霍頓房屋 (DHI) 2010 Q1 法說會逐字稿

Good morning.

My name is Courtney and I'll be your conference operator today.

At this time, I would like to welcome everyone to the D.

R.

Horton, America's Builder, first quarter 2010 earnings release conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you and Mr.

Don Tomnitz, you may begin your conference.

Thank you, Courtney.

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.

Some comments made on this call may contain 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's no assurance that actual outcomes will not be materially different.

All forward-looking statements are based upon information available to D.

R.

Horton on the date of this conference call, and D.

R.

Horton does not undertake any obligation to publicly update or revise any forward-looking statements.

Additional information about issues that could lead to material changes in performance is contained in D.

R.

Horton's Annual Report on Form 10-K, which is filed with the Securities and Exchange Commission.

Don?

First, we want to thank all of our DHI team members for generating our first profit since Q1 fiscal year 2008.

Congratulations to each of you.

We have all pursued a long and arduous road characterized by downsizing, impairing, and consolidating to adjust to an ever changing national, regional, and local economic and housing environment.

We have successfully negotiated the road together.

This, coupled with your superior effort to secure new lot positions at attractive prices over the last year, places DHI in a preeminent position in our industry with a great opportunity to build on what we have started.

It provides us the privilege of telling the public about your accomplishments in this conference call.

Stacey?

On a pre-tax basis including impairments, we are excited to report a pre-tax profit of $42.8 million.

Both our home building and financial services segment were profitable.

Our net income for the quarter was $192 million, or $0.56 per diluted share compared to a net loss of $62.6 million, or $0.20 per share in the prior year quarter.

Net income for the current quart includes an income tax benefit of $149.2 million related to the recent change in the tax law for NOL carrybacks.

Don?

Let's be clear, our goal this year is profitability in each and every quarter and for the entire fiscal year.

Profitability in the second quarter will be challenging as we will not close as many homes in the second quarter as we did in the first quarter.

We are entering the quarter with 4,136 homes in backlog and we will need to realize a backlog conversion ratio of greater than 100% to reach profitability.

With the extension and expansion of the homebuyer tax credit and with our available housing inventory, a high backlog conversion rate is entirely achievable.

But we do not expect to be as profitable as we were this quarter.

In the third quarter, we expect strong closings since homes must close by June 30th for the extended tax credit.

The third quarter will probably be our strongest quarter for profits this year.

We expect our September quarter will be the most challenging as the tax credit support for home sales will have expired.

As we move past the selling season, we'll be able to get a better read on core demand and we'll adjust our business accordingly.

Bill?

Net sales orders for the first quarter were 4,037 homes, up 45% in the same quarter in the prior year.

Our average sales price on net sales orders in the quarter increased approximately 3%, both sequentially and from the year ago quarter to $210,600.

Our cancellation rate was 26% in the quarter.

Our sales backlog increased 3% from the prior year to 4,136 homes or $884 million.

Our first quarter home sales revenues increased to $1.1 billion or 5,529 homes from $886 million or 4,068 homes in the year ago quarter.

Closings were unusually strong for our December quarter, driven by the original November 30th expiration date of the homebuyer tax credit.

Our average closing price for the quarter decreased approximately 8% from the year ago quarter to $200,400.

Stacey?

Our gross profit margin on homes sales revenue in the first quarter was 17.1%, up 160 basis points from our homes sales margin in the year ago period and up 460 basis points sequentially from our September quarter.

Approximately 300 basis points of this sequential increase was due to the average cost of our homes, declining by more than our average selling prices, partially due to our success constructing and closing homes on recently acquired finished lots in new communities; 15% of the first quarter closings were from new deals that were contracted for in fiscal 2009.

Margins on closings in our new projects are approximately 350 basis points higher than on the remainder of our closings.

Approximately 110 basis points of the sequential increase in gross margins was due to the current quarter change in our warranty and litigation accruals as a percentage of homes sales revenue.

Courtney, we're getting some background nose, can you make sure all lines are on mute, please?

(Technical difficulties)

Approximately 110 basis points of the sequential increase in gross margin was due to the current quarter change in our warranty and litigation accruals as a percentage of home sales revenue.

The final 50 basis points was due to a decrease in the amortization of capitalized interest and property taxes.

The decreased amortization resulted in reductions in our interest and property taxes incurred and capitalized over the past year and we have a greater mix of homes closed on acquired finished lots this quarter.

Bill?

As we had indicated on our year-end call, we expect lower impairments in 2010 primarily based on a reduction in our watch list at September 30, 2009.

In addition, this quarter we saw an increase in our home sales gross margin to 17.1%, an increase in our average sales price on our net sales, and good sales volume.

These positive results were incorporated in our first quarter impairment analysis when we reviewed all projects in the Company, and determined that projects with a pre-impairment carrying value of $5.3 million were impaired.

We recorded inventory impairments of $1.7 million as a charge to cost of sales.

We refer to our projects which have indicators of potential impairment, but were not impaired, as our watch list, which represents those projects deemed to be the highest risk for future impairment.

Our watch list is currently $478.7 million, down from $542 million at September 30, 2009, and also down from $1.2 billion at June 30, 2009.

The largest concentrations in our watch list are in California, Texas, Hawaii, and Illinois.

Also during our first quarter, we had net recoveries of $500,000 of earnest money and pre-acquisition costs.

If our margins and absorptions stay at current levels, we expect our impairments to remain at a relatively low level in our second quarter.

As we move past April 30th and the expiration of the tax credit, we will evaluate the impact on sales demand, sales prices, and expected margins for sales written after April 30th.

And we will incorporate these market conditions in our inventory impairment process as necessary in the June and September quarters.

We still expect our impairments in fiscal 2010 to be substantially lower than those we recorded in fiscal 2009.

Don?

Our consistent focus on SG&A was a key to our return to profitability.

We have leveraged our SG&A structure to focus on opportunities in our existing markets and division operations.

Home building SG&A expense for the quarter which includes all corporate overhead, in other words, a fully loaded number, was $128.4 million, or 11.6% of home building revenues compared to 14.1% in the year ago quarter.

