霍頓房屋 (DHI) 2011 Q2 法說會逐字稿

Good morning and welcome to the D.R.

Horton, America's Builder, the largest builder in the United States, second-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).

In the interest of time, we ask that you limit your questions to one question and one follow-up question.

(Operator Instructions).

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Don Tomnitz, CEO and President of D.R.

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; 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 will not be materially different.

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

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

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

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

Horton's Annual Report on Form 10-K, and our most recent Quarterly Report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

Don?

The fundamental drivers of demand for the home building industry, the overall economy, job growth, and consumer confidence are still weak.

National new home sales have remained at a low level, subsequent to the expiration of the tax credit in April of 2010.

However, our net sales orders this quarter reflected traditional seasonality, increasing 47% sequentially from the December to the March quarter.

Our backlog of 5,281 homes at March 31, 2011 is higher than our backlog at the beginning of the fiscal year.

And as a result, we expect our closings and pretax profitability to be higher in the second half of fiscal 2011 than in the first half.

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

We plan to continue to aggressively open new communities and adjust our price points and product offerings to the demand we see in each of our individual markets.

Mike?

Our homebuilding pretax loss was $32.4 million, which included $14.3 million of inventory impairment and lot option charges.

Financial services pretax income was $1.6 million, which included $2.5 million of recourse expense.

Our net income for the quarter was $27.8 million or $0.09 per diluted share, compared to $11.4 million or $0.04 per diluted share in the prior-year quarter.

Net income for the quarter included a $59.2 million non-cash tax benefit from a reduction in our unrecognized tax benefit reserve.

During the quarter, we received a favorable result from the IRS on a ruling request concerning the capitalization of inventory costs.

This ruling request and related potential tax benefit have been disclosed in prior quarterly SEC filings.

Bill?

Our second-quarter home sales revenues decreased 18% to $733 million on 3,516 homes closed, from $894.8 million or 4,260 homes closed in the year-ago quarter.

Our average closing price for the quarter was down 1% compared to the prior year and essentially flat sequentially at $208,500.

Homes closed in the March quarter represented 91% of the beginning backlog compared to 88% in the December quarter.

We expect that our backlog conversion rate going forward will remain around or below 90% as we return to more normal conversion rates this year.

Don?

Net sales [over from] the second quarter increased 47% sequentially to 4,943 homes, reflecting the seasonal increase from the spring selling season.

However, sales orders were down 23% from the same period last year, when we saw a 55% year-over-year increase as buyers were signing contracts to meet the April 30 sales deadline on the Federal Homebuyer Tax Credit.

In the March quarter, our average sales price on net sales orders was up 1.5% year-over-year to $207,700.

Our cancellation rate was 25% and our active selling communities increased 4% sequentially.

Our sales backlog decreased 16% from the prior year, but increased 37% sequentially to 5,281 homes or [$1.1 billion].

We expect another difficult year-over-year net sales order comparison next quarter, since our third quarter fiscal 2010 sales of 4,921 homes included extremely strong demand in the April period from the tax credit.

A positive comparison would require that we sell approximately the same number of homes or greater in the June quarter than we sold in the March quarter.

Stacey?

Our gross profit margin on home sales revenue in the quarter was 16.2%, down 180 basis points from the year-ago period, reflecting the weaker housing market we continue to experience since the expiration of the Federal Homebuyer Tax Credit.

However, our margin increased 60 basis points sequentially, primarily due to improvement in our core margins.

Mike?

In our second-quarter impairment analysis, we reviewed all projects in the Company, and determined that projects with the pre-impairment carrying value of $59.4 million were impaired, which resulted in $13 million of impairment charges, the majority of which were in Hawaii, Florida, and California.

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 at the highest risk for future impairments.

After this quarter's impairments, our watch list now totals $432 million, up from $408 million at December, 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.

Bill?

In the second quarter, we reduced our homebuilding SG&A expense, which includes all corporate overhead, to $123.2 million from $129 million in the year-ago quarter.

However, with the decrease in homes closed, SG&A expense increased to 16.8% of homebuilding revenues compared to 14.4% in the year-ago quarter.

Sequentially, our homebuilding SG&A expense increased $4.3 million, primarily due to increased advertising costs for the spring selling season and higher payroll taxes.

We continue to actively manage our SG&A levels relative to our expected number of homes closed, and we have begun implementing additional cost reductions throughout the Company.

Stacey?

Homebuilding interest expense was $14.7 million for the quarter, which represented 43% of our homebuilding interest incurred.

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

Our second quarter homebuilding interest incurred of $33.8 million decreased 26% compared to the prior year, primarily due to the $1 billion of debt reduction that we achieved in fiscal 2010.

We expect our interest incurred to be reduced even further in the third quarter to approximately $32 million.

Mike?

Financial services pretax income for the quarter was $1.6 million compared to $1 million in the year-ago quarter.

87% of our mortgage company's business was captive during the quarter.

Our company-wide capture rate was 61%; our average FICO score was 702; 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 61% of our volume.

Don?

Our total inventory increased by $74.3 million, excluding non-cash items since December 31.

We increased our homes in inventory by $115.2 million in the spring selling season, and decreased our investment in residential land and lots by $40.9 million.

Our homes and inventory at the end of March totaled 10,500 homes, up 1,400 homes from December but down 3,400 homes from a year ago.

As of March 31, 1,200 of our homes were models; 5,500 were speculative homes; and 2,400 of the specs were completed.

We reduced our completed specs by 20% during the quarter, which we're extremely proud of.

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

Bill?

In our second fiscal quarter, our total land, lot and development investments were $184 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 relatively low levels.

At March 31, 2011, we owned approximately 89,000 lots, of which 23,000 are finished.

We controlled an additional 27,000 lots through option contracts, with a net earnest money deposit balance for these lots of $13.6 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.

