霍頓房屋 (DHI) 2011 Q1 法說會逐字稿

Good morning welcome to the D.R.

Horton, America's builder and the largest builder in the United States first quarter 2011 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)It is now my pleasure to introduce your host, Don Tomnitz, CEO and President of D.R.

Horton.

Thank you, Mr.

Tomnitz.

You may begin.

Thank you and good morning.

Joining me this morning are Bill Wheat, Executive Vice President and CFO, Stacey Dwyer, Executive Vice President and Treasurer, and Mike Murray, Vice President and Controller.

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 D.R.

Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes may not be materially different.

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

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

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

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

Horton's annual report on form 10K, which is filed with the Securities and Exchange Commission.

Don?

Thank you, Stacey.

As we expected, our first quarter was challenging.

The fundamental drivers of demand for the homebuilding industry, the overall economy, job growth and consumer confidence are still weak, even though recent reports show some small improvements nationally.

Our year-ago comps for both sales and closings were very strong due to the original expiration date of the federal home buyer credit.

Our divisions worked hard to generate sales and closings during this seasonally slow quarter, and our backlog conversion rate was historically high at 88%, but was below the near 100% or better conversion rates we achieved while the tax credits were in place.

We are hopeful that we will see a good increase in sales demand in the upcoming Spring season.

However, given the week macroeconomic conditions, high levels of existing homes for sale, and tight mortgage availability, we remain cautious and realistic in our expectations and will adjust our business to compete in the current market conditions.

We are prepared for the Spring season, and we plan to continue to open new communities, adjust our price points and product offerings to the demand we see in each of our individual markets.

Mike?

Our net loss for the quarter was $20.4 million or $0.06 per diluted share, compared to net income of $192 million or $0.56 per diluted share in prior year quarter.

Homebuilding pre-tax loss was $21.4 million dollars, which included $8.4 million dollars of inventory impairment and lot option charges.

Financial services pre-tax income was $4.2 million, which included $1.8 million of recourse expense.

Bill?

Our first quarter home sales revenues decreased 31% to $761.1 million on 3,637 homes closed from $1.1 billion on 5,529 homes closed in the year-ago quarter.

Our average closing price for the quarter was up 4% from the prior year and down 3% sequentially, to $209,300.

Don?

Net sales orders for the first quarter were down 17% from last year to 3,363 homes.

The net sales quarters in the prior year quarter included strong demand in October from the first-time home buyer tax credit that was in effect last year.

Based on current sales demand, and fact that tax credits were supporting sales last year through April, we expect that achieving positive sales comparisons the next two quarters will be difficult.

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

In the December quarter, our average sales price on net sales quarters was essentially flat year-over-year at $209,800.

Our cancellation rate was 28%.

Our active selling communities were up 3% sequentially.

Our sales backlog decreased 7% from the prior year to 3,854 homes or $794 -- $795.4 million.

Stacey?

As we mentioned on our year-end conference call, we expected gross margin pressure in fiscal 2011 as we continue to adjust to the prevailing markets in each of our communities.

This was evident in our first quarter results as our gross profit margin on home sales revenue in the first quarter was 15.6%, down 150 basis points from the year-ago period and down 140 basis points sequentially.

The margin decline reflected the weaker housing market we continued to experience during the second half of the calendar year.

Mike?

In our first quarter impairment analysis, we reviewed all projects in the company and determined that projects with a pre-impairment carrying value of $26.2 million were impaired, which resulted in $6.4 million of impairment charges, the majority of which were in California and Arizona.

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 of the highest risk for future impairments.

After this quarter's impairments, our watch list now totals $408.1 million, up from $346.7 million in September, with the largest concentrations in California, Illinois, and Florida.

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

Stacey?

In the first quarter we reduced homebuilding SG&A expense, which includes all corporate overhead, both year-over-year and sequentially to $118.9 million.

However, with the decrease in homes closed, SG&A expense increased to 15.5% of homebuilding revenues compared to 11.6% in the year-ago quarter.

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

Bill?

Homebuilding interest expense was $16.2 million for the quarter, which represented 46% of the homebuilding interest we incurred.

We directly expense a portion of our interest incurred when our homebuilding debt level exceeds our active inventory.

Our first-quarter homebuilding interest incurred decreased 29% compared to the prior year to $35.2 million.

We expect that our interest incurred and our direct interest expense to be lower in fiscal 2011 than in fiscal 2010 due to the $1 billion of debt reduction that we achieved last year.

Mike?

Financial services pre-tax income for the quarter was $4.2 million, compared to $6.7 million in the year-ago quarter.

82% of our mortgage company's business was captive during the quarter.

Our company-wide capture rate was approximately 62%.

Our average FICA score was 708 and average combined loan value was 92%.

Our product mix in the quarter was essentially 100% agency-eligible, with government loans accounting for 61% of our volume.

Don?

Our total inventory decreased by approximately $29 million excluding non-cash impairment charges during the quarter.

We reduced our homes inventory by $66.9 million and increased our investment in residential land and lots by $45.5 million.

Our homes inventory at the end of December, totaling 9100 homes, down 400 homes from September.

1200 of our homes were models, 5,000 were speculative homes, and 3,000 of these specs were completed.

We reduced both our total and completed specs by 200 homes during the quarter.

We continue to manage our total homes and inventory relative to our expectations of sales demand, and we offer spec homes primarily to accommodate our first-time and relocation buyers.

Bill?

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

We have been actively contracting for finished lots to increase her active selling communities, sales, closings, and profitability.

In our first fiscal quarter, our total land lot and development investments were $188 million, primarily in finished lots.

In fiscal 2011 our spending on finished lots will remain largely dependent on our sales base, while our spending on land and development costs will continue to be at relatively low levels.

Mike?

At December 31, we owned approximately 89,000 lots, of which was approximately 24,000 are finished.

