DR Horton Q3 Earnings Call Transcript

123jump.com Staff
19 Aug, 2009
New York City

The homebuilder quarterly revenue declined 36% to $914.1 million. Net quarterly loss narrowed 64% to $142.3 million helped by lower charges and a benefit from provision for income taxes. The company lost 45 cents a share versus a loss of $1.26 a share a year-ago quarter.

D.R. Horton, Inc. ((DHI))
Q3 2009 Earnings Call Transcript
August 4, 2009 11:00 a.m. ET

Executives

Donald J. Tomnitz - Vice Chairman, President & Chief Executive Officer
Bill W. Wheat – Director, Executive Vice President & Chief Financial Officer
Stacey H. Dwyer – Executive Vice President & Treasurer

Analysts

Ray Huang - JPMorgan
Megan McGrath - Barclays Capital
David Goldberg - UBS
Joshua Pollard - Goldman Sachs
Nishu Sood - Deutsche Bank
Kenneth Zener – Macquarie Capital Securities
Michael Widner - Stifel Nicolaus & Co.
Josh Levin – Citigroup
Dan Oppenheim - Credit Suisse
Carl Reichardt - Wells Fargo
Alex Barron - Agency Trading Group
Jim Wilson - JMP Securities
Jay McCanless - FTN Equity Capital Markets
Jade Rahmani - KBW
Stephen East - Pali Research

Presentation

Operator

Good morning. My name is Sarah and I will be the conference operator today. At this time, I would like to welcome everyone to the D.R. Horton Incorporated, America''s Builder, third quarter 2009 conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star and then the number one on your telephone keypad. If you’d like to withdraw your question, please press the pound key.

I would now like to turn the call over to our CEO, Don Tomnitz. You may begin your conference.

Donald J. 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. 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 DR 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 DR Horton on the date of this conference call, and DR 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 DR Horton''s Annual Report on Form 10-K and the most recent Form 10-Q, both of which were filed with the Securities and Exchange Commission. Don?

Donald J. Tomnitz

Net sales orders for the third quarter were 5,089 homes, down 7.5% from the same quarter in the prior year. Third quarter sales were up 22% sequentially from our March quarter, which is stronger than the usual seasonal trend.

Our average sales price on net sales orders in the quarter decreased approximately 7% from the year-ago quarter to $208,100 but was up sequentially compared to $203,000 in our March quarter. Our cancellation rate improved to 26% from 39% in the year-ago quarter and from 30% in the March quarter.

Our sales backlog were down year-over-year, increased 18.5% sequentially to 5,430 homes or $1.1 billion. Our third quarter home sales revenues were $896.6 million, 4,240 homes compared to $1.4 million, 6,167 homes in the year-ago quarter.

Our average closing price for the quarter decreased approximately 8% from the year ago quarter to $211,500. Stacey?

Stacey H. Dwyer

Our gross profit margin on homes sales revenue in the third quarter before inventory impairment and land option write-off was 11.3%, a 120 basis point increase from our home sales margin in the year-ago period.

Approximately 130 basis points of the increase was due to the average cost of our homes declining by more than our average selling prices, geographic mix shift and the effect of prior inventory impairment on homes closed during the quarter.

Also, contributing 80 basis points to the margin increase was a decrease in the amortization of capitalized interest and property taxes as a percentage of home sales revenue, resulting from reductions in our interest and property taxes incurred and capitalized over the past year.

These increases were offset by a 90 basis point increase in our warranty accrual. Our gross profit margin declined from the March quarter due to greater proportion of speculative homes closed in the June quarter, and an increase in the number of older completed specs closed, which had a higher cost structure. Bill?

Bill W. Wheat

During our third quarter impairment analysis, we reviewed all projects in the company and determined the projects with the combined carrying value of $1.4 billion had indicators of potential impairment.

We evaluated these projects and determined that projects with a pre-impairment carrying value of $258 million were impaired. We recorded inventory impairments of $102.9 million as a charge to cost of sales to reduce the carrying value of these impaired projects. Our west region incurred the largest portion of these charges.

Of the remaining $1.2 billion of evaluated projects, which were not impaired, the largest concentrations are in California, Texas and Florida. We also recorded $7.9 million dollars in write-offs of pre-acquisition costs and earnest money deposits related to land option contracts that we do not intend to pursue. Don.

Donald J. Tomnitz

Homebuilding SG&A expense for the quarter was $134.3 million compared to $194.7 million in the year-ago quarter, a reduction of $60 million. The 31% decrease in our SG&A is inline with our 31% decrease in homes closed this quarter. We have and will continue to actively manage our SG&A levels relative to our expected number of home closings. Bill.

