quarter.
We've taken advantage of market opportunities that are there really at a fairly reasonable pace.
I would expect some activity to continue there but overall, as Don has talked about, there are still a number of headwinds in front of us operationally in the business so we are still very cautious as we look forward to next year in terms of really what the market is going to bring to us.
And so we're going to maintain sufficient levels of liquidity on the balance sheet and when we see the market opportunities then we'll choose to start incrementally investing.
- President and CEO
Based upon our option model, basically our investment back in the business is focused really on our vertical construction, so as we continue to add new flags, bottom line is what we're investing in is the vertical construction in those new flags.
- Analyst
Okay, thank you.
Operator
Your next question comes from the line of Joshua Pollard from Goldman Sachs.
Your line is open.
- Analyst
Hi, good morning guys.
First question is on the expanded and extended tax credit.
We expected October to be flat for you guys relative to September but now you guys are seeing a bit of a November slowdown.
When do you expect the tax credit, Don, to actually start being beneficial to your orders?
- President and CEO
I think as the traditional selling season starts, which is always around Super Bowl weekend, we believe that that will have some significant impact.
Once people get finished with the holidays and get into that after the Super Bowl is when we traditionally had our traditional selling season.
- Analyst
Okay.
And I have two more quick ones .
The one is on your specs.
It looks like that ticked up a little bit.
Can you talk about what percentage of your orders came from spec in the quarter or what percentage of some deliveries you guys are trying to get out by November 30th are coming from your spec
- EVP, Treasurer
The number I can give you, Josh, is the number of homes that were sold and closed in the same quarter, 41% for us this quarter.
In terms of what we'll deliver in November, I'm not sure any of us have any kind of good information to give you on that right now.
- President and CEO
We have the information but we just aren't going to give it to you.
- Analyst
I was going to say, Stacey, I know you've got it, I know you just don't want to tell me.
- President and CEO
Just wanted to be clear on that.
I would say to you on our specs, though, one of the things that has led us to where we believe we're clearly leading the industry in this recovery is by virtue of the fact that we are maintaining specs in our communities because the buyers that we have are buyers, once they're qualified, they want to buy and close very quickly.
So we believe that we'll continue to maintain a reasonable spec count in each one of our communities.
- Analyst
So are you guys actually kicking the construction engine back into gear ahead of the April ending of the tax credit so that you can deliver by June?
- President and CEO
We are clearly focused on selling all of the homes we can by the expiration of the April 30th tax credit so we are maintaining inventory levels which we think will meet the demand that's going to be generated by that tax credit, yes.
- EVP, CFO
And while at the same time continuing to manage it community by community based on the demand that we're seeing so that we keep our spec count and our inventory levels in line, as well.
- President and CEO
And just to let you know that our spec count, we reduced our specs and at the same time, if you take a look at what our specs are that are greater than six months, completed and greater than six months, that's only 800 units of inventory, and ones that are completed greater than a year are only 400 or so.
So we really do not have an age spec problem and we focus on moving through those completed specs as quickly as possible.
- Analyst
Another quick one, on your cash flow.
The seasonality there was a little off and it seems like seasonality on everything was off, orders were up more than expected, deliveries, down more than you had seasonally expected.
Do you think that's the same issue on your cash flow?
And could you talk about how much of your cash flow you would have expected to see in a normal September quarter that may come through in your December quarter?
- EVP, CFO
Absolutely as we said, the pattern is different this year.
With the tax credit impacting timing as far as closing goes, yes, some of our cash flows I think did move into the first quarter and so I think that will positively impact cash flow in the first quarter.
And as we move forward, we hope to continue to generate positive cash flow.
As far as what it would have been versus what it is that's difficult to say exactly what the full impact of the tax credit is but clearly it has moved the seasonal trend.
- President and CEO
But I want to remind everybody I think we projected we would have about $1 billion of free cash flow at the beginning of '09 and we delivered $1.1 billion, and we're telling people we'll have positive cash flow in 2010 and we'll deliver that, just a timing issue.
