霍頓房屋 (DHI) 2010 Q3 法說會逐字稿

Greetings and welcome to the DR Horton, America's Builder, the largest builder in the United States, third quarter 2010 earnings release conference call.

At this time, all participants are in a listen-only mode.

A brief question-and-answer session will follow the formal presentation.

(Operator Instructions).

As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Mr.

Don Tomnitz, President and CEO for DR Horton.

Thank you, Mr.

Tomnitz, you may now begin.

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.

As usual, before we get started, Stacey?

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 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 DR Horton's current report on Form 8-K dated February 8, 2010, which updated our annual report on Form 10-K, and our most recent quarterly report on Form 10-Q, all of which are filed with the Securities & Exchange Commission.

Don?

Thank you, Stacey.

We want to thank all of our DHI team members for generating an operating profit for the third consecutive quarter.

Congratulations to each of you.

You're successfully competing in a difficult housing market.

We're three-quarters of the way to our goal of profitability in each and every quarter, but we still have a very challenging quarter in front of us.

So far, this year has unfolded as we expected.

We saw strong sales through April, and we just had our strongest third quarter of homes closed in three years.

We entered the year expecting the second half of the calendar year to be more challenging because of the full forward effect of the federal tax credit, combined with normal seasonality and a continued weak economy.

Consequently, we began slowing our construction starts at the end of March quarter in anticipation of a drop-off in demand.

We will continue to be realistic on our expectations and will adjust our business to compete now and in the future.

Stacey?

Our net income for the quarter was $50.5 million or $0.16 per diluted share, compared to a net loss of $143.8 million or $0.45 per diluted share in the prior year quarter.

Homebuilding pretax income was $37.4 million which included $30.3 million of inventory impairment and lot option charges and an $8.3 million loss on early retirement of debt.

Financial services pretax income was $8.9 million which included $3.1 million of recourse expense.

Bill?

Our third quarter home sales revenues increased 54% to $1.4 billion on 6,805 homes closed, from $896.6 million on 4,240 homes closed in the year ago quarter.

Our average closing price for the quarter was down 4% to $202,500.

The timing of our revenues and earnings so far this year have been driven by the timing of tax credits instead of normal seasonality.

And we believe our operating strategy of having specs available to close by June 30th let us capture more of the available tax credit demand.

While the September quarter would typically be our strongest for closing volume and profitability, our June quarter will be our strongest quarter in fiscal year 2010.

Don?

As we expected, sales have slowed significantly after the April 30th deadline for signing a home purchase contract to qualify for the federal tax credit.

As a result, net sales quarters for the third quarter were down slightly, 3% from the prior year at 4,921 homes.

Our sales in April were extremely strong followed by a sharp decline in May, a 20% sequential increase in June and then an approximate 10% increase in July.

As we look at our sales comps for the next three quarters, it will be difficult to achieve year-over-year increases since each of the quarters saw strong sales volume driven by the various tax credits in effect.

While we remain focused on gaining market share, for us to see significant, sustainable sales growth, we need to see improvement in the overall economy, the jobs landscape, and consumer confidence.

In the June quarter our average sales price on net sales quarters in the quarter was essentially flat at $208,400.

Our cancelation rate was 28%.

Our active selling communities were up 7% sequentially.

39% of our net sales came from communities opened in fiscal year 2009 or later.

Our sales backlog decreased 18% from the prior year to 4,430 homes or $954.4 million.

Stacey?

Our gross profit margin on home sales revenues in the third quarter was 17.2%, up 590 basis points from our home sales margin in the year ago period and down 80 basis points sequentially from our March quarter.

Our gross margins have been in the 17% to 18% range in each of the first three quarters this year with some volatility within the range.

Our core margins increased 50 basis points from Q2 to Q3 as the average cost of our homes declined by more than our average selling prices.

This was more than offset by the sequential gross margin impact from typical changes in estimates for development and construction completion costs, and warranty and litigation accruals, which are magnified when quarterly revenues fluctuate significantly as they have this year.

A contributing factor to our core margin improvement was that 35% of third quarter closings were from new deals that were put under contract in fiscal 2009 or later.

Margins on closings in our new projects are approximately 200 to 300 basis points higher than on the remainder of our closings.

Our goal is to maintain our gross margins in the 17% to 18% range or higher.

However, if current market conditions persist, we could see margins pressure in future quarters.

Bill?

In our third quarter impairment analysis we reviewed all projects in the Company and determined that projects with a pre-impairment carrying value of $86.8 million were impaired which resulted in $29.1 million of impairment charges.

The majority of which were in the Chicagoland area.

We refer to our projects which have indicators of potential impairment but were not impaired this quarter os our watch list which represents those projects deemed to be at the highest risk for future impairments.

Our watch list is currently approximately $350 million, down from $525 million at March 31, with the largest concentrations in California, Illinois, and Florida.

$350 million is the lowest watch list balance we have reported during the downturn.

And about half of the sequential reduction resulted from the removal of projects that no longer needed to be on the watch list.

Our inventory impairment process in future quarters will incorporate any changes in market conditions and any adjustments we make in our business.

However, we continue to expect fewer impairments than we incurred in 2009 and previous years.

Don?

Our consistent focus on controlling SG&A has been a key to our return to profitability.

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

Homebuilding SG&A expense for the quarter, which includes all corporate overhead, was $143.2 million or 10.4% of homebuilding revenues compared to 14.7% in the year ago quarter.

SG&A increased only $8.9 million or 7% on a 60% 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 $19.6 million in homebuilding interest expense during the quarter which was approximately 47% of the $41.3 million of interest we incurred.

We are required to directly expense a portion of our interest incurred while our homebuilding debt level exceeds our active inventory.

We recognized the loss of $8.3 million on the early retirement of $345 million of principal amount of our senior notes during the June quarter.

This charge primarily related to the premium paid for the debt and also includes the write-off of unamortized discounts and issuance costs.