Mike?

We ended the quarter with $1.4 billion of homebuilding cash and marketable securities.

Cash used in operations for the March quarter totaled $70.6 million, primarily due to increased homes in inventory in response to seasonal demand.

During the quarter, we repurchased $64.7 million of various issues of our notes for $67.2 million plus accrued interest.

And the balance of our public notes outstanding at March 31 was $1.9 billion.

Stacey?

Subsequent to quarter end, we repaid at maturity the remaining $70.1 million of our 6% notes.

Also, as previously announced, we redeemed the remaining $112.3 million of our 5.375% notes due 2012, which will result in a loss on early debt retirement of $6.3 million next quarter.

The amount remaining on our debt repurchase authorization after these transactions is $241.7 million.

Our note maturities for the rest of fiscal 2011 are only $106 million with no further maturities until May of 2013.

At March 31, our homebuilding leverage ratio, net of cash and marketable securities, improved 350 basis points from a year ago to 18.7%.

Gross homebuilding leverage at March 31 improved 670 basis points from a year ago to 42.9%.

These leverage improvements are due primarily to our lower debt balance.

Don?

We continue to focus on the fundamentals of our business -- bringing homes to market at the right price points; controlling finished lots; closely monitoring our home and spec inventory in relation to our sales; further reducing our SG&A costs; maintaining our strong balance sheet and cash balances.

Although our 47% sequential increase in sales reflected traditional seasonal demand, for us to see significant sales growth, we need to see sustained improvements in the overall economy, the jobs landscape and consumer confidence.

As we mentioned earlier, we are excited by the prospect of our closings and pretax profitability being higher in the second half of fiscal 2011 than in the first half.

Thank you to all of our D.R.

Horton employees for continuing to work hard and navigate through a difficult homebuilding environment.

We appreciate all of you.

This concludes our prepared remarks.

We'll host any questions you now have.

(Operator Instructions).

Nishu Sood, Deutsche Bank.

So, first question I wanted to ask was about the end market segments.

The theme last year, the consensus theme among investors and the builder community was that the first-time buyer was where you wanted to be.

And you folks, obviously, did a terrific job of harvesting demand from the Homebuyer Tax Credit.

This year, the theme seems to have shifted and now it seems to be more about the move-up buyer.

And you did mention in your commentary that you're trying to make more move-up product available.

So I wanted to just get your thoughts on that, because you folks have traditionally been a first-time buyer-oriented builder.

So what's the right strategy for D.R.

Horton going forward?

I think, clearly, we adjust as the market adjusts.

Before the downturn, we clearly were selling a bigger percentage of second-time homes as well as first-time homes, but my percentage changes.

Last quarter, 55% of our homes that we closed were first-time homes.

And we've made a conscious effort in a number of our markets to move up into the move-up buyer market simply because we see more demand in that market.

And we see a lot of fragmented builders in that market, primarily small and medium-size builders across the country -- some public, some private.

But we see a great opportunity in that move-up segment at this point in time.

So we're beginning to expand that portion of our business.

Got it.

Great.

And second question I wanted to ask was -- it related to your balance sheet and your community counts.

If I look back to a couple of years ago, the kind of peak of your -- the size of your balance sheet, your balance sheet is about 60% smaller now and it includes a lot more cash.

So if you factor that in, it's probably shrunk even a little bit more.

And yet your community count over that same period is almost level.

So, if I'm looking from the outside, I could -- maybe you're obviously less involved in land development, less involved in larger communities.

I just wanted to get your thoughts on what's driven that bigger trend.

You've become a lot more capital-efficient over the past few years, so why is that and what can we expect going forward?

Clearly, what I've said before on previous conference calls is we plan on being a land-light company, moving forward.

We've rewritten our underwriting guidelines.

Currently, we're looking for a return of our capital that we invest in land and lots of somewhere between 12 to 18 months.

We're certainly not interested in any five-year projects any longer in this Company.

So -- and we continue to work with sellers, developers, as well as banks, in terms of working on option deals.

So, one of our goals has been -- and we've executed very well on this, and our goal going forward will continue to be -- to aggressively increase our flag counts as we look at various parts of the country.

And the way that we continue to focus on doing that is do option contracts with sellers.

Michael Rehaut, JPMorgan.

First question on pricing and incentive levels, and how you're seeing that flow through to gross margins.

You had a little bit of an improvement sequentially from first quarter on the gross margins side.

And I wanted to know -- has the, I guess, the backdrop in terms of pricing and incentive levels, as you've seen it in the spring so far, has it been stable?

And do you see perhaps some further improvement in the back-half, either driven off of greater leverage from higher volumes?

Or perhaps a continued, more stable pricing/incentives environment?

Well, frankly, we are proud of the fact that our incentives remained low this time.

And if you look at our 60 basis point increase in gross margin, 50 basis points of that was from the fact that our incentives stayed flat.

Yes, relative to our costs.

So our core margins were 50 basis points of that.

On a go-forward basis, though, I believe that, as we move into the third and fourth quarters, obviously, we're very competitive out there, and we have a game plan to sell and close X number of units.

We're hopeful that our gross margins will remain solid as we move into the third and fourth quarter, but we don't know.

It's to be determined.

And it's really going to be based upon what our competition does out there.

One of the things that adversely affects our gross margins today is just the competitors around us from time to time dropping their prices significantly, and us having to adjust our prices.

We've been consistently trying to hold our gross margins where they are and I think we've done a very good job of it.

The one very important fact that we're talking about before the conference call that everybody needs to know about, is that we closed a larger percent of completed homes this quarter than we have in the past three or four quarters.

And our gross margins held very well.

So we're extremely proud of that and it's freshened up our inventory.

Jonathan Ellis, Bank of America Merrill Lynch.