- Analyst
Last question, really, a modeling one.
Your community count what was it in the fourth quarter?
- EVP, Treasurer
We have not historically given a community count.
We've talked a little bit in terms of directionally and really what we've seen year-over-year is towards the end of fiscal 2009 we were actually getting new flags flying.
They didn't contribute a lot to our sales but we have seen a sequential increase in our active selling community.
- Analyst
Sequential increase quarter-over-quarter or sequential increase year-over-year?
- EVP, Treasurer
Quarter-over-quarter.
- EVP, CFO
June to September we've seen an increase, limited impact overall in our metrics in the fourth quarter.
On a year-over-year basis in terms of overall communities that are actively selling, I believe we're still slightly down versus a year ago levels.
- Analyst
Thank you very much.
Operator
(Operator Instructions) Your next question comes from the line of Josh Levin from Citi.
Your line is open.
- Analyst
Good morning.
You mentioned, I think you were talking about increased accruals for warranty and litigation.
Could you just elaborate what does that exactly relate to?
- EVP, CFO
Sure.
As we disclosed in all of our filings, we estimate what our future liability may be related to warranty expenses and any other claims that we may have related to our products which usually comes in the form of litigation in the ordinary course of business.
Our warranty liability typically comes through within two to three years following the closing of the home and so as our tail of closed homes in the past starts to come down, that will start to moderate.
The tail in terms of estimated liabilities for other product issues is a longer tail and we simply look at overall claims activity.
We look at overall closing activity.
We look at our insurance policies in terms of the coverage that we have on our insurance for such claims and adjust those balances really on a quarterly basis, and those balances have consistently increased as our tail has increased over the years.
And so the difference in the quarterly volume, the quarterly margin just reflected that normal adjustment.
- Analyst
Okay, and just one follow-up.
It's November, we're all sitting here trying to figure out how good or bad the spring selling season is going to be.
As you sit there and you guys try to plan for the spring selling season what do you think is the single most important factor that's going to determine how good or bad the spring selling season is going to be?
- President and CEO
The thing that drives our business the most is job creation and then solid unemployment so if you look at the macroeconomic environment, it's not good for us.
If you look at where we are positioned, I believe we are properly positioned to capitalize on bringing entry level buyers out of their apartments into a single family home, and we've focused on that very very sharply over the last three years.
So we're fighting the headwinds but we think we're very well positioned within the industry but until the unemployment rate starts to drop and there are jobs created, then we're going to have a tough time.
So we basically are continuing to focus on capturing market share in each one of our markets because we're competing almost exclusively with under capitalized builders, even the public ones and the private ones, so we feel like we are clearly in a strong position to continue to sign up option contracts and not have to borrow a nickel from anyone, any bank to build our vertical construction, which makes us an incredibly strong purchaser of lots from a developer or from a bank.
- Analyst
All right, thanks guys.
Happy Thanksgiving.
Operator
Your next question comes from the line of Stephen East from Pali.
Your line is open.
- Analyst
Thanks.
Good morning guys.
Could you help me out a little bit reconciling what you all have been talking about?
You said you spent about $377 million on land in aq and development this year but quarter-over-quarter inventory was only down about $19 million before charges.
Lots were only down about 1,000 lots that were owned.
And so I would have expected that implies that you spent $300 million or so, $250 million or 300 million, on either going vertical or acquiring or developing.
Could you just sort of shed some light on that?
- EVP, CFO
In the quarter, or overall inventory did stay relatively flat.
It was slightly down.
Our homes in inventory was slightly up so there was a slight use of cash on homes.
We generated some cash by incrementally working down our net owned lot count during the quarter.
But as we are spending cash on finished lot deals, as we're taking down finished lots off of option contracts, as we raise these new flags, so yes there are some cash out flows for finished lots.