We control an additional 31,000 lots through option contracts up 5% from September 30 with a net earnest money deposit balance for these lots of only $12.4 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.

Bill?

Cash flow from operations for the December quarter totaled $49.5 million generated by the decrease in homes and inventory and mortgage loans held for sale, partially offset by a decrease in payables and liabilities and our spending on finished lots and development.

We ended the quarter with $1.5 billion of homebuilding cash and marketable securities.

The balance of our public notes outstanding at December 31 was $2 billion, which reflects the repurchase of $62.5 million of notes during the quarter.

Our note maturities in fiscal 2011 and 2012 are $177 million and $133 million respectively.

We have $421 million remaining on our debt repurchase authorization at December 31, 2010.

Stacey?

At December 31, our homebuilding leverage ratio net of cash and marketable securities was 17%, an 11 percentage point improvement from a year ago.

Gross homebuilding leverage at December 31 was 43.9%, a 9% percentage point improvement from a year ago.

These leverage improvements are due primarily to our significant debt reductions in cash-flow generations.

Don?

There are still challenges in the homebuilding industry - rising foreclosures, significant existing home inventory, high unemployment, tight mortgage lending standards and weak consumer confidence.

However, as we have mentioned before, new home inventory remains low, interest rates are favorable, and housing affordability is near record highs.

In addition, we are beginning to see small improvement in national consumer confidence and unemployment.

Although their impact varies significantly from market to market.

In two weeks, the Spring selling season begins in earnest, and we will begin to get a much better read on demand.

We will also see if the small improvements in consumer confidence and jobs are sustainable.

Over the last three years D.R.Horton has increased our national market share of new home sales by 50% from 3 .8% to 5.8%.

Our long-term strategy has proven successful throughout the downturn, and we will continue our focus on providing affordable homes, increasing number of active selling communities over a broad geographic footprint, controlling our costs, maintaining our strong balance sheet, and profitably out-selling our competition in each and every marketing community.

This concludes our prepared remarks, and we will now entertain questions.

Thank you.

We will now be conducting a question-and-answer session.

(Operator Instructions)In the interest of time, we'll answer as many questions as possible, we ask that you limit yourself to one question and one follow-up.

One moment while we poll for questions.

Thank you.

Our first question is coming from the line of Stephen East of Ticonderoga Securities.

Please state your question.

Thank you good morning everyone.

Good morning.

D.T., if you look at your gross margin decline, it sounds like you are really just trying to hit the market in sending what you think is an appropriate way.

Am I interpreting that right?

And can you talk about what your spec strategy is moving forward?

I know last Spring you had a lot of specs that you wanted to put out into the market because of the tax credit.

Has your thought process changed or are you trying to reduce that spec, and the gross margin impact moving forward between incentives and specs.

Well, you are correct that we have had a strong spec strategy.

I would say to you that our gross margin decline really is a function of the competition in the marketplace.

As one of my regional presidents, David All, says, it doesn't do any good to have an unrealistic gross margin out there on the house if it's above what the market is willing to pay, so we have adjusted gross margins on a market-by-market, subdivision-by-subdivision, and house-by-house basis.

We have reduced our specs on our total inventory this quarter.

I would say to you that that will probably increase at the end of the next quarter depending upon our sales, but we are loaded, locked and loaded as they say with our specs on the ground anticipating a much better selling season then what our past sales have reflected.

So I think we're definitely ready for the spring selling season.

Okay.

And then on, along those lines, have you started to see any uptick in traffic yet, or is it just too early for you.

I know you said a couple of weeks from now you will have a better -- but what you are seeing in your early take, and the other question is, where you think community growth goes this year and how much land spend you think you have to put into it.

I am not a big traffic guy, but D.R.

is on the road this week and has been going through Louisiana and Alabama on his way to Florida.

And he is happier than I have heard him in a long time, and it's been based upon the amount of traffic that he is actually seeing in our model homes.

So I would say to you that based upon his input and my input being on the road, we are seeing more traffic.

And I think that is a very good thing in terms of where we see the market coming for this Spring selling season.

Absolutely.

And on the community growth and the land spend?

Yes, Stephen, in terms of active communities, our strategy is to continue to increase our community count.

Obviously, we have older communities rolling off so there is a netting effect, but our strategy is to continue to try to incrementally improve our communities.

Active selling communities were up 3% sequentially this quarter, up about 18% year-over-year, so that continues to go.

In terms of our land and lot spend, essentially on our finished lots we're basically replenishing the lots that we're selling through, our finished lot supply has not changed a whole lot.

If we see better sales, we would expect that to start increasing to max those sales.

Our total spend on finished lots, land and development this quarter of $188 million was basically roughly in line with the pace that we spent last year, we spent a little over $800 million last year, so I wouldn't see a major shift in that unless we see a major shift in the sales pace.

Frankly, we still want to maintain our model of being a land-light company, especially on the ownership side and that's our focus is to still continue to focus on option deals, even though we may give up some gross margin by doing the option deals, we feel like that is a better place for our balance sheet to be.

Just one more piece of color around the specs - last year at this time, we were running at 63% spec, so we were definitely anticipating some increased demand from the tax credit.

This year we are at 55%.

So you are seeing us keep that a little bit lower.

Thank you.

Thank you our next question is from the line of Josh Levin of Citigroup.

Please state your question.

Good morning.

On the last call, I guess you caused a big what-to-do.

You said that you did not think that new home sales would be all that great in 2011.

Relative to what your view was on the last call, have you seen anything to really change your opinion at the margin, either more pessimistic or optimistic?

No, I think we were very factual and I think clearly, when we -- our fourth quarter conference call, proved out what our first quarter results were.

I don't see anything in 2011 that is going to make 2011 better than 2010.