First question was -- just on gross margins, you talked a little bit, as you said, about pursuing opportunities in the move-up market.

Can you help us to understand whether there's any gross margin difference you see right now between the move-up product and the entry level product?

The question was gross margins on the move-up and the entry-level product?

Correct.

Our underwriting guidelines are the same, regardless of the product.

So we don't necessarily expect to have a difference in our margins versus -- you know, move-up versus first-time.

But to the extent that in the move-up market a buyer may select more options, that provides some additional opportunity for margins versus perhaps the same level on a first-time home.

But in general, we would expect similar margins.

Okay, great.

And then my second question is just on land generally.

I think, last quarter, you talked about gross margins on land purchase in 2009 having met a 100 basis point differential with margins on land purchased in 2010.

Any update on that?

And then, secondly, the watch list and the increase this quarter -- was any of that related to land that's been purchased since 2009?

In terms of the margin differential between land in '09 and '10, we're seeing a similar trend to what we saw a quarter ago.

I wouldn't characterize the increase in the watch list of about $30 million as being heavily driven by more the '09 land purchases.

It would just be across the portfolio of our inventory.

From a year ago, the watch list is actually down about $100 million or about $90 million.

So I wouldn't say it's driven off of the increase, most recent quarter, off of '09 purchases, no.

Okay.

Thank you.

Michael Rehaut, JPMorgan.

Thanks.

I appreciate --

We got cut off there, somehow.

Yes.

Thanks for letting me ask my follow-up.

I really appreciate that.

The second question was just on community count.

You mentioned, I believe, it was up 4% -- I'm sorry -- 4% sequentially?

Correct.

And -- but you continue to aggressively open up new communities.

So I was wondering if you could kind of give us, first off in the quarter itself, what it was on a year-over-year basis as well as -- on a year-over-year basis what you're, at this point, expecting year-end to be.

On a year-over-year basis, our communities are up 20% versus last year.

Going forward into forward quarters, while we continue to plan to aggressively open new communities on a gross basis, what it's more difficult to predict is the pace at which older communities will roll off.

The demand environment basically sets that.

So we're not necessarily -- we would expect and hope to be able to at least hold our community count at current levels.

Hopefully, continue to increase them incrementally; but in terms of holding or getting exact projections on forward community counts, we're not really at a point to be able to do that very well.

Part of that has to do with how tough we're negotiating out there also, because obviously, we're looking for a good return on our underwriting criteria.

So as a result, sometimes we think we're going to make a deal and we don't make a deal.

So it just all depends.

The year-over-year percentage increase is probably going to trend down a little bit, Michael, because we had a pretty good jump from our March quarter to our June quarter in terms of active selling communities last year.

Great.

Thank you.

Dan Oppenheim, Credit Suisse.

[Certainly], you guys have always focused on affordability.

And I think you noted that in that release here in terms of just the greater affordability these days.

How do you think about that in the first-time buyer versus some of the financing issues these days at the low end of the market?

Well, as the underwriting criteria continues to change, our buyers continue to find the increased down payment.

They have figured out how to qualify for the loans.

I think our Home Buyers Club has helped our first-time homebuyers immensely.

Our mortgage company has a very successful what we call HBC -- Home Buyers Club.

And we're helping people understand what it takes to have a good credit rating and good FICO score.

And those people are increasingly contributing more and more to our sales.

So I think we're -- irrespective of what happens, I think that we're dealing with it as it changes from day-to-day.

Okay.

And then, secondly, wondering just as it relates to communities, given some of the different trends you're seeing across the regions, geographically, where are you looking to add communities over the course of the year in terms of replacing?

Anywhere we can make a 20% gross margin, Dan.

And frankly, clearly, there are a number of places -- Texas continues to be a strong market for us, and the Carolinas as well as -- at Las Vegas, we're continuing to add communities.

And also in the state of Florida.

So those are our primary areas that we're focusing on today.

Okay.

Thanks very much.

Josh Levin, Citi.

Over the last few quarters, you've been a bit more bearish than your peers and more accurate than your peers in predicting the outlook for new home sales for the industry as a whole.

How has your outlook for the industry changed compared to what it was, say, one or two quarters ago?

Are you more optimistic?

Less optimistic?

Unchanged?

Well, as I said, clearly, we're excited about the prospect that our profitability levels and closings will be higher in the second half of fiscal year '11 than the first half.

In general, though, as we look forward over the next two to three years, we don't expect a significant improvement in the demand, because clearly, one of the things that drives demand in our business the most is job growth.

And we're not seeing the kind of job growth that I think will increase our sales dramatically.

So, we're preparing the Company, as we have over the last three to four years in this downturn -- we think this is the fifth year of the downturn for us -- we're continuing to have a muted outlook going forward, and we want to have an extraordinarily strong balance sheet, and continue to keep a conservative approach to the business.

We don't see much reason to take any big risk out there on the land and lot side or with the housing side today, relative to what we see coming forward in the next two or three years -- contrary to a number of our competitors.

So just to be clear, when you think about sales in aggregate in the industry, you're not really expecting that much of an increase over the next two to three years?

I think the homebuilding industry over the next two to three years will be very similar to what it has been for this year, with the potential for slight improvements but not significant improvements.

Well, okay.

Thank you very much.

Stephen East, Ticonderoga Securities.

D.T., first, if I could ask you about the specs.

You all, when we were visiting with you all, there was a belief that you were going to take your specs down.

They increased this quarter and I know that's seasonal, but they increased quite a bit more than I would have expected.

As you all look at your spec strategy right now, where do you think you're going to be going?

Well, clearly, we're spec'ed up, as I was say, for the selling season.

I think we've had a reasonably good selling season; clearly, a 47% increase sequentially and our sales was an extraordinarily -- was a good accomplishment.

