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DR Horton (NYSE:DHI)

Q4 2011 Earnings Call

November 11, 2011 11:00 am ET

Executives

Mike Murray - VP and Controller

Bill W. Wheat - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Director and Member of Executive Committee

Stacey H. Dwyer - Executive Vice President, Treasurer and In Charge of Investor Relations

Donald J. Tomnitz - Vice Chairman, Chief Executive Officer, President and Member of Executive Committee

Analysts

Steven Bachman - RBC Capital Markets, LLC, Research Division

David Goldberg - UBS Investment Bank, Research Division

Michael Rehaut - JP Morgan Chase & Co, Research Division

Nishu Sood - Deutsche Bank AG, Research Division

Stephen F. East - Ticonderoga Securities LLC, Research Division

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Daniel Oppenheim - Crédit Suisse AG, Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Stephen Kim - Barclays Capital, Research Division

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Alex Barrón - Housing Research Center, LLC

James McCanless - Guggenheim Securities, LLC, Research Division

Jack Micenko - Susquehanna Financial Group, LLLP, Research Division

Jordan Hymowitz - Philadelphia Financial

Operator

Good morning, and welcome to the D.R. Horton, America's Builder, the largest builder in the United States, Fourth Quarter and Fiscal Year 2011 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Don Tomnitz, President and CEO. Thank you, sir. You may begin.

Donald J. Tomnitz

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.

As usual, before we get started, Stacey?

Stacey H. 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 statement. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and our most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission. Don?

Donald J. Tomnitz

For the past several years, we have been focused on the basics of the Homebuilding business, with the singular goal of returning to profitability. We supplemented our existing land positions with newer, finished lot positions which enhanced our gross margin. We limited our investment in land and lot inventory, which benefited operational cash flow. We adjusted our overhead structure, which reduced our SG&A expenses, and we reduced our outstanding debt significantly, which improved our balance sheet leverage and resulted in less interest expense.

In fiscal 2011, we realized the benefits of these strategies and have achieved operational profitability, this time without a tax credit. We closed 16,695 homes, 8 fewer than 2 years ago in fiscal 2009. However, our bottom line results were greatly improved versus fiscal 2009, as our pretax income increased $569 million. $362 million of the increase was due to reductions in inventory impairment and land option cost write-offs, and $35 million was due to reductions in mortgage recourse and reinsurance expenses in fiscal 2011 compared to 2009. The remaining pretax income increase of $172 million reflects true operational improvement on essentially flat volume, a combination of reduced SG&A, improved gross margins and less interest expense. We'd like to thank all of the D.R. Horton team members for helping us achieve profitability in fiscal year 2011, and most importantly, we look forward to another year of profitability in fiscal year 2012. Bill?

Bill W. Wheat

Our Homebuilding operations generated pretax income of $27.4 million for the quarter, which included $12.8 million of inventory impairment and lot option charges. Financial services pretax income for the quarter was $6.4 million, which included $3.9 million of recourse expense. Our net income for the quarter was $35.7 million or $0.11 per diluted share, compared to a net loss of $8.9 million or $0.03 per diluted share in the prior year quarter. For the fiscal year, our net income was $71.8 million or $0.23 per diluted share. Mike?

Mike Murray

Fourth quarter home sales revenues increased 17% to $1.1 billion on 4,987 homes closed from $921.1 million on 4,281 homes closed in the year-ago quarter. Our average closing price for the quarter was flat compared to the prior year and up 1% sequentially to $215,300. Our home sales revenues for the fiscal year were $3.5 billion on 16,695 homes closed, down from $4.3 billion on 20,875 homes closed in fiscal 2010. Our average closing price for the year was up 3% from the prior year to $212,200. Don?

Donald J. Tomnitz

Net sales orders for the fourth quarter were up 7% from last year to 4,241 homes on a 2% increase in active selling communities. In the September quarter, our average sales price on net sales orders was up 6% compared to the prior-year quarter and flat sequentially at $218,700. Our cancellation rate for the fourth quarter was 29%.

Net sales orders for fiscal 2011 were 17,421 homes and our average sales price was up 3% from last year to $214,000. Our cancellation rate for the fiscal year was 27%. Our sales backlog at September 30, 2011, increased 18% from the prior year to 4,854 homes or $1 billion, a great start to achieving our goal of profitability in the first quarter of fiscal 2012. Stacey?

Stacey H. Dwyer

Our gross profit margin on home sales revenue in the fourth quarter was 16.1%, down 90 basis points from the year-ago period due to increased incentives and discounts and warranty costs, partially offset by a decrease in amortized interest. Sequentially, incentives and discounts were flat; however, our gross margin declined 40 basis points due to increased warranty costs, partially offset by a decrease in amortized interest. Our gross profit margin on home sales revenue for fiscal 2011 was 16.1%, down 120 basis points from fiscal 2010, primarily due to increased incentives and discounts, but our gross margin on home sales revenue has improved 300 basis points from fiscal 2009. Mike?

Mike Murray

Homebuilding SG&A expense for the quarter, which includes corporate overhead, was $124.2 million or 11.6% of Homebuilding revenues, compared to 13.2% from the year-ago quarter. For the fiscal year, Homebuilding SG&A totaled $480 million, down $43 million compared to fiscal 2010. As a percentage of Homebuilding revenues, SG&A increased to 13.5% in fiscal 2011 compared to 12.1% in fiscal 2010, but improved 100 basis points compared to 14.5% in fiscal 2009. Bill?

Bill W. Wheat

We are now seeing the benefits of our aggressive debt reduction over the past several years, as Homebuilding interest expense was down 44% from the year-ago quarter to $9.5 million and our fourth quarter Homebuilding interest incurred decreased 18% to $29.7 million. For the fiscal year, Homebuilding interest expense directly and amortized to cost of sales decreased 32% to $141.3 million from $208.4 million in fiscal 2010, and it has decreased 37% from fiscal 2009. Fiscal 2011 Homebuilding interest incurred dropped 25% to $130.2 million compared to the prior year. Stacey?