Bill W. Wheat

We recorded $20.3 million in interest expense during the quarter. We will continue to recognize a portion of our interest incurred as interest expense as long as our home building debt level exceeds our active inventory.

Financial services pre-tax income for the quarter was $2.8 million, compared to $9.4 million in the year-ago quarter. 80% of our mortgage companies'' business was captive during the quarter. Our company-wide capture rate was approximately 69%. Our average FICO score was 721 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 64% of our volume. Stacey.

Stacey H. Dwyer

We expect to receive the majority of our net income tax receivable of $125 million in our September quarter. Our net remaining deferred tax assets of $165 million are expected to be realized primarily through net operating loss carry-back to tax year 2007, based on projected tax losses to be incurred in fiscal 2009.

We expect our deferred tax assets to result in an additional tax refund in the future with the majority of the refund expected to be received in the first quarter of fiscal 2010. The benefit from income taxes of $19.6 million dollars recognized in the quarter relates primarily to adjustments to the tax provision recorded for fiscal 2008, resulting from the finalization and filing of our tax return for that year.

Our reported net loss for the quarter was $142.3 million or $0.45 a share, compared to a net loss of $399.3 million, or $1.26 per share in the prior-year quarter. Bill.

Bill W. Wheat

Our overall inventory decreased by approximately $185 million excluding non-cash impairment charges during the quarter. Our dollars invested in construction in progress and finished homes declined by $54 million, excluding non-cash impairment charges, even though our homes and inventory increased slightly from March to 10,900 at June 30, 2009. This dollar decrease is primarily a result of a 23% reduction in our completed spec homes to 2300 at June 30th from 3,000 at March 31st.

Our absolute number of speculative homes and inventory remained flat from March to June. However, as a percentage of inventory, specs declined to 51%. We plan to continue to adjust both our total number of homes and inventory and our number of speculative homes in the coming quarters to match future demand. Don.

Donald J. Tomnitz

Our land and lot acquisition spending remains limited and we continually reevaluate our land development plans based on current sales trends. We have spent approximately $225 million year-to-date through June on land and lot acquisition and land development expenditures and will easily spend less than the $500 million guidance previously given for fiscal 2009. Bill.

Bill W. Wheat

Our supply of owned land and lots at June 30, 2009, was approximately 90,500 lots, down 32% from a year ago. We plan to continue to adjust our own land and lot supply inline with our expectations for future home sales and closings.

We control an additional 24,000 lots through auction contracts, which includes 5,000 lots for which we do not expect to exercise our option, but the contract has not yet been terminated. Our net earnest money deposit balance at June 30th was approximately $17.7 million on a net remaining purchase price of $577.6 million.

We have no unconsolidated joint ventures and we rarely use land bank arrangements or deposits or typically low percentage of purchase price. Don.

Donald J. Tomnitz

We generated approximately $124 million in operating cash flow in the quarter bringing our fiscal year-to-date total to $1.1 billion. We have generated positive cash flow in each of the past 12 consecutive quarters for a total of $5.2 billion. We ended the quarter with approximately $1.97 billion of unrestricted home building cash and $62 million of restricted cash. The restricted cash is primarily collateral under various letter of credit agreements and approximates our outstanding letters of credit. Stacey.

Stacey H. Dwyer

In the current quarter, we repurchased approximately $87.8 million of our outstanding notes for $84 million plus accrued interest, which brings our repurchases for the year-to-date period to approximately $308.3 million.

As of June 30th, we have $295 million remaining on our debt repurchase authorization. During the quarter, we terminated the credit agreement governing our revolving credit facility with our substantial cash balance and our expected future cash position; we did not anticipate a need to borrow from the facility through its maturity in December of 2011.

Also during the quarter, we issued $500 million of 2% convertible senior notes due 2014. The conversion rate is equivalent to an initial conversion price of approximately $13.06 per share and upon conversion; we can choose to settle the bond in cash, stock or combination thereof.

The stated use of proceeds, which for general corporate purposes including the repayment or repurchase of outstanding indebtedness. At June 30th, our home building leverage ratio net of cash was 34.5%, an 850 basis point improvement from a year ago and well within our target operating range of less than 45%. Don?

