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D.R. Horton, Inc. (NYSE:DHI)

F1Q2011 Earnings Call Transcript

January 27, 2011 10:00 am ET

Executives

Don Tomnitz – Vice-Chairman, President and CEO

Stacey Dwyer – EVP and Treasurer

Mike Murray – VP and Controller

Bill Wheat – EVP and CFO

Analysts

Steven East – Ticonderoga Securities

Josh Levin – Citigroup

Michael Rehaut – JPMorgan Chase

Jonathan Ellis – Bank of America/Merrill Lynch

Carl Reichardt – Wells Fargo Securities

Nishu Sood – Deutsche Bank

Joshua Pollard – Goldman Sachs

Mike Widner – Stifel Nicolaus

John Benda – SIG

Dan Oppenheim – Credit Suisse

Joel Locker – FBN Securities

Alex Barron – Housing Research Center

Jade Rahmani – KBW

Ken Zener – KeyBanc

David Goldberg – UBS Financial

Michael Smith – JMP Securities

Operator

Good morning, and welcome to the D.R. Horton, America’s Builder, the largest builder in the United States, first quarter 2011 earnings release conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) 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.

Don Tomnitz

Thank you, and good morning. Joining me this morning are Bill Wheat, Executive Vice President and CFO; and Stacey Dwyer, Executive Vice President and Treasurer; and Mike Murray, Vice President and Controller. Before we get started, Stacey?

Stacey Dwyer

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, which is filed with the Securities and Exchange Commission. Don?

Don Tomnitz

Thank you, Stacey. As we expected, our first quarter was challenged. The fundamental drivers of demand for the homebuilding industry, the overall economy, job growth, and consumer confidence are still weak even though recent reports show some small improvements nationally.

Our year-ago comps for both sales and closing were very strong due to the original expiration date of the federal homebuyer tax credit. Our divisions worked hard to generate sales and closings during this seasonally slow quarter. And our backlog conversion rate was historically high at 88%, but was below the near 100% or better conversion rates we achieved while the tax credits were in place.

We are hopeful that we will see a good seasonal increase in sales demand in the upcoming spring season. However, given the weak macroeconomic conditions, high levels of existing homes for sale and tight mortgage availability, we remain cautious and realistic in our expectations, and we will adjust our business to compete in the current market conditions. We are prepared for the spring season. We plan to continue to open new communities, adjust our price points and product offerings to the demand we see in each of our individual markets. Mike?

Mike Murray

Our net loss for the quarter was $20.4 million or $0.06 per diluted share compared to net income of $192 million or $0.56 per diluted share in the prior year quarter. Homebuilding pretax loss was $24.1 million, which included $8.4 million of inventory impairment and lot option charges. Financial services pretax income was $4.2 million, which included $1.8 million of recourse expense. Bill?

Bill Wheat

Our first quarter home sales revenues decreased 31% to $761.1 million on 3,637 homes closed from $1.1 billion on 5,529 homes closed in the year-ago quarter. Our average closing price for the quarter was up 4% from the prior year and down 3% sequentially to $209,300. Don?

Don Tomnitz

Net sales orders for the first quarter were down 17% from last year to 3,363 homes. The net sales orders in the prior year quarter included strong demand in October from the first time homebuyer tax credit that was in effect last year. Based on current sales demand and the fact that tax credits were supporting sales last year through April, we expect that achieving positive sales comparisons in the next two quarters will be difficult.

While we remain focused on opening new communities and gaining market share for us to see significant sustainable sales growth, we need to see improvements in the overall economy, the jobs landscape, and consumer confidence. In the December quarter, our average sales price on net sales orders was essentially flat year-over-year at $209,800. Our cancellation rate was 28%. Our active selling communities were up 3% sequentially. Our sales backlog decreased 7% from the prior year to 3,854 homes or $795.4 million. Stacey?

Stacey Dwyer

As we mentioned on our year-end conference call, we expected gross margin pressure in fiscal 2011, as we continued to adjust to the prevailing markets in each of our communities. This was evident in our first quarter results, as our gross profit margin on home sales revenue in the first quarter was 15.6%, down 150 basis points from a year ago period and down 140 basis points sequentially. The margin decline reflected the weaker housing market we continued to experience during the second half of the calendar year. Mike?

Mike Murray

In our first quarter impairment analysis, we reviewed all projects in the company and determined that projects with a pre-impairment carrying value of $26.2 million were impaired, which resulted in $6.4 million of impairment charges, the majority of which were in California and Arizona. We referred to our projects, which have indicators of potential impairment, but were not impaired as our watch list, which represents those projects deem to be of the highest risk for future impairments.

After this quarter’s impairments, our watch list now totals $408.1 million, up from $346.7 million at September with the largest concentrations in California, Illinois, and Florida. Our inventory impairment process in future quarters will incorporate any changes in market conditions and any adjustments we make in our business. Stacey?

Stacey Dwyer

In the first quarter, we reduced our homebuilding SG&A expense, which includes all corporate overheads, both year-over-year and sequentially, to $118.9 million. However, with the decrease in homes closed, SG&A expense increased to 15.5% of homebuilding revenues compared to 11.6% in the year-ago quarter. We will continue to actively manage our SG&A levels relative to our expected number of homes closed. Bill?

Bill Wheat

Homebuilding interest expense was $16.2 million for the quarter, which represented 46% of the homebuilding interest we incurred. We directly expense a portion of our interest incurred when our homebuilding debt level exceeds our active inventory. Our first quarter homebuilding interest incurred decreased 29% compared to the prior year to $35.2 million. We expect that our interest incurred and our direct interest expense to be lower in fiscal 2011 than in fiscal 2010 due to the $1 billion of debt reduction that we achieved last year. Mike?

Mike Murray

Financial services pretax income for the quarter was $4.2 million compared to $6.7 million in the year-ago quarter. 82% of our mortgage company’s business was captive during the quarter. Our companywide capture rate was approximately 62%, our average FICO score was 708, 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?