Stacey H. Dwyer

Financial services pretax income for the quarter was $6.4 million compared to $4.8 million in the year-ago quarter. 86% of our mortgage company's loan originations during the quarter related to homes closed by our Homebuilding operations. Our mortgage company handled the financing for 61% of our home buyers this quarter with virtually all loans meeting eligibility requirements for sales to Fannie Mae, Freddie Mac or Ginnie Mae. Government loans accounted for 60% of our mortgage company's volume this quarter and our mortgage company's borrowers during the quarter had an average FICO score of 702 and an average loan-to-value of 92%. Financial services pretax income for the year was $19.1 million compared to $21.4 million in the prior year. Don?

Donald J. Tomnitz

Our total inventory decreased by approximately $39 million during the quarter. We reduced our homes in inventory by $57 million and increased our investment in residential land and lots and land held for development by $18 million. Our homes in inventory at the end of September totaled 10,500, down 900 homes from June. As of September 30, 1,100 of our homes were models, 5,600 were speculative homes and 2,800 of the specs were completed. We continue to manage our total homes in inventory relative to our expectations of sales demand, and we offer spec homes primarily to accommodate our first-time buyers, relocation buyers and the real estate agent community. Mike?

Mike Murray

In our fourth fiscal quarter, our investments in land, lots and development costs totaled $209 million, primarily in finished lots, bringing our total spend for fiscal 2011 to $790 million. Future investments in finished lots will remain largely dependent on our sales base, and we expect our spending on land and development costs will continue to be at relatively low levels. We are focused on managing our supply of owned, finished lots in line with our sales demand in a low-risk, capital-efficient manner. At September 30, 2011, we owned approximately 86,000 lots, of which 22,500 are finished. We controlled an additional 27,000 lots through option contracts with a net earnest made deposit balance for these lots of $14.6 million. Bill?

Bill W. Wheat

In our fourth quarter impairment analysis, we determined that projects with a pre-impairment carrying value of $37.1 million were impaired, which resulted in $10.2 million of impairment charges, the majority of which were in Georgia and Arizona. We refer to projects which we deem to have the highest risk for future impairments as our watch list. Our watch list now totals $354 million, down from $377 million at June 30, 2011, with the largest concentrations in California, Illinois and Arizona. Our inventory impairment process in future quarters will incorporate any changes in market conditions and any adjustments we make in our business. Stacey?

Stacey H. Dwyer

Cash flow from operations for the September quarter totaled $90.2 million, primarily due to the decrease in homes in inventory. Our fiscal 2011 cash flow from operations totaled $14.9 million. We ended the year with $1 billion of Homebuilding unrestricted cash and marketable securities, even after reducing debt by $1.5 billion over the past 2 years. During the quarter, we paid at maturity the remaining $106 million of our 7 7/8% notes and repurchased a total of $77.1 million of various issues of our outstanding senior notes. Our remaining debt repurchase authorization at September 30, 2011, was $422.9 million. The balance of our public notes outstanding at September 30 was $1.6 billion with no maturities until May of 2013. Bill?

Bill W. Wheat

At September 30, our Homebuilding leverage ratio, net of cash and marketable securities, was 18%, an increase of 190 basis points from a year ago. However, gross Homebuilding leverage at September 30 improved 660 basis points to 37.7% from a year ago, due primarily to significant debt reductions. Don?

Donald J. Tomnitz

Our financial performance this year demonstrates the progress our company has made toward achieving consistent profitability, balance sheet strength and market share gains. Even though market conditions remain challenging, our goal in fiscal 2012 is to be profitable every quarter and for the full fiscal year. Our September backlog is 18% higher than it was a year ago, which positions us for a strong start to fiscal 2012. Our sales in October and November to date have been in line with our expectations, and we look forward to another year of normal seasonality in fiscal 2012. We will continue to provide new homes for both first-time and move-up buyers; control our construction costs, SG&A and inventory levels; and maintain our strong balance sheet and liquidity.

Again, we want to thank all of our DHI team members for their hard work this past year. We are very proud of the results you continue to produce. This concludes our prepared remarks. We'll host any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Stephen East of Ticonderoga Securities.

Stephen F. East - Ticonderoga Securities LLC, Research Division

Due to -- if you look at what was going on with your gross margin, I understand that it was warranty. But if you look at your spec, did you have some spec impact on that gross margin decline also? And how should we think about the impact in 2012 on your gross margin with the specs?

Donald J. Tomnitz

I think really if you look at our gross margins, obviously in 2010, there was an investor tax credit or a tax credit -- federal tax credit which amounted to about $8,000, Steve. And if you look at what we did in the first part of fiscal year 2011, we are trying to maintain a similar volume in '11 that we experienced in '10, and one of the ways that we are doing that was through incentives and discounts. And in essence, we're trying to be the Federal Government, so to speak, to our buyers and we're trying to equate that $8,000 to a certain extent to attract people in our doors, because there's really no reason, post the tax credit, for very many people to be coming into our models, and we're seeing reduced traffic load. So I would say to you on a go-forward basis we're back to the government is not involved with the tax credits any longer. We anticipate improving gross margins in fiscal year '12 over fiscal year '11.

Stephen F. East - Ticonderoga Securities LLC, Research Division

That's helpful. And then if you look at your 2012 op margin, you touched on some of that. I am assuming you're expecting that to go up. If you sort of rank order between volume, price, gross margin, SG&A, how would you rank order the improvement drivers you would see in the op margin?