But net-net, we still reduced our overall inventory slightly and we would expect to generate additional cash flow as we see more closings come into October and November.
- Analyst
Would the lion's share of the cash spend in the quarter, would it have gone to the lots or would it have gone to increasing the vertical dollars?
- EVP, CFO
The vast majority of the spending for both this quarter and for the year are all on finished lot purchases.
But for vertical, absolutely.
Overall, our spending is on vertical.
- Analyst
Okay, and then DT, you talked some about the conversion rate, you all touched on that.
I'm hearing some builders are starting to, they were understaffed, starting to have to hire project supers, et cetera.
On the conversion rate, are you all seeing any of that?
Was that an issue where you'll probably be bringing people on or do you think you have the right human capital structure going on right now?
- President and CEO
Clearly as we add flags we're adding a few superintendents and obviously adding salespeople.
We're not adding any back office staff.
We believe we have the proper staffing to carry on our back office sufficiently.
But those are the only people that we're bringing on and in many instances when we bring on a new flag we're trying to load up our superintendent with another project before we hire another superintendent.
So our hiring is limited, but from a positive perspective, at least from my positive perspective, it's great to be bringing on a few people as opposed to be laying people off.
We see our business growing.
- Analyst
Okay, and just one last question.
On the economics of fee building, is that attractive to you all?
Do you have any interest in doing it or are you doing it?
- President and CEO
No, sir, and no, sir.
- Analyst
Okay.
Thanks a lot.
Operator
Your next question comes from the line of Michael Widner from Stifel Nicolaus.
Your line is open.
- Analyst
Good morning guys.
Most of my questions have been asked and answered.
Just wondering if you could elaborate a little bit more on the cancellation rate and whether you're seeing anything change there.
And specifically the reason I ask is that with your focus on spec homes, fairly rapid delivery and the first time buyer tax credit, for most of the quarter expected to come to an end, I just would have expected the cancellation rates to be coming down.
And so just a slight increase Q over Q, so I was just wondering if you could talk about what you're seeing from the buyers there.
- President and CEO
I think the cancellation rates continue to stay relatively flat simply because of the fact that as the underwriting guidelines continued to be tweaked and improved, increased slightly, I think that's what maintaining our can rate where it is.
- EVP, CFO
I think it's reflective of the economic weakness, as well, and the weakness in employment right now.
You're having changes in people's lives right now as they lose jobs so I think that's having some impact, as well.
- Analyst
So if I'm interpreting that right, the cancellations are still being driven primarily by a credit availability and people that would like to buy a home failing to qualify for a loan and that's driving the can rate as opposed to, "I changed my mind," found a better offer, et cetera.
- President and CEO
That is correct.
- Analyst
Okay, and then just one quick follow-up on that.
Wondering if you could talk a little bit about, you mentioned that 64% of the loans in the quarter were government, I believe, but wonder if you could talk a little bit about LTV trends and if we're seeing substantial reliance on the 90 plus financing available through the FHA.
- EVP, Treasurer
We have seen our cumulative loan to value stay in the low 90% range.
That's really been consistent for us.
I think we've ran between 89% and about 92% for the last six or seven years.
So basically people are taking advantage of the mortgage products that are available to them and for people who can qualify for the FHA in terms of price points if they can close a loan with 3.5% down that's a product they're choosing to use.
- Analyst
All right, great.
Thanks guys.
I appreciate it.
Operator
Your next question comes from the line of Alex Barron from Agency Trading Group.
Your line is open.
- Analyst
Hi, good morning guys.
So I'm thinking as you look into the next six months to try to take advantage of this extended tax credit, do you guys anticipate increasing the number of specs proactively to try to capture as many of those buyers by June 30?
- President and CEO
I believe our unit inventory relative to our projected closings for the fiscal year currently is at a good solid position so I would not anticipate our spec inventory increasing dramatically.
I think we're specked out right.