Stacey?

Financial services pretax income for the quarter was $8.9 million compared to $2.8 million in the year ago quarter.

93% of our mortgage company's business was captive during the quarter.

Our company-wide capture rate was approximately 61%.

Our average FICO score was 705, and our average combined loan to value was 92%.

Our product mix in the quarter was essentially 100% agency eligible, with government loans accounting for 66% of our volume.

Bill?

Our total inventory decreased by approximately $169 million, excluding noncash impairment charges during the quarter.

We reduced our homes in inventory by $220 million and increased our investment in residential land and lots and land held for development by $51 million.

Our homes in inventory at the end of June totaled 10,800 homes, down 22% from March, of which 1,200 were models, 6,100 homes were speculative, and 3,100 of these specs were completed.

We continued to manage our total homes in inventory relative to our expectations of sales demand.

And we offer spec homes primarily to accommodate our first time home buyers who represented 60% of the third quarter closings captured by our mortgage company.

As we enter the second half of the calendar year, which is a slower selling season, we expect that our homes in inventory will decrease further in our September quarter.

Don?

Our land and lot acquisition investments remain controlled and we continue to evaluate our land development plans based on current sales trends.

We have been actively contracting for finished lots to increase our active selling communities and increase our gross margins.

In our third fiscal quarter we invested approximately $228 million, primarily in finished lots.

Our spending on finished lots will remain largely dependent on our sales pace while our spending on land and development costs will continue to be at low levels.

Our supply of owned land and lots at June 30, 2010, was approximately 89,200 lots of which approximately 22,200 are finished.

We control an additional 27,300 lots through option contracts, up 24% from March 31, and our net earnest money deposit balance for these lots is only $10.6 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.

Stacey?

Cash flow from operations for the June quarter totaled $159.3 million, primarily from earnings and the decrease of homes in inventory.

This cash generation was offset by our spending on finished lots and development and an increase in our mortgage loans held for sale.

Our fiscal year-to-date cash flow from operations totaled $587.1 million.

We ended the quarter with approximately $1.7 billion of homebuilding cash and marketable securities, even after repurchasing $345 million of our outstanding notes in the open markets through reverse inquiries during the quarter.

The balance of our public notes outstanding at June 30 was $2.2 billion.

Our remaining note maturities now total only $63 million in fiscal 2010 and $205 million in fiscal 2011.

After June 30, we repurchased an additional $53.3 million of our outstanding notes.

Subsequent to those repurchases, our board has approved a $500 million debt repurchase authorization effective through July 31, 2011.

As we mentioned in our press release, with these repurchases and the scheduled maturities in September, our retirement of debt for the fiscal year will total at least $1 billion.

Bill?

At June 30th our homebuilding leverage ratio net of cash and marketable securities was 17.5%, a 13.2 percentage point improvement from a year ago.

Gross homebuilding leverage at June 30th was 45.6%, an 8.6 percentage point improvement from a year ago.

This improvement in leverage is due primarily to our cash generation and reductions of outstanding debt.

Don?

In summary, our financial performance this quarter demonstrates the progress our Company has made towards achieving profitability, balance sheet strength, and market share gains in this challenging and uncertain housing market.

Our most important accomplishments this quarter include pretax income totaling $46.3 million, home sales gross margins increased 590 basis points over the prior year same quarter as we continued to improve the cost and design of our products and continued to open new communities on recently acquired lots at higher margins.

Fully loaded SG&A which, again, includes all corporate overhead as a percentage of revenues was 10.4%, up only $9 million on a 60% increase in homes closed.

$883.6 million in homebuilding debt repurchases and redemptions this fiscal year-to-date and total principal payments in fiscal year 2010 will total more than $1 billion.

There are still challenges in the homebuilding industry -- rising foreclosures, significant existing home inventory, high unemployment, tight mortgage lending standards, the expiration of certain government support for the housing and mortgage markets, and weak consumer confidence.

However, new home inventory remains low.

Interest rates are favorable, and housing affordability is near record highs.

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

Consistent profitability at DHI is the ultimate goal.

DR and I celebrate our 28th anniversary in 12 days.

In the 28 years we've been together, DHI is currently in the strongest position ever, as evidenced by the strongest balance sheet in our history, a large national footprint with significant and increasing penetrations in the majority of our markets and the best people in the industry.

DHI is in a preeminent position to capitalize on the future of the homebuilding industry, whatever it may be.

Again, we thank all of our DHI team members who continue to out-sell and out-perform the industry.

Our third quarter is over.

Now we need to focus intently on marching toward profitability in Q4.

Keep up the great work.

This concludes our prepared remarks.

We'll host any questions.

Thank you.

(Operator Instructions).

Our first question is coming from Joshua Pollard with Goldman Sachs.

Please proceed with your question.

Good morning.

My first question is on your comments on June and July, the 20% and 10% sequential increases there.

I am wondering if you feel like that is the performance you're seeing across your markets in these two months?

And if not, where you think you're taking share.

Do you think it is from other smaller private builders or do you think it is coming from the short sell side and the existing home side?

I will handle the second part of the question.

Frankly, I believe we're taking market share from both the small and medium-sized builders who are under-financed, under-capitalized,.

But also we continue to sell the largest percentage of new homes each quarter of all of the public home builders.

And I think that's reflective clearly of our strategy of making spec homes available essentially to the first time home buyers and also the realtor community who sells a large percentage of our homes.

So clearly we are taking market share from the whole industry currently.

In terms across our Company we are seeing increase from May to June to July in each of our internal regions.

And then the quick follow-up to that is what percent of your sales are coming from realtors this quarter, and maybe if you can compare it to a year ago?

And then my bigger follow-up is if you look at the backlog burn rate, it has just been trailing right around that 100% range.

Is that something that you guys feel like you can keep up for a long time or has that been more a phenomena of what's been going on with different tax credits?

Thank you.