Don Tomnitz

Our total inventory decreased by approximately $29 million, excluding non-cash impairment charges during the quarter. We reduced our homes and inventory by $66.9 million and increased our investment in residential land and lots by $45.5 million. Our homes and inventory at the end of December totaled 9,100 homes, down 400 homes from September. 1,200 of our homes were models, 5,000 were speculative homes, and 3,000 of these specs were completed. We reduced both our total and completed specs by 200 homes during the quarter. We continue to manage our total homes and inventory relative to our expectations of sales demand, and we offer spec homes primarily to accommodate our first-time and relocation buyers. Bill?

Bill Wheat

Our land and lot purchases remain controlled, and we continue to evaluate our land development plans based on our current sales trends. We have been actively contracting for finished lots to increase our active selling communities, sales, closings, and profitability. In our first fiscal quarter, our total land lot and development investments were $188 million, primarily in finished lots. In fiscal 2011, our spending on finished lots will remain largely dependent on our sales pace while our spending on land and development costs will continue to be at low levels. Mike?

Mike Murray

At December 31, we owned approximately 89,000 lots, of which approximately 24,000 are finished. We control an additional 31,000 lots through option contracts, up 5% from September 30, with a net earnest money deposit balance for these lots of only $12.4 million. We are focused on managing our supply of owned finished lots in line with our sales demand in a low-risk capital-efficient manner. Bill?

Bill Wheat

Cash flow from operations for the December quarter totaled $49.5 million, generated by the decrease in homes and inventory and mortgage loans held for sale, partially offset by a decrease in payables and liabilities and our spending on finished lots and development. We ended the quarter with $1.5 billion of homebuilding cash and marketable securities. The balance of our public notes outstanding at December 31 was $2 billion, which reflects the repurchase of $62.5 million of notes during the quarter. Our note maturities in fiscal 2011 and 2012 are $177 million and $133 million respectively. We have $421 million remaining on our debt repurchase authorization at December 31, 2010. Stacey?

Stacey Dwyer

At December 31, our homebuilding leverage ratio, net of cash and marketable securities, was 17%, an 11 percentage point improvement from a year ago. Gross homebuilding leverage at December 31 was 43.9%, a 9 percentage point improvement from a year ago. These leverage improvements are due primarily to our significant debt reductions and cash flow generations. Don?

Don Tomnitz

There are still challenges in the homebuilding industry; rising foreclosures, significant existing home inventory, high unemployment, tight mortgage lending standards, and weak consumer confidence. However, as we have mentioned before, new home inventory remains low, interest rates are favorable, and housing affordability is near record highs.

In addition, we are beginning to see small improvements in national consumer confidence and unemployment although their impact varies significantly from market to market. In two weeks, the spring selling season beginnings in earnest, and we will begin to get a much better read on demand. We will also see if the small improvements in consumer confidence and jobs are sustainable.

Over the last three years, D.R. Horton has increased our national market share of new home sales by 50% from 3.8% to 5.8%. Our long-term strategy has proven successful throughout the downturn, and we will continue our focus on providing affordable homes, increasing our number of active selling communities over a broad geographic footprint, controlling our costs, maintaining our strong balance sheet, and profitably outselling our competition in each and every market and community.

This concludes our prepared remarks. And we’ll now entertain questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is coming from the line of Steven East with Ticonderoga Securities. Please state your question.

Steven East – Ticonderoga Securities

Thank you. Good morning, everyone.

Don Tomnitz

Good morning, Steven.

Steven East – Ticonderoga Securities

If you look at your gross margin decline, it sounds like you’re really just trying to hit the market and then sending what you think is an appropriate way. Am I interpreting that right? And can you talk about what your spec strategy is moving forward? I know last spring you had lot of specs that you wanted to put out into the market because of the tax credit. Has your thought process changed? Are you trying to reduce that spec and the gross margin impact moving forward between incentives and specs?

Don Tomnitz

You’re correct that we have had a strong spec strategy. I would say to you that our gross margin decline really is a function of the competition in the marketplace, as one of my regional presidents stated also as it doesn’t do any good to have an unrealistic gross margin out there on the house of – it is above what the market is going to pay. So we have adjusted our gross margins on a market-by-market, subdivision-by-subdivision, and house-by-house basis. We have reduced our specs on our total inventory this quarter. I would say to you that that will probably increase at the end of the next quarter depending upon our sales, but we are loaded – locked and loaded, as I say, with our specs on the ground anticipating a much better spring selling season than our past sales have reflected. So I think we’re definitely ready for the spring selling season.

Steven East – Ticonderoga Securities

Okay. And then on – along those lines, have you all started to see any uptick in traffic you had or is it just too early for you? I know you said a couple weeks from now you’ll have a better, but just sort of what you’re seeing in your early take. And the other question is, where you think community growth goes this year and how much land spend do you think you have to put into it?

Don Tomnitz

I’m not a big traffic guy, but D.R. is on the road this week and has been going through Louisiana and Alabama on his way to Florida. And he is happier than I’ve heard him in a long time, and it’s been based upon the amount of traffic that he is actually seeing in our model homes. So I would say to you that based upon his input and my input being on the road, we are seeing more traffic. And I think that’s a very good thing in terms of where we see the market coming for this spring selling season.

Steven East – Ticonderoga Securities

Absolutely. And on the community growth and the land spend?

Bill Wheat

Yes, Steven. In terms of active communities, our strategy is to continue to increase our community count. Obviously we have older communities rolling off. So there is a netting effect, but our strategy is to continue to try to incrementally improve our communities. Active selling communities were up 3% sequentially this quarter, up about 18% year-over-year. So that continues to go. In terms of our land and lot spend, essentially on our finished lots, we’re basically replenishing the lots that we are selling through. Our finished lots supply has changed a whole lot. If we see better sales, we would expect that to start increasing to max those sales. Our total spend on finished lots, land and development this quarter of $188 million is basically roughly in line with the pace that we spent last year. We spent a little over $800 million last year. So I wouldn’t see a major shift in that unless we see a major shift in the sales pace.

Don Tomnitz

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

Stacey Dwyer

Just one more piece of color around the specs, last year at this time, we were running at 63% spec. So we were definitely anticipating some increased demand from the tax credit. This year we’re at 55%. So you are seeing us keep that a little bit lower.

Steven East – Ticonderoga Securities

Thank you.

Operator

Thank you. Our next question is from the line of Josh Levin of Citigroup. Please state your question, sir.

Josh Levin – Citigroup

Good morning.