Donald J. Tomnitz

Well, I'd say all of the above. We're -- and I don't mean to be a wise guy, which I have tendency to be from time to time. But we're focusing on all aspects of the business and clearly, we focused on our SG&A at this company as one of our strong suits. But in terms of our gross margins, one of the other things that we're doing is -- if you noticed, our community count was only up about 2%. We're in the process of culling underperforming subdivisions, especially in our operationally East region. And so as a result, we would anticipate that our gross margins will be going up simply because of the fact that we're culling underperforming subdivisions, as well as we continue to drive down our cost and work with our vendors as well as our subcontractors. I know that they're trying to push cost increases. We, at the same time, are pushing back simply because of the fact that the business is not where it needs to be.

Stephen F. East - Ticonderoga Securities LLC, Research Division

I appreciate that. You mentioned October, November as expected. What were your expectations?

Donald J. Tomnitz

Well, we can't share our sales budgets with you. We do expect to sell more units and close more units in fiscal year '12 than what we did in '11, so we're selling at a pace in the first 2 months that will help us achieve those higher sales and closing targets for fiscal year '12.

Operator

Our next question is coming from Stephen Kim of Barclays Capital.

Stephen Kim - Barclays Capital, Research Division

First question I had for you relates to the conforming loan limits. Was curious if you could remind us what you think the impact would be if those limits were to come back up and why.

Stacey H. Dwyer

Well, for us, Stephen, with the price point that we are focused on, we've seen very little impact from the loan limits lowering. I don't believe it would have a significant impact for us if the loan limits go back up.

Donald J. Tomnitz

I would just also add is that Ken Gear -- we are participating with the Leading Builders of America this year and their indication is that what they see in Washington right now most likely is going to affect second time -- or second homes more than anything, and we don't have a lot of second-time buyers -- or second home buyers.

Stephen Kim - Barclays Capital, Research Division

Right, right. Not yet at least. Is there -- that comment you just made there, is there any reason to think -- should we read anything into your involvement in that this year versus prior years?

Donald J. Tomnitz

We're just trying to be a part of the industry and be a team player.

Stephen Kim - Barclays Capital, Research Division

Is that a change that you've made? I mean, in the past, I can't recall, were you not part of that consortium?

Donald J. Tomnitz

We've been a part of it. We're a bigger participant this year than we've been in the past years.

Stephen Kim - Barclays Capital, Research Division

My next question's related to incentives again. Can you give us a sense for how you modulate incentives? Is there sort of a company-wide approach or rubric by which you modulate incentives? Or is that something to which significant leeway is given to divisional managers?

Donald J. Tomnitz

I don't want to seem too unsophisticated here because that seems to be a sophisticated question, but I would say to you that we drive -- we ask our division presidents to hit their sales and closing targets, and they control their level of incentives at the local level, all the while trying to hit their bonus points and their bonus plan, which is to achieve, for the large part, 20% gross margins and 10% SG&A. And clearly, we're not hitting those targets yet but that's what they're getting paid to hit. So they're trying to balance their incentives and their discounts in the marketplace, hit their sales goals and closings goals and also get their bonus points on balance.

Operator

Our next question is coming from Ken Zener of KeyBanc Capital Markets.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

You talked about the 2% subdivision growth year-over-year. I assume -- are you willing to give us a community count yet?

Donald J. Tomnitz

No.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Okay. So with that in mind, you talked about culling. I mean, if you're taking down your subdivisions, does that mean you kind of expect a flat community count underlying your outlook right now and it's simply that you're going to have better absorption within those communities? Is that kind of how you're thinking about it?

Donald J. Tomnitz

I don't think we're looking for flat. It could be flat. Our division presidents and our land acquisition people out there trying to tie up and get under contract every deal that makes sense. We process a lot of deals through here every day, but the key is the ones we're culling, before we cull them, we're going back to the seller and asking for a lower price that makes our gross margins work. And if we're not getting those, then we're going to cull them. So as a result, I don't think we'll be down, but I don't think we'll be up dramatically.

Stacey H. Dwyer

I was just going to say, for reference, this quarter, Ken, we were down 4% sequentially, but you still saw our sales increase. So we're trying to make sure that we keep the most productive of the communities, even as we're choosing to let a few go.

Donald J. Tomnitz

The key to making money in this business is to get as high of absorptions per community as we possibly can.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Right, and I think it's very interesting because it seems to me that you're culling communities that are largely option-based versus ones where you own the community outright. That would be the assumption, correct?

Donald J. Tomnitz

It's hard to cull them when you own them. We've got to work through them.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

That was my logic.

Bill W. Wheat

You're right. You're exactly right.

Donald J. Tomnitz

We have some that we own we'd like to cull, but we haven't figured out how to cull them yet.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Right. And given that you've been very effectively blending in new lots to improve your margins, with 22,000 finished today of your 86,000 owned, I assume roughly 1/3 of your communities are still mothballed. Could you kind of walk us through the longer-term implications of the flexibility we're seeing right now relative to your closings, as contrasted to the land -- legacy land which you can't cull and obviously is not at a rate that you want to sell out today? Could you kind of walk us through maybe how that will play out as you work into your legacy land?

Donald J. Tomnitz

Ironically, that question was asked during our director's meeting over the last couple days, and we do have land that we have that is mothballed, so to speak, that we believe are well-positioned pieces of property. But clearly, to make those deals work and to bring them out of mothball, we have to have some appreciation in housing prices and also some appreciation in lot prices that are available on the market today. So as a result, I'd say over the next 3 to 5 years, we'll begin to work that down. But I clearly expect at the end of 5 years that we could still have half as much of that land still mothballed, because land prices still have to escalate some for us to bring those projects into production.

Operator

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

Nishu Sood - Deutsche Bank AG, Research Division

I wanted to ask my first question about your debt repurchases. You folks have done a nice job of bringing your debt balances down, balancing that against the need to maintain your cash balances. So I wanted to think about going forward into the next year. What's the -- how much further will we go? Obviously, your cash balance, I think, has come down to $720 million unrestricted, plus the restricted amount. The $400 million, I think, $25 million or so you mentioned on the debt repurchase authorization you have. So what's the kind of constraints, the goal? I mean, what's the plan going forward here?