Although as we look back, and we were talking before the conference call, it pretty much was in the range of our second-quarter increase in sales over our first-quarter sales over the last four, five or six years.

So we didn't get a huge pop, but we got what was a traditional pop for us in the second quarter.

Clearly, as we move into Q3 and Q4, we bring our inventory down and then we build our inventory back up for the selling season typically in January and February.

So I would say our specs will be coming down over the course of the next two quarters.

And our inventory will also.

That's right.

It's really moved in line with our total inventory.

And while our total specs moved up, as a percentage of our inventory, they've actually decreased this quarter, down to 52% from the mid-50s or right around 55% last quarter.

And in terms of completed specs, we're at the lowest level of completed specs we've been in 18 months.

Okay.

That's really helpful.

And then if we turn to looking at both your gross margin and your SG&A, the expectations moving forward, you said you don't know where pricing will be, what your competitors will do.

If we ignore that and really just look at what you all are trying to do internally, et cetera, where do you think your gross margins move over the next three, four quarters?

And then your SG&A, that was the highest that I think we've seen in the downturn.

And what's going on there and where you think -- what are you doing to change that and where do you think that winds up?

Well, as I said earlier, we're hopeful that our gross margins hold over the course of the next two or three quarters.

And we believe they will.

I don't think they'll drop dramatically.

So I think that we are looking at pretty stable gross margins going forward.

Our SG&A, clearly, was a disappointment to us this quarter.

But, in our own defense, we at the corporate office want to continue to support our divisions who -- and our regions -- who had a higher closing number budgeted than what we internally thought they could achieve.

But we wanted to support them and we didn't want to tell them that they couldn't achieve what they thought they could achieve.

As it became clear that their expectations were greater than what the market was going to give them, we clearly began cutting our SG&A.

And I can tell you, as of two weeks ago, we had our four regional presidents in, and they have specific SG&A caps that they have to hit and they're going to be at by [4/30].

And we're comfortable that our SG&A in the second half of the year will be dramatically lower than what it was in the first half of the year.

Okay.

That's really helpful, thanks.

Josh, Goldman Sachs.

On your guidance, it calls for better profitability in the second half.

You guys lost about $50 million on a pretax basis for the first half.

And I'm wondering whether or not you're expecting your second half profits to outpace your first half losses?

We are anticipating trying to achieve that.

I think it's going to be nip and tuck, but our goal for the year is to -- for the full fiscal year, is to be profitable.

My second question is back on this first-time versus move-up debate.

Some are saying that it's just an easier comp for move-up and hence harder for first-time.

But it seems like the change in your strategies suggest that there's something more structural going on.

Could you talk about which of those two, whether it's comps or better fundamentals, that's driving your move to the move-up?

And whether or not you're seeing something out there that folks just aren't talking about right now?

I'll tell you what we clearly see, and as I've mentioned before for the last two or three years, Don Horton and I have been on the road all the time.

And when D.R.

was on the road probably six months ago going through some of our divisions, he said, gee, why are we letting this builder take this segment of the market and we're not competing against them?

And from a cost perspective, we believe that we can deliver a house in the move-up segment much more cost-effectively and offer more competitive sales price than the competition.

And, as I said earlier, a number of those competitors were small and medium-sized builders, and a lot of them, non-public builders.

And so as a result, by being in the field, we identified a segment of the market that we believe that we can exploit much more competitively than our competition.

So as a result, we're moving in that direction in as many divisions has where that market is characterized by what we saw in Texas.

So when you said you just think that there's easier competition and maybe less expensive lots there that you want to take advantage, more so than it being a better group of buyers today?

Well, let me -- first of all, there's no easy competition out there today.

(laughter) But we -- and the lots are not any less expensive.

And there's not any less competition for the lots; it's just a function of the fact that there are buyers in that segment of the market who have, all of a sudden, said, "Gee, I may not be able to sell my house for X; I've had it on the market for a while, but I can sell it for 90% of X.

I've been in my house for 20 years and I can -- I'm not negative; I'm not underwater on my mortgage, and I'd like to have a new home.

And I can afford that new home."

And so as a result, there are buyers out there who can sell their home and move up -- as a result.

I think that's part of the market that we're focusing on, dominating the entry-level portion of our business, but we want to add the move-up market to increase our market share across the country.

And Don, if I could just sneak one last one in, the weather in the South has been very newsworthy.

You guys have some exposure there, a bit more than most of your peers.

I wanted to know if you guys have quantified the effect so far, if you guys have communities that are affected?

Or ultimately, what you think the net result is going to be for your financials?

Thanks a lot, guys.

Well, clearly, the tragedies in Texas, which has had millions of acres burned and a number of dwelling units be lost, and then what's happened in Alabama and Mississippi and places like that, prayers are with those people.

As far as being adversely affected in terms of our subdivisions, we have not.

And clearly, as homes have been destroyed, the positive for our business is, is that there are opportunities for us to rebuild homes for those people who have lost their homes.

And some of those communities people will move out of and move into communities that weren't destroyed, where our subdivisions are located.

So, generally speaking, I see no negatives associated with our financials, and I do see some opportunities for us to help people get into homes that have lost their homes.

David Goldberg, UBS.

A question -- in your opening comments, you talked about adjusting product and price to hit market.

And I just want to make sure I understand -- are you talking about -- is this what, when you talk about maybe doing more move-up and focusing, is that what you're talking about?

Are you also -- maybe de-contenting product and redesigning product?

And if it is the latter, what kind of opportunities do you think are out there, in terms of redesigning and de-contenting at this point in the cycle?

There's both parts of it, and one of the things I really want to impress upon people is we continue to drive the cost of our homes down.

And that's one of the advantages that we have in the market because, obviously, we're able to offer a more competitively priced unit.

So, is there as much on the table with our vendors and our suppliers as what there was a couple of years ago, three years ago?