Don Tomnitz

Good morning.

Josh Levin – Citigroup

On the last call, I guess you called a big what to do. You said that you did not think that new home sales would be all that great in 2011. Relative to what your view was in the last call, have you seen anything to really change your opinion at the margin, either more pessimistic or optimistic?

Don Tomnitz

No. I think we are very factual, and I think when we – clearly when we – our fourth quarter conference call proved up on our fourth quarter results were, I don’t see anything in ’11 that’s going to make ’11 better than ’10. And I think that we’re still realistic in terms of we need job growth, we need consumer confidence, and we still have issues with qualified people with tighter mortgage underwriting. So I think 2011 will be a marginal weak year in the homebuilding industry. Our goal is still to be profitable in 2011, and we are going to struggle more in ’11 than we did in ’10 to be profitable.

Josh Levin – Citigroup

Okay. And just to follow up on the gross margin going forward, Stacey, you talked about 2011 facing some margin pressure. How should we think about gross margin for the year? I mean, is there still more pressure to come you think?

Don Tomnitz

Well, I would say to you on the gross margin side, clearly we’re going to be competitive in the marketplace, as we have always been. And going into the second quarter, we do have, even though our spec count percentage is down. We still have 55% of our inventory out there as specs. We do have some aged inventory that we want to move. So I would say to you that being competitive, given our inventory and given some of our aged inventory, I think that our margins will continue to be under pressure in the second quarter.

Josh Levin – Citigroup

Thank you very much.

Operator

Thank you. Our next question is coming from the line of Michael Rehaut of JPMorgan Chase. Please proceed with your question, sir.

Michael Rehaut – JPMorgan Chase

Thanks. Good morning, everyone.

Don Tomnitz

Good morning.

Michael Rehaut – JPMorgan Chase

First question, on the – some of the comments that you said right at the beginning of the call seems to be, I don’t know, maybe in some ways a little contradictory to the more cautious tone where – at the beginning you said maybe there are some signs of improvement. You just mentioned the traffic being little better. You’re hopeful. At the same time, gross margins being where they are and it’s still being a tough environment. How you’re supposed to – how should we think about reconciling that? I mean, obviously it’s still a tough environment, but I guess those signs and that hopefulness, given that you’re still fairly pessimistic it sounds like, where are you getting those signs and hopefulness, I guess, is the question.

Don Tomnitz

Well, first of all, I’d say that we’re realistic as opposed to pessimistic. And secondly, I think you can reconcile very simply. The first quarter is our seasonally long quarter for the entire fiscal year. And so we’re lower than at the bottom of the ocean right now. And if we can’t be optimistic after our worst quarter seasonally, there would be something wrong with us. So we are optimistic relative to where we’ve been and where we are today in terms of the fact that there is going to be a better market in the second and third quarter than what we’ve experienced in the first quarter in terms of sales and closings.

Michael Rehaut – JPMorgan Chase

Okay, fair enough. Second question on the gross margins, just to go back to that for a moment, it seems like you continue to adjust to the marketplace. Do you feel that the gross margins will be more dominated by the continued pricing trends or incentive levels, or do you anticipate – how do you think about land costs though as that impact? And did that have any play in the first quarter decline from 4Q in terms of the step-down?

Don Tomnitz

Our margins are going to continue to be under pressure based upon the competitiveness in the marketplace. We are outselling everyone else in the industry. We are going to continue to outsell and out-close everyone else in the industry. We are better positioned than anyone else in the industry. So, as a result, as I’ll quote one more time, David All [ph], it doesn’t do any good to have an unrealistic gross margin on a house if the market perceives to this overprice. So we are trying to control our cost as strongly as we can, and we are trying to meet the market in each and every sale that we have. So as a result, depending upon what every other builder is going to be doing out there, which were all fighting for market share, were all fighting for a limited number of sales in the marketplace, I think over the next couple months there’s going to be some extreme competition in the marketplace. But again, we’re going to continue to outsell and out-close everyone in the market.

Michael Rehaut – JPMorgan Chase

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

Stacey Dwyer

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

Don Tomnitz

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

Bill Wheat

Basically, we’ve been in a market for the last six months where demand has been at a very low level. So therefore the competition for that low level of demand has been intense, and I think that’s reflected in the margin. As we go through the year, we see some seasonal increase. Hopefully, some higher level of volume in the marketplace would help to provide some stability for margins, but we will see. We do expect it to be very competitive continuing through the year.

Michael Rehaut – JPMorgan Chase

One last quick one, if I could squeeze one in on community count, you said it’s up 18% year-over-year in the first quarter. Should we expect a similar type of year-over-year type of trends, up 15% to 20%, let’s say, for the fiscal ’11 on average?

Don Tomnitz

I think that’s going to be difficult to achieve, but I will tell you this that we are out there trying to do every option deal on finished lots that makes sense to us in the market, and we’re beginning to go further and further out from some of our core markets and given to other areas where there are finished lots albeit perhaps not as desirable as our core markets. But we’re trying to drive buyers out to those markets by offering a more competitively priced product.

Bill Wheat

Yes, Mike, last year you saw us ramp up our community count rather dramatically on a sequential basis throughout the year. While we continue to expect to increase our community count, we might not be increasing it sequentially as dramatically as we did a year ago. So the year-ago comparisons may start to moderate a bit, but again we expect to sequentially continue to try to increase our community counts.

Michael Rehaut – JPMorgan Chase

Great. Thank you.

Operator

Thank you. Our next question is coming from the line of Jonathan Ellis of Bank of America/Merrill Lynch. Please proceed with your question.

Jonathan Ellis – Bank of America/Merrill Lynch

Thank you. First question, just want to ask about – you talked a little bit about the tighter mortgage underwriting standards. There didn’t seem to be any material change in the cancellation rate this quarter. So I’m wondering – is the expectation – perhaps there’s a pickup in cancellation rates in the coming quarter. And then the related question being, you said you are seeing tightening standards, is it more from the Fannie-Freddie side, or FHA?