Bill W. Wheat

Nishu, in terms of our cash balance, what we look at is our cash and our marketable securities, and those 2 items combined are both unrestricted. So we're right at a $1 billion there. Our target cash and marketable securities balance at year end is $1 billion, so we are basically sitting at our target level. With that and with where our balance sheet is today, we would expect our debt repurchases to decline at a pace versus what we saw this past year. Our balance sheet is in good shape. To the extent that we generate additional cash flow that's in excess of what we need to run the business, we could certainly devote some more of that to debt repurchases, but we do expect the pace of debt repurchases to slow.

Nishu Sood - Deutsche Bank AG, Research Division

And second question on the deferred tax asset. So you've got 2 profitable years under your belts here, and you've got another profitable year forecasted. So I know these standards aren't hard and set but by the kind of 3-year rule, you seem to be all set. So when would that come back on balance sheet?

Bill W. Wheat

We're certainly heading in the right direction, and we continue to evaluate it. And we do get to take into account some level of projections, but the standard that we're applying is very clear in saying that anytime you have a cumulative pretax loss in recent years, which we are using the 3-year average, that is significant negative evidence that until you get past actually having that cumulative loss for a 3-year period, it's very difficult to relieve the valuation allowance. So just to give you a little bit of sense where we are, our current cumulative 3-year pretax loss is $446 million. And that's largely the result of losses that we incurred in fiscal 2009, so as we look forward, we would expect that by the end of fiscal 2012 -- we would expect and hope that we would be out of the cumulative loss position by the end of 2012. And then at that point, depending on how things look, what positive evidence we had, we could see that reverse. But just very directly, we do not expect the reversal to occur before the end of 2012, and then it could be a bit longer depending on conditions and what positive evidence we have at that point.

Nishu Sood - Deutsche Bank AG, Research Division

Got it. So the 3-year window that you folks are using is a very conservative, historic-looking window?

Bill W. Wheat

It's consistent with the standard, and it's consistent with the guidance that we're hearing from our public accounting firm.

Operator

Our next question is coming from Adam Rudiger of Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

I'm most curious if -- with your feedback from your local sales managers, if you look at the buyers, if there's any kind of pattern emerging or if you could kind of categorize where the bulk of your buyers are coming from. I'm just curious if it's first-time buyers that are seeing rents rising and they want to move out because of that. Or is it family issues and they're just outgrowing their previous residence? So I'm just wondering what kind of trends that you can categorize and what they were.

Donald J. Tomnitz

Probably all those college graduates who have moved home with their parents and their parents are trying to get them out of the house again. Well, frankly, if you will recall that we mentioned that we're focusing more on the move-up buyer and the move-up buyer is becoming an increasing part of our business as you can see, we now have -- 53% of our buyers are first-time buyers, and that's down from 58% in 2010. So we clearly have bought -- we clearly have built in both those segments -- during the 2000 to 2007 time frame, we were probably focused more 40% on the first-time buyer and the rest on the move-up buyer. So our plan that we implemented several quarters ago to focus more on that second-time buyer is being seen both in the percentages I just shared with you, as well as our ASP moving up as it has.

Stacey H. Dwyer

I think the interesting point though, Adam, because that's one of the things I know our sales people emphasize with people coming in the door. It's a very favorable time to lock in your monthly payment on your house, whereas rents can rise as the market recovers and that's definitely something that we point out to our buyers.

Donald J. Tomnitz

And as we shared with our board yesterday, clearly the buyers are coming in and they're still looking for value. They're buying slightly larger properties [ph], but they're still looking for good value.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

And my second was just on those communities that you said in the East that you were trying to cull. Is there a common theme, whether it be location or down to the metro level or product type or when you bought the land or optioned the land -- is there any common theme to the ones that are underperforming?

Donald J. Tomnitz

Well, I'd say a number of those are more in the Carolinas, and we entered into some deals in the Carolinas early on that we thought were well-priced lots, and as the demand in those markets has declined some, those lot prices weren't attractive, were not as attractive as we thought. But most of those are primarily in the Carolina areas, some in the Georgia area, but that's the primary location.

Operator

Our next question is coming from Dan Oppenheim of Crédit Suisse.

Daniel Oppenheim - Crédit Suisse AG, Research Division

I was wondering, firstly, in terms of capital, you talked about the debt repurchases as being a real benefit. Some of your peers have also looked at some of the stock repurchases as of late. Have you considered that at all? What are your thoughts there?

Bill W. Wheat

Well, the first thing that we look at is our cash balances and our liquidity and making sure we have sufficient cash for our operations and then cushion, given that we do not have a bank facility. So we certainly do take a look at potential for stock purchases, but it's not as high a priority today. We want to make sure that we are in good position to reinvest in our operations when we start seeing more favorable conditions out there. So stock is not necessarily a high priority.

Daniel Oppenheim - Crédit Suisse AG, Research Division

And then second question relates to some of the mothballed communities and such talk that many could be mothballed still years from now. There's not fully marked and how that you're fully evaluating those right now? Is it the cash you'd still need to put into those products to bring those to market? Or is it just the way the land is marked at this point?

Bill W. Wheat

Adam, a lot of those communities are those that would have a substantial development expenditure associated with them, and they may be fairly well-located but not yet in the development corridor where those lots will be needed in the marketplace. And it just doesn't justify the substantial amount of development spend we'd have to put out there relative to other opportunities for that capital in the market of buying finished lots or more nearly completed parcels of land that are closer to being finished lots.

Donald J. Tomnitz

One of the things we continue to focus on as we approve deals on a day-to-day basis on an individual deal-by-deal basis is, how quickly can get a return on our cash? And as Mike indicated, the development deals obviously, it's hard to get your cash back in 1 year from the date that you pull those out of mothball and start a development on them. Typically, that's a 2-year return on cash.