I think the backlog turn will moderate back into more historical ranges.

We may be able to achieve something better than what we achieved before we went into the downturn simply because we are running with a little bit higher spec percentage because our first time home buyer percentage is higher.

But the 100%-plus conversion rates you've seen in the last two quarters are not something we would expect to sustain.

In terms of realtors --

On a historical basis we have focused largely on the realtor community because, as you know, advertising is a very small percent of our overall revenues which is much lower than all the other builders.

And frankly we appreciate the realtors very much because they bring us a qualified buyer in most instances, and we can actually assign a success rate to that a lot easier than we can advertising.

Just a rough number, I would say that our realtor sales consistently average above 60%.

It depends upon clearly what kind of promotions we have going in various markets at various times.

But again the realtor community has been a big aid to Horton over its existence since 1978.

Thank you.

Our next question is coming from Michael Rehaut with JPMorgan.

Please proceed with your question.

Thanks.

Good morning, everyone.

First question, I was hoping if you could describe, on the gross margin side, if specs, obviously that has been a key part of your strategy going forward, but if you were, with ending the quarter down sequentially in terms of your homes under construction, and I believe your specs as well, did that play a role in some of the sequential fall-off from 2Q to 3Q?

And are you comfortable right now in terms of your specs in terms of what you have in inventory?

I know you mentioned that you plan to further lower homes under construction in general, but would you say that that sequential fall-off was more due to a more aggressive inventory workdown during the quarter?

No.

We really wouldn't, Mike.

As Stacey mentioned during the call, our core margins in the quarter which really represent the margins on the homes that closed actually increased by 50 bips from Q2 to Q3.

We do continue to see our historic difference of 200 to 300 basis points in margins between spec and build jobs, but that has not -- certainly did not weaken during the quarter.

I'm sorry, Bill, but when you say core margins, pre-impairments went from 18.0 to 17.2, right?

The reported homes margin decreased 80 bips sequentially.

Our core margins increased by 50 bips, and as Stacey referenced that was offset by routine adjustments in estimates and accruals for development and construction completion costs and litigation accruals.

The impact on gross margin from Q2 to Q3 offset that.

I can give you an example to describe what a type of adjustment like that would be.

But really it is driven by the fluctuation in revenues.

We have seen significant volatility in our revenues from quarter to quarter, and so the same adjustment on an accrual in a low volume quarter will have a much greater impact on margin than it will in a higher volume quarter.

If there is confusion on that, I certainly wish you would follow up on it because one of the things that we're very sensitive about but also very proud of is that our core margins on our homes closed did increase by 50 bips.

No, I appreciate that.

Thanks for the clarification.

The second question just in terms of the strength in orders or the rebound that you have seen a little bit sequentially, I was wondering and I know you don't break this out as much, but I think it is an important part of the story, I believe last quarter you had said that community count was up sequentially and year-over-year by it was either low or mid single digits, if I recall.

I was wondering if you can give an update as to where you are there in terms of year-over-year and sequentially for 3Q and how you're thinking about 2011, as well?

Our active selling communities were up about 7% sequentially from Q2 to Q3.

On a year-over-year basis they're up about 20%.

Our goal for fiscal year '11 is to continue to increase our community count as we help investors as well as developers as well as banks work through their own lot positions.

Would you say for 2011 you're also looking for double-digit gain?

We're focusing on a gain.

I don't want to get focused on a single or double digit increase but we're certainly continuing to enter into new contracts on a daily basis in each one of our regions.

A lot of whether it is a double-digit increase or single-digit increase will be dependent on the level of sales that we see in the market.

Great.

Thank you.

Thank you.

Our next question is coming from Josh Levin with Citigroup.

Please proceed with your question.

Thank you.

Good morning, everybody.

You said that we could see some gross margin pressure if sales don't pick up.

How do we think about that?

If sales continue to trend along these levels do you start lowering prices or increasing incentives, or would you wait for sales to drop from here?

What's the evolution of the pricing strategy over the next few months?

Clearly each one of our divisions and each one of our regions have stated specific sales goals, and they adjust their incentives relative to the number of units we want them to sell and close.

As we have said before, it doesn't make any sense to hold out for unrealistic gross margins if the market is not willing to pay you those margins.

As Stacey said in our conference call, our margins have really ranged between 17% and 18%.

Our goal is to keep it between 17% and 18%.

And I would say to you that we're going to make small adjustments as necessary to continue to hit the sales volumes and closing volumes that we want to hit as a Company.

Okay.

And you talked about sequential increases in orders in June and July.

Was that driven primarily by increased incentives or prices or was it more a rebound after the tax credit drop?

I think a focus of two things.

Really, a slight rebound.

But secondly we have focused on sales programs and sales contests in each one of our regions.

And we just completed one in our south region as of this weekend and had very good sales over the weekend.

So as a result, one thing that Horton has not done a lot in the past in our history is had national and regional sales contests and sales incentives, and we are focusing on that to drive our sales and our volume and our closings in those regions where we want to drive it further.

Thank you very much.

Thank you.

Our next question is coming from Alex Barron with The Housing Research Center.

Please proceed with your question.

Good morning, guys.

Good job on the SG&A.

I wanted to ask or get a little bit more insight into your impairments.

I noticed you mentioned your watch list has been dropping significantly, especially quarter over quarter.

Given the slowdown in the sales in the last few months, I am trying to understand what are the drivers of the watch list coming down so significantly?

Alex, the biggest driver this year has been the improvement in our gross margin.

As referenced this quarter, our margins were up 590 bips in Q3 versus a year ago, so as we're achieving better margins across the board, that has caused a significant reduction in our watch list.

This quarter specifically, as we got past the tax credit and were able to get a glimpse as to post tax credit demand, we were able to more closely evaluate some individual projects, and those projects that were performing better than we had assumed when we put them on the watch list, we were able to remove some of those from the watch list.

