霍頓房屋 (DHI) 2012 Q1 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 of America, first-quarter 2012 earnings release conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Donald Tomnitz, President and CEO. 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's no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K, which is filed with the Securities and Exchange Commission. Don?

We are off to a strong start for fiscal 2012. We made $27.7 million in net income in our first quarter. And we are focused on maintaining profitability in each upcoming quarter. The spring selling season begins soon and our sales and operational teams across the Company are energized and prepared for increasing traffic and sales activity. We have homes available in inventory and a good supply of finished lots to meet the potential additional demand. If 2012 is the first year of the US housing recovery, we expect it to reflect uneven improvement across our operating markets, with some markets experiencing increases in demand and others remaining weak. We remain flexible with a profitable business model at current demand levels, but have the ability to increase our production in response to a stronger demand. Although macroeconomic and housing conditions remain soft, we are cautiously optimistic for the remainder of 2012, after achieving almost a $50 million improvement in pretax income compared to the year-ago quarter. Mike?

In the first quarter, our homebuilding operations generated pretax income of $25 million, and our financial services operations generated pretax income of $4.2 million. Income tax expense of $1.5 million primarily represents state income taxes. Our net income for the quarter was $27.7 million, or $0.09 per diluted share, compared to a net loss of $20.4 million, or $0.06 per diluted share, in the prior-year quarter. Bill?

Our first quarter home sales revenues increased 16%, to $884 million on 4,118 homes closed, from $761 million on 3,637 homes closed in the year-ago quarter. Our average closing price for the quarter was up 3% compared to the prior year, and was flat sequentially at $214,700. Don?

Net sales orders for the first quarter were up 13% from last year to 3,794 homes on a 3% decrease in active selling communities. In the December quarter, our average sales price on net sales orders of $217,000 was up 3% compared to the prior-year quarter and down 1% sequentially. Our cancellation rate for the first quarter was 26%. Our sales backlog at December 31, 2011, increased 18% from the prior year to 4,530 homes, or $975 million. Stacey?

Our gross profit margin on home sales revenue in the first quarter was 16.8%, up 120 basis points from the year-ago period. 100 basis points of the increase was due to cost improvements and decreased incentives and discounts. 60 basis points of the increase was due to a reduction in amortized interest and property taxes. Also contributing 40 basis points to the margin increase was a reduction in the cost of remaining development obligations for completed projects, and collection of old development receivables in excess of previous estimates. Partially offsetting these increases was an 80-basis-point decrease related to costs for warranty and construction defect claims. Sequentially, while incentives and discounts were flat, our gross margin improved 70 basis points, again, primarily due to a reduction in the cost of remaining development obligations for completed projects and collection of old development receivables in excess of previous estimates. Bill?

Homebuilding SG&A expense for the quarter, which includes corporate overhead, was $119 million, essentially flat with the year-ago quarter on a 13% increase in homes closed. As a percentage of homebuilding revenues, SG&A was 13.4%, compared to 15.5% in the year-ago quarter, reflecting both the improvement in volume and our continued efforts to reduce costs. We also continue to see the benefits of our aggressive debt reduction over the past several years as homebuilding interest expense was down 57% from the year-ago quarter to $6.9 million, and our first quarter homebuilding interest incurred decreased 21%, to $27.9 million. Mike?

Financial services pretax income for the quarter was $4.2 million, which included $1.7 million of recourse expense. 83% of our mortgage companies loan originations during the quarter related to homes closed by our homebuilding operations. Our mortgage company handled the financing for 60% of our home buyers this quarter, with virtually all loans meeting eligibility requirements for sale to Fannie May, Freddie Mac, or Jenny May. Government loans accounted for 57% of our mortgage company's volume this quarter, down from 61% in the year-ago quarter. Our mortgage company's new borrowers during the quarter had an average FICO score of 710 and an average loan-to-value ratio of 91%. Stacey?

Since September, our total inventory increased by approximately $30 million, excluding noncash items. We increased our investment in residential land and lots by $40 million and reduced our homes in inventory by $10 million. Our homes in inventory at the end of December totaled 10,200 homes, down 300 homes from September. As of December 31, 1,100 of our homes were models, 5,700 were speculative homes, and 2,700 of the specs were completed. We expect our number of homes in inventory to increase in the March and June quarters in response to seasonal demand. Don?

In our first fiscal quarter, our investments of land, lots, and development costs totaled $229 million, which reflects that we continue to find good opportunities to open new communities and replenish our finished lot supply. Future investments in finished lots, land and development, will remain largely dependent on our sales pace. We remain focused on managing our supply of owned, finished lots in line with our sales demand in a low-risk capital-efficient manner. At December 31, 2011, we controlled approximately 115 lots, of which 86,000 are owned, 29,000 are option. Our current finished lot supply includes 22,000 owned lots and 23,000 option lots. We also expect an additional 27,000 of our total control lots to be developed within the next 12 to 18 months for a finished lot pipeline of at least 72,000 lots available to us over the next two years. Bill?

We used $3 million of cash in operations in the December quarter, primarily due to our investments in residential land and lots and a reduction of accounts payable, offset by our net income and decreases in mortgage loans held for sale and homes in inventory. We ended the quarter with $1 billion of homebuilding unrestricted cash and marketable securities. During the quarter, we repurchased $10.8 million of our 6.5% senior notes due 2016. The balance of our public notes outstanding at December 31 was just under $1.6 billion, with no maturities until May of 2013. Mike?