Donald J. Tomnitz

In conclusion, our industry continues to face many challenges, high although moderating levels of both new and existing inventory, continued high levels of foreclosures, tight credit for our home buyers and continued limitations of mortgage products available, low consumer confidence, increasing unemployment, continued pricing pressure in certain markets, appraisal problems in certain markets and the uncertainty of our further tax incentives at the state or national levels.

These headwinds continue to impact our business both in our sales volumes and operating margins. However, we did see a reduction in the pace of our quarterly sales declines. In addition, as we mentioned earlier, our sales were up 22% sequentially from the March quarter, which is stronger than the usual seasonal trend.

Our cancellation rate improved to 26% from 30% in our March quarter. DR Horton has a solid balance sheet to weather the downturn and is in a strong position to capitalize on the eventual housing recovery.

During the quarter, we generated an additional $124 million of operating cash flow for a total of $5.2 billion over the past 12 quarters. We opportunistically access the capital market, raising an additional $500 million by issuing 2% convertible debt.

We continue to reduce our inventory dollars, our number of completed specs, and our spec percentage, and we continue to reduce our SG&A. Home building, down $60 million and a 31% year-over-year. We will continue to reduce our owned lot position, while we focus on option lot opportunities.

Our current focus remains on targeting the entry level buyer, managing our SG&A and continuing to negotiate lower construction costs, as we position DHI to return to profitability as soon as possible. Returning to profitability is our number one goal for fiscal 2010.

We want to thank all of our DHI team members, who continue to outperform all of our peers. We are especially proud of our sales team this quarter which significantly outsold all of our competition in the industry. Keep up the great work. DHI will lead the industry in to the housing recovery.

This concludes our prepared remarks. We''ll host any questions you may have.

Question-and-Answer Session

Operator

At this time, I would like to remind everyone in order to ask a question, please press star and then the number one on your telephone keypad. Your first question comes from Michael Rehaut of JPMorgan. Your line is now open.

Ray Huang – JPMorgan

Hi, guys. This is actually Ray Huang in for Mike. You guys were able to talk about April orders in your last conference call. I was wondering if you had any commentary or color on July, business weekend of August.

Donald J. Tomnitz

Ray, we really do not. There is really not any clear trend and really historically from June to July. There is really not any clear historical trend from June to July as well. So, we really don’t have any comment on July at this point.

Ray Huang – JPMorgan

Okay. It’s like a typical seasonal drop off you’re seeing in July?

Donald J. Tomnitz

As I said, there really isn''t a typical seasonal pattern from June to July. Some years are down, some years are up and so it''s a little difficult to say, whether we''re inline with any seasonal pattern since we really don''t discern a pattern in the month of July.

Ray Huang – JPMorgan

I guess in the quarter that just ended, other guys don’t give community comp, but if you guys could give just a sense of the absorption pace per community, order pace in the quarter and also where that was last quarter and also the year ago?

Stacey H. Dwyer

Probably the best way to answer that is, as we talked earlier, we had about a 7.5% decrease in our sales this quarter. Our sales communities we estimate to be down in the high teens. So, we did have improved absorption year-over-year and we have increased absorption compared to the March quarter simply because our sales were up 22% sequentially and we’ve certainly not opened that community in the June quarter.

Ray Huang – JPMorgan

Lastly, I guess the east segment was pretty on the year-over-year basis. Is there any particular markets within that that were above average or below average or do you have any color on that?

Donald J. Tomnitz

I think that one, Carolinas in particular, Charlotte is strong and I’d also say that Mobile/Pensacola area is strong, but I’ll also say to you that the east is on an aggressive schedule to open more new communities and some of those have come on line in the most recent quarter, but not nearly as many we as we anticipate going forward.

Stacey H. Dwyer

The other markets in that regions that would be showing strength for us are Maryland and Virginia divisions. We''ve seen increased affordability in those markets and we''ve also seen improved job situation there.

Operator

Your next question comes from the line of Megan McGrath of Barclays Capital. Your line is now open.

Megan McGrath - Barclays Capital

Hi, thanks. Good morning. I’m trying to think about the interplay between your lower margins, better pace in terms of orders, higher impairments this quarter. I''m wondering if what you''re seeing maybe is some price elasticity coming back into the market so you''re willing to maybe impair and bring prices down because it’s actually giving you some better orders or am I reading too much into that?

Bill W. Wheat

Overall, I wouldn''t necessarily read that into it across the board. Clearly, prices are not declining at the same pace. We did see a sequential slight increase in our average sales price in our sales orders this quarter. But as far as the impairments and what became impaired this quarter it''s really just a function of the individual process, where we review every project and we clearly have a number of projects that we are still on the bubble.