SG&A increased only $1.4 million or 1% on a 36% increase in homes closed.

We will continue to actively manage our SG&A levels relative to our expected number of home closings.

Bill?

We recorded $26.9 million in home building interest expense during the quarter.

We are required to expense a portion of our interest incurred as interest expense while our home building debt level continues to exceed our active inventory.

Financial services pre-tax income for the quarter was $6.7 million compared to a pre-tax loss of $2.9 million in the year ago quarter.

90% of our mortgage Company's business was captive during the quarter.

Our Company-wide capture rate was approximately 61%.

Our average FICO score was 702 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 63% of our volume.

Stacey?

During our December quarter, we received a tax refund of approximately $113 million related to our taxable loss in fiscal 2008.

Subsequent to September 30th, new legislation was passed that extended the NOL carryback period from two years to five years.

We evaluated our options under the five-year carryback and we elected to carryback our tax loss from fiscal 2009.

As a result, we increased our income tax receivable by approximately $200 million and have filed for a $352 million refund which we expect to receive in the second quarter of fiscal 2010.

The remaining $30 million of our $382 million income tax receivable is expected to be received from state and federal tax refunds in future periods.

Our deferred tax asset is now $915.2 million and is fully reserved at December 31, 2009.

Bill?

Our total inventory decreased by approximately $80 million during the first quarter.

Our homes in inventory at the end of December totaled 11,500, of which, 1,100 were models, 7,300 were speculative, and 2,900 of these specs were completed.

Of the first quarter closings captured by our mortgage Company, 66% were to first time buyers who typically purchase spec homes.

So we continue to manage both our total number of homes in inventory and our number of speculative homes to match expected demand.

Our unsold completed homes older than six months were 600 homes at December 31, 2009, down from 800 at September 30.

We are prepared for the spring selling season and for current demand created by the federal homebuyer tax credit with our current spec level.

We will continue to manage our spec levels very closely as we move closer to the April 30th sales contract deadline for the homebuyer tax credit.

Don?

Our land and lot acquisition investments remain controlled and we continually reevaluate our land development plans based on current sales trends.

We have been actively contracting for finished lots to supplement our existing land positions and increase our current average gross margins.

In our first fiscal quarter, we invested approximately $200 million primarily in finished lots.

Our spending on finished lots will be largely dependent on our sales pace.

Our spending on land and development costs will continue to be at very low levels.

Bill?

Our supply of owned land and lots at December 31, 2009 was approximately 88,000 lots, of which approximately 22,000 are finished lots.

We control an additional 24,000 lots through option contracts and our net earnest money deposit balance for these lots is only $9.3 million.

We are focused on managing our supply of owned, finished lots in line with our sales demand in a low risk, capital efficient manner.

Don?

We generated approximately $220 million in operating cash flow in the quarter, which included $113 million federal income tax refund.

Future cash flows, excluding federal tax refunds, will be dependent on our inventory levels which will be dependent on sales levels in the spring and summer, especially after the federal tax credit expires.

As we have mentioned before, we are focused on changing the source of our cash flow from inventory and balance sheet reductions to income.

We ended the quarter with approximately $1.9 billion of unrestricted home building cash.

Stacey?

In the December quarter, we repurchased approximately $173.2 million of our outstanding notes for $171 million plus accrued interest.

The balance of our public notes outstanding at December 31, 2009 was $2.9 billion.

Subsequent to quarter end, we have repurchased $7.5 million of our outstanding notes.

We have redeemed $130.9 million of our 4.875% senior notes which matured in January and we have announced our intent to redeem in February the remaining $95 million of our 5.875% senior notes due 2013 at a price of 101.958%.

Our remaining note maturities in fiscal 2010 total $84.6 million.

At December 31, our home building leverage ratio net of cash was 28%, a 730-basis-point improvement from a year ago.

This improvement in leverage compared to the prior year is due primarily to the increase in our cash balances, continued reductions in outstanding debt, and the positive impact to equity from both the expansion and the NOL carryback period and the change in accounting principle for debt with conversion options.

Bill?

On October 1, 2009, we adopted and applied retrospectively the FASB's new authoritative guidance which specifies that the liability and equity components of convertible debt be separated and that our interest costs reflect our non-convertible debt borrowing rate as of the issuance date of the convertible notes.

As a result, the carrying value of our convertible notes has been reduced to $373.8 million at December 31, 2009 with a primary offset to increase additional paid in capital.

While the cash coupon on these convertible notes is still 2% the effective rate for the notes for GAAP purposes is approximately 9.7%.

September 30, 2009 and prior periods have been adjusted for this accounting change and we will file an 8-K to reflect these adjustments to our fiscal 2009 Form 10-K in the next two weeks.

Also, our first quarter 10-Q that we expect to file later today will summarize the effects of this accounting change on our previously reported September 30, 2009 financial statements.

Early adoption of this authoritative guidance was not permitted.

Don?

In summary, there were numerous positives for the quarter, the most important of which include, we were profitable with a pre-tax income of $42.8 million in the quarter; we saw a 45% increase in our sales with our ASP increasing both sequentially and year-over-year.

Fully home building SG&A which includes all corporate overhead as percentage of revenues was 11.6%, up only $1.4 million or 1% on a 36% increase in homes closed.

Positive cash flow for the past 14 consecutive quarters now totaling over $5.4 billion.

We continued to reduce our debt as he reflected in our $173 million of repurchases in Q1, our announced redemption of $95 million in senior notes due 2013, and $131 million of notes which matured in January, leaving us with only $85 million in remaining maturities in fiscal 2010.

Lastly and most importantly to answer some of our critics, it is clear we are selling homes at a profit while working our way through our own lot positions as evidenced by our 17.1% gross margin this quarter.

There's still challenges in the home building industry; rising foreclosures, high inventory levels of available homes, high unemployment, tightening FHA lending standards, and weak consumer confidence.

However, new home inventory remains low, interest rates are favorable, housing affordability is near record highs and near-term demand should be boosted by the homebuyer tax credit.