- Analyst
Okay, and also, given your comment that you expect more closings next year, I was looking at the trend in the operating cash flow this year and it seems to be have declined every quarter, so I'm just trying to figure out, do you anticipate cash flow might be negative in the first half and positive in the second half then?
- EVP, CFO
Alex, I think what you've seen in terms of the decline in sequential cash flows is that we have slowed our liquidation of our balance sheet.
That has been a large driver of our cash flows, but as we move into fiscal '10 and we focus on profitability, our hope, our goal is that our cash flows shift from a liquidation of our balance sheet towards profitability and we start to generate cash flows from profitability.
Obviously we'll continue to manage our balance sheet closely based on the sales demand we see.
If sales slow down we'll reduce inventory levels and flow cash from that level.
If sales increase, then hopefully we'll see profitability from cash flows but we may also invest further in our balance sheet which could drive negative cash flows.
So we're really not providing absolute guidance.
Any guidance we provide on cash flows is all contingent on what we see in the sales environment this next year.
- Analyst
Okay.
Great.
Thanks.
Operator
Your next question comes from the line of Timothy Jones from Waseserman & Associates.
- Analyst
Hi, everybody.
- President and CEO
Mr.
Jones, how are you, sir?
- Analyst
Thought you forgot about me.
- President and CEO
That was one thing,I guess Navy Seals never die.
- Analyst
First of all you guys gave the homes under construction I think it was 11,600, the models and the specs and the finished.
Can you give us the same numbers for last year at this time?
- EVP, CFO
Sure.
Last year our total homes under construction were around 12,400.
Our model homes a year ago were around 1,500, our total specs were around 6,900 of which about 3,100 were complete a year ago.
- Analyst
Is the 11,600, historically you thought you would under normal times deliver about twice that number.
Does that historical relationship seem reasonable?
- President and CEO
Based upon my previous answer I would say that we'll let everyone do the math this year.
It's a different market than what it was on a historical basis, so clearly we're positioned to do two times that and we'll have to see how the market cooperates with us.
- Analyst
Okay, thank you.
Second question is first of all, a housekeeping question.
Where is that $110 million of deferred tax receivables on the balance sheet?
I have deferred tax receivables of zero on my balance sheet.
- EVP, CFO
Move up one line to the income tax receivable balance, and what we saw this quarter is as we finished our year and we firmed up exactly what our taxable loss would be, the balance that was in the deferred income tax line moved up to income tax receivables.
You see an increase in that balance to $293 million.
So it just moved up a line.
- Analyst
And that's both the $110 million or the $200 million, or not?
- EVP, Treasurer
That's going to be the $113 million that we've already received in October.
The additional $150 million that we expect to receive through federal income taxes.
But then the $200 million from the recent legislation change is not reflected anywhere on our balance sheet so that's not going to be in any receivable right now.
- Analyst
Will it be on in the first quarter?
- EVP, CFO
It will be on in the first quarter.
That legislation changed during the first quarter so we are not able to retroactively apply a change in the law back to the fourth quarter so that will be a first quarter event.
- Analyst
I have another question but I don't know where it is.
Okay, that's good enough.
Thanks.
Operator
Your next question comes from the line of Jay McCanless from FTN Equities.
Your line is open.
- Analyst
Good morning, everyone.
Wanted to continue the tax question, it's a hypothetical.
If you decided during fiscal '10 to aggressively liquidate specs and land inventory at a loss what is the maximum federal tax refund you believe you could gain from that?
- EVP, Treasurer
Maximum would be our entire inventory balance, I guess.
But right now, the amount that we have stated as the incremental $200 million, that is the full amount of our entire net operating loss for tax purposes that we have available to us, so that is really the minimum that we have but it also fully captures our full net operating loss.
What a forward projected loss could be into the future, that's really not necessarily predictable.
You would have to factor in reductions in home inventory, reductions in land inventory.