Operator

Our next question is coming from Michael Rehaut of JPMorgan.

Michael Rehaut - JP Morgan Chase & Co, Research Division

First question on SG&A, came in a little bit higher than we had expected. I mean if you look sequentially, revenues were up $100 million and our SG&A was up about $10 million, so I was wondering if there was any year-end stuff in there. And in terms of the variable element of SG&A, any guidance going forward relative to a change in revenue would be helpful.

Stacey H. Dwyer

We've looked at our SG&A nine ways to Sunday because, as we always say, that's the first line item Don Horton looks at when he picks up his financials. So when we look at it sequentially, there were really 2 main factors that caused the sequential increase. And the first is, many of our comp plans are tied to profitability. We had much stronger profitability in the fourth quarter than we did in the third quarter or in the prior parts of the year, and so our incentive comp was higher in the fourth quarter. The other thing that was higher for us was some seasonality in our maintenance cost and utilities. We had a very, very hot summer across many of our markets and we did see an increase in our utility costs. As we look at the trend in our SG&A though, in the first half of the year -- the second half of the year compared to the first half of the year, our SG&A was actually down 2%, but our closings were up 34%. So we have taken a lot of measures in the second half of the year compared to what we ran in the first half, and in this fourth quarter, our SG&A was up 2% year-over-year on a 17% increase in revenues. So again, as we look at our quarter SG&A, extracting the variable piece, we think we're in a lot better position this year going into our first quarter than we were last year.

Michael Rehaut - JP Morgan Chase & Co, Research Division

And before I hit on the second question, can you -- again, the variable piece on that, is that a 4% to 5% number? Or how should we think about that?

Stacey H. Dwyer

That's probably within the range, or maybe 3% to 5%, just kind of depending on the quarter.

Michael Rehaut - JP Morgan Chase & Co, Research Division

Second question, I was just hoping to get -- you kind of hit on Carolinas and Georgia. I was hoping to maybe just get a kind of a regional overview of which areas you felt have done maybe a little better than expectations or on the stronger end of the spectrum. Obviously, everything on a relative basis but -- and conversely, which regions are still a little bit more challenged or higher incentives, et cetera?

Donald J. Tomnitz

Well, I'd say, to give you a little bit of clarity on it, Florida, to us, is doing very well relative to what everyone else is doing and people's expectations down there. If you take a look at what we're doing in the Pensacola, Mobile, Alabama area, which is our northern Florida market, as well as in Southeast, Southwest Florida, the Miami, Fort Myers, Naples and Tampa market, we're doing well in those markets. Orlando is getting stronger for us, and Jacksonville should get stronger for us. The market that I'm most excited about in terms of improvement across the U.S. right now is certainly in Florida. We have a lot of anticipation for fiscal year '12 in the Carolinas, especially in the Myrtle Beach, Hilton Head, Charleston area. Atlanta continues to do well for us. The state of Texas is still a major producer for us, producing a lot of our pretax income. Texas has been weaker for us this year than it was last year, largely a function as the fact that in 2010, when we had a tax credit, we really loaded up on specs because we thought we could sell a lot of specs in Texas due to the tax credit. And we sold and closed a lot of specs in 2010 in Texas. So they have had year-over-year difficult comps in Texas. Even though they're down, they're still doing very, very well from a profitability perspective. I look at Las Vegas, and what's cost down [ph] was done for us in Las Vegas, and even though we're earning back mostly, largely our impairment dollars out there, I don't think anyone in Las Vegas is doing the kind of job that we're doing in Las Vegas today. California is still weak for us, but it's getting better. But it's just -- it's a slow market with a tough budget and a tough deficit with the state. And I think California will continue to be a weak market for us in the years ahead just because of what exists out there. And I'd be really remiss if I didn't mention Matt Farris in the Pacific Northwest in Seattle, our top PTI performer in the company this year and doing a great job for us in Seattle. So that's pretty much our markets.

Michael Rehaut - JP Morgan Chase & Co, Research Division

One last one if I could skip it in. Warranty costs, do you think those should level out in '12, given that it was a little bit up sequentially 4Q?

Bill W. Wheat

Warranty is something that's very difficult to predict, and there always is a bit of volatility in there in terms of dealing with the tail of homes that we've delivered over the past 7 to 10 years relative to our low level of revenues today. And that's where you see a little bit of volatility in our margin there. Certainly, it's something we pay a lot of attention to and we're focused on operationally in dealing with that and taking care of our customers. I can't necessarily give you any guidance on where we expect it to go, but we certainly feel like we're reserved very well, and we've got a handle on any warranty issues that we may be dealing with in our operations today.

Donald J. Tomnitz

I guess the last color on markets, I don't want to leave him out because Terry Stanley in central Texas is doing a great job for us and producing very good returns for us in central Texas.

Operator

Our next question is coming from David Goldberg of UBS.

David Goldberg - UBS Investment Bank, Research Division

First question, I want to follow-up on the comments. Bill, I know you mentioned before about having $1 billion in cash and targeting $1 billion of cash and marketable securities in a year. I think that's great to have such good liquidity, but I'm wondering, how do you get to the $1 billion target? How do you work towards that number? What makes that the right amount of cash for your balance sheet?

Bill W. Wheat

Well, first thing we look at is what our working capital needs on a seasonal basis. We will add homes to inventory during our second and third quarters of the fiscal year, and our expectations for that need is $200 million to $300 million. So that's $200 million to $300 million of our need, and then past that, typically we would -- in our capital structure, we would have a bank facility in place that would perhaps be in the range of $500 million, which would allow us some flexibility in terms of efficiency with our cash. We don't have that facility today and so essentially, we're keeping some cash as cushion in replacement for what we would normally have available in a bank facility. And what that cushion provides us with is it provides us with opportunity capital to the extent that we see good opportunities in the businesses or we see improvements and want to make further investments in our business. But it also provides us cushion against the downside. If there were a major shock to the system, which we've certainly seen several of those over the past few years, that might cause disruption in the capital markets. And it might keep us from being able to access the capital markets, or if it shocked consumer confidence in our potential homebuyers and if we saw a drop in sales or an increase in our cancellation rates, that cash cushion provides us with insurance to be able to continue to operate without losing any sleep over our liquidity.