We will continue our focus on providing affordable homes with the first-time buyer, controlling our costs, contracting for new communities with attractively priced finished lots, and maintaining our strong balance sheet.

Again, 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 competition in the industry.

D.R.

and I have never been more proud of you.

Keep up the great work.

DHI is leading the industry into the housing recovery.

This concludes our prepared remarks, and now we'll host any questions.

(Operator Instructions) We'll pause for a moment to compile a Q&A roster.

Your first question comes from the line of Joshua Pollard from Goldman Sachs.

Your line is open.

Good morning, and thanks for taking my question.

Don, thanks for the clarity on the seasonal trends.

I think it helps set investor expectations for the year and the quarters in context and for your goal for profit.

Could you take a moment and talk about the seasonality of gross profit margins in 2010 and potentially your expectations there?

Well, clearly we're proud to start off the first quarter with a 17.1% gross margin.

I believe as we move into the second quarter, which we're currently in today, we should be able to maintain that margin into the second quarter and even into the third quarter.

After the tax credit expires and July 1 starts, I would anticipate our gross margins to runoff some in the fourth quarter.

That's an unknown.

As I say, come July 1 we're going to have a new housing environment.

We're prepared to deal with whatever comes at us, and if the tax credit expires and there's not another one, then we'll deal with that just as we've dealt with everything else.

When you, when you talk about the gross profit margins you mentioned about 300, or excuse me, I think150 basis points coming from some warranty reversals.

Are your comments about second and third quarter having similar gross margins inclusive or exclusive of those factors?

And I have one quick follow-up.

We would, this is Bill, we would expect to have, to be able to maintain our margins just inclusive of all of those factors.

The change in warranty accruals, the change in capitalized interest and property taxes are normal occurring adjustments.

Sometimes there are increases, sometimes they're decreases but we expect to be able to maintain our margins for the next quarter or two in the range we reported this quarter.

Okay.

Great.

My last follow-up is, many of your competitors have talked about January being positive in particular on traffic and order levels.

Are you seeing similar strength and could you maybe give as much detail as possible?

We don't have final numbers yet.

We do expect to show a positive year-over-year comparison in January.

And part of it is seasonal, part of it is driven by the tax credit.

We would typically expect to see stronger traffic beginning about now.

We always look at Super Bowl Sunday.

We are a week before that, but we certainly would expect to see the stronger traffic and we are seeing that in some of the reports that are coming in.

And, Josh, we're not big believers in tracking traffic.

What Don Horton and I are really focused on are tracking sales.

And not withstanding the fact that our traffic counts may be down or less, what we're really focused on is our conversion rate and clearly as the traffic has declined over the years, giving different months in the fiscal year, our goal is how do we convert the largest amount of traffic coming through our models at any one point in time.

Is that conversion rate, where is that conversion rate today?

Actually, what we track at the corporate office is net sales.

I couldn't tell you the conversion rate.

But we are seeing positive trends in our net sales in January.

Great.

Thank you very much.

Thank you.

Your next question comes from the line of Megan McGrath from Barclays Capital.

Your line is open.

Hi, thanks.

I wanted to follow-up actually on Josh's question around seasonality.

When you talk about fourth quarter being potentially your most difficult quarter, and you just talked about that on margin, is that the expectation that you might have to lowering prices after the expiration of the tax credit or do you actually think that 4Q volumes could be lower than, let's say, 2Q, which would be pretty rare?

Actually we do believe that fourth quarter volumes will be less than the second quarter and the third quarter volumes just simply because we're, we believe a number of sales, we don't know exactly how many, but we believe that a number of the sales are being driven by the tax credit.

So to the extent that that tax credit expires, clearly, I think that will adversely effect our sales in the fourth quarter.

Relative to inventory, we're focusing on reducing our inventory post-March to comply with the expiration of the tax credit.

To the extent that there's more volume than we anticipate in the fourth quarter, we can ramp our inventory back up again.

Okay.

Great.

And then to get a little bit more color on your comments around impairments, given what you've said around the potential -- that 2Q is going to be a little bit more difficult to achieve profitability, and especially 4Q, is that taking into account impairments?

Should we automatically expect impairments to go up next quarter given your comments around profitability or is that already taking that into account?

It's already taken into account.

We expect as long as volumes and margins stay at reasonable levels in Q2, we expect our impairments in Q2 to remain at a relatively low level.

We will start getting a better read on where core demand is, where core, where core margins are post the tax credit at the end of April and then we will factor that into our impairment evaluations.

I think that's reflective.

That's one of the reasons why we choose to share with you our watch list, because certainly as our watch list continues to decline, we anticipate our impairments to continue to decline.

Great.

Thanks very much.

Your next question comes from the line of Dan Oppenheim from Credit Suisse.

Your line is open.

Thanks very much.

I was wondering if you could talk about the plans in terms of building specs and inventory.

You guys have done a lot better in terms of the orders both in fiscal 4Q and 1Q based on some of the specs you had.

How aggressive do you plan to be with specs in building them in 2Q, and what does that mean as you think about the cash flow for the second quarter given the likelihood of lower closing volume?

I'll take the first half and Stacey or Bill can take the second behalf.

We believe we're properly positioned today with our inventory to meet the demand, i.e., the spec inventory to meet the demand that's going to be associated with the tax credit.

Clearly, what we're doing currently is to the extent we need to start additional specs to replace spec sales, and those new spec units can turn and close by the expiration period, which is June 30th, then we'll start additional specs.

But basically, we're properly [specked] today and it's only a replacement of the specs as we need them to meet the 6/30 closing dates.

Yes, and cash flow for Q2 will be positive.

We are expecting a $352 million income tax receivable so that's going to drive the cash flow from operations.

In terms of whether we would be cash flow positive without that, purely from an operational basis, part of that will depend on what we do choose to do with our inventory of homes under construction and that's going to be driven by the sales that we see over the next few months.

Go ahead.

And clearly a driver of our cash flow is our closings volume, and as we've stated we do expect to close fewer homes in our second quarter, so that, we will not have that driver of cash flow in the second quarter, then we expect it to increase again in the third.