That's something that we are evaluating right now before we finally make our decision on how we're going to apply the expanded carryback.
- Analyst
I'm confused.
I thought the $200 million was on fiscal '09 results but shouldn't you all also be able to take a loss during fiscal '10 and potentially recoup previous taxes paid?
- EVP, CFO
The law does not allow us to use both years.
We have to choose between either our fiscal '09 or our fiscal '10, so we could wait a year and make the decision then but we have substantial amount available to us today.
We would have to see a taxable loss of a substantially larger amount than we have today to increase that overall refund.
- Analyst
Okay.
All right, and then my other question, what should we expect for percentage growth in your community counts in fiscal '10?
- President and CEO
We really don't give community counts and really, it's difficult to assess.
In each one of our markets our land acquisition, people and our division presidents are focused on tying up every deal that makes economic sense to us, and in some markets there are a lot of deals we can tie up and in other markets there are very few.
But typically speaking, I'd be surprised in each one of our markets if we didn't add 10 or so new flags over the course of 12 to 18 months.
- EVP, CFO
And then you will roll off the low projects so there's always a netting effect as well.
- Analyst
Okay, great.
Thank you.
Operator
Your next question comes from the line of Jim Wilson from JMP Securities.
Your line is open.
- Analyst
Thanks, good morning guys and Stacey.
Could you give a little bit of color on what you've seen within markets or some of your better performing volume markets and some of your worst, and maybe give the same kind of color from a pricing standpoint?
- President and CEO
I don't want to get into the ABCDF scenario, but our strong markets clearly are all of our markets in Texas which include San Antonio, Houston, Dallas/Fort Worth, Austin, Killeen.
Those markets performed well for us last year and they're improving significantly in 2010 over 2009.
The other market that is doing extremely well for us is Seattle.
I would call strengthening markets that we see are Southern California, Atlanta to a certain extent.
And weaker markets, clearly Las Vegas, Chicago, Hawaii, and to a lesser extent Florida and Phoenix.
- Analyst
And your comments would apply really to both the volume and the pricing picture for each of those cities in general?
- President and CEO
Yes.
- Analyst
Okay.
That's all I had incrementally so thanks a lot.
Operator
Your next question comes from the line of Stephen Kim from Alpine Woods.
- Analyst
Hi guys, good morning.
I had a question for you regarding your options.
I noticed that it looks to me like you did about, you entered into about 6,100 new land options or options for that amount of units.
I wanted to get a sense for whether you think that that kind of addition to your land bank in the form of options is likely to accelerate as we go into the fourth quarter based on what you see currently.
And I was curious about what you think the average price increase that you have to pay for, how much higher the purchase price is for those options than they would have been if you had opted to pay cash.
- President and CEO
The second part of your question is that wouldn't be an option for us and we're just not paying cash for virtually anything today.
Until the market begins to clearly stabilize, I think you would be ill-advised to do that because one of the things that clearly a rolling option contract affords you is the opportunity to adjust the purchase price if the market does soften.
So I don't really have a feel for that because it's just not something that we're focused on.
Our ability to do it going forward, Steve, clearly, we believe in calendar year 2010 that there will be increasing opportunities for builders like Horton who have a strong cash position and a strong position in our markets.
One of the things we continue to do is maintain our big footprint across the US, so we anticipate in calendar year 2010 continuing to add at an escalating rate the number of contracts and flags that we have in just the second half of calendar year 2009.
- Analyst
Okay.
So that's not entirely answering my question but I think I get the idea.
Let me ask the second part of my question a slightly different way.
When you're evaluating what strike prices you are willing to accept on these land options, are you assuming if prices and costs, hard costs, stay relatively the same as where they are now that you could make a gross margin approaching 20% when you're doing your feasibility analysis?
Or are you targeting a margin a little lower than that?
Can you give us a sense for what kind of margins are baked into the feasibility analysis on these lot options?
- President and CEO
Typically 18% to 20%.