No, there's not.

We just had a Board meeting and that similar question was asked.

But there are still those opportunities.

And as we continue to be the largest builder in the US for the ninth consecutive year, and we have higher inventory levels out there and typically have more specs per community than other builders, it provides us a great opportunity to work with our vendors and our suppliers, who obviously are looking for volume themselves.

And our starts provide them that opportunity to have higher volume.

And they're looking for business just as we're looking for business.

And what we're finding is we're getting very competitively priced, both products and materials -- and labor.

And just to summarize, there's room for more if we have to take more price cuts, there's some offset potentially?

It's a day-to-day battle, as I told our Board.

And yes, it is -- there are opportunities out there, but the opportunities are out there for those who ask.

And as D.R.

has quoted many times in this Company, you never know till you ask.

And we continue to ask, because we don't know if we can get our prices lower, but it's our goal to get them lower.

Got it.

And then just a quick follow-up here.

I want to go back to the question on the land-light model and options.

And I just want to get an idea of how liquid do you think or how much land is in the market right now that you can buy like that?

And how concerned you get about, at some point in the future, with nobody really developing land at this point, being able to remain land-light, as we move through the next two or three or four years leverage going to be, if the market really doesn't improve and you don't get some home price appreciation?

Well, I think it's going to be difficult in terms of land value, simply because right now, most of the raw land doesn't have much value relative to the development cost.

And then that related to the finish line costs.

So I think that, clearly, today, we are [in] a preferred buyer of developers and banks simply because we continue to be the largest builder and we're starting more inventory, and selling more homes, and closing more homes than anyone else in the industry.

I think there's no question that, going forward, that it will become more competitive as we chew through the finished lot supply in this country.

And I will say this -- we have a commitment in this Company that, today, we want our capital that we invest in land back in 12 to 18 months.

Do I see that increasing?

I see that increasing slightly, but we have a firm commitment that we are not going to go long on land.

And to the extent that we need to go and tie up lots from a developer, we're going to be a lot better off to find an investor to hold anything that doesn't meet our underwriting criteria at the time, simply because we prefer not to have it on our books.

And we would rather achieve a lower gross margin on Phase 2 of a 400-lot project if we feel only comfortable with the first 200 lots.

Got it.

Thank you.

Bob Wetenhall, RBC.

Just curious how much pain in terms of margins you're willing to sacrifice, if you churn out in the second half, you're not seeing the volume that you anticipated?

Day-to-day, subdivision by subdivision analysis; contract by contract that the salespeople bring into their sales manager -- clearly, there's a point at which we don't want to go below in every community, but it's a community by community basis.

I believe that if you look at our impairments and where we've got our land on our books today going forward, that, added with over 50% of our closings, are coming from new deals that we've added since 2009.

We'll reiterate that I feel like that our margins where they are today are sustainable over the next couple of quarters.

If -- switching over to gross margins, it sounds like you're a little disappointed by performance this quarter.

Is it realistic just for modeling purposes and thinking about the full year that you guys can bring SG&A under $475 million?

Well, let's back up.

We're very proud of the quarter that we just turned in, in terms of our sales, our closings -- on a sequential basis, in particular.

And most importantly, we're sitting on 5,261 units in backlog and our backlog is larger than it was at the beginning of the year, which I think if you apply our traditional percentage of our backlog closed in an ensuing quarter, you'll find that we're in a wonderful position, I think, for Q3 and Q4 to have the prospects of having more closings and higher profitability.

Our SG&A is clearly a disappointment.

But it was our own fault, because we wanted to continue to support our divisions based upon their budgets, based upon what they thought they could do in the first half of the year.

When we clearly saw that they were not going to be able to achieve that, this Company has been built on the lowest SG&A in the industry.

And we're going to -- we've cut our SG&A, and we believe that we'll be substantially lower in the second half than the first half.

You did say -- can we come in under --?

$471 million.

$475 million.

$475 million.

Our goals for SG&A for the year are clearly to be below $475 million.

Great.

And just one quick question.

Can you comment on traffic since the end of the quarter?

The only thing we can count -- I know people sometimes spoof us for this, but traffic is not as important as what percentage of the people walking through the door that we close.

So, the real issue is we really count sales and closings.

And our sales and closings for the second quarter were up dramatically, and we think that our sales and closings will be good through Q3 and Q4.

Thanks a lot.

Jade Rahmani, KBW Asset Management.

Thanks for taking the question.

I wanted to ask on cash flow where you think -- well, operating cash flow in the quarter, if there were any one-time increases -- decreases in payables and accrued expenses that occurred?

And then also post the debt retirement moves you've made, where do you think leverage is right now?

Yes, the cash flow, there really weren't any one-time cash flow events that occurred this quarter.

The use of cash this quarter is entirely attributable to the increase in our homes and inventory during the quarter.

So it's working capital that we would expect to return as cash inflows in the second half of the year.

And clearly, our inventory will be coming down in the second half of the year.

So, obviously, that ought to be a positive to our cash flows.

Okay.

And any idea post the debt retirement moves that you made subsequent to quarter end where leverage should be?

Well, our gross leverage continues to come down.

We're down to around 42%, I believe, on a gross leverage basis now.

With the April debt reductions, we have another $106 million that matures in August.

We would expect our gross leverage to get down around 40% or maybe slightly lower by the end of the year.

We will continue to look in the open market, as we have been, to see if there are further opportunities to repurchase selective portions of our outstanding debt.

That could bring that a bit lower, but that's our expectations right now.

Jay McCanless, Guggenheim.

(multiple speakers) With increasing your presence in move-up, does it make economic sense, or will it at some point in the future, to roll up some of these smaller builders that you're talking about, and doing a larger acquisition strategy?

Clearly, right now, we're happy with managing our own business and we don't have any interest in M&A activity at this point in time.