And I think we are still realistic in terms of, we need job growth, we need consumer confidence, and we still have issues with qualified people with a tighter mortgage underwriting.

I think 2011 will be a marginal weak year in the homebuilding industry.

Our goal is still to be profitable in 2011, and we are going to struggle more in 2011 than we did in 2010 to be profitable.

Okay, And just to follow up on the gross margin going forward, Stacey, you talked about 2011 facing some margin pressure.

How should we think about gross margin from here.

Is there still more pressure to come, you think?

I would say to you on the gross margin side, clearly we are going to be competitive in the marketplace as we have always been, and going into the second quarter, we do have-- even though our spec count percentage is down, we still have 55% of our inventory out there as specs.

We do have some aged inventory that we want to move, so I would say to you that being competitive, given our inventory and given some of our aged inventory, I think that our margins will continue to be under pressure in the second quarter.

Thank you very much.

Thank you.

Our next question is coming from the line of Michael Rehaut of J.P.

Morgan Chase.

Please proceed with your question, sir.

Thank you.

Good morning, everyone.

First question on some of the comments you said right at the beginning of the call, seems to be, maybe in some ways a little contradictory to the more cautious tone where at the beginning you said maybe there is some signs of improvement.

You just mentioned the traffic being a little bit better.

You are hopeful.

At the same time, gross margins being where they are, and it still being a tough environment, how are you supposed to -- how should we think about reconciling that?

Obviously, still a tough environment, but I guess, those signs and that hopefulness, given that you are still fairly pessimistic it sounds like, where are you getting those signs and hopefulness I guess is the question?

First of all, I'd say that we are realistic as opposed to pessimistic, and secondly, I think you can reconcile it very simply.

The first quarter as our seasonally low quarter for the entire fiscal year, so we are lower than--at the bottom of the ocean right now and if we can't be optimistic after our worst quarter, seasonally, there would be something wrong with us.

We are optimistic relative to where we have been and where we are today in terms of the fact that there is going to be a better market in the second and third quarter than what we have experienced in the first quarter in terms of sales and closing.

Okay.

Fair enough.

Second question, on the gross margins, just to go back to that for a moment, it seems like you are continuing to adjust to the marketplace.

Do you feel that the gross margins will be more dominated by the continued pricing trends or incentive levels or do you anticipate, how do you think about land cost though as that impact.

And did that have any play in the first quarter decline from 4Q in terms of the step down?

Our margins are going to continue to be under pressure based upon the competitiveness in the marketplace.

We are out-selling everyone else in the industry.

We are going to continue to out-sell and out-close everyone else in the industry.

We are in a better position than anyone else in the industry, so as a result, I will quote one more time David All, "it does not do any good to have an unrealistic gross margin on a house if the market perceives it as overpriced," so we aretrying to control our costs as strongly as we can, and we are trying to meet the market in each and every sale that we have.

So as a result, depending upon what every other builder is going to be doing out there, which we are all fighting for market share, we're all fighting for a limited number of sales in the marketplace, I think over the next couple of months there is going to be some extreme competition in the marketplace.

But again, we're going to continue to out-sell and out-close everyone in the market.

So land costs aren't coming to the equation as well in this past quarter going forward?

When we look our land cost as a percentage of our revenue, they are not different at all in terms of sequential or year-over-year comparisons, so I don't really think it is the land cost that is going through our cost of sales that is impacting the margin right now.

That said, the other thing is, we consistently rework our rolling option lot prices simply because of the fact that we can, so as a result, when the margin start to work their way down, because the land cost is getting higher as a percentage of the overall cost of sales price, we are back with the seller, whoever that may be trying to work that price down.

Basically we have been in the market last six months where demand has been at a very low-level, so therefore the competition for that low level of demand has been intense, and I think that is reflected in the margin.

As we go through the year, we see some seasonal increase.

Hopefully some higher level of volume in the marketplace would help to provide some stability for margins but we will see.

We do expect it to be very competitive continuing through the year.

One last quick one, if I could squeeze one in on community count?You said it is up 18% year-over-year in the first quarter.

Should we expect a similar type of year-over-year type of trends up 15% to 20% , let's say, for the fiscal 2011

I think that is going to be difficult to achieve but I will tell you this, that we are out there trying to do every option deal on finished lots that makes sense to us in the market, and we are beginning to go further and further out from some of our core markets and get into other areas where there are finished lots, albeit perhaps not as desirable as our core markets.

But we are trying to drive buyers out to those markets by offering a more competitively priced product.

Last year, you saw us ramp up our community counts rather dramatically on a sequential basis throughout the year.

While we continue to expect to increase our community count we might not be increasing it sequentially as dramatically as we did a year ago.

So the year-ago comparison may start to moderate a bit, but again, we expect to sequentially continue to try increase our community counts.

Thank you.

Thank you.

Our next question is coming from the line of Jonathan Ellis of Bank of America, Merrill Lynch.

Please proceed with your question.

Thank you.

First question, I just want to ask about, you talk a little bit about the tighter mortgage underwriting standards.

There did not seem to be any material change in your cancellation rate this quarter, so I'm wondering, is the expectation that perhaps there is a tick-up in the cancellation rates in the coming quarter and then the related question being, let's say you are seeing tightening standards, is it more from the Fannie-Freddie side or FHA?

The tighter mortgage lending standards is really just a continuation of everything we have seen throughout the downturn.

The banks are getting a lot of push-back right now from Fannie and Freddie, and since we don't bank our mortgages, we basically are using underwriting standards that are given to us by the banks who will take our mortgages.

And so I would not say there is anything significant that has changed recently or that we see going into the Spring, but compared to the easy credit that was available when we were seeing the rise in prices and the really strong demand, it's a tighter mortgage environment, and that still remains our number one reason for cancellation right now.

Okay, great.