At December 31, our homebuilding leverage ratio, net of cash and marketable securities, was 17.5%, compared to 17% a year ago. Gross homebuilding leverage at December 31 improved 650 basis points to 37.4% from a year ago, due to debt reductions and increased equity. Stacey?

Before we move to Q&A, we wanted to share our expectations for some of our operating metrics. With 4,530 homes in backlog, and an expected conversion rate below 90%, we expect fewer closings in Q2 than in Q1, consistent with recent years' trends. Seasonally, Q2 and Q3 experienced the strongest sales demand, which then results in our strongest deliveries in Q3 and Q4. Our current expectation is for home sales gross margin to remain in the mid-16% range. We anticipate a seasonal increase in SG&A expense in the second quarter, primarily due to payroll taxes and seasonal advertising, which will result in a higher SG&A percentage in Q2 versus Q1. In Q3 and Q4, variable components will increase the absolute SG&A expense amount, however, our SG&A percentage should improve as we close more homes and leverage our fixed-cost structure. Don?

Simply put, our business feels more positive. We are entering fiscal year '12 feeling better than we have in six years, and it's been a long six years. We've started the year with $28 million of net income and double-digit percentage increases in our sales, closings, and backlog in the first quarter. January sales are also up year over year, in line with our expectations. Both our gross margin and SG&A percentages improved versus last year, and our balance sheet and liquidity remain strong. While the housing industry and the overall economy have not gained significant traction, we are increasing our market share by finding attractive opportunities across our markets that are producing improved results for D.R. Horton.

We remain focused on achieving profitability in each quarter and for the fiscal year '12. As always, we want to thank all of our DHI team members. We've been the largest builder in America for the past 10 years and you have just delivered a tremendous first quarter. We are very proud of the results you have produced and we look forward to a great fiscal year '12. We've worked hard to position our Company for profitability. Now, let's go lead the industry into the next up cycle and sell more homes, leverage our fixed cost, and continue to outperform the competition. This concludes our prepared remarks. Now we'll host any questions you may have.

(Operator Instructions) Our first question comes from the line of David Goldberg from UBS. Please proceed with your question.

Thanks. Good morning, everybody. Nice quarter.

Good morning, David.

My first question was on the change in FICO score sequentially. It feels like it's up a little bit versus where we were, maybe not so much first quarter of '11 -- of '10, excuse me -- yes, fiscal first quarter '11, but certainly throughout fiscal '11, it seems like it's come up. Is that mix shift or are you seeing any change in underwriting at this point?

I don't think there's any substantial change in underwriting. We noticed the same thing you did, that Q1 was a little bit stronger. It was in line with Q1 last year, but stronger than the balance of fiscal year 2011. I don't know we can attribute that to anything in particular.

Okay. Easy enough. Next question was a little bit more theoretical. I kind of wanted to look out, and Don, I think in the prepared remarks you mentioned that community count was down 3%. And I kind of wanted to talk about, as you look forward into the recovery, how you think the land position that you have today supports the growth pattern and the growth expectations that you have, and if you think -- if you could kind of think about your land position in terms of the usability given current conditions and how active you're going to have to be in the land market; do you think you control and own enough and option enough land now to go out and grow the way you want to outside of the kind of increasing the leverage in existing communities?

Well, I do believe we have adequate lots for the next two years, as I mentioned in my comments. I do believe, as we've worked through this calendar year and somewhat into calendar year '13 that the finished lot supply in good markets is going to be depleted. And we're focusing on tying up as many good deals as we can currently in anticipation of that. Clearly, at some point in time, we'll have to get back into the land development business, as we have been in the past. I want to remind you that our go-forward plan is to have a -- really a light and lean land supply. Our current underwriting guidelines require that any land that we invest in, any land that we develop, that we get our capital returned in 18 months; sometimes at the worst case basis if it's a great deal, 24 months.

But currently, our plan is and has been for the last several years as we move forward, anything greater than a two-year supply, we're going to be partnering with other land developers to make sure that they hold those lots that will require greater than two years as opposed to us holding them on our balance sheet. So I feel good about where we are. We still are clearly the preferred buyer for banks and developers because we're the largest builder. We're also starting the most specs of anybody in the market, and we're selling the most homes of anyone in the market. So I feel like as we continue to work on a depleted land and lot supply, we continue to be the preferred buyer.

Our next question comes from the line of Dan Oppenheim from Credit Suisse. Please proceed with your question.

Great. Thanks very much. Was wondering, you had talked about being cautiously optimistic about the spring here and it's a bit less quotable than your comments with the expectations in recent years. But wondering -- wondering how that relates to the thoughts in terms of specs. You've done a very good job managing that in the past. How much more do you think you will build based on the cautious optimism that you have right now?

Well, frankly, we're cautious. I think clearly, we have clearly repositioned this Company, have it in a great position today to capitalize on the market as it's going to materialize given the current economic situations. I think the cloud that hangs over us and the reason that we use the adjective cautious is because there a lot of issues both internationally as well as nationally that we have no control over. So as a result, we're just focusing on the next 12 months ahead when we say cautious, because there's an election coming. There are a lot of issues on the table. And we don't know how those are going to impact the home building business, Dan.