Stacey Dwyer

The tighter mortgage lending standards is really just a continuation of everything we’ve seen throughout the downturn. Banks are getting a lot of pushback right now from Fannie and Freddie. And since we don’t bank our mortgages, we basically are using the underwriting standards that are given to us by the banks who will take our mortgages. And so I wouldn’t say there is anything significant that’s changed recently or that we see going into spring. But compared to the easy credit that was available when we were seeing the rise in prices and a really strong demand, it’s a tighter mortgage environment. And that still remains our number one reason for cancellation right now.

Jonathan Ellis – Bank of America/Merrill Lynch

Okay. Great. And then just my second question, can you share with us, I think you did last quarter, percentage of deliveries and orders from new communities in the quarter? And then also a related question, as you talk about community count growth for the coming year, any sense based on where we stand today, whether that community count expansion may be more back end loaded and front end loaded in terms of the sequential change? Thank you.

Bill Wheat

Yes. We’ve been talking for a while now about the number of our sales and closings that have come from communities that we contracted for beginning in fiscal ’09 or later. Clearly, that has become a much bigger part of our business. This quarter we have ticked up to around 50% or better in terms of both sales and closings that have come from those communities. So now that has really become our business, and that will continue to grow. Of course, we start to see some of those ’09 communities start to roll off as well. So that’s a survey statistic that we still have. It’s not becoming – it's not quite as relevant today, and we would expect it to become even less relevant in future quarters as that’s now really – that really is our business.

Stacey Dwyer

Go ahead, Jonathan.

Jonathan Ellis – Bank of America/Merrill Lynch

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

Stacey Dwyer

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

Mike Murray

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

Don Tomnitz

But again, as I said, we’re going further and further out from our core markets where there are plenty of developed lots and on a very selective basis and trying to offer the buyer a more competitively priced house further out. And so I think that we will add communities like that, but it’s not going to be as much as what we’ve added in the past. But there were so many core subdivisions that were available at one point in time. Those are beginning to decrease in number.

Jonathan Ellis – Bank of America/Merrill Lynch

Okay. Thanks, guys.

Operator

Thank you. Our next question is from the line of Carl Reichardt of Wells Fargo Securities. Please state your question, sir.

Carl Reichardt – Wells Fargo Securities

Hey, guys. How are you?

Don Tomnitz

We’re great. Good morning, Carl. I guess you surprised me this morning. I walked into Stacey’s office, and you must be taking happy pills.

Carl Reichardt – Wells Fargo Securities

More in the morning. Bill or Don, the watch list increased in the quarter, sequentially up. Is that a function of communities that you purchased relatively recently, not meaning your standards, or is that a function of the broader market? I guess I’m trying to figure out if that’s really related to new stores or related to older stores to the extent the watch list would increase.

Bill Wheat

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

Don Tomnitz

And where that happened primarily was inland California where we did enter into some deals in early ’09, and they didn’t prove to be as good as the olds as what they should be. And post the tax credit environment, inland California dried up and has blown away. I don’t think you can find it anymore.

Carl Reichardt – Wells Fargo Securities

Okay. And the store count increase, as you’ve indicated, sort of more aggressive in the second quarter versus the rest of the year, is there a concentration where you’re expecting to see the store count and the stores increase in number, or is that more broad across the business?

Don Tomnitz

Clearly, where we entered into most of the – the majority of our deals is in our Eastern region, which is in Florida, the Carolinas, Georgia, Alabama and even in Northwest (inaudible). Just obviously fought her, but primarily that’s where we’ve entered into most of our deals today.

Carl Reichardt – Wells Fargo Securities

Okay. Great. Thanks, guys.

Operator

Thank you. Our next question is from the line of Nishu Sood of Deutsche Bank. Please go ahead with your question.

Nishu Sood – Deutsche Bank

Thanks. My question I wanted to ask was on the gross margins as well. You folks described that you are responding to market conditions and so that’s what led to the gross margin deterioration in the December quarter. I just wanted to understand a little bit better. Demand has obviously been quite weak since the end of the tax credit. So weakness would have affected the third quarter as well, and yet you are – I’m sorry, your September quarter. And your September quarter margins were stable. So I just want to understand the delta in terms of the weakness and how you’re responding to it, maybe what types of incremental pricing or incentive strategies you are using that led to delta between the September quarter and the December quarter.

Don Tomnitz

I’ll start off by saying one of the reasons for the delta is, as Bill mentioned earlier, is that our ’09 communities are obviously getting older. They were entered into at a higher lot price than what subsequently we’re able to get lots in some of those markets. And D.R. has said on a number of occasions, the second leg down in the homebuilding industry started May 1st as the tax credit – it's the second tax credit expires. So I think it’s a focus of – it's actually expiring, but not as much pricing power in the marketplace because obviously our sales have come down. But secondly, because the ’09 lot deals with the second leg down in the homebuilding industry where the lot prices were richer than what they ultimately needed to be.

Bill Wheat

And we have – while this – the leg down in margin this quarter was more dramatic than we saw last quarter. If you go back to our margins in the first half of ’10, second quarter specifically, we were up around 18%. It did step down to the low-17s in the last two quarters. And so I think what you’re seeing this quarter is you’re seeing the impact of the tougher selling environment as we went through the summer. And the sales environment that we had in the summer and into the early fall have been showing up in closings more than in the fall season through the December quarter. So I think it’s – while it’s not an even ratable decrease each quarter, I think it’s reflective of the topper sales environment we saw beginning May 1st on through the summer and into the fall.

Nishu Sood – Deutsche Bank

Got it. Got it. And so second question is following up on what you were talking about with Carl. The community count expansion that you folks have had has been in – as you mentioned some places like Alabama, obviously a lot of communities there, places like Utah. And then places where a lot of builders have been expanding communities like Florida. So your breadth of community expansion is much, much broader than the other builders. I wanted to get an understanding of what you are seeing that leads to this kind of broader footprint for a community expansion? Is that D.R. Horton kind of specific model issue, or what – why you’re finding opportunities in place that others aren’t?

Don Tomnitz

Well, I’d say, first of all, that we start off with a strong cash position. Secondly, we had a goal of continuing to aggregate the national market share, which we have done. And thirdly, we are willing to build specs in our communities. So when we go to a seller of lots whether it be an individual or a corporation or a bank, we are certainly with our business model to preferred buyer of those homes. And we do maintain more specs per community than most builders largely to accommodate that first time homebuyer or that relocation buyer, as well as the realtors who basically want to bring our customer into our home and collect their commission as quickly as possible, and that doesn’t work very well for them when you’re taking 90 to 120 days to build a build job. So, as a result, I think those factors clearly make us the preferred buyer.