Great.

Thanks.

And I guess I was wondering you're talking about buying land and where with the cash position that you have.

Have you set any goals in terms of what you would like to acquire in fiscal 2010 in terms of the number of lots or dollars to invest?

Well, we're focused really on contracting for lots on an option basis, with as little earnest money as possible.

We are in a position where we really don't want to buy very many lots all cash unless there's, it is at a significantly reduced price.

But the bottom line is, we're not anticipating, as I mentioned to you earlier in the conference call, to spend very much on land development or land acquisition or even land development.

What we're really focused on is contracting for option lots as well as purchasing some finished lots on an all-cash basis if the yield is there.

The way we're managing our overall lot inventory is we're focused on our position of owned finished lots.

Today we own about 22,000 finished lots.

That's a little more than a year's supply, that's pretty good.

We have 24,000 optioned lots, which the vast majority of those are finished lots as well.

So we have those in position, in a flexible low risk position, to be able to bring into our own supply as need be.

So, so we're focused really on our own finished lots position.

Great.

Thanks very much.

Your next question comes from the line of Josh Levin from Citi, you're line is open.

Good morning.

Morning, Josh.

When you purchase lots during the quarter, what kind of assumptions were you making about absorption rates and home prices, were you using absorption rates and home prices from the quarter?

Say your question one more time now.

So during the first quarter when you purchased finished lots, you, obviously, when you were trying to calculate the price you were willing to pay, you had to make assumptions about absorption rates and home prices going forward.

Were you using absorptions rates and home prices from the first quarter when you made you're decision about what price to pay for finished lots?

Yes.

Especially on and all-cash basis.

As, again, most of our purchases were under option contracts where we're doing take downs on a monthly or quarterly basis.

Most of them are quarterly basis.

So, yes, we're basing those purchases of those lots based upon the pricing and absorptions of Q1.

To the extent that the pricing erodes into Q2 or Q3 or whenever our next take down is, obviously, the beautiful things about the option contracts it affords us the opportunity to go back and rework the price of those lots based upon what the absorption as well as the sales price of homes is.

Sure.

Okay.

You got tremendous operating leverage on your SG&A during the quarter.

I mean, the SG&A barely moved despite the uptick in orders.

How much more operating leverage do you think there is?

Will it be this significant going forward?

I put this in the category of no good deed shall go unpunished.

To answer your question, in this Company, every day from the corporate level to the regional level to the division level, SG&A is a constant focus in this Company and has been for the 26 and a half years I've been here.

And has been ever since Don Horton came from Arkansas to Texas, and it probably -- it was when he was in Arkansas he started focusing on SG&A.

I don't know how much more leverage we have, but clearly we are focused on trying to keep our SG&A at the current level or better.

To the extent that we have fewer closings in Q2, that percentage could go up, but we have proven beyond any reasonable doubt over the last three years that we have been the most efficient operator in the industry with the lowest all-in, fully loaded SG&A and we will continue to be so.

Thank you very much.

Your next question comes from the line David Goldberg at UBS, your line is on.

Thanks, good morning.

Good quarter, guys.

Thank you, David.

First question is actually about the changes at the FHA that happened recently in terms of seller-funded concessions and how that's affecting the business going from 3% -- going from 6% to 3% allowable concessions?

Those rules are not in effect yet, David.

They are proposed, and I believe the timing for implementation is going to be sometime this summer.

So it's hard to answer.

If the incremental 3% closing cost is the deciding factor between when someone can buy a home, then they may have to save a little longer.

I mean, it kind of comes back to the same thing that we were saying when some of the loan products went away, you just have to plan a little longer, save a little longer to be able to get into a home.

And as we said in our conference call, one the things that we're looking at are all the different catalysts to our current sales, and to the extent that one or two of those catalysts expire or have been canceled, then it's incumbent upon us as we have done over the last three arduous years, as I've said, to adjust our business model to deal with whatever the facts are at the time.

Right.

Got it.

Just a follow-up question is on competitive environment when we look at the expiration of the credit that's coming obviously.

It seems to me that a lot of the public and private builders that we're talking about are building more spec inventory this time and trying to be a little bit more prepared in terms of having units that can close on time.

I'm wondering if you can talk about the competitive landscape, if you feel like that's a trend your seeing from your competitors, and if you're worried about pricing in that kind of environment?

Well, it's always interesting when they come to the dance late, which it seems like that our competitors are coming to the dance late, and that's one of the reasons why we think our Q4 will be a tougher quarter for us than any other quarter because clearly we have the spec inventory today.

I think some of our competitors are just beginning to increase their spec levels.

And as a result, we could have additional excess new home capacity or inventory in the fourth quarter and we'll have to deal with that as we see.

Clearly, we're positioned and have been positioned during this entire downturn to meet the demand that's generated by the tax credit.

I believe we're in a preeminent position, we've got the finished inventory in a number of our communities.

We have spec inventory that's coming on at various stages of construction.

So, again, I think by virtue of the fact that the home has to be sold by April 30th and closed by June 30th, some people better increase their inventory turns to meet the deadlines that are in place.

So we feel very good, and there will be competition bringing on additional inventory, but it's not nearly as competitive as where we are in terms of our cost and our pricing structure.

Got it.

Thanks.

Your next questions comes from the line of Ken Zener from Macquarie.

Your line is open.

Good morning.

Good morning.

Good morning.

You have given some good details about the gross margin, the increase, you've talked about the 300 basis points due to the cost being lower than the decline in sales there.

So, and then you also said 15% of your closings were tied to new lots that were roughly 350 points higher, so that means 60 BPS came from the new lots 250 BPS from the overall lower cost structure.

What led to that actual acceleration in this quarter as opposed to the prior quarter and did that surprise you?

We've been preparing to report better gross profit margins.

Our people have been working all this past year to reduce their costs, adjust their products, and then adjust their pricing and incentive levels to the new product.

And so really it's the culmination of the work over the past year.

Our core margins showed dramatic improvement this quarter for several factors.

First, we've done a lot of work on our costs.