Okay, great. That's all I had. Thanks.

Our next question comes from the line of Nishu Sood from Deutsche Bank. Please proceed with your question.

Thanks. Good morning, everyone.

Good morning.

I wanted to ask a very interesting statement you made about developing 27,000 lots I believe you said, over the next 18 months. So I wanted to understand the dynamics of that. Does that mean -- is that simply a statement about the lack of availability of finished lots and therefore the need to develop? Is this a -- is this coming from lots that are projects that are moth balled, or is this the pursuit of new -- new projects -- new development opportunities in the market?

Yes, an issue I could clarify a little bit. The 27,000 lots, those are lots that we own today that are either partially developed or undeveloped, but that our expectations with our current business plans would anticipate that we would begin to develop those lots in the next 12 to 18 months. Obviously, the choice of whether to invest the capital and develop those lots will be dependent on our sales base. But in terms of looking at our land and lot pipeline, those 27,000 lots are available to us to be developed and to be finished for our sales if the sales warranted.

Got it, got it. So this is coming from your own land pipeline now. The general view I think that investors have taken that moth balling becomes a necessity because -- had become a necessity because demand had shrunk and that therefore, there were certain areas where it became unprofitable to build. Is this then a tentative indicator that demand is spreading back to, let's say, areas that were C-grade before and that the economics are becoming more feasible, or how should we interpret that?

No, this is really no change in our outlook in terms of C markets, as you call them. We still have about 43,000 lots that are moth balled that we do not expect to be developing within the next 12 to 18 months. Some of those might come online after that timeframe, but some could be much significantly longer.

The demand clearly is still in the A markets, and that's where we're focusing. And clearly to the extent that we bring a portion of those or all of the 27,000 lots into development, those are going to be in good locations where basically heretofore we've been able to find option lots that would have precluded us from having to develop the lots.

Our next question comes from the line of Michael Rehaut from JPMorgan. Please proceed with your question.

Thanks. Good morning, everyone. The first question was just on comments with regards to January and you also -- if I heard you correctly, say that the housing industry hasn't yet gained significant momentum. So, the question is in effect is, there's been a lot of speculation around current demand and to the extent that there is a lot of views that there is some positive momentum here, how are we to think about entering the spring, are you seeing things pick up at all, or is it just more along the same type of pace that you're currently seeing -- that you saw in the December quarter?

I can tell you, as you know, Don Horton and I spend quite a bit of time in the field, two to three weeks a month. And both his travels and my travels, which have been to separate markets, as we visit with each and every one of our sales people as we travel through those markets, indicates that our sales people are optimistic, because their traffic's up and there are more buyers in their models each and every week that we have progressed since December. So obviously, December is a very slow period of the year for us, with the holiday season and so forth. But certainly into January, we've felt very, very good about our traffic and our sales.

Okay. Second question I guess, maybe a two-parter, if I can cheat a little bit. But you'd mentioned community countdown 3% year over year. I was hoping maybe you could share what you expect that to be -- community count growth in 2012? And secondly, if you could highlight any regions that were let's say stronger than corporate average or weaker than corporate average.

Well, I think that the 3% down is just, it's an accounting issue. It's a point in time. And we expect our community count and count the rest of calendar year '12 to increase. That's going to be contingent obviously on our ability to find good and profitable land and lot deals. I'm going to refrain from commenting on markets, because of two things. One, I think Bobby does a great job of grading the markets. And secondly, I think that our good markets need to be kept to ourselves as we continue to exploit the markets ourselves as opposed to letting our competitors know about our good markets.

Our next question comes from the line of Jade Rahmani from KBW. Please proceed with your question.

Thank you. It's Jade Rahmani from KBW. I wanted to ask about the deferred tax asset. We're seeing quite a few banks recapture their DTA after several quarters of profitability. You have been profitable for four quarters in the past few years and indicated you expect to be profitable each quarter of the year. Do you expect to reverse it this year, and is this a once a year review that happens with your fiscal year end?

Yes, Jade, we do review this every quarter. And I can update you on where we are this quarter. If you recall, last quarter at the end of our fiscal year '11, we commented that one of the significant pieces of negative evidence that weigh into our decision is the fact that we have been in a cumulative loss position on a three year trailing basis. And based on the way the standard reads that we have to apply, that is a piece of evidence that is very difficult to overcome, to justify reversing the valuation allowance. At September 30, that three-year loss position was at $445 million. At December 31, that three-year loss position has dropped to $355 million.

Our expectation is that we will emerge from a three-year loss position by our fourth quarter of fiscal 2012, and at that time, that significant piece of negative evidence gets pulled out of our evaluation. And at that point in time, then that could be the earliest possible quarter in which the valuation allowance could be reversed. And at that point, we will have to weigh in on how profitable our year has been, how significant it has been, how sustainable we feel our earnings stream is at that point in time as we look forward into fiscal 2013. And we certainly do expect the valuation allowance to be reversed. Q4 this year would be the earliest, but there is the chance that it could -- it could be a few more quarters into fiscal '13.