So it is a continual evaluation quarter to quarter, project by project, and when it no longer makes sense to be on the watch list, we take it off.

Got it.

And my other question has to do with the absolute sales level or sales pace we have seen in the last few months.

Now that the tax credit has gone, do you guys feel that that is borrowing sales from the future or do you think it is something more structural where certain first time buyers maybe just don't have the means to buy a home?

What are your general thoughts about the tax credit?

Do you want it to come back or do you want it to stay off or have you heard anything along those lines?

I think clearly the two tax credits have pull forward demand, and now, as we see in July, we're getting back to a more normalized demand.

They had a couple of months there where we were going through the pain and the process of getting off the tax credits, so withdrawal from the federal tax credits.

Frankly, I don't want the tax credits to be reenacted or be recreated or extended.

We want to get back to a normalized market.

It is a lot easier to run a business based upon designing your business with the current demand as opposed to having any kind of stimuluses or incentives to create abnormal demand.

I do believe that a lot of the first time homebuyers are back in the market, slowly but surely as they adapt to the changing guidelines for down payments and mortgage underwriting.

And one of our pre-eminent parts of our Company is our homebuyers club who continually graduate people as they educate them on how to clean up their credit and become aware of the credit systems.

The expiration of the tax credit really doesn't change the mortgage qualification or approval process.

Those funds could not be used at the time of closing towards closing costs and they could not be considered in terms of the debt to income levels for people's qualification process.

Great.

Thanks.

I will get back in the queue.

Thank you.

Our next question is coming from Timothy Jones with Maloney Securities.

Please proceed with your question.

You and DR have made a lovely couple for the last 28 years.

I am sorry I didn't receive my invitation to your anniversary party.

I was wondering what sort of anniversary present you might send us.

I am having second thoughts about that.

Maybe a free trip to the ranch with you?

No.

Have Horton drive me again.

Never mind.

First of all, what were your finished and total specs and homes under construction in March?

We had 13,900 homes under construction at March 31, and of that 7,300 were specs, 2,900 completed.

On how many models?

1,200.

So you basically brought your spec inventory down, the total specs by 1,200 units.

You said at that time that you would expected to dramatically reduce your specs.

And I think you did a very good job in April.

But I still think that probably having only 200 less finished units and still having over 6,000 specs accounts for over half your units under construction is still too high given the market we're in right now.

Would you like to comment on that?

Certainly.

We are bringing that down as we speak, and we have been bringing it down.

At September 30th we will tell you it will be much lower than what it is today because we'll get our total inventory in line with pretty much what we expect to close times two over the course of the next twelve months.

And we'll have our specs running somewhere around 50% of our total inventory which is where historically we have run.

One of the things we're doing with our spec inventory in particular is we're trying to match that and keep a supply of homes out there for the first time home buyer.

First time home buyers for us in this quarter were 60%.

So we're doing a good job of keeping those two numbers pretty close together.

We're en route to accomplishing your goal.

Okay.

And explain a little more about this core margin, the three things that have affected it, that have affected your gross margins by 80 basis points.

It is actually more, it's 130.

You did give warranty and so forth and especially the land development and how is that flowing in.

Absolutely.

Let me give you an example.

Our core margins increased by 50 basis points during the quarter.

These other factors, which the largest portion of this quarter related to changes in estimates on development and construction completion costs, all of these other things offset that by 130 basis points.

Is that a nice way of saying cost overruns?

No, actually no.

It is actually the opposite.

That's why I want to give you an example.

What we see a lot of times when we wrap up a development project is we close out the project and we have credits that may be available to us.

It may be reimbursements of certain of our development costs from municipalities or other entities that we may see.

And so those are actually positive -- have a positive impact on margin.

So in this quarter, or last quarter Q2, we saw $7 million of those sorts of development credits come through as positive impact on margin.

Last quarter on the low revenue that we saw in Q2 that was a 75 basis points improvement to margin, positive impact on margin.

That was the second quarter, right?

That was the second quarter, right.

Now, of course, these credits have nothing to do with our quarterly closings volume.

They just occur when we wrap up the projects.

This quarter development reimbursements, post closing credits from developments, were around $3 million.

Our homebuilding revenue was much higher this quarter, so that $3 million positive impact on this quarter's homebuilding revenue was about a 25 basis points positive impact on margin.

So the sequential difference between those two, 75 basis points positive in Q2, 25 basis points positive in Q3, that actually causes a sequential decline, a negative impact sequentially of 50 bips.

It is a timing issue.

It is timing.

And those items have nothing to do with the actual closings volume and we have seen a lot more volatility in quarterly closings volume from quarter to quarter.

And the warranties, anything out of the normal goal there?

You see some of the same sort of things in terms of sequential changes based on the revenue volume, but the warranty litigation had a 20 bip negative sequential impact.

The other biggest piece was also changes in estimates on our vertical construction and the sequential change there was 40 bips.

How did that happen?

What did you change there?

It is the same sort of things.

When we close out our homes and we have estimates of what is remaining to spend, we will leave those accruals out there, we will pay our bills.

And then at some point there is a day of reckoning in terms of do we need this remaining accrual.

So typically there is some relief of that accrual several months after a home's closed, so that's typically a positive impact on margin.

Last quarter in Q2 that was a 70 basis point benefit to margin.

This quarter it was a 30 basis points benefit to margin, so sequentially we lost 40 bips.

Very helpful.

Thank you very much.

Thank you.

As a reminder, please limit yourself to one question and one follow-up.

Our next question is coming from Stephen East with Ticonderoga Securities.

Please proceed with your question.

Thank you.

That was a great help there, Bill.

That was a big part of my questioning there.

If you look at the gross margin in your backlog, your core gross margin in your backlog, given how you all have been talking about specs and pricing and driving volumes, is there any deterioration in the backlog?

It is overall hanging in pretty good, Stephen.

We have been looking at our new projects and our old projects.

Our new projects are are hanging in above our thresholds.