And my second question, can you share with us, I think you did last quarter, percentage of deliveries and orders from new communities in the quarter.

And then also related question, as you talk about community count growth for the coming year, any sense based on where we stand today, whether that community count expansion may be more of back-end loaded than front-end loaded in terms of the sequential change?

Thank you.

Yes, we have been talking for a while now about the number of our sales and closings that have come from communities that we contracted for beginning in fiscal 2009 or later.

Clearly that has become a much bigger part of our business.

This quarter we have ticked up to around 50% or better in terms of both sales and closings that have come from those communities.

Now that has really become our business, and that will continue to grow.

Of course, we start to see some of those 2009 communities start to roll off as well, so that is certainly a statistic that we still have.

It's not quite as relevant today, and we would expect it to become even less relevant in future quarters as that's now really is our business.

I was just going to say on sequencing for community count.

It will be dependent on opportunities, Jonathan and really our absolute level of what we end up opening is probably going to be somewhat dependent on the level of demand we do see and the need to replenish and continue to expand our communities.

I think on a year-over-year basis, we will see the biggest growth in the second quarter and I think that year-over-year growth number is going to moderate through the third and fourth quarters as we're averaging larger community count numbers.

But again, as I said, we're going further and further out from our core markets, where there are plenty of developed lots on a very selective basis, and trying to offer the buyer a more competitively priced house further out, and so I think we will add communities like that, but it is not going to be as much as what we have added in the past.

There are so many core subdivisions that were available at one point in time and those are beginning to decrease in number.

Okay.

Thanks guys.

Thank you.

Our next question is from the line of Carl Reichardt of Wells Fargo Securities.

Please state your question, sir.

Hey, guys, how are you?

We are very good.

Good morning.

I guess you surprised me this morning when I walked into Stacey's office.

You must be taking happy pills.

Four in the morning.

Don, the watch list increased in the quarter sequentially, is that a function of communities that you purchased relatively recently, not meeting your standards or is that a function of the broader market?

I guess I'm trying to figure out that is related to new stores or older stores to the extent the watch list would increase.

The increase is primarily related to the broader conditions but there are some of the newer stores that are representing some of the projects on the watch list.

And where that happened primarily was inland California, where we did enter into some deals in early 2009, and they did not prove to be as good deals as what they should be.

Post-tax credits, the environment, inland California dried up and is blown away.

I don't think you can find it any more.

Okay.

And the store count increases you indicated sort of more aggressive in the second quarter versus the rest of the year, Is there a concentration we are expecting to see the stores increase in number or is it more broad across the business?

Clearly, where we entered into most of the majority of our deals is in our Eastern region which is in Florida, the Carolinas, Georgia, Alabama, and even in Northwest Florida, too, which is obviously part of Florida, but primarily that is where we entered into most of our deals today.

Okay, thanks guys.

Thank you.

And next question is from the line of Nishu Sood of Deutsche Bank.

Please go ahead with your question.

Thanks.

My first question I wanted to ask was on the gross margins as well.

You folks described that you're responding to market conditions, and so that is what led to the gross margin deterioration in the December quarter.

I just wanted to understand a little bit better, demand has obviously been quite weak since the end of the tax credit.

Weakness would have affected the third quarter as well and yet -- I'm sorry, your September quarter, and your September quarter margins were stable.

So I just want to understand the delta in terms of the weakness and how you are responding to it and maybe what types of incremental pricing or incentive strategy you are using that led to the delta between the September quarter and the December quarter.

I will start off by saying one of the reasons for the delta, as Bill mentioned earlier, is that our 2009 communities are obviously getting older.

They were entered into at a higher lot price than what subsequently we were able to get lots in some of those markets.

And like D.R.

has said on numerous occasions, the second leg down on the homebuilding industry started May 1 as the tax credit, the second tax credit expired.

So I think it is a function of the tax credit expiring, but also -- and not as much pricing power in the marketplace because obviously our sales have come down but secondly, because the 2009 lot deals with the second leg down in the homebuilding industry where the lot prices were richer than what they ultimately needed to be.

And we have, while the leg down and margins this quarter was more dramatic than what we saw last quarter, if you go back to our margins in the first half of 2010 in the second quarter specifically, we were up around 18%.

It did step down to the low 17%s in the last two quarters, and so I think what you are seeing this quarter, you are seeing the impact of the tougher selling environment as we went through the summer and the sales environment that we had in the Summer and into the early Fall, then showing up in closings more than in the Fall season through the December quarter.

So I think it's--While it is not an even ratable decrease each quarter, I think it is reflective of the tougher sales environment we saw beginning May 1 on through the Summer and into the Fall.

Got it, got it.Second question, following up on what you are talking about with Carl, the community count expansion that you folks have had has been in, as you mentioned, some places like Alabama, obviously a lot of communities there, places like Utah and then places where a lot of builders have been expanding communities like Florida.

So your breadth of community expansion is much, much broader than the other builders.

I wanted to get an understanding of what you are seeing that leads to this kind of broader footprint for community expansion.

Is D.R.

Horton a specific model issue, or why are you finding opportunities in places that others aren't?

Well, I'll say, first of all that we started off with a strong cash position.

Secondly, we had a goal of continuing to aggregate the national market share, which we have done and thirdly, we are willing to build specs in our community.

So when we go to a seller of lots, whether it be an individual or corporation or a bank, we are certainly, with our business model, the preferred buyer of those homes.

And we do maintain more specs per community than most builders, largely to accommodate that first time home buyer and that relocation buyer, as well as the realtors who basically want to bring a customer in our home and collect their commission as quickly as possible, and that does not work well for them when you're taking 90 to 120 days to build a bill job.

So as a result, those factors clearly make us the preferred buyer.

Okay.

Thanks a lot.

Thank you.