Okay, thanks for that. And just to follow up, I want to confirm as a profitable company, that you expect to pay no federal cash taxes so long as you have this significant DTA, and secondly --

Okay.

And then once it reverses, just technically that you would be accruing a tax rate in your income statement.

Yes. Second part first. When we reverse the valuation allowance, we will be accruing our standard income tax expense. In the past, that has been for federal and state combined, around a 38% rate. That would be our current estimate after we reverse the allowance. In terms of taxes paid, there will be state taxes that we would expect to pay in the states where we are profitable. Right now, our estimate on that is around a 3% rate on our pretax income.

We will perhaps to the extent we have taxable income overall, have to pay a slight amount of federal income tax due to the alternative minimum tax requirements in the tax law. They won't let you get away with zero tax. Right now, our estimate for what we might have to pay in alt min tax is 2%, an effective rate of 2%. So that's what's reflected in our current quarter. We have a 5% effective income tax rate. That reflects 3% for the state, 2% for federal. Now, alt min, when you pay it in the future, we will get to use that as a credit against future income in later years after we've used up our NOL against future years of income.

Our next question comes from the line of Adam Rudiger from Wells Fargo. Please proceed with your question.

Good morning. Thank you. Don, you mentioned that you spent a lot of time in the field and you also commented in your opening remarks or one of your comments that your business feels more positive. I was wondering if you could elaborate on those two comments and share with us any patterns or themes that you've been picking up from your buyers and what's driving them to take the plunge right now, if there's any kind of elasticity towards rates or really what themes you're picking up on.

Well, I think the real key factor is that the availability of foreclosed homes still remains low. But most importantly, the process through which the buyer has to go through in order to have a small percentage chance of securing, actually closing on a foreclosed home is very laborious. Furthermore, the state of most of these foreclosed homes are in a difficult position. They require quite a bit of work, and even though the buyer has to come up with a down payment and with our homes, they typically would have to come with what we call a lot of cash out of pocket to make the foreclosed home more livable.

So if you take a look at that process and those factors associated with foreclosed homes and then take a look at the fact that they can buy new home in a new community that has better school systems in many instances, and better neighbors than what they are living around, then in many instances we have the best buy for that buyer out there in a timely process. Also, you have to remember, a number of these buyers are all of a sudden becoming qualified or they're getting the down payment and they don't want to have to wait three to four or five months to see if they're going to get a foreclosed home and be able to close on it and then take the cash out of their pocket to own it. The new home buying process today is a very seamless process and a very timely process. And with the number of specs that we have available out there on the ground for realtors and our buyers, we offer the preeminent buy relative to the foreclosed homes.

I think another factor that's driving some of the demand, Adam, is we've had very high affordability for a while, but rents were also relatively low. And now we're starting to see more headlines and hear from more of our buyers that they're seeing their rents increase and that improves the equation when they're looking at their house payment compared to their rent payment.

That's interesting. Thank you. So, the consensus seems to be out there that we bottomed and the outlook is getting more favorable. I think when that happens, people start looking a little bit more, looking out further into the future and thinking about what the longer term earnings power is. Can you draw -- for all the builders. Can you share any thoughts on what you think about three, four, five years out, what you think the earnings power margins might look like?

Well, I would say to you that clearly there have been a number of small, medium-size builders who have left the market. They do not have the financing. If you look at the public builders, we have continued to acquire more and more market share in each one of our markets. As we continue to control the land and lot supply, which is necessary as we go forward, of course with our strong balance sheet, that affords us the opportunity to control the land, control the lots and to be able to, most importantly, develop the lots when the demand increases; I believe that DR Horton as a company has an opportunity to continue to acquire market share and increase our market share in each and every market. My personal goal, and I'll say my personal goal, as we go through all this is I believe that five years out, we're coming very close to our 50,000 units that we closed in 2006. So that tells you what I think the possibility is for us in this industry.

Just to tag on with operating margins. In terms of our historical operating margins, we have always targeted a 20% gross margin, 10% SG&A, so 10% dropping to the pretax line. So we are working towards that. We're not there today, but we believe we'll continue to progress and as the market improves, we will get back to those historic operating margins as well.

And perhaps the last thing I would like to say is that clearly, if you look at all of our competitors in the industry, we have the strongest balance sheet in the industry. So clearly we have the balance sheet to get to that 50,000 units and continue to meet the demand as it moves forward and continue to take market share.

Our next question comes from the line of Joel Locker from FBN securities. Please proceed with your question.

Hi. You just bought back 3 million shares or so just to offset some of the dilution in the convertible and just wanted to see what your idea of that going forward was, if you're going to offset more by buying more shares maybe possibly lower, or how you looked at the dilution factor of the convertible.

Sure. We had an opportunity in the spring where we still had an abundance of cash above our $1 billion target goal. We were at the same time retiring debt and increasing our land investment, and we were also taking the opportunity to retire some stock at prices we thought were attractive at the time. Going forward, we're closer to the $1 billion target cash that we have, and we're going to be weighing all of those opportunities going forward. Our capital structure on the debt side is much more in line with where we need it to be. Our gross leverage is now down under 40%, but we're starting to see more opportunities to invest in our core business as well. As demand increases, we'll need some of our capital for cash -- or for homes and inventory. So we're going to be weighing those. I don't know that we have any firm expectations of what further share repurchases would be, but we're going to take care of the core business first.