Secondly, there still is the effect of prior impairments, although the effect of impairments this quarter was actually less than it was in the fourth quarter.

And as we have seen over the last several quarters, we have continued to work through our older specs and so we had less of an impact from old completed specs moving through our closings this quarter.

So really all of those factors contributed to the improvement in our core margin.

And please realize, we've been in an extraordinary strong position over the last two to three quarters as we are one the few builders starting any significant inventory in any of our subdivisions.

And typically if you go subdivision-by-subdivision as Don Horton and I do and we see the competing subdivisions across the streets from our existing subdivisions, we have started the most homes of anyone in the industry.

So as a result, the subcontractors and the vendors are very excited about doing our work and they're very excited about pricing it competitively so we can continue to start more homes.

We have been the life blood of a lot of our subcontractors and vendors.

Due costs, due pricing.

Right.

And then I guess related to that, how do you expect over the next two quarters, I realize you're being appropriately cautious on the fourth quarter, but over the next two quarters, do you expect that 15% from new lots to go up?

What do you expect it to go to?

And what are your current units under construction?

Well, let Bill answer the second part of that question because he knows those numbers better than I.

But I would say to you that we expect that 15% to increase as we continue to attract more and more sellers to us, because one of the things that attracts sellers to us is the fact that we are starting homes and we're carrying a higher spec inventory than most of our competitors.

So we are a natural first-time buyer for lots compared to everybody else in the industry.

In terms of our homes under construction, we have 11,500 total homes under construction, of which 1,100 of those are models.

That's basically flat in total with where we were a quarter ago.

We have 7,300 of those homes are spec this quarter.

So we're prepared for the selling season with those specs.

And just a bit more color in terms of visibility on where the new project percentages could go.

During the first quarter, our sales in our new projects were 25% of our total sales.

So we're seeing that increase coming down the line, and where it could go is that will be really the result of the work of our people and continuing to work and sign up new projects.

But we'll see the increase coming in forward quarters.

Thank you.

Your next question comes from the line of Joel Locker from FBN Securities, you're line is open.

Hi, guys.

Just on the community count.

Was that up again sequentially like last quarter?

That was up sequentially.

We are still down a little bit year-over-year.

We do expect probably to lap that sometime in the next couple of quarters and actually show a positive comparison year-over-year.

Got you.

And just a follow-up questions, do you have a breakdown of your orders per month in the first quarter?

We have it.

We typically don't report our individual month results.

We did state on our last conference call that obviously October was a good month of sales as we were nearing the tax credit expiration.

We saw a seasonal decline in November and in December.

Both seasonally and with the expiration of the tax credit.

Got you.

All right.

Thanks a lot, guys.

Your next question comes from the line of Nishu Sood from Deutsche Bank.

Your line is open.

Hi.

This is actually Rob Hansen on for Nishu.

I know you mentioned that you're not putting many dollars into inventory this year, but I just wanted to get a sense of whether or not your active inventory will be increasing and if it will be enough to cover the interest costs.

In other words, can we expect that excess interest line to come down over the year?

We do expect it to come down somewhat over the year, primarily, though because we have reduced our debt and our interest incurred is declining.

It's a little difficult to predict exactly where the balance of interest incurred and where our active inventory will be versus our debt and that will largely be dependent on what we see in the marketplace.

Right now and in the next couple of quarters I don't expect our active inventory to increase much over the current levels.

If we see better stability in the marketplace and we choose to increase our inventory down the line then we would see an increase there.

But that's a little difficult to predict on the active inventory right now.

Okay.

And then in terms of the communities that you're bringing back on line, what's kind of the percentage breakdown in terms of new communities versus bringing back mothballed communities?

Probably the best indication we have of that, Rob, is the breakdown that we just gave you on the closings for new projects and the sales as a percentage of our mix, 16% of closings, 25% of sales.

The rest of it is coming from legacy projects, some of which I would say are not necessarily mothballed, it's just as we move into new phases or additional locations we are bringing on some projects that were not previously active.

Okay.

Thank you.

Your next question comes from the line of Bose George from KBW, you're line is open.

Okay.

Good morning.

Actually I had a couple little questions on the mortgage side of your business.

One was, your loans held for sale fell by about $56 million despite the increase in closings, I was wondering if this just reflected your ability to sell these loans faster?

And curious since it did help the cash flow?

This is another of the timing differences that followed the tax credit.

Usually we would expect our highest closings in the final month of the quarter.

This quarter we saw our highest closings in November, and so we had a longer time period to sell the mortgages that were originated in that heavy delivery period.

We would actually expect that not to be a recurring trend.

We would expect to then continue to see our higher closings in the final month of the year and you'd see that mortgage loan held for sale balance increase again.

Okay.

Great.

Thanks.

And then the second issue is just on the mortgage repurchase facility.

That fell to $6 million from $69 million, does that reflect your funding it with cash or was it the same issue you just highlighted?

Primarily the same issue I just highlighted.

Okay.

Great.

Thanks a lot.

Thank you.

Your next question comes from the line of the Mike Widner from Stifel Nicolaus, your line is open.

Good morning, guys, and congratulations on a very solid quarter.

Thank you.

So most of my questions have been answered.

Just I wanted to ask you maybe if you could comment a little bit on the deferred tax credit and what conditions we might need to see for that to come back onto the balance sheet?

Well, I knew we would get this question.

Well, it's nice to actually be able to talk about the future potential of that since we did have a profitable quarter.

In all discussions around the potential of bringing that back on to our balance sheet, basically what we will have to show is some consistent trend of profitability, and expectations and visibility to a good, solid future trend of future profitability before we can start considering bringing the valuation allowance on our deferred tax credit off.

So we don't expect that will be an event that's going to occur in the next couple of quarters.

But depending on our profitability, depending on what we see in the marketplace later in this year and our visibility into 2011 and beyond then we'll start evaluating that.

But it's not a next couple quarter event.

And touch on a pet peeve of mine, obviously, that is a subjective analysis and we're, by tradition, a much more conservative Company than most of our peers, and so I wouldn't, I would agree with Bill, it's not going to be something that's going to happen immediately.

Okay.