Our next question is coming from Joshua Pollard of Goldman Sachs.

Please state your question.

Good morning to you all.

Good morning.

I would like to hear a little bit about what the strategy is on SG&A.

If you guys look back, maybe a year ago, you guys were very confident in your ability to be profitable, partially because of the sales environment you were expecting, but additionally because of the work you guys were doing on the SG&A front.

If the sales environment doesn't quite pick up as you might expect, in the first couple of quarters of this year, what, following the bucket, of quick to cut for you guys and if you can quantify it?

That would be very helpful.

First of all, I will say to you, that we are extraordinarily proud of our SG&A in terms of total dollars, which we are right at about $118 million for the quarter.

Which that includes everything, including corporate and secondly, it is down from the previous quarter.

Thirdly I would say to you, and we do a lot of analysis around here comparing ourselves to others, but if you look at the fact that the number two or number three builder in the country is closing -- we're closing about 30% more homes than they, and we're running the same total dollars of SG&A.

I think that is an extraordinary accomplishment.

Having said all that, clearly the first quarter was our weakest quarter.

We are prepared for a better selling season in the second and third quarter, and basically, there are core SG&A costs that are associated with expecting better sales and closings in the second quarter and the third quarter.

Clearly though, we are unhappy at 15.5%, I think is the number, and we are going to focus on working that down if the sales don't materialize as we expect them to do, because 15.5% to us is totally unacceptable.

Could you quantify how much you cut over the course of a one to two quarter period, if you found out that the things weren't as robust as you had hoped.

I'm trying to get a sense of what the levers are and what you guys could cut that we would be able to see in fiscal 2011 versus if things weren't as robust, what would have to wait before showing up in your income statement until fiscal 2012.

A couple of thoughts, one, don't forget that when we started all of this that we had $1.5 billion dollars of total SG&A in the corporation, and we thought we had done a good job when we had cut it to $0.5 billion of total annual SG&A.

Now we are running closer to about $480 million worth of SG&A, and that is coming down.

So we definitely have the ability and we have the guts to cut it.

As we move forward, in terms of dollar-specific, we are more focused on the percentage of our SG&A as a part of our revenue, so the revenue portion of the SG&A is also very important to us.

But if the sales don't materialize, then there'll be subdivisions, which include salespeople and some superintendents, who we won't need because we will be closing down those communities if the sales don't materialize as we expect them to do.

Understood.

My one last question is around mortgage cutbacks.

I do not see any information in the press release on it.

Could you talk about what your most recent experience has been into the close of the year and also, if you could discuss how the Countrywide deal with Fannie and Freddie, how that may affect your go forward of potential markets (inaudible).

Thanks a lot guys.

We really haven't seen much change in our activity there.

We had total recourse expanse in our financial services operation of $1.8 million during the quarter.

Our total reserve balance on the mortgage company is $36.2 million, which was slightly down a couple of million dollars from the previous quarter.

So really we haven't seen much change in the activity at all but that is something that is continually evolving.

It's difficult to know what impacts some of these bank settlements and interplay between the banks and Fannie and Freddie my be.

But it is something that we are in touch with on a regular basis, and we are monitoring and will react as we need to.

I think the Countrywide settlement with Fannie, was a benefit to the industry overall because basically, you got the overhang away from Countrywide and B of A ,and B of A and Wells are purchasers of our mortgages, so as a result, I think they basically, with the settlement, certainly appear to have a clean slate and are in business in order to move forward and continue to buy our mortgages.

Thank you.

Your next question is coming from Mike Widner of Stifel Nicolaus.

Please proceed with your question.

Good morning.

Good morning.

Most of the questions have been answered, but let me follow up on something that you guys just brought up, the SG&A expense levels and you brought up the peer comparison.

So certainly, the expense cutting has been pretty impressive but you have another peer that reported this morning that is down in the single digits in SG&A as a percent of revenue, has been running at that level for, I know, at least eight quarter now.

You guys kind of talk about over the long term, as things get better, kind of targeting 10-ish percent, at least you have in the past.

So just wondering if you could sort of reconcile all of those.

What is your expected level as we get kind of closer back to a run-rate environment - high single digits or low double digits, tenish, and since you brought the peer comparison, why?

I will be glad to answer that question.

First of all, our goal certainly is to get our SG&A as a percentage of revenues back out of the teens and back into the 12s as our -- certainly as our goal.

I would say secondly, and we obviously compare ourselves to all of our peers and some of the people who are not our peers, and that company that reported today has done an excellent job.

I would say to you though, what this company at D.R.

Horton is focused on, is we have continued to maintain our geographic footprint.

We are still in 26 states and 72 markets, and we are positioning and have positioned, and will continue to position this company to take advantage of the upturn in the housing industry, and I will say to you that when the upturn in the housing industry comes, that we will be much better positioned and much -- and in a much better position to generate profits then some builder who's in three or four states.

I think that is a good answer.

And I kind of agree with you on all that.

One other thing that you brought up early in your comments, you mentioned market share.

I guess, first quick question, what are you using to measure it, it sounds like the numbers that you threw out are sort of deliveries or orders as a percentage of new home sales.

Is that the measure you're going by?

Right, we took our latest 12-month sales for each of last years into December and compare that to the national new home sales numbers that were reported.

Okay.

I guess just to follow up on that, because you brought it up, the new home sales number is certainly not the most accurate number out there but it's probably one of the better ones that we have.

You actually were in the 4.7% market share range back in 2006, so while you are certainly impressive last year, at good market share growth, certainly the tax credit, as you have acknowledged, had a lot to do with that and if we look at where you stood last quarter, your fiscal first quarter, last calendar quarter you were kind of down more, tax credit behind us, in the high 4% range.

And so I guess I'm just looking for your views on whether the market share gains that you got in the past year were sustainable.