Okay.

We have bought several positions, though, from smaller builders or smaller developers rather than buying a builder in its entirety.

There have been a number of builders who have just basically said, "I'm going to get out of the home building business.

Do you want to buy my subdivision?

Or my lot position?" And that's -- most of the time, we've been able to buy those from them on an option basis as opposed to cashing out the builder -- certainly, we don't need any additional employees from that builder nor any additional land on our books.

So, the preferred way is just to slowly but surely work him out of his position or her position.

Okay.

And then, same line of questioning -- is there opportunities -- are there more opportunities in the distressed market maybe to buy some move-up subdivisions than there are entry level at this point?

Yes, I don't think there's a big difference.

Clearly, most of the subdivisions out there we think are in the entry level portion of the business.

And it's all tied specifically, and frankly, to the banks determining what asset they're going to sell when.

And some of them are moving move-up subdivisions; some are moving entry level subdivisions.

But then it gets back to, truly, what is it in that particular locale?

Because what's move-up in Seattle is not move-up in San Antonio, Texas.

Okay.

Thanks, everyone.

Alex Barron, Housing Research Center.

I think you guys have done a really good job of anticipating, I guess, the length of the downturn and, therefore, aggressively paying down your debt.

Just kind of wanted to get your outlook for what you guys will continue to do on that front over the next year or two?

We've done quite a bit here in April.

We have another maturity in August.

We have now taken out our 2012 maturities, so we don't have anything really due or won't until May of 2013.

I would expect we would still incrementally repurchase some additional debt as we find opportunities in the market.

Our pace for those opportunities has slowed this year.

We've had a little over $60 million each quarter.

And so I wouldn't expect it to be a lot different than that.

Hopefully, we'll still see opportunities to continue at that pace for a few more quarters.

It's really a balance.

And we're balancing our liquidity with our overall balance sheet, and with making sure that we still have some capital available to the extent we see opportunities in our business.

And so we had a sufficient working capital to keep the homes and inventory that we need to keep when we see the demand.

And so that's really the considerations that we're considering.

And as Bill mentioned, we expect to be closer to 40% in terms of gross leverage by the end of the year.

And that's a really comfortable level for us in terms of gross leverage.

Okay.

My second question, I guess you guys have already touched on a number of questions related to SG&A, but I'm still trying to understand, I guess, a little bit of sort of what drove the sequential increase?

Was it more like your -- what I would call the fixed portion of the SG&A went up?

Or was it more variable stuff like commissions and that kind of thing?

And I guess I'm struggling a little bit to get to your [$475 million] number, so I'm just trying to get some comfort there.

Alex, the two items that we mentioned in our prepared remarks for the sequential increase of $4.3 million were advertising costs related to the spring selling season.

Our sequential increase in advertising costs from first quarter to second quarter was a little over $2 million.

We would not expect to continue spending that level of advertising going forward post the spring selling season.

And the second factor is a little more than $2 million from payroll taxes.

And this is a seasonal factor that occurs every year for us.

When the calendar year rolls over, any employees whose earnings are higher than the FICO limitations began paying Social Security tax again.

And the Company's portion of that is -- it begins being paid in the first part of the year.

So we always see a sequential increase in our payroll taxes from our December quarter to our March quarter.

And those two items fully account for the sequential increase in our SG&A.

With those seasonal factors, with the actions that we're taking right now throughout our Company, we expect that we can reduce our pace of SG&A in the second half of the year, and come in below the pace we've showed the first two quarters.

And just to be clear, we're talking about -- with the previous caller, we are absolutely confident that our SG&A for the second half of the year is going to come in under $450 million.

(multiple speakers) That's $475 million.

(laughter) Our goals are to be below $475 million.

Got it.

Okay.

Thank you very much.

Kenneth Zener, KeyBanc Capital Markets.

With a 40% -- if you hit 40% gross leverage by year-end, and let's say you get your DTA back, which is perhaps possible, given that you might have two sequential positive years and if the outlook is positive, what would you guys do with the capital?

And what does that say about the growth prospects if you get all this equity back?

It's obviously not cash, but that would significantly reduce your gross leverage from that 40% number.

Well, to the extent when the DTA comes on, I'm not necessarily endorsing your assumption it will come on at year-end, but to the extent that it does, again, it's non-cash.

That's certainly -- there's more flexibility on the balance sheet, and certainly, it puts us in a very strong position when we see opportunities in the market.

And when we see -- we feel more comfortable with investing in our business to take advantage of the eventual upturn, that gives us a lot of flexibility.

We would have room to increase leverage and have capital to invest in our business at that point.

Yes.

It will be interesting.

I guess -- and another question, it's kind of related to -- Don, your comments about a very slow recovery, which I think is an accurate outlook.

With the slow recovery, can you comment on the dynamic that you, as well as the public builders, face in terms of profitability to the extent you keep capitalizing interests to inventory?

Obviously, you're targeting, not expensing it.

But to the extent that the recovery is delayed each year, everybody, including yourself, is picking up maybe 150 bps or a little more of headwind on your inventory dollars that you're carrying.

And what does that kind of say about the recovery prospects?

I know you're trying to blend in new land, but is there a hurdle that's always being raised to the extent you continue to capitalize interest on the active inventory?

Thank you.

I think Mike would like to put a little color on that, so.

On the active inventory, Ken, we're only capitalizing the interest associated with our eligible or active inventory any given quarter.

We're directly expensing the balance of it.

And then if you look at our interest -- capitalized interest rolled forward, we're actually expensing, through cost of sales, with our closings in a given quarter, a very similar amount -- a little bit greater, actually, than what we're capitalizing in any given quarter.

For our inventory that's not currently active, we're not capitalizing any interest.

It's not adding to a future drag or a future gross margin reduction that we're going to have to have.