Great.

Thanks.

And you provided some pretty good color on your expectations for gross margins over the rest of the year.

Just wondering if you might also provide a little color, you've mentioned before, Don, kind of normalized gross margins in a healthy new homes sales environment being kind of anywhere in the 18% to 22% range.

The 17% that you've sort of implicitly guided toward is a bit low, just wondering on your view, what gets that number up, how high does it get and how long do you think it might take to get there?

Well first of all, I think that you have job growth in the economy, and there's obviously no job growth to speak of today.

And, secondly, I think we have to have consumer confidence, and, thirdly, I believe that a number of people in the country are still under water on their mortgages, and I think those three things have to be cleared up before we start to have, to get back to more normalized margins.

The way that we are managing our business model here is, is that we certainly think that we've got two more challenging years ahead of us.

I don't expect job growth or consumer confidence to change dramatically, so we, I don't expect 18% to 22% gross margins on a consistent basis for a couple of years.

Well, great.

I appreciate the comments and color.

Well, that's a negative outlook, but it's a realistic one from here.

Well, I would agree with you on that and let's hope that everything turns around faster.

It would be nice if we were wrong.

Yes.

Okay.

Thank you.

Your next question comes from the line of Carl Reichardt from Wells Fargo.

Your line is open.

Hi, guys, how are?

Well, we're doing good this morning, Carl.

I'm glad to hear it, Don.

Just on community count.

I've got a follow-up on Joel's question earlier.

As you guys are looking out through fiscal 2010, Stacey, can you give me a sense as to where you think that's going to be sequentially or year-over-year versus 2009?

If you have a rough idea at this point?

I would say right now we don't have a rough idea that we have enough confidence in sharing with you.

We certainly have our internal goals.

A lot of it will depend on what we can bring on line this year because when we're looking at option deals, our turn around time to getting those open is really short.

So if we are successful in tying up as many option contracts as we would expect, we could see a good increase.

If we're not as successful, we could be flat to slightly up.

And your store size in these new communities is likely, I would think, substantially smaller than what you had been taken down at the peak right?

That is, that is correct.

That will be a tradition that continues.

By the way, in the time period of opening our models, we have got construction superintendents and construction managers out there who are opening these communities in 15 days from the time that we sign the contract and pour the slab.

We have a model open and operational.

Okay.

Great.

And then, Bill, just had a question for you back on the margin this quarter and the 110 basis points from warranty and litigation accruals.

Can you give me a little more, I think I understand where this is, but can you give me a little more detail on that specifically what, I'm assuming this is closings in which in which you didn't need to book the contingent warranty and it ran off.

But the litigation side and what you're thinking about how that will impact the next couple of quarters, do you have visibility there?

On both litigation and warranty, really they are estimates and largely estimates of expectations of future claims based on the history of our claims, based on our tail of closings that we have closed in the past.

And so each quarter as we close homes, we book an estimate of what we expect those future claims would be, and then we adjust any of our estimates based on claims history.

If you recall last quarter, the impact in the current quarter on, as a percentage of revenues, was actually hurt our margin by around 50 basis points if I recall.

This quarter, the adjustment there relative to last quarter was an improvement of 110 basis points.

And so really, what we look at is our experience in terms of both the warranty and litigation.

We look at our tail.

And typically we are adding to those accruals each quarter as we close additional homes.

It's just a matter of how much we add relative to the revenue that we had in the quarter.

This quarter we had much higher closings volume.

And so the relative change in the overall accrual had a less impact.

Okay.

I understand.

All right that makes sense.

Okay.

Thank very much guys.

I appreciate

Your next question comes from the line of Michael Rehaut from JPMorgan, you're line is open.

Hi, thanks.

Good morning, everyone.

Good morning.

First question, I just wanted to circle back to earlier talk about tax credit, but also the change in FHA going from 6% to 3% in terms of help on the closing.

In that type of world which we might enter, we would be entering later this year, can you just give me a sense of the flexibility you have in your plans?

Because you've talked back you know anticipating perhaps making tweaks and changes, flexibility in terms of your average selling price and also incremental incentives?

First of all, I think we're better positioned than anyone in the industry with our current product as well as with our average sales prices.

The way I look at the changes in all, whether it be FICO scores, whether it be the 3% to 6%, or 6% to 3%, we're all going to have to deal with it as buyers come in our door, and we, I think that we're properly positioned to do that.

I think to take the noise away from the industry, it would be good to get whatever is going to be enacted, enacted and whatever's going to be terminated, terminated so we get back to a more normalized home building environment and get the tax credits and that sort of thing out of our business so that we can fully compete with one another out there.

And we believe we're better positioned to compete in the industry than anyone else.

So we're hoping that we get back to no tax credit, whatever the FHA percentage is, and let's move on and find out who's standing when it's all said and done.

But I guess, what I'm getting at is the 200 ASP that we saw in orders in the quarter, I mean, that, could that, just within the mix that you offer go to 180 without a real drop in gross margins?

Do you have that flexibility in terms of your product offering with similar margins to make an adjustment or would you have to give some back on incentives and discounts?

Well, I think it's going to be a combination of both, but let me say clearly as Don Horton and I have been in the field for three weeks a month for the last two years, one of the things that we've done very well in this Company, and we'd invite anyone who's listening or any of the analyst community to come out, we've really repositioned our products such that we're building in Albuquerque homes from 800 square feet and larger.

And in California we're building homes that are selling from $160,000 down 50%, 60% off the peak, so notwithstanding whatever changes, I think we're positioned with our product to the extent, with a good margin in it, because we don't have loss leaders in this Company.

We track, as we've said for years, every house is a profit center for us.

And we don't have loss leaders in any one of community, so our low end product, our lowest priced product in the Company, should make the same gross margin as the remaining product in that particular subdivision.

So we believe we're well positioned to handle whatever comes at us.

Okay.

Thanks, Don, and just a couple housekeeping.

The impact from prior impairments, Bill, if you could give that for the quarter?

You'd mentioned that as well as, can you give us a sense of the average incentive that you're offering today as a percent of home price, and where that was relative to the peak and what normal is?