And if you're modeling, if your share price averages $14 going forward, would that count in the diluted share count going forward?

The diluted share count is actually an earnings calculation, and we need to earn a certain amount of net income. Right now, I believe the number's around $70 million in a quarter, before the convert would become dilutive because for the calculation to include the shares, we would add back the interest that's flowing through our income statement related to the convert. So it's really more than the stock price, it's the amount of earnings that we have and whether the share count would be dilutive. And actually, if we earn $70 million, even if the stock is below the $13.06, we would include the shares.

Our next question comes from the line of Mike Widner from Stifel Nicolaus. Please proceed with your question.

Good morning. Congrats on another quarter of profitability.

Thank you.

Without going into kind of market by market detail, wondering if you could talk about sort of on a percentage basis, where would you describe markets as sustainably or at least apparently sustainably getting better and getting closer to not necessarily normal, but substantial improvement and what percentage of the markets would you say are still kind of stuck in the mud, for lack of a better word?

I'm going to be very general because again, I don't want to talk specifically about our markets any longer. But I would say to you, as Don Horton says, the Sunbelt continues to be where a lot of people want to live and are focusing on living in the future. So those markets are good for us. And as a comparison, I would say that the north continues to be weak for us compared to the Sunbelt markets.

Got you. And then another question, I guess. You talked about getting back to 50,000 units. Obviously that's a pretty robust growth trend from here. One way to get there is kind of 25% growth a year for the next five years. Another way, it takes 10 years and it's slower growth. So just as you contemplate kind of how all this nonsense unfurls both in the US and globally, what's your expectation?

Well, first of all, I qualify that as a personal goal. I thought that was a major accomplishment for us in 2006 to post 50,000 units more than any other builder in the US had ever closed before. And certainly we led the industry to that number. I don't know if it's going to take us five years. I don't know whether it's going to take us seven years. I just know that our balance sheet is positioned for us to be able to come back to that number more quickly than many anticipate, and certainly more quickly than other competitors in the industry.

Our next question comes from the line of Bob Wetenhall from RBC Capital Markets. Please proceed with your question.

Good morning. This is Steven Beckman in for Bob Wetenhall. How are you?

Great. Yourself?

I'm doing well, thanks. Just a couple quick questions. You made several comments on SG&A towards the end of your prepared comments. But in terms of the full year, do you expect SG&A to be relatively flat in '12 versus the [$480 million] in '11?

We would expect our percentage to be improved compared to '11. A lot of what the absolute dollar amount does though will be dependent on the absolute level of homes closed, because a portion of that is going to be a variable cost. So if we have significantly higher homes closed, the dollars will be higher. If we have flat homes closed, then we would expect our dollars to be lower than what we incurred last year.

Fair enough. And I guess the follow-up being the cancellation rate was 26%, which is on the low end compared to the last few quarters. We were just wondering if you were seeing any trend shift in cancellation activity or if it was just noise in the quarter?

Probably just noise in the quarter. We're still seeing a lot of the same drivers of cancellations, primarily mortgage qualification.

Our next question comes from the line of Stephen Kim from Barclays Capital. Please proceed with your question.

Thanks a lot. Again, congratulations on a strong performance.

Thank you.

My first, yes, my first question relates to your comments that as -- that if the recovery occurs in '12, which I think it will, but if it does, you expected it to be not uniform across the country, some markets will outperform others and that sort of thing. I was curious as to whether or not you could give us an idea, the markets which you are seeing or anticipating to see greater, stronger trends, what is your margin profile look like in those markets, understanding that some geographies tend to have better margin profiles generally speaking?

Well, again, I would say to you, and I'm not going to, again, not going to speak specifically about specific markets, Steve. But again, if you look at our Sunbelt markets and certainly our Coastal markets, I think that's clearly where we're seeing some of our best gross margins today. And I think there's a reason for that. And I think a number of our coastal markets have had terrific declines in lot prices over the course of the past five or six years. And in many instances, we're offering houses, finished houses for what the lots were costing five or six years ago, so there's an incredible buying opportunity for people that -- who can qualify and who want to own a second home in those markets.

And there will be additional information in the 10-Q on a regional basis. We report our six operating regions in our segment reporting in our financials and in the MD&A that will have some commentary around the reasons why certain regions are more profitable and what's driving the changes there as well. So there will be some additional color in the 10-Q.

And I just came out of one of our markets where our gross margins were running 25% to 30%. And you wouldn't believe me if I told you that and I certainly wouldn't tell anybody where I was. So as a result, we do have some markets that are overperforming.

Yes, well, that's great. And that's good to hear. I guess my second question relates to your comment about your personal goal getting back. I don't want to make too much of this. I know it can be misinterpreted. And my intent is not to belabor it. But --

Let's not forget 2007, Steve, at your conference--

Yes. Well, I think that was Citi's conference, so that was different.

Oh. You were, you were there, though.

I heard about it, yes. So my question relates to as we look forward, what we can expect in terms of market share for Horton, which obviously I know that that's something that you work very hard and are very proud about maintaining strong market shares in your markets. At the peak, we saw an unusually large percentage of the starts in the country that were single-family detached for sale. And the conventional wisdom today is that it is unlikely that the mix of starts as we get back into recovery, will have quite the same proportion of single-family detached for sale housing. So I was wondering, A, whether you factor that into your thinking of where you think you can grow and the targets you set internally. And then secondly, whether or not you think there's an opportunity to alter your mix of product so that you can capture more of whatever starts happen to come through over the next five years.