And with our reduction and our debt, and our reduction and our leverage, our expectations over the next couple of years is that the impact of interest on our margin will decline.

We will actually see some wind at our backs in terms of improvement in margin from interest over the next couple of years, because of the debt reductions we've made.

Michael Smith, JMP Securities.

Just a quick question on some regional land issues.

I'm wondering what it looks like regionally into the metro -- in specific metros as far as your ability to find lots to pencil out?

We've been hearing a lot about the shortage of land supply and the shortage of lots that are out there, especially in good locations.

I'm wondering if that's -- if you can just give us some regional color on that?

And if that's in any way slowing your progress in any particular metros?

We're not really finding a shortage of lots, finished lots in any of our markets currently.

In fact, we have more opportunities in those markets than we're actually contracting for.

And it affords us the opportunity to push for a good lot price in order to enhance our gross margins to meet our underwriting guidelines.

The other thing, as I've noticed this year, is that there are more and more banks who are actually dealing with their foreclosed assets.

And a couple of the banks we have been working with for several years, who we haven't gotten very many deals from, are all of a sudden now we're contracting with those banks.

So I'm optimistic that there are still plenty of assets out there -- finished lots that banks are holding, that are working their way through the system, so that we can continue to supplement our lot position.

Don't forget, we're still, by virtue of our size and by virtue of what a big percentage we are in each one of our markets, we are definitely the preferred buyer in each one of these markets.

Yes, that's -- I was going to follow-up with that.

Do you think that maybe some of the difference between your comments and some other builders, and some of the private guys you've talked to or land brokers, is that you're in a better position to get whatever lots are out there, either on pricing or even just your access to them?

Absolutely.

And as we keep reiterating to everyone is, is that by virtue of keeping more specs than the typical builder does in a subdivision, largely because of the fact that we don't spend as much advertising dollars as many other builders, because we rely upon our relationship with realtors to sell those homes more so than a lot of our competition, yes, without a doubt, we continue to add lots.

One of the things I think, historically, we've been more willing to do than some other builders is look at very small lot positions.

You know, whether it's 20 lots or 30 lots, we don't rule them out simply because it's a smaller position.

Okay.

And then just one quick follow-up.

To the extent that you guys are doing a little bit more move-up product and want to move in that direction, do you see that as slowing your conversion rate at all?

Or is it something that you feel like you can get a move-up house built just about as quickly as you could something that's a little smaller and more first-time?

I can tell you, we're turning our inventory faster than we've ever turned it.

And if you take a look at our construction cycle times today, they are shorter than they've been for many, many years.

So as a result, I don't think that we slow our conversion at all.

And we're not talking about building McMansions; we're talking about building second-time homes, which are slightly bigger, with a few more amenities in them than our entry level homes.

So it's pretty much the same product, a little bit larger, a few more amenities.

So it's not a new entry for us at all.

We've done this before in the past and we've always had a portion of it as our business, as our core business.

We're just increasing it as a portion of our core business.

Great.

Thanks a lot, guys.

Appreciate it.

Mike Widner, Stifel Nicolaus.

Thanks for taking the question.

Most of mine have actually been answered already, but maybe just following-up on the gross margin issues.

Some of your peers we've seen some one-timers in gross margins like warranty, reserve unwind and other sort of one-time charges.

Just wondering, I mean, there was a nice bit of a sequential improvement there.

I was just wondering if you could talk about that?

Is there anything in there that we might not see repeated or any tailwinds or anything like that?

Mike, we didn't have anything in the quarter that was kind of unusual or extraordinary.

It was a very consistent comp quarter-to-quarter in some of those other items.

It was -- the change for us quarter-to-quarter was really in core.

Yes.

And to just parse it exactly as it will be in the 10-Q, we had a -- well, actually, we don't talk about sequential in the 10-Q -- we had a 60 basis point improvement; 50 basis points was from core, and 10 basis points was from improvements in our interest, amortizing through cost of sales.

Got you.

So, appreciate that.

Any particular color on parts of the country that are looking better, where you think things may be turning faster and sooner, versus other parts that seem to be lagging behind, both in terms of buyer demand and then just broad economic conditions?

I think it's pretty much all pretty soft in most parts of the country.

And to differentiate between soft, softer, and softest, I'm not sure makes a whole lot of sense.

It's just very competitive in each one of our markets out there.

Until we see some job growth in all of those, it's soft, softer, and softest.

(laughter) I love your optimism, Don.

It's -- (laughter).

Well, let's go back here.

The one thing that we want everyone to know -- and someone has brought up today -- we want to make sure that we are telling you exactly what we're seeing out there.

Because the last thing we want to do -- we have optimism -- and we do have optimism for the second half of the year versus the first half in the year, but we don't have a lot of optimism in terms of the next two or three years being significantly better than what this year is going to be.

We position ourselves to compete in this soft market, and we are optimistic about our ability to compete as well or better than anyone else and perform as well as we possibly can in a tough market.

I certainly appreciate that.

And I guess we also have to just take the personalities into account.

If we think back a couple of years, you're on the call telling us all 12 months we're going to suck.

And so at least you're not saying that.

So, soft is better than sucking.

(laughter) Actually, you know what?

I was just a little -- I was a little conservative, because more than 12 months has sucked.

(laughter) That's all I've got.

I appreciate it, guys.

(laughter) Thanks, Mike.

Michael Rehaut, JPMorgan.

Just a couple of follow-ups.

You mentioned community count up 20% year-over-year for the quarter.

So that obviously implies a much more dramatic decline in sales per community.

And I was wondering if that's more because of just the tough comps a year ago, which everyone is aware of, or in addition, was there anything from perhaps smaller size communities that reflect perhaps your more conservative approach to trying to focus more on option and quick returns?