We have actually been seeing continual improvement in our old projects as we continue to work down the costs of our homes and adjust our product to the lower priced affordable product, so we have seen improvement there.

Our historic spread between spec and build jobs is staying about the same and overall improving versus what we were seeing a year ago.

So overall I think we're continuing to make progress on our margins.

Obviously we don't know what the environment will be going forward, and we do expect it is going to continue to be a challenging environment, so we could see some pressure, but so far we have been able to maintain margins pretty well here the last few quarters.

And I would say to you that in dealing with Rick Horton, our south regional President, and we had a screaming home sale in Texas this past weekend, and we sold a number of homes, and the good thing I heard from him yesterday late was that he thinks our margins in his region stayed pretty much in the same range in all of his divisions as they were prior to the sale.

Very good news to me.

That's exactly what I was looking for.

And then you all have done a great job in buying back your debt and I wish other builders would do the same.

As you look at it, one, do you have a debt level target that you are trying to get to over the next year or two?

And then if you look at qualifying inventory, how close are you to your debt levels and will we see interest expense?

Before Stacey answers that question, I will tell you what our desire is.

Nada.

We have a little ways to go to get to nada.

Yes.

I would not say that we have a specific goal, Stephen.

We're going to opportunistically continue to reduce our debt as long as that seems to be one of our best investment alternatives.

If we see a sharp recovery in the homebuilding industry, that may change our plans in terms of future debt reductions.

We still have scheduled maturities of just over $400 million coming due in the next three years.

So we're cognizant of that fact, as well.

And the qualifying inventory on it?

The qualifying inventory right now, this quarter we expensed 47% of our interest incurred.

There are two factors.

Our debt is coming down, but depending on our sales level, our active inventory could come down, as well.

At a minimum we would expect our interest that we directly expense to continue to come down.

It may not come down as a percentage of our incurred.

Okay.

Thanks.

Thank you.

Our next question is coming from Dave Goldberg with UBS.

Please proceed with your question.

Thanks.

Good morning, everybody.

I wanted to follow up on the question on the watch list a little bit.

And I understand that projects come off as the margin proves to be better than what you expected, but what I am trying to understand a little bit better is how you think about pricing as you consider the watch list on a go-forward basis.

Clearly even though things improved in June and July, maybe things weren't as good as the last time you ran the analysis, and I am just trying to get an idea, get some more detail maybe on how you think about sales pace and price when you think about putting together the watch list?

We try to be as realistic as we can with what we know at the time.

Clearly when we were evaluating our projects during the tax credit time, we realized that the tax credit was driving some of our sales, driving some of the volume we were seeing.

So we recognized and expected that there would be some decline in absorptions post the tax credit.

So this certainly has not been a surprise really in any area of our business.

But our assumptions when we're looking at our projects have typically assumed volumes either at or below current absorptions, and typically pricing at or below current pricing.

So we try to be realistic, try to be conservative in our assumptions, but it is a project by project analysis, and we will revisit again next quarter.

Frankly, we appreciate the questions about our watch list because I am sure all of you appreciate that we do have a watch list and we share it with you as opposed to our competitors.

It is a great deal of detail.

Just to make sure I understand, is it fair to say that if conditions stayed where they were at the end of July, and I realize we're maybe at a depressed bas, it is not necessarily reflecting exactly what's happening, some hangover, would the watch list grow from where we are now if we stayed where we were?

No, not necessarily.

Again, it is project by project, but I would not expect it to change materially if things stay basically the same.

As time moves on, those projects that perform a little better than we assumed may come off the watch list.

Those that perform a little worse may come on the watch list, so there will be movement in and out, but overall things stabilize from here.

I wouldn't expect significant changes.

One of the things helping our watch list, quite frankly, is our purchasing managers in the field who are doing a better and better job of buying our jobs, and we frankly, as we I think explained on the last conference call, have seen noticeable improvements in our costs, our direct costs.

That's the primary driver behind our margin improvement this year is our cost decreases.

And then just a quick follow-up.

I know you talked about the realtors and realtors helping your sales.

I am just wondering commission wise what you end up paying realtors versus internal salespeople and how negotiable that is on a go-forward basis as existing home sales slow and maybe that's a good avenue for realtors to look at.

Our typical commission to an outside realtor would be around 3%.

There are time when we will pay more if we're running a specific promotion.

We may pay 4% or 5%.

There are certain divisions that have a bonus structure, so if a realtor within a specified time period sells three homes they would get a bonus of $500 per additional home they close on top of the 3%.

In terms of what you are seeing running through our cost of sales, it is really close to 3%.

Internal sales commissions are structured a little bit differently.

They're probably going to be closer to 1.25% to 1.5%, and those are paid consistently on 100% of our homes that we close.

Got it.

Thank you.

Our next question is coming from Carl Reichardt with Wells Fargo Securities.

Please proceed with your question.

Hi, guys, how are you?

Wonderful.

How about yourself?

I am fine.

I am trying to get granular on this issue but I just want to make sure, Bill, you can't take the development credits that you anticipate and amortize them over the life of the community on a per house basis, it has to be timed at the end, is that right?

No.

In an ongoing project, if there is a change in estimates in an ongoing active project, then that would be spread over the entire project.

What I was discussing earlier were primarily credits that we received after the project is complete.

We do our best to try to estimate what those may be, what those reimbursements may be, but there is a lot of factors that go into what the ultimate credits may be.

And so once a project is done, we closed all the homes, we own no more lots, any adjustments post closing, post closeout do immediately come through the P&L.

I appreciate that.

And then, Don, I am curious about what you are seeing in the finished lot market.

Some of your peers have talked about continued competition for finished lots.

As I look through what you own now, where you have 22,000 or so finished, is it your sense, especially if you think sales are going to slow and the contribution from new projects is only 200 to 200 basis points up on the gross, that you may be much less aggressive at looking at finished lots over the next two to three quarters which would be, of course, beneficial to your cash flow and your debt buyback?