Okay. Well, first of all, let me say clearly, it goes without saying, but I want to say it clearly. And that is we're interested in growth but we're always at this Company interested in profitable growth. So notwithstanding the fact that my personal goal, we're never going to achieve my personal goal that the profitability is not there first. Secondly, we have as a company, and especially in the 2003, 2004, 2005 and 2006 time period, had a myriad of products out there on the marketplace, anywhere from single-family detached to single-family condos, detached condos to town houses to triplexes to podium-type buildings.

And so we're capable as we've proven to build any type of product. Where we see the demand today clearly is in single-family detached with a small smattering of town house and to a lesser extent, detached condos, single-family detached condos. So as a result, what we're focused on today is single-family detached. When that market becomes saturated, then we clearly have the experience and are prepared to move into the other different types of housing products, which we have proven that we can do in the past.

Our next question comes from the line of Ken Zener of KeyBanc Capital Markets. Please proceed with your question.

Good morning.

Good morning.

Two questions. If this is the bottom of the market, it's kind of a good problem question. But you're disciplined around not buying land, wanting to be a short builder, to avoid the -- well, some of the issues we had at the peak of the last cycle relative to the long land position. It kind of -- if you are really limiting your upside, I would say, given your low net leverage at current levels, as well as the potential DTA, can you kind of talk about how you're balancing the conservative approach you've taken through the last few years relative to the fact that if you do buy land and builders tend to make outsized margins on land versus the vertical construction costs, what should we look for? And especially land -- finished land's running out.

Well, what you should look for is for us to continue to lead the foray into increasing our sales and boosting our closings based upon acquiring additional land and lot positions as we continue to do today. Our only caveat is that we're not going to risk our already sterling strong balance sheet by getting into land positions that are in excess of two years. And we believe that we can continue to produce the kind of volume and the profitability by laying off anything that's greater than two years to an investor or to a partner, to hold that land that's in greater than two years. No one in the home building industry that I know of, including ourselves, were intelligent enough to figure out when to start laying off land quickly enough. So all of us ended up trashing our balance sheets and had future impairments based upon our inability to determine how much land we should hold at a specific time. So I guess after all these years with Horton, 28 years and DR being in the business longer than that, we've got our balance sheet back to the strongest in the industry.

We're not going to risk that in anticipation of a market that may have a future dip. And who knows what the market may bring. Currently, we sort of think that this is the bottom of the market. We're not certain. If you'll recall back three and four years ago, there were a number of people who were a lot smarter than we or at least they thought, who were out picking up finished lot deals and land positions and basically the market continued to work downward from that position. So once again, our position is we're going to grow profitably and we're going to grow faster than virtually any other builder, but we're going to do it in a sane way to preserve our balance sheet.

Ken?

I'm sorry, Bill.

Go ahead, Ken.

Just on the moth balled units, Bill, you talked -- I thought I heard you say 43,000. What was that last year and last quarter? Because I thought it was a bit lower, even though it's staying about 20% of your inventory dollars. And then can you talk about the distribution of these moth balled lots relative to your comments around finished lots in the end markets expiring over the next two years, so does your excess lots -- moth balled lots, happen to coincide where development of lots is going to have to occur?

In terms of the number of moth balled lots, we're flat with a quarter ago. And a year ago, we were at 44,000. So we're down about 1,000 there. And then in terms of the location of our moth balled lots, typically these are in areas that are a little bit further out from where the development is occurring today. It will take some market improvement and market expansion in general before we would feel the need to bring some amount of that land on, and then the other element that characterizes some of our held land is the fact that it would take significant development investment to bring those lots to market; and today, the returns aren't sufficient to justify that additional investment.

Our next question comes from the line of Michael Smith from JMP Securities. Please proceed with your question.

Good morning. Just -- most of my questions have been answered, but I'll do a follow-up to some of these. I'm just trying to understand this a little bit better. You talked about, I think if I remember correctly earlier saying that the overall housing market wasn't getting a whole lot more traction, but clearly you are seeing a pickup and you said even specifically in December and January seeing a pickup in your traffic levels and the number of buyers that you have in your models.

So I'm assuming -- and you mentioned this briefly, that you're kind of chalking that up to market share gains. Is there anyway for you to either quantify that or give more color on it? Is it sort of universal across all your markets, is it more concentrated in some markets than others? And how do you get a sense of what those market share gains are and how strong they are, other than just anecdotally noticing that maybe the overall market is pretty flat but you guys are obviously doing better on the traffic front?

I think a lot of it has to do with DR and I being in these markets and assessing the situations ourselves. Clearly, I will say to you, as I said earlier, we're getting better traction than is in the Sunbelt areas and the Coastal markets than we are in the Northern markets. And I think that will continue to be true.

There's generally in each of our markets at least one firm that tracks the relative performance of the home builders in that market. So that information is generally available, and we can track by specific market what our market share is based on either sales or building permits generally, are the two metrics that are tracked.