They're going to continue in the absence of the home buyer tax credit and if in fact, you're confident about that, or if potentially you face the fact that you've benefited from some pull forward in that market now that it's going to be tough to maintain share, let alone grow share given your market segment focused that you have.

I'll let Stacey deal with the numbers but as a general observation, let's not forget it was not a D.R.

Horton federal tax credit, but it was a national tax credit, so as a result it benefited all builders out there in the marketplace.

So notwithstanding the fact that some of our market share gains may have come from the tax credit nevertheless, everybody else out there was benefiting from the tax credit as well.

True, but certainly the spec focus and the first-time buyer focus, you guys have benefited disproportionately, and kudos to you, fantastic job but I think you did benefit more than most.

If you're giving us credit for a business model by focusing on the first-time home buyer who is basically was a bigger percentage of the buyers, then I agree with you, but we have always this company focused largely on the first-time home buyer and we still believe that on a go-forward basis, that is the best buyer in the marketplace today.

I will let Stacey then talk about the percentages.

The percentages have actually bounced around a little bit.

If you go back to 2004, we were 3.9% of the market, and so, now at 5.8% in 2010, that is still a significant increase.

Do we expect to keep all of the gains that we have achieved?

In certain markets, we probably can hang onto those.

In other markets as credit becomes more available to the private builders and as the luxury and move-up segments of the market where we focus a little less come back, we may give up some of those market share gains, but right now, it continues to be a market share gain for us in the first-time home buyer, which is the most active buyer segment.

I assure you that each one of our regional presidents and division presidents who are in the field on a daily basis, and Don Horton and myself, our goal every day when we get up is to focus on profitability but also to focus on continuing to aggregate market share and take advantage of those players in the marketplace who are frozen on the market because of financing or some other financial issue but nevertheless, our goal is to continue to aggregate market share.

Thanks, guys, I appreciate the candor and I think you have done well on those fronts, so congrats on a solid couple of years actually as we continue to recover.

Thank you.

It's not good enough but we are working on it.

Thank you.

You are next question is coming from the line of John Mendia of SIG.

Please state your question.

Mr.

Mendia, your line is open for question.

Hello.

Hello.

Good morning.

How are you doing today?

Sorry about that.

Don't worry about it.

Just a quick question on your watch list, can you break that down by geographic segment?

If you have that information?

Yes we can, and as Bill and Mike are looking up that data, I always like to remind people that we still are the only builder who provides people with a watch list, so we will continue to let you drill down on it.

Okay good.

We've got -- the largest concentrations would be in California, Illinois, Florida, Arizona, New Jersey, and then Texas, in descending order of proportion.

Okay that is very helpful.

And then, talking about the Spring selling season, are there any markets that stand out as going to be more robust than others and how do you feel your presence is there compared to some of the competitors in the market?

I would say our broad geographic footprint as I said before, 26 states and 72 markets, we are well prepared for the Spring selling season in all those markets.

It's hard for me to answer and I'm not going to get into, as one of my contemporaries does, trying to rate each market, I think what we told you clearly, so far, looks like inland California and the Carolinas are weaker markets for us today.

But we expect those markets with the exception of the inland empire, we certainly expect a lot of the Carolinas in the next two quarters, relative to what they produced for us this last quarter.

All right.

Thank you.

Thank you.

Our next question is from the line of Dan Oppenheim of Credit Suisse.

Please proceed with your question.

Thanks very much.

I was wondering, you talked about how D.R.

is out of in so many different markets right now and it happier than it's been in quite some time.

What do you need to see in terms of thinking about controlling more land via options.

Would you need to see a lot of real progress in the orders for the Spring, and how you are looking at that overall, and how much are you putting into so the optimism from just the traffic here so far?

Well, let me answer the question on the options.

We are trying to tie up every option deal that makes sense to us, irrespective of where it is located, subdivision, state, city, whatever.

If it makes sense to us, we are going to tie it up and try to make money building and selling and closing homes.

The optimism out there, I will tell you, as you travel around, and Mike Murray and I were in California and we were in Portland together, and we're about ready go to the Carolinas on Sunday and travel around, it's disheartening as you're going through subdivisions, if you're not seeing a lot of traffic, and we typically are in those subdivisions on the weekend because it helps us gauge the traffic, because that is when most of the traffic is typically in a sales office is on the weekend, so I think what D.R.

is clearly saying is, hey, he is seeing traffic during the week in subdivisions that he is traveling through in Alabama and Louisiana and Florida as a result.

That bodes well.

That is why he is feeling good, that's why we are all feeling good, because they can't sell someone a home who does not show up in our model, so the traffic is a good thing right now.

Thanks very much.

Thank you.

Our next question is from Joel Locker of FBN Securities.

Please proceed with your question.

Hi, guys, just wanted to talk to you about the backlog conversion and I guess it dropped about 1,000 basis points year-over-year, and I guess the first drop in about 15 quarters and you have some tougher comps from the tax credit, or at least the first credit expiring supposedly last November, but just wanted to see what the trend was going forward, if you're going to see a significant decline year-over-year in the second, third, and fourth quarter which are also -- or the second and third quarter are tough comps also.

In terms of a year-over-year comp, we probably will continue to see declines in our backlog conversion rate.

When the tax credits were not in effect in going back a little bit historically, 55% to 70% conversion rate was very normal for us.

Now with the higher level of specs going into the second quarter, depending on sales that we see and the timing of those sales, because the mortgage qualification process is now almost a minimum of 30 days, then we have inventory that is available that can help the conversion rate.

But in terms of achieving the conversion rates we did last year, with the deadlines in place that people had to close by to get tax credits, you probably won't see the same conversion.

Right, and did you have some of the backlog drop off because of higher interest rates or harder to qualify?

The cancellation rate at 28% is primarily going to be qualification.