At the right price and the right terms we're going to be very aggressive as we continue to replace some of our poor performing option contracts.

So I believe as we move forward we'll continue to be in a pre-eminent position simply because of the fact our inventory strategy of building specs and making them available to those first time home buyers places us in a strong position when we're dealing with sellers, whether they be banks, investors or developers, or whomever.

So I anticipate continuing to add new deals into 2011, as we mentioned earlier.

And the way we're approaching these new deals, the investment level is limited in each project.

We don't own a lot at any point in time, so we're turning our cash very quickly on these deals.

Right now it has not been a significant drain on our overall cash position simply because of the terms that we're trying to strike on our new deals.

Okay.

Appreciate it, guys.

Thanks.

Thank you.

Our next question is coming from Nishu Sood with Deutsche Bank.

Please proceed with your question.

Thanks.

I wanted to follow up with my first question on what Carl was just asking about your land strategy.

So sticking to, as you were talking about with Carl, mainly land spend on finished lots for quick turnaround, I wanted to ask specifically about challenges to that that might cause you to begin to look more upstream to land positions that require more development.

First thing was obviously some of the other builders have been talking about rising lot costs that are flowing through their income statement just because of how much a more aggressive a lot of your competitors have become, obviously you were earlier than folks.

And the other thing was just a scarcity of those finished lots.

Most of the markets that we look at, it sounds like there is not that many opportunities left like that.

Are either of those challenges creeping up and so do you expect to begin to look at lesser developed deals?

Currently given what we see as the demand going forward, and we believe that the next twelve to 24 months will be challenging in the homebuilding industry, we have one focus right now, and that is if we invest a dollar in a piece of land or lot we want that dollar returned to us within twelve months, and that's our underwriting criteria today.

Are we missing some deals out there?

Yes, we are missing some deals out there.

By our calculations the competitors we're losing those deals to are working for 15% gross margins.

And a lot of deals that they're closing, they're inventorying, they're banking, and we don't understand that, and we don't want to try to understand that.

But we're focused on continuing to produce a margin on our houses between 17% and 18% and getting back every dollar we put out to our divisions within twelve months if it is on a piece of raw land or whether it is on a finished lot.

But our main focus is continuing to do low earnest money, rolling option contracts with structured takedowns and limiting our spec inventory in those communities.

Got it, thanks.

That's very help.

Second question, at the beginning of this fiscal year you told us that you had a goal of achieving profitability for this fiscal year and it looks like you're going to come through on that, which is certainly a nice achievement given how tough things are out there.

But to borrow one of my favorite phrases of yours, no good deed shall go unpunished, so I have to ask you about 2011.

What are your initial thoughts on that?

Anything you're willing to give us on that?

I think 2011, as I said before, and 2012 both are going to be tough years in the homebuilding industry.

As we mentioned on our conference call, I just don't see any sustainability of growth or profitability until we get some jobs created in this country and until consumer confidence improves, and I don't see either one of those factors benefiting us in '11 and '12.

What I will say is that we will structure this Corporation's SG&A to meet the demand that's out there.

As far as our fourth quarter is concerned, we're sitting today with about 4,400 homes in backlog.

We think that places us in a decent position to have a decent shot at being profitable in Q4, but it is going to be a real challenge.

Our goal is to continue to take market share.

As I was in our purchasing manager's meeting out in Las Vegas last week, addressing over 90 vendors who came to Las Vegas, one of the things I told them is we're focusing on market share and at the end of the second quarter -- we don't have the statistics yet, but we will have -- DR Horton sold 25% of all the new homes at the end of our second quarter sold by all the public home builders.

So clearly we're increasing our market share across the country and we plan on continuing to do that at the expense of the small, medium-sized and large builders.

Great.

Thanks a lot.

Thank you.

Our next question is coming from Jonathan Ellis with Bank of America Merrill Lynch.

Please proceed with your question.

Good morning, John.

Can you hear me now?

Sorry about that.

Thought this was a Verizon commercial for a minute.

Unfortunately we use AT&T around here.

That's beside the point.

In any event the first question I have is just on your cancelation rate.

I notice that it did pick up sequentially and I'm just wondering was that a function of orders that, at least initially before the tax credit was extended, there was an expectation that the homes wouldn't be completed by the end of June?

Or anything else we should be sensitive to in terms of the sequential change in cancellations?

No.

As a matter of fact, what it was directly a function of is that we wrote every deal that we could write by April 30th.

And we knew our cancelation rate was going to increase, and I was surprised it only increased 28%, but nevertheless we wanted to give every buyer the opportunity to buy and close on a home.

And so if they had a pulse and they were warm, we wrote them, and so as a result we did have some cancellations because people couldn't qualify.

I see.

Okay.

So it was more qualification.

Got it.

The second question is just you talked a little bit about some of the promotions in place and I think, at least initially, the eastern region perhaps had been a little bit more proactive and other regions had followed subsequently in terms of offering promotions.

The question is, if I look at the trends in the quarter, pricing on orders were down in the East on a year-over-year basis for orders more so than any other region and most of them were actually up.

Is that just because the East was more aggressive or was it because the promotions were just more effective meaning that the customer base was more receptive to the promotions in the East than in other parts of the country?

You sort of hit a pet peeve.

I was in Stacey's office this morning discussing with her why we get hit with the fact that if our ASPs, average sales price, goes down, that it is a function of our incentives when really in the East specifically it is a function of our pricing and product offerings.

And one of the things that the Company -- two of the things the Company has done is, one, we have downsized our product significantly over the course of the past two years.

Secondly, we have taken a lot of the amenities and upgrades out of the house which also leads to a lower sales price, so if you look at those two factors in particular, that's one of the things that's driving our ASPs lower as we continue to try to capture as big a percentage of the first time homebuyers as we possibly can.

So the niche was more of a factor in the East than the other regions, is that fair to say?