I think it's definitely a combination.

The year-ago comp is going to be the largest reason out of those.

Incrementally in there, as we have had some of our older communities that were larger roll-off, we have been replacing them with smaller, newer communities.

And then we did open communities during this quarter that are probably not producing sales for us just yet, that should kick in, in future quarters.

Okay.

Appreciate that.

And just on the 50 bps of core improvement in the gross margin, with incentives flat, then I would assume -- you said that -- is it more than construction costs being lower?

Or just the higher margin contribution from newer communities?

Is that more or less the same thing?

Yes, it's all of the above.

It's our continued work on our vertical construction costs; it's our continued work on our lot costs as well.

And the role -- the increasing role of new communities.

As we bring on more new communities and we've contracted more in the current market, those come in at higher margins from the outset.

And so as we continue to work newer communities, then that gives us the opportunity to improve margins.

Or if a particular market is declining, at least maintain margins.

And so all of those things contribute to the continuing improvement.

And we would hope to be able to continue to do that.

What we don't know is what the market will bring to us.

Right.

And then just one last one, I think, bigger picture, Don, talking about your broader view over the next year or two or three.

Going back five years, I don't think many foresaw the type of decline and degree of magnitude and breadth or period of time.

At this point, I think there's still a lot of people in the market that, conversely, it's just out-of-mind to think we could get back to a 30-year average of 1.5 million starts.

I'm wondering if, given that you said that you didn't -- really haven't seen a pickup in employment growth, which is really one of the key central drivers to demand, we've had a couple of months right now of 200,000 jobs per month.

And I'm wondering, if that continues, as economists assumptions are very subject or change day-to-day, hour-to-hour, but if we see 150,000 -- 200,000 per month rate continue, and you're talking about a couple of million jobs per year, I'm wondering if that changes your outlook at all?

Clearly, it will improve our business.

And I see those numbers that are being released.

I guess I'm somewhat suspect of those numbers.

It seems like so many of the government numbers are revised for month-to-month and quarter-to-quarter.

So, today, I don't feel warm and fuzzy about the minimal job growth that we've seen.

I think we need significantly more job growth.

If we're still sitting with an over 8% unemployment rate; your neighbor still doesn't have a job; I also don't think that that incorporates the number of people who have dropped out of the workforce that are looking for a job.

So, I've read numbers where basically our effective unemployment rate is closer to 17% or 18%.

So those numbers don't bode well for homebuilding.

And those people who are outside the 8% who are in the 17% or 18%, those people have got to get back in the job market also.

So, right now, I see minimal effect on our business.

If it continues at this pace, it will help us.

But I still ask myself what the real unemployment rate is, how many people are not counted in the 8%?

Great.

Fair enough.

Appreciate it.

Joel Locker, FBN Securities.

Just one quick question on -- what were your customer deposits at the end of the quarter?

(multiple speakers) [Had a number] --

We have it?

Yes, just one moment.

Let's look it up.

We're at an average of about $2,400 per house (inaudible).

So at 1.2% or so, I mean, do you guys think about maybe increasing that just to fend off the cancellation rate or keep that lower?

Frankly, that deposit has very little to do with our cancellation rate.

Most of the time if someone is going to cancel, we typically don't keep their earnest money deposit because it creates a lot of ill will.

It's more of a sense of, "Yes, I'm interested in buying this home; let's go forward and see if we can qualify and close." But it's not a good track record to be confiscating people's earnest money out there.

It's also somewhat a typical percentage, either dollar amount or percentage by market.

And if we were to go outside the norm and require much more money upfront, that could actually put us at a disadvantage in terms of selling.

Right.

All right.

Thanks a lot, guys.

Adam Rudiger, Wells Fargo.

Most of my questions have been answered, but I just had one question.

Don, when you were talking earlier, you said that in order to have positive year-over-year orders in the third quarter, you have to have, I think, roughly sequentially flat orders.

And the way you said that suggested to me that you were not expecting to have roughly flat orders.

And if you look at your history, there's plenty of examples when you can have higher third-quarter orders in the second quarter.

So I was just wondering, more specifically, what your expectation was for the third quarter relative to the second quarter?

You're right, Adam.

We have had years in which the June quarter exceeded the March quarter.

We've had years in which the March quarter has exceeded the June quarter.

So it is certainly possible to be flat or better in our June quarter.

We are certainly hopeful that that will occur, but given really the inconsistency that we see from week-to-week and market-to-market today, it's difficult to say for sure if our June quarter will exceed our March quarter.

But we're certainly hopeful it will.

And frankly, I would say to you, to put a little additional color on it, I think we started the selling season very strong.

And I think the selling season is not as strong as what it was at the beginning, so that's why we're tempering our expectation of third quarter sales.

Makes sense.

That's all I had.

Thank you.

Thank you.

Thank you.

There are no further questions at this time.

I would now like to turn the floor back over to management for closing comments.

We thank you for joining us on our call this second quarter.

Clearly, we're very excited about our 47% sequential increase in sales and our 5,200-plus homes in backlog, because I think that positions us well for Q3 and Q4.

Clearly, our SG&A is an issue to us.

We've taken the action that's necessary to bring our SG&A in line.

As Bill mentioned, our expectation for the second half of the year is to have our SG&A come in at less than $475 million, which I think will put our SG&A back in line in Q3 and Q4 to more normalized levels.

I want to tell all of our salespeople and all the other people in the Company, we think you've done a good first half of the year.

We have tough competition for the second half of the year.

We had great sales force sequentially in the second quarter over the first quarter.

We are the ninth consecutive year in a row that you are the largest builder in America.

We're all very proud of that.

As I tell all of our salespeople, execute the competition and outperform your competitors.

Thank you and good bye.

This concludes today's teleconference.

You may disconnect your lines at this time and thank you for your participation.