In this quarter, based on actual results in those projects and our plans for those projects moving forward, then that created the impairments, while I wouldn''t make any general comments about it.

Donald J. Tomnitz

I also would remind you that we cleared some age specs this quarter more so than we did last quarter, and also our number of homes that have been completed for a period of six months are the lowest they''ve been since fiscal year ''07. So, really we reduced some aged inventory and I think that was one of the main factors on our margins.

Megan McGrath - Barclays Capital

That actually leads into my next question, which maybe you’ve just answered, but in the past I think that you''ve said that for you, the margins on your spec homes haven''t been significantly different than your dirt sales. Is it just that this quarter you were selling older specs versus newer and that''s where you saw all the difference or is that relationship changing?

Bill W. Wheat

That''s really where we see the difference. Whether you''re talking about a spec job or a build job, the real difference in margins on the gap between the two comes, when a home becomes older, say you close it more than 12 months later than the date in which you started the home. That''s where we see the substantial gap in terms of our margin and so this quarter we did clear some of those older specs and that did have an impact on this quarter''s margin. Going forward to the extent that we''re able to manage our completed homes and our aged completed homes at ideal levels, then we should see some improvement margin from that.

Donald J. Tomnitz

Please, let''s recall one thing. We''re the leader in the industry with our sales because we''re offering product available to our customer, when they are prepared to buy, sell or buy and close. So, as a result notwithstanding the fact that we have 51% of our inventory as specs and that we have a tendency from time to time to clear our aged inventory it''s a positive for us to have most of our sales being generated from our specs.

Bill W. Wheat

In terms of our overall margin, it''s really a function of how well we manage that. If you look at our margin this quarter on homes, it was above 11%. If you look back at our history through this downturn, we have only had one quarter in which we had a single-digit margin in terms of home sales gross margin. So, we''ve been able to manage it relatively well. At times, it has been a little higher than we would like, but we feel like we have it pretty well inline right now.

Operator

Your next question comes from David Goldberg of UBS. Your line is now open.

David Goldberg – UBS

Thanks. Good morning, everybody. First question is actually a little bit what''s going on in the land market and how competitive the bidding is in the land market and how aggressive some of the other public builders have been in terms of pricing when you''re going to put lots under option?

Donald J. Tomnitz

Well, first of all, I’d say and I''m glad you clarified your question because we''re not interested in buying any land that''s not developed currently nor are we just interested in developing the land that we own that''s undeveloped right now.

David Goldberg – UBS

Right.

Donald J. Tomnitz

As far as the option contracts, there is some competition in the marketplace. I''d say the one thing that we focused on at Horton was we definitely had a first mover advantage because we started our aggressive option program as very early compared to everybody else in the industry. So, as a result, we have proven to banks and developers in the markets by virtue of having entered into these rolling option contracts earlier than the rest, that we, one, have the cash to perform and then we are performing. So, now many markets, the sellers, whether they be banks or developers or whomever are soliciting and seeking us as the builder in those marketplaces. So, I''m not finding currently a lot of competition with other builders for rolling option contracts.

Further, as I listen to our competitors, most of them are moving toward or have already moved to a build-to-order business model, which basically tells me that they''re not interested in absorbing as many lots vis-à-vis specs as we are.

David Goldberg – UBS

Interesting. The second question is that leads into it as well and that''s where do you think the spec count is kind of going as we look into the Federal tax credit expiring at the end of November and maybe the need to have some spec out there to meet demand with the existing home market. Do you suspect we''ll see a big ramp in specs as we kind of prepare for that?

Donald J. Tomnitz

No, sir. We are very comfortable with our spec level currently and most of our spec were 51% of our overall inventory, which came down some from the previous quarter. We are happy with our spec count, where it is today. I’d also say to you, I think there is a lot of concern about the $8,000 Federal tax credit setting at the end of November.

I think the real positive for the industry, a little positive, is the fact that home prices were up 0.9% according to Kishore last month and as long as we continue to have some stability and the slight increase in housing valuations, I think that''s a much stronger buying indicator for the public than an $8,000 tax credit. So, that''s what we are looking forward moving forward. I think we''ll suffer a little bit of loss in sales, but I think it will be made up if pricing continues to accelerate.

Operator

Your next question comes from the line of Joshua Pollard of Goldman Sachs. Your line is now open.

Joshua Pollard - Goldman Sachs

Good morning. You guys talked about your spec. Can you give some color around the age of your spec or if you could split up the specs that you have into what''s left in six months, what''s left in 12 months and what is it?