In terms of the impairment release this quarter, on homes gross margin that was $117 million release that had an impact of 10.5% on margin.

That's actually a lower impact than last quarter, we had $134 million run through and a 13.3% impact last quarter.

And in terms of overall incentive percentages compared to history, we don't report those in terms of specific numbers because a lot of things go into that.

But where we are today with our adjusted product, with our adjusted cost, with our current, with our pricing that we have set based on that cost in the market place today, clearly we are offering fewer incentives than we were a year or two ago.

You go into a subdivision and we have our standard price, you have your standard incentive package that's there.

But that's less than we were offering a year or two ago.

You know, Michael, along those lines to follow up on your question of earlier, there are a lot of our competitors trying to figure out what they really, they are analyzing their subdivisions and their product lines and all these sorts of things to try to create these niches.

There's one thing about Horton, truly the heart of the market today is entry level.

We know what we are.

We're the king of entry level and no one understands it like we do.

So we are well positioned to continue to capitalize on the heart of the market.

I appreciate that, Don, and, Bill, just one last thing, you've given us some directional guidance in terms of the incentives, is it also safe to say, though, that you still have a bit to go to get back to a normal level?

Well, clearly in a more healthy housing environment where there's job growth and there's a demand that we've seen at healthier times in the past, clearly, yes, there could be a time when we would see fewer incentives than we would see today.

As Don has shared we are still very realistic about what the future may hold and the overall health of the economy and the housing market, so we could be a ways away from that sort of environment again.

Your next question comes from the line of Alex Barron from Housing Research, you're line is open.

Yes, thanks.

Good morning, guys.

Good morning Alex.

Don, I was wondering if you could share your thoughts on the shadow inventory concerns, I guess some people have?

Yes, there's no question that there is shadow inventory out there.

I was reading in a bunch of reports last night before this conference call, and it's astounding to me of one that's still the high level of people who are under water on their mortgages in some of the key markets for the whole industry.

As well as the number of people who are delinquent and in foreclosure coupled with the fact that the bank inventory of foreclosed units.

So I think we're going to be continually dealing with that over the course of the next couple of years.

That's why we think the next couple of years in the industry will be challenging.

The thing that can help the industry the most is for us to begin to have some, as we've had, stabilization in values.

I was looking on a list of our ASPs and it's pretty interesting to me out of 33 of the markets that we track we really only, in our humble opinion, have weakness in our pricing in about four or five of those markets and the rest of our markets have stabilized pretty well.

But to get back to a point where we have some appreciation in housing values, I think is the only thing that's going to make our industry better going forward.

We're going to be fighting the shadow foreclosure, the delinquencies.

All of these people under water are on their mortgages.

We have to get housing values back somewhere closer to where they were, which is a long-term process.

Okay.

That's a fair answer.

I was also wondering, you guys mentioned you had, I believe it was 22,000, maybe I didn't get the number right, 22,000 finished lots that you own, and then you also had some other finished lots that you optioned.

So my question is what happens if you couldn't find additional optioned lots, are you guys going to start developing those other lots that you have?

Or are you going just, and how much money would it take to continue to develop those?

Or are you going to prefer keep on looking for distressed finished lots?

I think the answer so both questions is yes.

Currently we still see an adequate supply of lots in most of our markets of what we called finished lots owned by others who we can buy on an option basis.

We do have land that is mothballed.

We pull some of the land out every quarter and begin to develop it when it makes economic sense for us to develop it.

So as a result I think most of our lot inventory will be, our houses will continue to be built on the 22,000 lots that we own.

That's our goal, to work our way through our existing lot inventory, as well as to work our way through our 24,000 option lots and continue to add those.

We have partially finished lots, once we get finished with vast majority our 22,000 finished lots then we'll start focusing on how we work our way through the partially finished lots.

I'm somewhat disappointed as people continue to focus on our owned lot inventory, and I would say to you that we've done a wonderful job of continuing to work our way through our owned lot inventory as it makes economic sense and supplementing that with option deals.

The fact that we have $1.9 billion in cash, we're one the few builders starting specs in most of our markets, makes us the preeminent buyer for these option deals.

So I look at our owned lot inventory and say it's slowly but surely being merged in with our closings on option lots and we're having a wonderful merged gross margin on both product lines.

Looks good.

Thank you very much.

Yes, sir.

Your next question comes from the line of Timothy Jones at Maloney Securities.

Your line is open.

Morning all.

Good morning, Mr.

Jones.

I hope D.R.

is finally smiling.

Two housekeeping things, what were your cancellation rates a year ago?

I think it was 28% --

26% this year.

26%.

2/1 2009, 38%.

38%.

Okay.

Secondly, Bill, you gave the units under construction of 11,500 including 1,100 models.

Can you give the same number for the same period last year, December, last year and the specs?

While he's looking up that, while he's looking up that number, I will agree with you that one of our shareholders at our annual meeting noticed that Horton was smiling and he walked up and said, well, must be that you're returning to profitability, Horton, because you're smiling.

So you're exactly right.

He is smiling and he doesn't smile much.

Tell me about it.

Tim, a year ago our total homes under construction at December 31, 2008 were 10,700 homes.

And at that point in time we had 1,400 models.

And how many specs?

Total specs were 6,200.

Okay.

My question now, if you pull out those numbers, you basically got 3,100 sold homes and 7,300 specs right now.

You said you expect to deliver over 100% of your backlog, which is a little over 4,000, but less you're deliveries of 5,000, or 5,500.

Assume 4,500, is it safe to say that you'll deliver probably about 2,000 or two-thirds of the 3,100 under construction and about one-third of the 7,300 specs, which would be roughly 4,500?

Would you like to come work in our accounting department?

Well, our total backlog is 4,100.

So 4,500 closings would be approximately --

You've only got 3,100 under construction.

Yes, 3,100 under construction.

Okay.

We talked about we need to achieve 100% backlog conversion.

So that's over 4,000.

4,500.

So you basically need to do about one-third of the specs.

The question is.