So then let me ask you the follow-up. Going forward with this sort of optimism part of the cautious optimism, is that based more on the idea that you will continue because you're in strong position and you have the balance sheet that you do, that you will continue to gain market share and -- in at least most of your markets versus optimism that the worm is turning on the overall housing market? I mean, could you see a sort of flat 2012 in the overall market, but you continue to outperform because of those market share gains?

I think that we could see a slight improvement in the overall market for the entire industry in 2012. We would be disappointed if we didn't get our lion's share of that increase, so as a result, it's just slow, methodical improvement. We don't expect the new home industry to go back to 750,000 units overnight. I believe that for the new home industry, clearly as I've said before, that we are seeing some drivers coming our way from people tired of dealing with foreclosures and short sales, and also the affordability that's present in the new home industry today. So as a result, all those factors combined, I think it's going to be a slight upward trend in 2012 and hopefully a slightly better upward trend in 2013 as the economy -- US economy begins to recover and we start generating some new jobs in this country. The one driver that we're missing in our industry, and the reason we're strapping around in the marketplace trying to get additional marketshare is because there are no new jobs being created of any significance and until we get our act together in new job creation, the new home building industry will continue to scrape along the bottom with little ups and little downs, but no significant improvement.

Our next question comes from the line of Alex Barron from Housing Research Center. Please proceed with your question.

Thanks. Good morning.

Good morning.

Well, I think you ought to be commended because you've done a pretty good job of being profitable here at the bottom. So hoping for better things in the future.

Well, Alex, actually you made my morning because after reading some of the early morning releases, I was wondering if anybody was really that optimistic. We're very, very proud of what we did in the first quarter.

Well, good job. So my question is, when we met about a year ago. I think at the time your Company's goals were to kind of focus on reducing debt and using the free cash flow for that purpose and I guess kind of where you sit now, I'm wondering if you're still going to -- if that's still part of the strategy to kind of keep one foot on the breaks and one foot on the accelerator or do you think your $1 billion of cash would be more towards the use of buying land? Like how -- I mean, given that you're optioning land, it doesn't sound like you need a lot of capital so how are you thinking about that.

Well, clearly, we're cautiously optimistic and I think that's a good analogy. We've got one foot on the brake and one foot on the accelerator because, again, we don't see any substantial, significant, immediate improvement in the industry. It's going to be slow and methodical as we work our way back up. So we are very, very, protective of our $1 billion in cash and we are also very, very conservative as we look forward in terms of land positions. And as I said earlier, we're not interested in buying anything where we have to get our capital back in greater than two years right now; and frankly, most of it's 18 months. So we're prepared and positioned and experienced to do whatever's necessary to capitalize on an expanding market if and when we see a substantial increase in the market.

Okay. My other question is, are you starting to see or hear anecdotally that people who went through the foreclosure or short sale process and have been renting for the last few years, are they starting to come back into your sales offices to buy; and if so, how are you capitalizing on this trend if that's what's happening?

Well, I think we have seen those people and we have people in our own Company who have gone through the short sale and the foreclosure process who thought they were going to get a great deal and many of them have come back and bought a DR Horton home. Thank you. But at the same time, I think that that's still a very laborious process, as I've said.

Yes. And Alex, I think you may be asking a different question in terms of people who actually had their homes foreclosed on and are now looking to buy another home, is that right? We'll assume it is. But yes, we do see some of that. There's a certain timeframe after a short sale and a little bit longer timeframe after a foreclosure, where people can come back into the market and their credit doesn't reflect the effects of those occurrences. So we have seen some of that picking up and that's one of the things that we've mentioned a few times. Our mortgage company has the DHI Home Mortgage Buyers Club that helps people work towards homeownership and we have been working with some people who have been through those situations before.

(Operator Instructions) Our next question comes from the line Susan Berliner of JPMorgan Securities Inc. Please proceed with your question.

Good morning.

Good morning.

I just want to talk a little bit about the mortgage side. With regards -- just would love your updated opinion, are DTAs mostly behind you at this point, and have any of your customers talked about mortgage availability being a little bit easier over the past couple of quarters, or where does it stand?

I don't see any -- as Stacey said earlier, the mortgage qualification process is still a strenuous process, and it's -- the mortgage companies in general have higher underwriting guidelines than they had three or four or five years ago, so we don't see any relief in that respect at all.

Okay. And mortgage put backs, are those kind of behind you, you think, at this point?

We still have a few of those coming back to us. We have had very few relative to the number of mortgages that we underwrote over the years. We continue to be well accrued for any potential put backs; and frankly, we evaluate each and every put back and to the extent that we disagree with it, we're fighting very hard with those mortgage companies who are trying to put those back to us for reasons that are difficult to understand.

In the current quarter, we did have $1.7 million of resource expense. So still some impact there, and our total accrual, or reserve in the mortgage company remains at about $32 million.

Our next question comes from the line of Jay McCanless from Guggenheim. Please proceed with your question.

Good morning, everyone. First question, could you please repeat the guidance you gave at the end of the prepared remarks?

At a very high level, Jay, without reading the whole thing, we basically said with a lower backlog and a conversion rate below 90%, fewer closings in Q2 than Q1. Strongest sales in Q2 and Q3 lead to strongest closings in Q3 and Q4. Gross margins remain in the mid-16% range. Sequential increase in SG&A expense in the second quarter, which will result in a higher SG&A percentage. But in Q3 and Q4, higher absolute SG&A but lower percentages.