Donald J. Tomnitz

And we want to sleep well at night, I assure you.

David Goldberg - UBS Investment Bank, Research Division

So just to make sure I understand, the cushion should be above what the normal bank facility would be just in case there's a shock in the system. Is that repeating that correctly?

Bill W. Wheat

That's fair. We do still -- we're very realistic. And I would say we're still a bit cautious about the overall environment. It is still a challenging homebuilding environment out there today, and we feel like it's prudent to keep some level of cushion in this environment.

Stacey H. Dwyer

I'd say the flip side of that is we're also optimistic, and we want to make sure that we have the capital to invest when we're ready to do that.

David Goldberg - UBS Investment Bank, Research Division

Got it. My follow-up question was just on the mortgage market. I'm wondering if you guys are seeing any changes in underwriting standard, if you saw anything during the quarter, any tightening, any loosening, especially relative to FHA loans and the way those are being underwritten by FHA-approved lenders.

Stacey H. Dwyer

We're not seeing anything substantial in terms of changes in underwriting or loan availability, really, over the last 6 to 9 months. It continues to be a challenge and people still have to have good credit and have cash for the down payment, but we're really not hearing about incremental tightening right now.

Donald J. Tomnitz

David, by the way, before you get off, I want to say, we've known one another for a long number of years and we've talked to you a lot about D.R. Horton. And I've been disappointed over the years and the fact that I can't get through to you, but somebody must have gotten through to you because I appreciate you being one of our -- that you have us as one of our top picks. So I don't know whether that's you, Stacey or Justin [ph] or Bill, but it certainly wasn't me.

Operator

Our next question is coming from Bob Wetenhall from RBC Capital Markets.

Steven Bachman - RBC Capital Markets, LLC, Research Division

This is Steven Bachman in for Bob. Given your read-through in October and November, do you have any view on the pace of incentives in the next quarter? Or you said it was flat sequentially and you mentioned it was going to start decelerating. I was wondering if you had any read-through for 1Q.

Bill W. Wheat

It'd be hard to say we had a whole lot of read-through on the quarter yet considering we're not quite halfway there, especially in terms of closings and seeing the incentive margins coming in, but we're looking for it to be essentially flat with where we've been. We've seen some stability the past few quarters at the incentive level and we're kind of hopeful and optimistic that's going to continue.

Steven Bachman - RBC Capital Markets, LLC, Research Division

In terms of -- you mentioned the mix shift towards the move-up buyer from the first time buyer and its impact on pricing. Do you expect pricing to be up year-over-year in fiscal '12?

Bill W. Wheat

I do believe that our average sales price should increase slightly in '12 over '11 just based upon where our product offerings are today and where we're positioned today.

Steven Bachman - RBC Capital Markets, LLC, Research Division

And one last one. Cancellation rate was 29%, which was the highest of the year. Was that a seasonal trend? Or is there another pattern emerging that you guys have noticed?

Stacey H. Dwyer

I think that really what you're seeing there is the impact of some of the market disruptions and the impact on consumer confidence. It's primarily in August where you first really started seeing the significant market fluctuation. There's generally not a significant seasonality in our cancellation rate.

Bill W. Wheat

Everyone saw that disruption for a few weeks and then it basically would come back to more expected levels on our can rates.

Donald J. Tomnitz

And another thing that drives our cancellation rate is our special sales that we'll have in divisions across the country, and they generate a lot of sales and then they have a higher cancellation rate on those sales when they have a sales event. So sometimes that also impacts our cancellation rate.

Bill W. Wheat

That's a fairly normal pattern. We've seen that over the years, and we kind of bake that in when we plan events.

Operator

Our next question is coming from Jay McCanless of Guggenheim.

James McCanless - Guggenheim Securities, LLC, Research Division

My first question, I believe you said the community count was up 2% year-over-year but your spec count was up about 8% year-over-year. What's the current thought on specs? And are you all going to be a little more aggressive this coming year? Or maybe dial those back as you get through the year?

Donald J. Tomnitz

Well, we focus on specs very clearly around here all the time. We do have 2 or 3 things that are running on specs than what I would like, and I notified those 3 divisions that they needed to get their spec percentage down between now and the end of the year. And the main goal for that is in all of our divisions to have fewer specs in our first quarter than in the second quarter because clearly, at the end of the first quarter, we're going to be starting quite a few spec units in order to meet the spring selling season and spring demand.

Bill W. Wheat

And also, a bit of the increase is because we have seen a bit better sales pace and so our expectations are that we will see a bit more demand in our Q1 this year versus Q1 last year. Just one other stat: while our overall spec number may be up, the quality, the mix of those specs is better now than it was a year ago. One of the things we look at a lot are a number of completed spec homes that are older than 6 months old. Today, we have 600 of those homes. A year ago, we had 800. So while our total number of completed specs are up, our aged specs are down. So the mix is better.

Stacey H. Dwyer

And the backlog is at 18% compared to the 8% increase in specs, so we the like the mix of the inventory we have.

James McCanless - Guggenheim Securities, LLC, Research Division

And then my other question. I wanted to ask the mortgage qualification question a different way. Have you all ever disclosed what the rejection rate at DHI Mortgage is? And I don't know if you all would be willing to do that now, but I think that'd be at least one barometer to say, here's what's going in the mortgage market.

Stacey H. Dwyer

We have not disclosed that, Jay, and I certainly don't have it in front of me right now. It's not something that we've been prepared to discuss today.