Let's say there's 2,500 specs and 2,000 from the other, you're still going to have almost 5,000 specs left and you're only going to have one more month after the quarter to take advantage of the full tax credit, yes, you can take care of [lesser walks] but does that cause you some pause?

Well, Tim, the good news is --

Let me first of all, say, Jones, you were with Horton one time when he was asleep at the wheel.

I assure you that we're not sleep at the wheel on specs okay.

I think what your analysis is missing is that we're going to continue to sell homes this quarter, so not every home that is a spec today is going to be a spec when we report again at March 31.

It will be in backlog.

If it has not been closed, it will be in backlog at March 31, and then we have one more quarter to then close that backlog.

Nice answer.

Nice dodge on that one.

Bye-bye.

It's not a -- don't worry about our specs, we'll control those better than anyone else.

Your next question comes from the line of Jim Wilson at JMP Securities, you're line is open.

Good morning, guys, and Stacey.

Good morning.

Good morning, Wilson.

Let's see, on, I guess my first question, you mentioned that there were only a few markets left where you were seeing any weakness on pricing.

Could you just maybe your top three in terms of strength in pricing and weakness in pricing in terms of geographic location?

Firmly, one, I'll combine all of Texas and hopefully that will suffice, but I look at Houston, it had an extraordinary quarter and is having an extraordinary second quarter.

I say the same thing about San Antonio and both of our Dallas and Fort Worth markets and even a tough market like Austin is right now we're doing very well in Austin.

I think Texas because of that fact that we didn't have any big peak, we didn't have much of a valley and we have good job growth in Texas.

I was reading the other that we're expected to generate 100,000 new jobs in Texas in calendar year 2010.

So I look at Texas as certainly a strong market.

The weak markets continue to be Las Vegas and certainly Phoenix.

There are a lot of people under water on their mortgages in both of those markets.

And there are foreclosures and delinquencies.

The good thing about both of those markets is that the listings are declining in each one of those markets and that's a function of a couple things.

I think people are taking their homes off the market because they can't sell them, and, secondly, I think the banks are doing a good job of metering out the foreclosed homes they have.

That's my read on the strong and the weak.

Okay.

And then my other question is on the land acquisition environment, obviously, you did, I guess, a pretty good job at least spending $200 million and you suggested, obviously, higher margins.

Could you describe as you look at it, kind of incrementally in the deals you're looking at now is pricing on lots stable or is it getting more competitive and higher, or how would you kind of characterize it?

I think it's becoming a more competitive environment, both with the number of potential buyers as well as the pricing.

Certainly, I think that there are investors that entered the market three years ago entered a tad early.

I think the investors who are entering today think that the home building environment is going to continue to improve.

And we'll have it see what that holds.

As we said earlier, we can see our way to July 1, and then thereafter, we'll have to see what the home building market affords us.

We're well positioned to meet whatever the challenges are, but I think in general, for, I think there could be a temporary market condition where we've got more buyers and, at higher prices than what we've encountered over the course of the past 12 months.

Okay.

Good.

Thanks.

And good job.

It's not good.

But those are the facts.

Okay.

Your next question comes from the line of Buck Horne from Raymond James.

Your line is open.

Hi, good morning.

Sounds like most of my questions have been answered here and I don't want to extend the questioning on specs too much further, but would you be willing to quantify, or just kind of give us a ballpark idea what you think the right number of specs you'd like to enter the fourth quarter with, would be given where you think demand would drop off to?

I'd say right now that we're waiting to see the answer to that question as well.

And it's going to be driven by the sales volume that we see primarily after the tax credit has expired on the sales front at April 30.

The way we'll be managing through that through the spring is as we work into the heart of the selling season, we will slow down our starts during the selling season once we get to the point where we can no longer sell and close a home and still take advantage of the tax credit.

So we'll be working down our spec levels during this time the tax credit is still outstanding and hopefully we land it where we expect the demand will be.

But we'll start monitoring that as the expiration nears and after it passes.

I want to bring up something I haven't brought up before and as one of our regional presidents says, the homes that we're building today, obviously, with our 17.1% gross margin at Q1, to the extent that we end up with a few additional specs that we need to move in that fourth quarter, clearly we believe that we'll be moving those with a profitable margin in them, albeit it may not be 17.1%.

But our costs are, we believe, the best in the industry combined with our option lot purchases that we're making, so, therefore, not withstanding the fact that we may have a few extra specs, I think those still move at a good margin.

Okay.

And in terms of cycle times, can you give us a little bit of color on how fast you can start and guarantee a delivery given the pace you're working at today, and how fast can we put houses in the ground and deliver them before the tax credit deadline?

That's going to vary by really subdivision and division, depending upon the size of the product and how complicated it is, but also depends upon the division.

But largely speaking, it ranges from about, we can deliver product in some of our markets within 60 days, and in some markets it's going to take us four months.

So each one of our divisions and each one of our subdivisions in terms of supplementing our existing specs we're looking at whether or not we have time to construct those and meet the 6/30 deadline.

Thank you.

Yes, sir.

Your next question comes from the line of Joel Locker from FBN Securities, you're line is open.

Yes.

A follow-up question.

Did you mention the percentage of closings that were FHA in the first quarter, or VA?

We did.

But we'll have to find it again.

The (inaudible) total and government were a little over 60%.

63%.

Yes, we'll get you the exact number here, 63% in the quarter and then FHA was 47%.

47%.

All right.

Thanks a lot.

Uh-huh.

You're welcome.

There are no further questions.

Mr.

Tomnitz, I turn the call back over to you.

Thank you.

And thank you for joining our conference call.

Once, again, I give all of our teammates out there our heartfelt congratulations and appreciation because you absolutely out performed the industry this quarter.

As I said on my e-mail this morning, now we have to go do it quarter-by-quarter-by quarter, and we have a challenging second quarter ahead of us, but fully we expect all of you to do as good a job as you did in the first quarter.

Our goal is to make money, a profit, in each one of the four quarters this year and for the fiscal year.

So let's go do it again, you're only as good as you're last deal.

Thank you and good-bye.

This concludes today's conference call.

You may now disconnect.