Donald J. Tomnitz

Well, frankly, our number of specs that have been completed and unsold for a period greater than a year is less than 500. Our number of specs that have been completed and unsold for a period of six months is somewhere right around 1,000. So, all total we have six months and greater, a total of 1,500 homes relative to an inventory of close to what -- Actually, the total would be a 1,000. The greater than a year is a subset of the 1000 units and that 1000 units greater than six months that’s the lowest that we''ve been since sometime back in fiscal ''07.

Joshua Pollard - Goldman Sachs

Great. My other question was around July, back in May you talked about April orders being down 18% year-on-year. Could you give those -- the year-on-year change for July and also could you talk about the cadence of the June quarter? You talked about 18% in April, but what was it on for May and June?

Bill W. Wheat

In terms of July, we''re really not in a position to make any statement about July sales; particularly there is really not a clear historic trend from June to July. Some years were up, some years were down, and we''re only the morning of the second business day here in July. So, we''re not in a position to be able to definitively state what our July sales were.

As far as the sales cadence year-over-year during the quarter, clearly, since July was down year-over-year by 18% and for the quarter we were only down 7.5% that''s July -- April was down 18%. Clearly we performed better than that on a year-over-year basis in May and June. Roughly we were around flat to slightly down for the May and June period.

Operator

Your next question comes from the line of Nishu Sood of Deutsche Bank. Your line is now open.

Nishu Sood - Deutsche Bank

Thanks. Good morning, everyone. I wanted to ask first about the competition versus resale market foreclosures in particular. You folks have had some pretty good success in competing against foreclosures and I''m thinking of your short sales events Southwest. I know you had a new repo sale type event as well.

One thing that you might observe about the spring season is because of the foreclosure moratoriums there was probably less supply and that''s obviously going to change as we head into the summer here. So, I wanted to get your sense of that from the ground. Did you notice last competition from foreclosures during the spring selling season and what''s your outlook once the supply starts to rise again?

Donald J. Tomnitz

I think that we''re facing competition from foreclosures in each market. I think in the spring, clearly, notwithstanding the fact that there may be some homes that are being held off the market by banks and other lenders. The key is we''re still fighting competition and stiff competition with foreclosures.

The beautiful thing about what we''ve done over the last year is we''ve repositioned our product both in terms of size, cost, and price and in each one of our markets, our focus is how do we compete with the foreclosure pricing at any one point in time.

Clearly our sales for the last quarter reflect that we''re doing a good job in each one of those markets, especially relative to our competition. So, going forward, our plan is to continue to adjust our product size and offerings in each one of our markets such that we are competitive with a superior product and an equal to or slightly higher than foreclosure price.

Nishu Sood - Deutsche Bank

That''s helpful. Second question I wanted to ask, just following up on Dave''s question on the lot purchases, land to market out there. A lot has been made about the pickup in land purchase activity and your name does come up obviously in a lot of those discussions out there in the industry. However, as you described it earlier, Don, $225 million to date, and that obviously includes the incremental new purchase as well as takedowns on existing options.

So, I just wanted to get some reconciliation from you. Is that a reflection, for example how much of that, first of all, that 225 is incremental purchases? Is the fact that you''re going to come in well below the 500 million you forecasted at the beginning of the year? Is that simply reflection of optioning rather than purchasing outright or is the extent of pickup in land transaction activity being overstated somewhat?

Donald J. Tomnitz

I think it''s being overstated to a large extent on the marketplace, and I know our name comes up first in virtually every market, and hence I think the brokers are using our name to try to create a feeding frenzy in the market for option deals. So, as a result, I don''t see a lot of competition going forward, just simply because we carved out a lot of our lot positions in each one of our markets.

The 225 versus the 500, really is a function of the way we''re operating in the company and that is we''re just not going to bank lots for anybody today. We are going to close the number of lots that we think are the right number of starts for a particular community and then as we sell inventory that we''ve created in those spec inventory of those units we''re going to replace it based upon our need to replace it. So, we''re just not interested in banking anybody else''s land at this point in time.

Bill W. Wheat

Nishu, in respect to the options that we have tied up over the most recent quarter, you''ll see that our total number of option lots increased by about a 1000 this quarter from the previous quarter. So, there is some incremental increase there, but it''s not that dramatic. You also referenced the total amount of spending that we had spent as a portion of the $225 million. We have spent about $90 million of that 225 on land and lots during the year and the vast majority of that is on finished lot takedowns that we have purchased throughout the year.