Operator

Our next question is coming from Jade Rahmani of KBW.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

I just wanted to ask again on the mortgage environment. Have you seen any changes to the approval timeline, given all the refi activity that's been going on? And secondly, are any of the larger banks -- has any -- as the larger banks exit the correspondent business, have you seen any change in appetite on those banks that do purchase your mortgages?

Stacey H. Dwyer

I'll start on the approval timeline. The approval process, I don't think we've seen it be impacted by refi necessarily. It has expanded in terms of timeline if you compare it to last year or the year before, simply because the level of documentation that continues to be required, and it's generally going to take a minimum of 30 days from someone applying for a loan until they're fully approved.

Bill W. Wheat

And with regard to the impact of certain large banks choosing not to be in the correspondent business, we have had conversations with additional banks. There are certainly several banks that are still interested in being the correspondent business, and we expect our volume to shift to those banks. There could be some short-term impact on the timing and what the time it is from the time we originate a loan to when we sell it, if volumes are a bit greater than their infrastructure will support. But we don't expect there to be any long-term impact there.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

And just again on the timeline, what's the timing from approval to closing?

Stacey H. Dwyer

A part of that depends -- on the approval to closing, a part of it depends on whether the house is complete, so if someone's coming in early in the build process, it could be another month to 2 months before we close. From the point of approval though to closing, it could be a very, very short window, maybe 3 days to a week, if the house is ready to go and the buyer's ready to move.

Operator

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

Alex Barrón - Housing Research Center, LLC

Don, I think you guys have done a great job over the last few years in all aspects, and I guess my question to you -- as we're moving into 2012, you guys sound pretty confident that you'll see an increase in volume and I'm trying to I guess get a better feel for where that optimism is coming from. Are you starting to see some of the people who defaulted early on in the cycle come back and start buying homes again?

Donald J. Tomnitz

Well, let me be clear. We expect 2012 to be more profitable than 2011. Our plan is that the sales and the closings could be flat, but we expect them to be up. But we believe that we can make more profit in '12 on a similar number of closings in '12 as we had in '11. And to the extent that there is more demand out there, then we would expect our sales and closings to increase. But right now, we're just planning on being more profitable on a similar number of closings and sales. To answer your question on the other, it's just a function, I believe, that each one of our markets, our city managers and our division presidents are trying to carve out more market share in each one of our communities. We're also clearly trying to focus on -- we are focusing on, how do we achieve more absorptions per community? So to the extent that I don't see a lot in 2012 in an economic situation across the United States, the bigger picture, I don't see much improvement. I don't see jobs improving significantly. I don't see consumer confidence improving significantly, so our plan has been, how do we continue to get more out of what we have, continue to enter into new deals, as well as to take market share from other builders?

Alex Barrón - Housing Research Center, LLC

But I guess I'm still not clear. I mean, what's going to change? If you have a similar volume, what's going to -- where is that extra profitability going to come from? Are your land costs going down, your incentives going down? Like what's giving you that, I guess, optimism?

Bill W. Wheat

Well, the primary driver, we believe, is our continued work on folding in new communities that we have bought the land at today's prices -- based on today's selling prices of homes, culling through underperforming communities, replacing them with better communities. So we expect that we should be able to push margins up through that process.

Stacey H. Dwyer

We're also leveraging our SG&A better. As we look at where we're starting this year compared to where we started last year, we see some upside for us on SG&A. And then we've talked about our debt reduction. We're going to have less interest flowing through our income statement, probably. If we have huge volumes, we may have more capitalized interest flowing through, but as a percentage of revenue, that should be a declining percent.

Alex Barrón - Housing Research Center, LLC

And if I could ask another one, the cash flow -- I guess this was the first year where the cash flow wasn't as strong as previous years, so what changed there? Because I don't really see that you guys were buying more land or something.

Bill W. Wheat

We're essentially replacing what we're selling right now. Our inventory balance is essentially flat on the balance sheet this year versus last year, so we're not generating cash by liquidating our balance sheet as we had in the past several years. That's the primary difference. Now obviously, our profit isn't what it was last year, so we don't have cash flow from profit at the same level as this year -- as last year either.

Stacey H. Dwyer

I think in each of '09 and '10, we had significant tax refunds as well, Alex. And we didn't have a cash tax refund this year, even though we had an adjustment to our tax accrual with a tax benefit for income purposes this year.

Bill W. Wheat

We've been saying for quite some time our goal is to shift our cash flow generation from liquidating our balance sheet and getting tax refunds to turning to profitability, and that's our goal and that's where we would expect our cash flow to come from going forward.

Operator

Our next question is coming from Jordan Hymowitz of Philadelphia Financial.

Jordan Hymowitz - Philadelphia Financial

I have a question on your deferred tax asset. One of the banks, Pinnacle Bank, was the first company I've seen to actually reverse a deferred tax asset this year of any of you guys that had one, and that was after 5 quarters. Is there some reason the banking space is different in reversing deferred tax asset than the homebuilding space?

Donald J. Tomnitz

We ask ourselves that question. We're marketing our assets in the market and they're not. So I don't know where the rules go from there, but -- go ahead, please.

Bill W. Wheat

It's a subjective determination, for every company is different, the facts and circumstances. You'd have to look at the nature of their deferred tax assets as well as their outlook and ability to predict earnings going forward. In our case right now, the standard would tell us that a cumulative loss in recent years and a 3-year cumulative loss position that we're in today is a significant amount of negative evidence. That's very hard to overcome with any kind of positive evidence in our industry and our business that would allow us to reach the conclusion that we don't need a valuation allowance. But as we move forward through '12, as that significant evidence falls away, we'll be able to assess with maybe a lower burden of proof requirement than we currently have today without all the significant negative evidence, the cumulative loss. And we'll be evaluating our expectations for future profitability, as well as when those deferred tax assets, temporary deductible differences come back as tax deductions and against the earnings we expect to have.