- Analyst
Okay, great.
Perfect.
Thank you guys very much.
Operator
Your next question comes from the line of Michael Rehaut from JPMorgan.
Your line is open.
- Analyst
Hi, thanks, just a follow-up here.
When you were talking before about community count improving sequentially, would you see that trend continuing to increase given the lots that you've been tying up recently?
And if so, when would that necessarily result in a year-over-year increase if you keep the current pace of improvement steady that you saw this past quarter?
- President and CEO
We should have more flags open at the end of calendar year 2010 than we have at the end of calendar year 2009, as I just mentioned to Steve a few moments ago.
That we believe that for builders like Horton with a strong cash position, no requirement to borrow money from anyone, that we're a strong buyer from developers as well as banks.
And we believe that more lot option deals will become available from the banking institutions in calendar year 2010 than what we experienced in 2009.
- Analyst
Okay, and the option lots that you have this quarter, can you give us an idea of the percentage that was tied up in the last three months and the last six months?
- President and CEO
I can give you a general number and I would say well over 200 deals, option deals have been tied up in the last six months.
- Analyst
And what would that be in terms of number of lots?
- President and CEO
The typical deal is somewhere between 50 and 100 lots.
- Analyst
Great.
Thank you.
Your next question comes from the line of Alex Barron from Agency Trading Group.
Your line is open.
- Analyst
Thanks.
I had a follow-up.
Do you guys have the number of the dollars benefit to the gross margin from previous impairments for this quarter and also last quarter if available?
- EVP, Treasurer
The number for this quarter is $134.8 million.
Do you have it for the prior quarter?
- EVP, CFO
$134 million on homes this quarter.
Are you asking for the June quarter of '09, Alex?
- Analyst
Yes.
- EVP, CFO
Last quarter on homes was $112 million.
- Analyst
Okay, and the other question was did you guys quantify or measure somehow how many people or what percentage of your closings took advantage of the tax credit this quarter?
- EVP, Treasurer
We don't have access to that information, Alex, because people apply for the tax refund after they close their homes so that's not part of the closing process or the sales process.
- Analyst
Okay.
All right, thanks a lot.
Operator
Your next question comes from the line of Timothy Jones from Wasserman & Associates.
Your line is open.
- Analyst
Two quick questions.
One, you talk about going to more and more finished lots, then why did your land held for development, which I suspect is raw land, increase $30 million and accounts for about 25% of your total land inventory?
- EVP, CFO
It's about $30 million up over the year.
It's relatively flat with where it was in the third quarter.
There were some projects that earlier in fiscal 2009 we determined that we did not intend to go and develop in the next 12 to 18 months and so we early in fiscal 2009 we reclassified some projects under this category but that project list has remained relatively constant the last couple of quarters.
- EVP, Treasurer
Those would not be new land purchases.
- Analyst
It's not new land purchases?
Okay.
- EVP, Treasurer
Not new land purchases.
- EVP, CFO
Existing projects we've classified as land held.
- Analyst
You talked about November being seasonally slow.
I don't know if I caught it.
Did you say anything about October?
I know you said you expect first quarter orders to be up, but did you say anything about October?
- EVP, CFO
October held up seasonally strong.
We believe impacted largely by the tax credits being available through November and our availability of having some spec homes for those buyers.
- Analyst
Thank you.
Operator
There are no further questions.
I'll turn it back over to you for closing remarks.
- President and CEO
Thank you.
I'd like to thank all of our employees for 2009 and most importantly everything that everyone has done in this Company since December of 2006.
When I was standing in Stacey Dwyer's office and we were calling one of our Regional Presidents about the lack of sales, it's been a very long three years.
We think we have properly positioned Horton going forward and we believe that we can take advantage of our strong position in the industry to grow this Company once again and return to profitability.
Our motto is onward and upward.
So thank you very much.
Goodbye.
Operator
This concludes today's conference call.
You may now disconnect.