Nishu Sood – Deutsche Bank

Okay. Thanks a lot.

Operator

Thank you. Our next question is coming from Joshua Pollard of Goldman Sachs. Please state your question.

Joshua Pollard – Goldman Sachs

Hey, good morning to you all.

Don Tomnitz

Good morning.

Stacey Dwyer

Good morning.

Joshua Pollard – Goldman Sachs

I would like to hear a little bit about what the strategy is on SG&A if you guys look back maybe a year ago, you guys were very confident in your ability to be profitable partially because of the solid environment you are expecting, but additionally because of the work you guys were doing on the SG&A front. If the sales environment doesn’t quite pick up as you might expect in the first couple of quarters of this year, what’s all in a bucket of quick to cut for you guys? And if you could quantify, that would be very helpful.

Don Tomnitz

First of all, I will say to you that we’re extraordinarily proud of our SG&A in terms of total dollars, which we’re right at about $118 million for the quarter, which that includes everything, including corporate. And secondly, it’s down from the previous quarter. Thirdly, I would say to you, we do a lot of analyses around comparing ourselves to others. But if you look at the fact that the number-two or number-three builder in the country is closing – we're closing about 30% more homes than they, and we’re running the same total dollars of SG&A. I think that’s an extraordinary accomplishment.

Having said all that, clearly the first quarter was our weakest quarter. We’re prepared for a better selling season in the second and third quarter. And basically, there are core SG&A costs that are associated with expecting that our sales and closings in the second quarter and the third quarter. Clearly though we’re unhappy at 15.5%, I think is the number. And we’re going to focus on working that down if the sales don’t materialize as we expect them to do, because 15.5% to us is totally unacceptable.

Joshua Pollard – Goldman Sachs

Could you quantify how much you guys cut over the course of a one to two-quarter period, if you saw about that things weren’t as robust as you had hoped? I’m just trying to get a sense of what the labors are, and what you guys could cut that we deal with in fiscal 2011 versus things weren’t as robust, what would have to wake before showing up in your income statement until fiscal 12?

Don Tomnitz

Couple of thoughts. One, don’t forget that when we started all this, we had $1.5 billion of total SG&A in the corporation. And we thought we have done a good job when we cut it to $0.5 billion of total annual SG&A. Now we’re running closer to about $480 million worth of SG&A, and that’s coming down. So we definitely have the ability and we have the guts to cut as we move forward in terms of dollar specific or more focused on the percentage of our SG&A as a part of our revenue. So the revenue portion of the SG&A is also very important to us. But if the sales don’t materialize, then there will be subdivisions, which include salespeople and some superintendents who we won’t need because we’ll be closing down those communities if the sales don’t materialize as we expect them to do.

Joshua Pollard – Goldman Sachs

Understood. My one last question is around mortgage put-backs. I didn’t see any information in the press release on it. Could you talk about what your most recent experience had been into the close of the year? And also if you could discuss, how the Countrywide deal with Fannie and Freddie, how that may affect your go-forward potential mortgage put-back rates? Thanks a lot, guys.

Bill Wheat

We really haven’t seen much change in our activity there. We had total recourse expense in our financial services operation of $1.8 million during the quarter. Our total reserve balance for – on the mortgage company is $36.2 million, which was slightly down couple million dollars from the previous quarter. So really we haven’t seen much change in the activity at all, but that’s something that is continually evolving. It’s difficult to know what impact some of these bank settlements and interplay between the banks and Fannie and Freddie may be. But it’s something that we’re in touch with on a regular basis, and we’re monitoring and we will react as needed [ph].

Don Tomnitz

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

Operator

Thank you. Our next question is coming from Mike Widner with Stifel Nicolaus. Please proceed with your question.

Mike Widner – Stifel Nicolaus

Hey, good morning, guys.

Don Tomnitz

Good morning.

Mike Widner – Stifel Nicolaus

Let me – most of my questions have been answered. But let me follow up on something that you guys just brought up, the SG&A expense levels. And you guys kind of brought up the peer comparison. So, certainly the expense cutting has been pretty impressive, but you got another peer that reported this morning that’s actually down in the single digits in SG&A as a percent of revenue. It’s has been running at that level for at least eight quarters now, which – and you guys kind of talk about over the long-term, if things get better, you guys targeting 10-ish percent, at least you have in the past. So just wondering if you could sort of reconcile all those. What’s your expected level as we get kind of closer back to a run rate environment, high-single digits or low-double digits, 10-ish? And since you brought the peer comparison in that, why?

Don Tomnitz

I’d be glad to answer that question. First of all, our goal certainly is to get our SG&A as a percentage of revenues back into – out of the teens and back into the 12s is certainly our goal. I’d say, secondly, and we obviously compare ourselves to all of our peers and some of our people who are not our peers. And that company that reported today has done an excellent job. I would say to you though, what this company – D.R. Horton is focused on is we have continued to maintain our geographic footprint. We’re still in 26 stated and 72 markets. And we are positioning and have positioned and will continue to position this company to take advantage of the upturn in the housing industry. And I will say to you that when the upturn in the housing industry comes that we will be much better positioned and – much better position to generate profits in some deliveries in three or four states.

Mike Widner – Stifel Nicolaus

I think that’s it. Good answer, and I kind of agree with you and all of that. One other thing that you brought up early in your comments, you mentioned market share. I guess first quick question is, what are you using to measure? It sounds like the numbers you threw out are sort of deliveries or orders as a percentage of new home sales. Is that the measure you are kind of going by?

Stacey Dwyer

Right. We check our latest 12-month sales for each of the last years ended December. And compare that to the national new home sales numbers that were reported.

Mike Widner – Stifel Nicolaus

Okay. So I guess just a follow-up on that. Again, because you guys brought it up, I mean, then your home sales number, it’s certainly not the most accurate number out there. But it’s probably one of the better ones that we have. You actually were in the 4.7% market share range back in 2006. So while you are certainly impressive – last year at good market share growth. Certainly, the tax credit, as you have acknowledged, had a lot to do with that.