Mike Murray

A big part of the positive evidence that we will be looking for is the level of profitability that we see and the consistency of that profitability. As you look back at our just completed fiscal year, we lost money in the first 2 quarters and then we made money in the next 2 quarters. So while we have a year of profitability, it's not at a substantial level and it was not consistent. So as we move into fiscal '12, if we can generate profitability during the slower seasons of the year at a more substantial level, move into the second part of the year, grow our profitability and see more substantial profitability, that will be much stronger positive evidence that will support us reversing the valuation allowance that we do not have today.

Operator

Our next question is coming from Jack Micenko of SIG.

Jack Micenko - Susquehanna Financial Group, LLLP, Research Division

Most have been asked and answered, but I just wanted to ask an open-ended question on ASP. Obviously, land mix, market conditions, a lot of stuff goes into that number, but as you move maybe away from the entry-level buyer to some extent, how do you think about ASP trending over '12? Can you break out what your trade-up product ASP is relative to more of an entry-level product and talk maybe about how order ASP and sale ASP maybe begin to merge or maybe not? I don't know, just sort of an open-ended question on pricing.

Donald J. Tomnitz

I think it's very difficult to say what our ASP is on entry-level versus move-up, simply because each of those markets is so different. There's a different cost basis, both from a hard cost perspective as well as a lot cost, so -- just SG&A and everything else that's it's just -- it's too difficult for us to put a finger on it and say, well, here's what the ASP should be for entry-level and what it is for move-up. And a move-up house in one market is not a move-up house in another market. Clearly, California -- an entry-level house in California is definitely a move-up house in Texas or Florida. It'd be difficult for us to answer that question, sir.

Operator

We have a follow-up question coming from Stephen East of Ticonderoga Securities.

Stephen F. East - Ticonderoga Securities LLC, Research Division

You all noticed last time I didn't say anything because I didn't think it would be appropriate but talk about it [indiscernible] I won't say anything about that. Two questions, totally separate. DT, could you talk about -- when you talk about your land spend in 2012 not being significant or still curtailed, is that really because of where you all want to keep your balance sheet? Or is it more a function of what you're seeing out in the market? And then the second, just sort of an update on the put-back issue. I know you all have talked about whether it makes sense to do global settlements, et cetera, and just sort of a little data dump on what you're seeing.

Donald J. Tomnitz

Well, on land spend, we're still committed to our business model of being a land-light and a lot-light company. As mentioned earlier, our return on capital when we do buy finished lots and we cash them out, where we buy a piece of land and we develop it, our hurdle rate right now is we want the cash back in 12 months. And we'll do deals that are 18 to 24 months, very few 24-month deals, do 18-month deals but bottom line is, until we get a clearer picture on where the overall economy is going, we have very tight rein on our capital, on our cash. So as a result, it's a business model that, going forward, we still are convinced that we just don't want to be in land for a period longer than 2 years, so we're basically focusing on lot option deals and small development deals.

Stephen F. East - Ticonderoga Securities LLC, Research Division

So it sounds like though then you're seeing a rational market, just not maybe the duration and type that you want.

Donald J. Tomnitz

Do we see a rational market? Probably not. We see a number of deals out there that exceed our underwriting guidelines or don't comply with our underwriting guidelines. And we tell our division presidents, go back and rework the deal. Here's the way we will approve the deal. We miss some deals, but I'll go back to the old saying that someone mentioned to me on Wall Street years ago. And that is if -- land deals are like trains: you miss one and there's another one that's going to come along. And that's our attitude right now. There's no reason to load up our balance sheet on new land and lot deals with an unclear picture on where the economy and where our business is going. We think our business is improving clearly, but not to the extent that we're going to take risk that we don't see will be rewarded in the marketplace.

Bill W. Wheat

And then, Stephen, in terms of the mortgage put-back risk, we have pursued global settlements with some of our investors. We have completed a couple of global settlements over the last year. We are still in discussions with other investors regarding global settlements with them. Those settlements that we have reached are reflected in the reduction that we've seen in our a overall loan loss reserves over the past year or so. Our reserve a year or so ago was around $40 million. Today, it's at $33 million. The other factor that's reflected in that reduction in the reserve is the fact that over the course of the year, we have seen the level of put-backs requests decline somewhat over the last year, and so we'll continue to work with our investors, continue to deal with the requests that come in. And hopefully, we can achieve some additional settlements.

Stephen F. East - Ticonderoga Securities LLC, Research Division

Okay. The level of requests are declining. Is the payout ratio changing? Or where are you at on that?

Bill W. Wheat

The payout ratio is similar to where it has been in the past. There's still a significant number of requests that are ultimately rejected because there's no proof of true underwriting issues, and then the loss rate on them are pretty similar to what we've seen in the past.

Operator

Our final question is coming from Michael Rehaut of JPMorgan Chase.

Michael Rehaut - JP Morgan Chase & Co, Research Division

I guess I just wanted to hit on the mortgage put-back issue, so you were able to answer a lot of those questions. Just to clarify, you said the level of put-back requests have declined somewhat versus 2010. We've seen in a couple of other builders that the put-back requests in September kind of moved up a notch, kind of a material notch. Are you saying that's not the kind of case for yourselves? Or was your statement more just broadly fiscal '11 versus fiscal '10?

Stacey H. Dwyer

No, we were specifically talking to the fourth quarter, and our level of requests in the fourth quarter were lower than what we've seen in either second or third quarter.

Operator

There are no further questions at this time. I'd like to hand the floor over to Mr. Don Tomnitz for any closing numerous.

Donald J. Tomnitz

Thank you. Today is Veterans Day, and as a final thought on my part, let me share a favorite prayer of one of our realtors in the Dallas/Fort Worth area. "God, keep our servicemen and women safe, whether they are serving at home or overseas. Hold them in Your loving hands and protect them as they protect us. Please keep these servicemen currently serving and those who have gone before in Your thoughts. They are the reason for our many freedoms that we enjoy today." Thanks and good day.

Operator

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

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