It was a function of the East building smaller and lower priced homes.

And part of that is also they have a greater number of new communities that have factored in which are focused on the affordable products, so yes, their mix of affordable product has increased more than other regions.

Thanks very much.

Thank you.

Our next question is coming from Megan McGrath with Barclays Capital.

Please proceed with your question.

Good morning.

Thanks.

Just wanted to ask a little bit of a follow-up to that.

Could you give us any regional color?

Specifically on Texas we have heard some mixed things around the Texas market recently, but primarily focusing that that market is weakening a little bit or not growing as fast as other markets.

So any commentary on Texas?

Boy, there are sure a loft whiners out there among our competitors about Texas.

I would have to say we're kicking a lot of tail in Texas, and we have some great operators in Texas.

And I would say to you in Houston we have increased our market share dramatically down there because we have a great division President and great team down there.

And we continue to increase our market share in San Antonio.

We continue to increase our market share in Austin and Killeen.

And we also continue to increase our market share in the Dallas Fort Worth area which there was a report that came out recently that reflected that DR Horton had started 3,200 homes, and the number two builder with their five business names and operating entities in the Texas market, started less than 1,000 homes.

And so that's an incredible position for Horton to be in to have well over two-thirds of the market in the Dallas Fort Worth area and we're continuing to penetrate our existing markets in Texas deeper and deeper and taking market share away from our competitors.

That's the bottom line.

That's helpful.

Thank you.

And then just a follow-up to the conversation about the land market.

Just want to ask in general do you feel as if the land market and the market for finished lots or lots in general has adjusted yet to the slowdown in pace that we have seen in the market, or are they lagging a little bit in getting maybe prices more in line to get you guys --

Land sellers are always unrealistic whether it be in an up market or down market.

And I would tell you that a lot of the land and even finished lot pricing that we're seeing today is a function of the benefit of the tax credits over the last nine months.

And clearly the demand associated with the tax credits is far higher than the demand is going to be without the tax credits, so I think the land sellers have got some major adjustments downward in their finished lot prices to be able to sell the lots where we can market a home at the current market price.

Got you.

Thanks.

And just a quick one.

Do you have your deferred tax asset at the end of the quarter?

Yes.

We're at $879.2 million which is still fully reserved by valuation allowance.

Thanks very much.

Thank you.

Our next question comes from Dan Oppenheim with Credit Suisse.

Please proceed with your question.

Thanks very much.

Just wondering if you can talk a little bit about the trend in terms of the orders and such where you talked about the increase there in June and July.

With July, where is the absorption relative to what you would like it to be in terms of your goal?

And is that at satisfactory levels for sales per community or do you think you need to still do more in terms of promotions and marketing in terms of trends, August/September?

I will clearly say that our July sales are not where our goal is, and so as a result we're going to continue to be aggressively marketing homes in all of our regions and all of our divisions.

Our sales are slower than what we want them to be.

They're not slower than we anticipated.

We anticipated that post a tax credit that our sales would drop off rather dramatically, and unfortunately they did, but we're focused on a specific level of sales in closings, and we'll focus on that and will achieve that.

Thanks.

And then in the South you talked about the ability to have the promotions and then generate strong sales without hurting margins there.

It's certainly great to have customers respond without having to give anything away that way.

Wondering how aggressive you would end be being in terms of having to go after the absorption?

Clearly our goal, as Stacey mentioned, is to keep our gross margins at the 17% to 18% range.

As I mentioned earlier, our phenomenal sale this past weekend in the South region and specifically the state of Texas we held our margins very nicely during that sale.

And we would anticipate as we move forward is to keep our margins between 17% and 18% unless there is a dramatic slowing of demand more than we're seeing today.

Great.

Thanks very much.

Are there any other questions?

Yes.

Our next question is coming from George Bose with KBW.

This is Jade Rahmani on for George Bose from KBW.

I just wanted, on your gross margin, can you quantify the direct impact to margins of say a 1% price decline, other possible offsets and lower materials or construction costs that you are currently seeing?

We are continuing to see significant reductions, ongoing reductions in our construction costs.

As you can see on a year-over-year basis our average selling prices are still down slightly, but our margins are up significantly, so we have been successful in offsetting those thus far.

That's not guaranteed going forward.

It is something we'll continue to work on, but if we see on an apples-to-apples house a reduction in price of 1% we're going to do the best to offset as much of it as we can.

I don't have a clear answer for you, just in a theoretical case of exactly what we would be able to accomplish.

But rest assured that our vendors and our subcontractors are working very closely with us simply based on our volume.

They clearly are interested in doing business with Horton and growing their business as we continue to grow our business, so we have ultimate cooperation from our vendors which is tremendous based upon the trade show that we had in Las Vegas last week.

Great.

Thanks.

And then on the first time homebuyer and tax credit related sales, were those on average at lower prices and can you give the percentage of May through July sales that are coming from first time homebuyers?

For the quarter we had first time home buyers represented 60% of the closings that our mortgage company handled for the Company.

On average, since we do have probably a greater percentage of those being first time homebuyers, the average selling prices would be lower on those homes.

It doesn't mean the margins are lower, but on average the average selling prices are a bit lower when we have a higher first time home buyer percentage.

Okay.

And so then the May through July sales were around 60% level?

May through July, we actually get our best indication when homes close from our mortgage company, so I don't really have good color to give you on May through July.

We only have closings through June.

Okay.

Thanks very much.

Thank you.

Our next question is coming from Joel Locker is SBM Securities.

Please proceed with your question.

Hi, guys.

Do you have a percentage of land costs as a percentage of home sales for the third quarter, and if you have it for the year ago period, too?

We have been running right around the low 20% range on our lot cost pretty consistently for a long while in terms of the lot costs percentage of revenue.

Right.

So that hasn't changed at all or just nominally if anything?

Yes, just nominally if anything.

No significant change.