And if we look at where you stood kind of last quarter, fiscal – your fiscal first quarter, this last calendar quarter. You were kind of down more tax credit behind us in the high 4% range. And so I guess I’m just looking for your views on whether the market share gains that you’ve got in the past year are sustainable. Are they going to continue in the absence of the homebuyer tax credit? If, in fact, you are confident about that or if you potentially you face the fact that you benefited from some pull-forward in that market now that it’s going to be tough to maintain share, let alone grow share, given the kind of market segment focus that you guys have?

Don Tomnitz

I’ll let Stacey deal with the numbers, but just as a general observation. Let’s not forget that it was not a D.R. Horton federal tax credit, but it was a national tax credit. So, as a result, it benefited all builders out there in the marketplace. So, notwithstanding the fact that some of our market share gains may have come from the tax credit nevertheless everybody else out there was benefiting from the tax credit as well.

Mike Widner – Stifel Nicolaus

Well, true. But I mean, certainly, the spec focus and the first time buyer focus that you guys have benefited disproportionately, kudos to you. I mean, fantastic job. But I think you did benefit more than those.

Don Tomnitz

And if you are giving us credit for our business model by focusing on the first time homebuyer, we basically was a bigger percentage of the buyers that I agree with you. But as we’ve always in this company focused largely on the first time homebuyer, and we still believe that on a go-forward basis, that’s the best buyer in the marketplace today. I’ll let Stacey to talk about the percentages.

Stacey Dwyer

Yes. The percentages have actually bounced around if you go back. If you go back to 2004, we were 3.9% in the market and now at 5.8% in 2010. That’s still a significant increase. Do we expect to keep all of the gains that we’ve achieved? In certain markets, we probably can hang on to those. In other markets, as credit becomes more available to the private builders and as the luxury and move-out segments of the market where we focus a little less come back, we may give up some of those market share gains. Right now, it continues to be a market share gain for us in the (inaudible), which is the most active buyer segment.

Don Tomnitz

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

Mike Widner – Stifel Nicolaus

Thanks, guys. Appreciate the candor, and I think you’ve done well on those fronts. So, congrats on a solid couple years actually as we continue to recover.

Don Tomnitz

Thank you. It’s not good enough, but we’re working on it.

Operator

Thank you. Our next question is coming from the line of John Benda of SIG. Please state your questions. Mr. Benda, your line is open for question.

John Benda – SIG

Hello.

Stacey Dwyer

Hello?

John Benda – SIG

Hey, good morning. How are you doing today?

Don Tomnitz

Good. Good morning.

Mike Murray

Good morning.

John Benda – SIG

Sorry about that. Just a quick question on your watch list, can you break that down by geographic segments with that information?

Don Tomnitz

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

Bill Wheat

The largest concentrations would be in California, Illinois, Florida, Arizona, New Jersey and then Texas, in descending order of proportion.

John Benda – SIG

Okay. That’s very helpful. And then talking about the spring selling season, are there any markets that stand out as – are going to be more robust than others and how do you feel your presence is there compared to some of the competitors in the market?

Don Tomnitz

Well, I would say our broad geographic footprint, as I said before, 26 states and 72 markets, we’re well prepared for the spring selling season in all of those markets. It’s hard for me to answer it, and I’m not going to get into as one of my (inaudible) trying to raid each market, I think what we told you clearly was that so far it looks like inland California and the Carolinas are weaker markets for us today. But we expect those markets sit with the exception of the entire colleagues that Inland Empire. We certainly expect a lot of the Carolinas in the next two quarters relative to what they produce for us this last quarter.

John Benda – SIG

All right. Thank you.

Operator

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

Dan Oppenheim – Credit Suisse

Thanks very much. I was wondering you talked about how D.R. is out into markets right now and is happier (inaudible). What do you need to see in terms of thinking about controlling more land via options? What do you need to see a lot of real progress in the orders in the spring, just how you’re looking at that overall and how much you’re putting into sort of the optimism from just the traffic here so far?

Don Tomnitz

Well, let me answer the question on the option deals. We are trying to tie up every option deal that makes sense to us irrespective of where it’s located, subdivision, state, city, whatever. But if it makes sense to us, we’re going to tie it up and try to make money building and selling and closing homes. The optimism out there, I will tell you, as you travel around and Mike Murray and I were in California and we were in Portland together and we’re about ready to go to Carolinas on Sunday and travel around.

It’s disheartening as you are going through subdivisions if you are not seeing a lot of traffic, and we typically are in those subdivisions on a weekend because it helps us gauge the traffic because that’s what most of the traffic, specifically in the sales offices on the weekend. So I think what D.R. is clearly saying is, hey, he is seeing easing traffic during the week and subdivisions, so he is travelling through in Alabama and Louisiana and Nevada. So as a result, that bodes well. I mean, that’s why it’s feeling good, that’s we’re all feeling good because we can’t sell somewhat a home who doesn’t show up in our month. But the traffic is a good thing right now.

Dan Oppenheim – Credit Suisse

Great. Okay. Thanks very much.

Operator

Thank you. Our next question is from Joel Locker of FBN Securities. Please proceed with your question.

Joel Locker – FBN Securities

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

Stacey Dwyer

In terms of a year-over-year comp, we probably will continue to see declines in our backlog conversion rate. When the tax credits were not in effect and going back a little bit historically, 55% to 70% conversion rate is very normal for us. Now, with higher level of specs going into the second quarter, depending on the sales that we see and the timing of those sales, because the mortgage qualification process is now almost a minimum of 30 days. And then we have inventory that’s available that could help that conversion rate. But in terms of cheating the conversion rates we did last year with the deadlines in place that people had to close by to get tax credits. You probably won’t see the same conversions.

Joel Locker – FBN Securities

Great. And did you have some of the backlog drop-off because of higher interest rates or harder to qualify?

Stacey Dwyer

We have the cancellation rate at 28%. It’s primarily going to be qualification. I didn’t hear anything specifically from our mortgage company or division in terms of any other cancellations being rising interest rates.

Joel Locker – FBN Securities

Right. And just one last question on, do you have a number for customer deposits in the quarter?