Okay, thanks. And then the other question that I had, on last quarter's conference call, I believe there was a discussion about culling neighborhoods, unprofitable neighborhoods, culling unprofitable specs. Where are you with that process and has the sales activity that you have seen over the last two months, has that changed the process and just a general update on what you're thinking of those now?

Clearly, we have continued the culling process of our lower margin subdivisions. We tried to retrade them initially, rework the sales price on the lot. If the seller is not willing to do that, then we exit that subdivision. Where most of that happened, quite frankly is in the Carolinas and we've made a lot of progress in culling our lower margin subdivisions in the Carolinas. It's a continuing process, and even though we believe we are entering into profitable contracts, at times, we don't. And we go back and rework those contracts or cull those. But that will be a continuing process of the Company.

It's the same thing on our spec inventory. That's a continual process, month to month, week to week. Our sales teams are focused on moving aged inventory and keeping our spec inventory in line with sales. So it's just an ongoing part of our management.

But as far as our specs are concerned, we continue to offer the right number of specs in the right number of communities. Every once in a while, we'll get an aged spec and there is an incentive to move that spec. But it's a strong position for us to be in because realtors across the country still sell a large percentage of our homes for which we are very grateful because they bring a qualified buyer to us and it's a seamless process once that realtor brings that buyer into our sales office.

Our next question comes from the line of Jack Micenko from SIG. Please proceed with your question.

Hey, thanks for taking the question. Most have been asked and answered but I was just thinking about the commentary that we had just wrapped up about spec, and slow methodical overall, but it does seem like the industry, one of the bigger opportunities for the industry is this notion of higher rents and continued higher rents. So just wondering sort of philosophically, you've always been a spec builder, specs ramp into the seasonal demand period as well, but have you this year maybe thought about your spec business a little differently given the rise in rents? Is there anything you can talk to there just sort of conceptually?

I think, the answer to your question, our spec strategy has not been dictated or changed much by the rent increases that we've -- or renters are experiencing. I will say one thing, they may be disappointed with the increases in their rental rates, but one of the big factors that's preventing them from becoming a non-renter is the fact that either their credit history needs to be improved or the fact that they don't have the down payment. So as a result, as Stacy mentioned earlier, our Home Buyer's Club are taking those people and converting them into home buyers as we educate them on the financial system, which most of those people are good credit risk, it's just that they have not understood the financial reporting system and gotten themselves in some difficulty in terms of their credit history. And our Home Buyer's Club is doing a fantastic job of converting those people into home buyers and most of those that we get through the process and graduate are DR Horton buyers.

Okay, and then on the moth ball side, is it basically coming down to employment levels? Obviously a lot goes into what makes a moth ball not a moth ball going forward, but how do we think about -- is it new home pricing? Obviously you've probably written this stuff down. Doesn't make sense to sell it here, but does employment need to move out to those areas, or is it we need to see 10%, 12% price increases? How are we thinking about the moth balls generally?

I think generally, as we mentioned, we have land -- all on a continuum on probably from 1 to 10 years, but most of it somewhere in the three to five year range, my perception is; and as the depleted, as the lot supply -- the finished lot display becomes depleted and that's going to be one driver. The second driver is, is clearly the land component of a finished lot today in many markets is nominal, and so as a result, we're going to have to have some increase in housing prices to justify being able to pay the land seller something for their land or for our land, have the value that we got on it on our books today in order to bring it into development. So I think it's a function of two things. But clearly, we're depleting the finished lot supply. As we deplete that finished lot supply, we're going to have to start developing lots. And as a result, there's going to be some increase in the value of housing prices as that depleted lot supply occurs and land will become developable for us that we've got moth balled.

Our last question comes from the line of Jade Rahmani with KBW. Please proceed with your question.

Hi, just two quick follow-ups. One is on the watch list. I didn't hear you give a brief update, or if you care to share that. Then secondly, the FHA regionally, disclosed additional risk reduction steps, including requiring indemnification from certain lenders. Wondering if you think that could have any impact.

Jade, on the watch list, we had a watch list of $363 million at the end of December, which is slightly up from $354 million at the end of September. But primarily, that's been pretty much in line and that's reflective of the more stable market conditions we've seen. Have not seen a lot of change in that, and that showed up as low impairments this quarter.

Okay, and then just the FHA, on their additional requirements for lender indemnification. Anything on the FHA?

We haven't seen anything, or had a chance to evaluate that at this point.

There are no further questions at this time. I would like to turn the floor back over to Mr. Tomnitz for closing comments.

Thank you. And thank you for joining our Q1 conference call. As you can tell, we are very pleased with our Q1 performance. And again, we would like to thank all of our DHI team members for a great quarter. And as usual, as I saw on the back of a ship in the harbor recently, to quote, the name of the boat was Never Enough, and frankly, there's never enough performance and good performance from us. And as you can tell, our investors and our shareholders expect more from us. So please go out there. We have a big challenge in Q2, and we expect to be able to achieve profitability in Q2, Q3, Q4, and have a very, very good and profitable fiscal year '12. Thank you.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.