I did not hear anything specifically from our mortgage company, our divisions of the terms of any of the cancellation is being from rising interest rates.

Right.

And just one last question, do you have a number for customer deposits at the end of the quarter?

While she's looking that up, I will also say our cancellation rate, even though it is 28%, does not concern me.

Clearly I would like to have 18% or 19%, where historically it was during the good days, but our sales people have been instructed, do not worry about qualifying them.

Write the contract and then turn it over to the mortgage company and let the mortgage company qualify them, so as a result, what we are trying to do is make certain if we have a buyer in front of a salesperson, that we write that buyer and take them out of the market and try to get them qualified.

And our earnest money liability from customer deposits is about $9.4 million.

$9.4 million.

All right, thanks a lot guys.

Thank you.

Thank you.

Our next question is from the line of Alex Barron of Housing Research Center.

Please state your question.

Good morning.

How are you?

Good morning, Alex.

I had a question regarding your comment about having to go out further to look for land.

I think last year, my understanding is that you guys were, in 2009 you were one of the early movers finding land deals and somehow everybody jumped on the bandwagon I guess in late 2009 and early 2010,and my understanding is the land prices went up, so my question is, is the reason you're having to go out further because most of the land in the better places has been tied up and there is no more?

Or is it because the land prices are high and sellers aren't coming down.

Is a combination of both things.

Clearly there is a finite amount of completed lots and obviously a finite number of completed lots in the core markets and so as a result, as the builders chew up those finished lots, then we're having to go up to the next concentric circle and look for those lots.

As well as, clearly, as the supply is diminishing, the sellers, whether they be banks or whether they be individuals, are asking slightly higher prices.

So it's just a combination of those two things in addition to trying to provide clearly the buyer with the most competitive priced value in the marketplace for maybe a little bit better drive.

And they are more difficult to qualify if we can offer them a house at a lesser price, same quality, then we are going to go do that.

Okay.

My second question is, with regards to your overall strategy, sounds like you guys are, as you said, being realistic about the current market conditions so if they persist for let's say another year or two, last year you guys focused on buying down debt, is the focus going to remain the same to generate cash to continue to pay down debt?

Especially since you are not really buying land to develop it and stuff?

That is still part of our focus, today, Alex, in terms of the use of our cash.

We are still out there reducing our debt.

We are focused on being as efficient as we can with our cash.

We don't expect to see the same level of cash generation, and depending on the sales level, we'll depend on our level of investment in our inventory, but we do continue to focus on our balance sheet and we want to maintain the strength of that balance sheet because we think that provides us a good position to respond when we do see some improvement in the marketplace.

If I can squeeze in one last one, what is driving up the watch list?

Is it prices are going lower or sales pace is going lower?

Alex, I think it is primarily some margin compression and some sales pace that we saw in the quarter.

It's kind of a sensitive relationship.

When you see margins drop, you would expect to see that the watch list improve or the watch list increase.

Got it.

Okay, thanks a lot.

Thank you our next question is from Jade Rahmani of KBW.

Please proceed with your question.

Thanks for taking the question.

I wondered if you could comment on raw material costs.

By some measures, lumber, for example, was up close to I think about 10% last quarter, and I was just wondering if you are seeing any pressure there and what the time lag might be on where you could see some margin impact from raw material prices.

I think the good thing about commodity prices based upon what I have seen in the market the last couple of days, is that commodity prices are beginning to come off all-time highs.

Lumber prices, we have good relationships with our lumber suppliers and we typically lock in our lumber prices for a period of 3 to 6 months and clearly, we have higher lumber prices working their way through our closed homes now.

And so that had some impact on our gross margins negatively.

But I would say to you that lumber prices, as many years as we have been in this business, they always have a tendency to peak about this time of the year, and then they have a tendency to decline throughout the rest of the calendar year so I anticipate that the lumber prices will begin to come down through this quarter and the next two quarters.

We continue to have good dialogue with all of our vendors across all the product categories, and the consistent thing is, everyone would like to raise their prices.

We would love to be able to accept those price increases, but right now, in a depressed sales environment, we're withstanding very low volumes in 2010, unless we see some lift in 2011, we are going to be, at the negotiating table still with our vendors try to keep those prices where we are or lower.

So in a flat sales environment for 2011 versus 2010 because of tax credits but then some economic improvement, are you expecting for D.R.

Horton to see higher year-over-year raw material cost?

Probably on average, nothing significant.

There will be certain categories that will move both up and down and our goal is to balance that and continue to keep our cost relatively flat.

All right.

Thank you very much.

Thank you.

Our next question is from the line of Ken Zener of KeyBank.

Please proceed with your question.

Hello.

Hi, Ken.

Don, in the past, you talked about being the Wal-Mart of builders.

Is it fair to say now, that you're perhaps now the Dollar General as you enter these non-core markets, which largely explains the different gross margin trends between you and others?

So basically turns versus margins versus the risk that you are now taking on of non-core markets?

First of all, I would say to you, that we are just beginning to go into these non-core markets as we try to continue to generate houses that are priced more affordable than what the core markets are providing us the opportunity to so I would say to you --

10% of closings?

Less than that.

Okay, thank you.

What we are trying to do, is as these finished lots are depleted in the core markets, then obviously we need to move out of the next concentric circle, just as in the good times as a developer you continue to move out to the next concentric circle and by the time the market crashes, you are too many concentric circles out, going on to the next concentric circle, which makes sense for where people want to live and commute from.

These are not blind moves.

We are evaluating each one of those, and as Don has said several times, we are only going to do deals that make sense, and it makes sense if there is demand, if there is the potential to get good returns in those communities.

Our underwriting standards don't change relative to where the subdivision is located.

Okay.