Don Tomnitz

While she is looking that up, I’d also say, our cancellation rate, even though it is 28%, doesn’t concern me. Clearly, I’d like to have it at 18% or 19% where historically was during the good days, but our salespeople have been instructed, don’t worry about qualifying them. Right the contract and then turn it over to the mortgage company and let the mortgage company qualify him. So, as a result, what we’re trying to do is make certain if we have a buyer in front of a sales person that we write that buyer and take them out of market. I’m trying to get them qualified.

Stacey Dwyer

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

Joel Locker – FBN Securities

$9.4 million. All right. Thanks a lot, guys.

Stacey Dwyer

Thank you.

Operator

Thank you. Our next question is from the line of Alex Barron of Housing Research Center. Please state your question.

Alex Barron – Housing Research Center

Hey, good morning, guys. How are you?

Don Tomnitz

Good morning, Alex.

Alex Barron – Housing Research Center

I have a question regarding your comments about having to go out further and look for land. I think last year, my understanding is that you guys were – well, in 2009, you guys were one of the early moves finding land deals and then somehow everybody jumped in the bandwagon I guess late ’09, early 2010. And my understanding is the land prices went up, so my question is, is the reason you’re having to go out further because most of the land and the better places have been tied up. And there is no more or is it because of the land prices are high and sellers aren’t coming down.

Bill Wheat

I think as a combination of both things, clearly there is a finite amount of completed loss, and we obviously a finite number of completed lots in the core markets. And so as a result, as the builders queue-up those finished loss, then we’re having to go out to the next concentric circle and look for those loss, as well as clearly as the supply is diminishing, the sellers, whether they be banks or whether they be individuals, are asking slightly higher prices. So it’s a combination of those things in addition to trying to provide clearly the buyer with the most competitive priced value in the marketplace for maybe a little bit better drive and more difficult to qualify if we can offer them also the lesser price, same quality, then we’re going to do that.

Alex Barron – Housing Research Center

My second question is with regards to your overall strategy, it sounds like you guys are – as you said, being realistic about the current market conditions. So if they persist for, let’s say, another year or two, lastly you guys focused on buying down debt. Is the focus going to remain the name that generates cash to continue to pay down debt, especially since you are not really buying land for developing and installing.

Don Tomnitz

That’s still part of our focus today, Alex, in terms of the use of our cash, we are still out there reducing our debt. We are focused on being as efficient as we can with our cash, but we don’t expect to see the same level of cash generation. And depending on the sales level, we’ll depending on a level-of-investment in our inventory. But we do continue to focus on our balance sheet, and we want to maintain the strength of that balance sheet because we think that provides us a good position to respond when we do see some improvement in the marketplace.

Alex Barron – Housing Research Center

Got it. If I could squeeze in one last one, what’s driving up the watch list? Is it prices are going lower or is the sales pace is going lower?

Bill Wheat

Alex, I think it’s primarily some margin compression and some sales pace that we saw in the quarter. It’s a kind of a sensitive relationship. When you see margins drop, you would expect to see that the watch list improve or the watch list increase.

Alex Barron – Housing Research Center

Got it. Okay. Thanks a lot.

Operator

Thank you. Our next question is from Jade Rahmani of KBW. Please proceed with your question.

Jade Rahmani – KBW

Thanks for taking questions. I wondered if you could comment on raw material costs by some measures. Lumber, for example, was up close to, I think, about 10% last quarter. And I was just wondering if you’re seeing any pressure there and what the time ladies and gentlemen might be on where you could see some margin impact from raw material prices?

Don Tomnitz

I think the good thing about commodity prices based on what I’ve seen in the market the last couple days is that commodity prices are beginning to come up all-time highs. lumber prices, we have good relationships with our lumber suppliers. We typically lock I our lumber prices for a period of three to six months. And clearly we have higher lumber prices working their way through our closed homes now. And so that had some impact on our gross margins negatively. But I’d say to you that lumber prices, as many years as we’ve been on this business, they always have a tendency to speak about this time of the year, and then they have the tendency to decline throughout the rest of the calendar year. So I anticipate that the lumber prices will begin to come down through this quarter and the next two quarters.

Stacey Dwyer

And we continue to have good dialogue with all of our vendors across all the product categories. And the consistent thing is everyone would like to reach their process. We would low to be able to accept those price increases, but right now in a depressed sales environment where we’ve seen very low volumes in 2010 unless repeat some list in 2011, we’re going to be at the negotiating table still with our vendors trying to keep those products, they are all over.

Jade Rahmani – KBW

Joining a flat sales environment, say, for 2011 versus 2010, because of the tax credit. But then based on economic improvement, are you expecting the D.R. Horton to see higher year-over-year raw sauce.

Stacey Dwyer

Probably on average, nothing is significant. There will be certain categories that will move, both up and down. And our goal is to balance that and to continue to keep our costs relatively flat.

Jade Rahmani – KBW

All right. Thank you very much.

Operator

Thank you. Our next question is from the line of Ken Zener of KeyBanc. Please proceed with your question.

Ken Zener – KeyBanc

Hello.

Stacey Dwyer

Yes.

Don Tomnitz

Hi, Ken.

Ken Zener – KeyBanc

Don, in the past you talked about bringing the Wal-Mart builders. So, is it fair to say now that you are perhaps now the dollar general as you enter these non-core markets, which largely explains the different gross margin trends between you and others? So basically turns versus margins versus the risk that you are now taking on non-core markets?

Don Tomnitz

First of all, I would say to you that we’re just beginning to go into these non-core markets as we try to continue to generate houses at a price more affordable than what the core markets are providing us the opportunity to. So I would say to you that –

Ken Zener – KeyBanc

10% of closings?

Don Tomnitz

Say again.

Ken Zener – KeyBanc

10% of closings?

Don Tomnitz

Less than that.

Ken Zener – KeyBanc

Okay. Thank you.

Don Tomnitz

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

Bill Wheat

These aren’t blind moves. I mean, these – we're evaluating each one of those. And as Don has said several times, we are only going to do the deals that makes sense. And it makes sense if there is demand, if there is the potential to get good returns in those communities.