And your sales, obviously they were up 20% from May to June and then another 10% from July.

Did you give out a nominal figure for May on net orders?

No, we did not.

We talked about the trend after the tax credit, after the first month post the tax credit.

We talked about the sequential improvement, 20% to June and an additional 10% in July.

I guess being significant it could be 20% down or 80% down and just trying to get a baseline to see.

Also to get that baseline you would need to know how great sales may have been in April.

So to really give the full picture you would have to perhaps go back to the start of the year.

Right, but you could work back from just the nominal number in May.

I was just trying to get some kind of how the quarter went, whether it was, could have been 3,000 and 800 or back up somewhere along those lines.

So you guys I guess obviously are not going to disclose that?

No.

We prefer not to.

We did see a significant decline in May.

We did see very good sales in April.

I have always said a month is not a trend, so basically we've refused to do that over the years just simply because the quarter is really what we're focused on.

April wasn't a trend.

Neither was May.

Just the last question on customer deposits, just backlog at quarter end, if you have that figure?

I would say deposits continue to be minimum, that's not the real reason that someone is going to close or not close a home.

They're running a little over 1% of the sales price.

A little over 1%.

All right.

Thanks a lot, guys.

Thank you.

Our next question is coming from Jay McCanless with Guggenheim Partners.

Please proceed with your question.

Good morning, everyone.

Can you repeat what the lots under option were at the end of the quarter?

Lots under option at the end of the quarter were 29,300.

27,300.

27,300.

Okay.

Thanks.

And then my other question, on August 17, Treasury is supposed to have this thing called the Future of Housing Finance Conference.

Didn't know if you had any thoughts on that and what if anything you would like to see come out of that conference that might help DR Horton?

I don't have any expectations of any of those people up there right now, so we're just focusing on reacting to the market and continuing to grow our business back.

Hopefully we'll deal with a stable market relative to what the government is doing to housing.

Our goal is to continue to deal with the market conditions that come our way, and that includes anything that would change on the mortgage financing front.

The changes have been numerous over the three to four years of the downturn, so we will continue to adapt and adjust, but as Don said we don't have any specific expectations or goals for that conference.

Frankly we, as a Company, don't participate with the other builders in a lot of those initiatives they have up there.

We just focus on dealing with our Company and meeting the challenges we have as the challenges change from time to time.

Okay.

Thank you.

Thank you.

Our last question is from Michael Smith with JMP Securities.

Please proceed with your question.

Thank you.

Good morning, guys.

Two questions.

One, can you talk a little bit just about order patterns in June and July?

And what I mean by that is where are you seeing strength, where is still relatively weak compared to April?

And if you want to talk geographically or submarkets or mix issues or anything like that.

Just trying to get some color on what's out performing what out there?

You are making Stacey nervous right now.

We have one of our competitors who does a great job of grading the markets, so I would ask you to please wait until he has a conference call because he does a much better job than we.

We're just approaching each individual market, trying to penetrate each market more profitably as we move forward.

And the color on those markets changes so dramatically from month to month and quarter to quarter that we just stopped giving color on the markets.

In general, though, in terms of those trends I would say June and July have been stronger than May almost across the board, and June and July continue to be weaker than April almost across the board.

Got it.

That helps.

And then second question, as far as the off balance sheet DTAs you have that you have taken evaluation allowance, now that you have been profitable a few quarters in a row and maybe going forward, do you have any visibility on when you will be able to start bringing those back on your book and what that process might eventually look like?

Before Bill answers that question, I will tell you it will be later than most of the other builders bringing theirs back on.

Just simply because of Bill.

That's a great way to end the call.

I am not trying to sell any dissension here, guys.

There is no dissension, we just laugh about it.

There's nothing you can do about it.

However, if we continue to generate profits on a quarter by quarter basis and other builders do not, we will recognize it before them.

Going forward, it will all depend on the level of profits we generate and how consistent we are able to, and our visibility into how well we can operate profitably in the post tax credit environment.

So this is our last quarter in which we'll be getting some profits from the tax credit.

Next quarter, as Don has already said, it is going to be challenging to be profitable.

But we believe it is achievable.

To the extent we're successful in adjusting our business to the environment for 2011 and we can continue profitability, then we can start having some serious discussions around when is the appropriate time to bring that back onto the balance sheet.

As far as trying to nail a specific time right now, I am not going to do that.

We don't know what the next quarter and next year are going to bring, but rest assured as we get closer to that time and as we have better visibility we will share that.

We will disclose that in our 10-Q.

We'll let you know what we're looking at.

Then you will start having a better feel for the timing.

It is not going to be in the next quarter or two.

Is it same to assume they will come back on in chunks as opposed to all at once?

It would typically be in larger chunks if not all, is the guidance that we hear, but that's an ongoing discussion as well.

There is actually not a lot of precedent out there for companies who have taken full valuation allowances and then recover and actually get back to a point where they can bring it back on their balance sheet.

It is an emerging item and an issue for the accounting firms to deal with, as well.

Great.

Thanks a lot, guys.

Appreciate it.

Thank you.

There are no further questions at this time.

I would now like to turn the floor back over to Mr.

Tomnitz for closing comments.

Thank you.

We're very proud of the fact that our closings increased dramatically this last quarter.

Our sales orders were only down slightly, and most importantly our core margins continued to improve.

I believe that proves beyond a doubt that DR Horton's strategy was correct and our business model superior.

I want to thank two people, or two groups of people.

One, all of the DR Horton team members who continue to out-perform everyone else in the industry.

And most importantly our realtors who have been with us for many, many years and I think enable us to out-sell everyone else in the industry.

The realtors have been a great asset to DR Horton, and we appreciate all the buyers you bring us.

Bottom line is that we have finished the third quarter, and as I told all of our people earlier in the conference call, the third quarter is over and now we need to march towards profitability in the fourth quarter.

So thank you very much, and we appreciate everything you do for us.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.