Related to that, in your earlier comments about finished lots, it seems that as finished lot do deplete, whether it is in the interior market versus the exterior ones, it could be seen as an inflationary factor for the sector overall, or it could be seen as just a rising premium to those that need or want lots, either for volume or to replenish.

If you could make some comments around that, and then, what have your auditors indicated about the DTA recovery, if you actually do have two consecutive years of profitability, meaning 2010 and 2011, notwithstanding the level of that profitability.

Thank you.

I will start on the DTA discussion.

Clearly we need a consistent trend and expectations of profitability.

So to the extent that we do have two years of profitability, we can have some very good discussions with our auditors about the DTA and the recoverability of it.

So we would expect if we have a profitable year in 2011, that we would have some discussions around it, exactly when that timing would be, would be dependent on the level of profitability we have and our expectations for the level of profitability going forward relative to the size of the DTA.

So clearly, a profitable 2011 would be good news for the DTA recoverability.

As far as the core markets premium, premium is a word we don't use very often in the home building industry but I will tell you, D.R.

and I travel around to the extent that we do have a subdivision where there are no other competitors or no significant competitors.

We are always reminding our division presidents, that notwithstanding the fact that we have a 20% gross profit margin goal in each subdivision and each house to the extent that we are the only builder in a core deal, we will clearly state, and I just told two division presidents this last week, take your margins to 25% and start asking 25% because there are no other lots that can compete with you.

Thank you.

Thank you.

Our next question is from the line of David Goldberg of USB Financial.

Thank you.

Good morning, everybody.

Good morning David.

First question, I know we have talked about it (inaudible) but I was wondering if you could give us, when you talk about the traffic that you are seeing and that D.R.

Horton is seeing out in the field today, is there a way to think about the quality of that traffic.

I know we have talked about the underwriting standards and tighter underwriting standards, and I'm wondering if the people that are in your communities are folks that can qualify to buy homes in the end, or if they're just kind of people that are attracted by affordability and it might be tougher to convert in the selling season.

Well, first of all, I will say to you, that just having a unit of traffic show up is a good thing, whether they can qualify or not.

Secondly, though, if we do have a unit of traffic that shows up that can't qualify, one of the things our mortgage company is doing an extraordinary job of, and that is we are recruiting those buyers into our home buyers club and helping them work their way through the financial morass of how do I improve my credit, and we are graduating a lot of those buyers, and they are about 80% of them are buying a D.R.

Horton home.

So I would say to you, we'd love to have a unit of traffic that is well-qualified, but if it's not we're willing to work with them to help them get qualified, and it may be a three-month process, it may be a six-month process but we are graduating those people in selling 80% of them a D.R.

Horton home.

That is a really good idea.

Thank you.

My follow-up question was actually, and maybe it's a little bit of a follow-up on one of the earlier questions, I know you said you don't change your underwriting standards based on geography, do you change them at all based on outlook?

In other words, if you are maybe more or less pessimistic as you look forward, is it impacting your underwriting standards in the market-specific area?

I tell you, we have a pretty hard and fast underwriting guidelines here, and really what it centers around is a 20% gross profit margin.

Do we approves some deals that have an 18% up front gross margin?

We do.

But I would say that to 99% of all the deals that we approve have an up front day one 18% or greater gross margin.

The other factor that goes in there too, though, is how we allocate our cost of capital to our division.

So if they are doing a rolling log option contract, that is their lowest cost of capital allocation.

If they are buying land that requires full development or some level of development, that is a higher risk business, we assign a higher cost of capital that gets factored into the gross profit margin that we are looking at, so in terms of a return on our capital, we are looking at a higher return given a higher risk, But the risk is really the land ownership and not the market because if we do an option deal in a market, we can always walk away from that or restructure the deal.

If they own outright, we can't do that.

Just so we don't get caught up in a discussion around the bps and the exact percentages, the 18% to 20% that D.T.

was mentioning is a before interest number.

So that is where our divisions are focused on our before interest and then ultimately, then they factor in based on the timeframe of the deal, the ultimate charges they will incur on the capital.

Got it.

Thank you.

We are reaching the end of our allotted time for question and answers.

We have time for one final question.

That question is coming from the line of Michael Smith of JMP Securities.

Please proceed with your question.

Good morning.

I'll make this fast.

I know it has been a long call.

I'm just curious, we have been seeing some data and also hearing that sales sort of sequentially improved throughout the quarter, and I'm wondering if that was your experience as well, and if you'd just give some color what things look like month to month.

In terms of the year-over-year cost versus last year, we did see improvement each month through the quarter.

But in terms of the absolute level of sales that we saw, we did not see increase through the quarter, and we would not have expected to see sequential absolute improvement each month.

Seasonally, we always would expect to see declines from the month of October to November to December and then you start to begin to see that absolute level of volume turnaround in January and through the Spring.

But as far as on a percentage basis, year-over-year, you did see better costs each month?

Yes we did.

That's it, guys, I appreciate it.

Thank you.

Thank you.

Mr.

Tomnitz, if there are no further questions at this time, I would now like to turn off or back over to you for closing comments.

Thank you.

We appreciate everyone joining the call.

We did not achieve profitability in the first quarter.

Our goal is to strive for profitability each and every quarter.

As we said earlier, we think that will be more difficult.

It will be equally as difficult, I think, in Q2.

We are clearly looking at Q3 and Q4 as the opportunity for us to generate a profit.

The Spring selling season is going to be here, the Super Bowl is in the Dallas-Fort Worth metropolitan area in Arlington Texas.

This is our Super Bowl.

I would tell our salespeople and all of our divisional presidents and regional presidents, we need to make sure that we win this Super Bowl this year, because this is very important to us to be able to report a profitability in fiscal year 2011.

So I thank each of you for your hard work.

We need to work a little harder, and we need to get back to sustained profitability.

Thank you very much.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.