Don Tomnitz

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

Ken Zener – KeyBanc

Okay. I guess, related to that, in your early comments on finished lots, it seems that as finished lots do deplete, whether it’s in the interior markets versus the exterior ones, it could be seen as an inflationary factor for the sector overall or it could be seen as just a rising premium to those that need or want lots, either for volume or to replenish. So if you can make some comments around that. And then, what have you order just indicated about the DTA recovery if you actually do have two consecutive years of profitability in ’10 and ’11, notwithstanding the level of that profitability? Thank you.

Bill Wheat

I’ll start on the DTA discussion. Clearly we need a consistent trend and expectations of profitability. So, to the extent that we do have two years of profitability, we can have some very good discussions with our auditors about the DTA and the recoverability of it. So we would expect if we have a profitable year in 2011 that we would have some discussions around it. Exactly when that timing would be, would be dependent on the level of profitability we have and our expectations for the level of profitability going forward relative to the size of the DTA. So clearly, a profitable ’11 would be good news for the DTA recoverability.

Don Tomnitz

As far as the core markets bringing this award that we don’t use very often in the homebuilding industry, but I will tell you D.R. and I travel around to the extent that we do have a subdivision where there are no other competitors, or no significant competitors. We’re always reminding our division presence, but notwithstanding the fact that we have a 20% gross profit margin goal in each subdivision and each house to the extent that we are the only builder in a core deal. We will, and quoting, I just told too division presence this last week, take your margins at 25% and start asking 25% because there are no other loss that could compete with it.

Ken Zener – KeyBanc

Thank you.

Don Tomnitz

Yes.

Operator

Thank you. Our next question is from the line of David Goldberg of UBS Financial. Please go ahead with your question.

David Goldberg – UBS Financial

Thanks. Good morning, everybody.

Don Tomnitz

Good morning, David.

David Goldberg – UBS Financial

First question, I know you’ve talked about it, I mean (inaudible), but I was wondering if you could give us – when you talk about the traffic that you are seeing in that – kind of see now in the field today, is there a way to think about the quality of that traffic? I know we’ve talked a lot about underwriting standards and tighter underwriting stands, and I’m wondering if the people that are in our communities with folks that can qualify to buy homes in the end or if it’s just kind of people that are attracted by affordability. And might be tougher to convert in the selling season.

David Goldberg – UBS Financial

Well, first of all, I will say to you that just having a unit of traffic show up is a good thing, whether they can qualify or not. Secondly though, if you do have a unit of traffic, it shows up that can’t qualify. One of the things that our mortgage companies doing an extraordinary job, and that is we’re recruiting those buyers into our homebuyers and helping them work their way through the financial morales of how do I improve my credit. And we’re graduating a lot of those buyers and they are – about 80% of them are ADR (inaudible) homes. So I would say to you, we loved our unit of traffic. That’s well qualified. And if it’s not we’re willing to work with them to help them get qualified. And then maybe a three-month process and maybe a six-month process, but we are graduating those people and selling 80% of them at D.R. Horton.

David Goldberg – UBS Financial

All right. That’s that. It’s just really good idea.

Don Tomnitz

Thank you.

David Goldberg – UBS Financial

My follow-up question was actually and maybe a little bit of a follow-up on one of the earlier questions. I know you said change your underwriting standards based on geography. Do you change them on based on outlook? In orders, if you are maybe more or less pessimistic as you look forward, is it impacting your underwriting standards in a market=-specific area.

Don Tomnitz

We have a pretty hard and fast underwriting guidelines here, and really what it centers around is a 20% gross profit margin. Do we approve some deals that has an 18% upfront gross margin. We do. But I would say that 99% of all the deals that we approve have an upfront day-one 18% or greater gross margins.

Stacey Dwyer

The other factor that got it in there to those, how we allocate our tough-to-capital tier division. So if they are doing a rolling lot option contract, that is their lowest cost of capital allocation. If they are buying land that requires full development or some level of development, that’s a higher risk business. We assign a higher cost of capital to that. It gets factored into the gross profit margin that we are looking at. So in terms of the return on our capital, we’re looking for a higher return, given the higher risk. But the risk is really the land ownership and not the market, because if we do a option deal in a market, we can always walk away from that restructure of the deal. If we own it outright, we can’t do that.

Bill Wheat

And just so we don’t get caught up in a discussion around the BPs and the exact percentages, the 18% to 20% that DT was mentioning is for interest number. So that’s where our divisions are focused on before interest and then ultimately then they factor into based on the timeframe of the deal the ultimate charges that they will incur on their capital.

David Goldberg – UBS Financial

Got it.

Operator

Thank you. We’re reaching the end of our allotted time for question-and-answer session. There’s time for one final question. That question today is coming from the line of Michael Smith of JMP Securities. Please proceed with your question.

Michael Smith – JMP Securities

Good morning, guys. I’ll make this fast. I know it’s been a long call. I’m just curious – we've been seeing some data and also hearing that sales sort of sequentially improved throughout the quarter, and I’m wondering if that was your experience as well. And could you just give some color on what things look like month-to-month?

Bill Wheat

In terms of the year-over-year comp versus last year, we did see improvement each month through the quarter. But in terms of the absolute level of sales that we saw, we did not see increase during the quarter. And we would not have expected to see sequential absolute improvement each month. Seasonally, we always would expect to see declines from the month of October to November to December, and then you start to begin to see that absolute level of volume turnaround in January through the spring.

Michael Smith – JMP Securities

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

Bill Wheat

Yes. Yes, we did.

Stacey Dwyer

Yes.

Michael Smith – JMP Securities

That’s it, guys. I appreciate it. Thank you.

Stacey Dwyer

Thanks.

Operator

Thank you. Mr. Tomnitz, there are no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Don Tomnitz

Okay. Thank you. We appreciate everyone joining on the call. We did not achieve profitability in the first quarter. Our goal is to strive for profitability each and every quarter. As we said earlier, we think that will be more difficult. It will be equally as difficult I think in Q2. We are clearly looking at Q3 and Q4 as the opportunity for us to generate a profit. The spring selling season is going to be here. The Super Bowls in Dallas-Fort Worth metropolitan area and Arlington, Texas. This is our Super Bowl I would tell our salespeople and all of our division presidents and regional presidents. We need to make sure that we win the Super Bowl this year because this is very important to us to be able to report a profitability in fiscal year ’11. So I thank each of you for your hard work. We need to work a little harder and we need to get back to sustained profitability. Thank you very much.

Operator

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

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