Operator

Your next question comes from the line of Ken Zener of Macquarie. Your line is now open.

Kenneth Zener – Macquarie Capital Securities

Given the rise in units under construction, I think it’s 10,900; is that correct?

Stacey H. Dwyer

Yes.

Donald J. Tomnitz

That''s correct.

Kenneth Zener – Macquarie Capital Securities

Is there any reason to think the ratio of units under construction before delivery, it’s a two time to change?

Bill W. Wheat

Our target is still to keep about the level of inventory that is about half of our forward projected closings on an annual basis. It''s always fluctuating. If you look at recent history, we have been slightly above that number as we have been working our inventory down and our sales have been declining, but our target is to keep it about half of our projected, 12 months closings.

Kenneth Zener – Macquarie Capital Securities

So, I mean that really pretends that you guys are at a point of acceleration, especially given that your guys’ spec count will be coming down. You made comments about community growth next year, would you mind expanding on that at all?

Donald J. Tomnitz

I''d say two things about that. Yes, we do. We are in a position of accelerating our growth. We believe that 2010 will be a better year overall than 2009. We''re at the bottom in 2009. The other part of the question was?

Stacey H. Dwyer

I think there''s probably a little bit seasonality in there too, Ken, because traditionally Q4 is going to have some of our highest deliveries. I know seasonality has been a little hard to judge. The 10,900 is going into both year end and then also into the expiration of the federal tax credit. So, we will continue to monitor our inventory in relation to our sales and we''ll make adjustments on our starts, as we need to.

Bill W. Wheat

As we mentioned, at least a quarter ago, even though we don''t give community count, we believe our number of net communities will be higher in 2010 than what it was in 2009.

Operator

Your next question comes from Mike Widner of Stifel Nicolaus. Your line is now open.

Michael Widner - Stifel Nicolaus & Co.

Good morning, guys. Just wondering if you could comment a little more on the SG&A expenses, I know you''ve highlighted how much it''s down year-over-year. This is the first q-over-q increase we saw since 2007. I''m just wondering, number one, you could comment on sort of the very modest q-over-q increase, but also provide some guidance on what we should expect for a trend there?

Bill W. Wheat

We did see the slight increase from Q2 to Q3, clearly as we closed more homes. During this quarter, we closed 4200 homes this quarter versus 3600 last quarter. There are some sales commission expenses and the like that move with our volume levels. Our headcount remain relatively flat to slightly down from Q2 to Q3 overall. We did have some additional expenses really on a non-cash basis. Our deferred comp plan accrual increased this quarter as the stock market improved this quarter.

So, that was a portion of the increase, but overall, if you go down the list of the categories in our SG&A, you continue to see declines in the majority of the categories. You see some increases in some of the non-cash items that are tied to market performance and you see slight increases in variable portions of salary that are based on volume or in some markets slightly better profitability levels.

Michael Widner - Stifel Nicolaus & Co.

Okay. Well, thanks for that. I guess if you guys were to ballpark, where you would target SG&A as a percentage of home building revenue. I think in the past you had mentioned somewhere around 10%. You''re running higher well above that and then well above where you were last year each quarter so far this year on a percentage of revenue basis. So, I was just wondering if you could update us at all and maybe where your target is for SG&A. Do we expect it to trend downward or flatten out and grow if we see the pace of home sales grow?

Donald J. Tomnitz

As one of our division President says so eloquently, no good deed should go unpunished, and notwithstanding the fact that we continue to have the lowest SG&A in the industry, we continue to get questions about our SG&A. To answer your question specifically, our goal is to keep our SG&A. Stacey.

Stacey H. Dwyer

On goal ongoing is always to keep it at 10% or less. It''s going to be challenging. Obviously, we just reported above 14% for this quarter and we will be looking to both continue to reduce our SG&A costs, where we can. We''re also looking, as Don said of hopefully increasing our volume going in to 2010 with sales and closings cooperating. So, we think that a combination of those factors will allow us to continue to drop it. I can''t tell you that it will be at 10% for fiscal year 2010 though. They will continue to be challenging in the short-term to continue to work that SG&A percentage down.

Operator

Your next question comes from Josh Levin of Citi. Your line is now open.

Josh Levin – Citigroup

Good morning, everyone. You guys have a lot of cash and you''re getting some more with the tax credits, the tax refunds. Do you think it''s possible that you''re actually overcapitalized relative to the opportunities that you face?

Bill W. Wheat

Absolutely not, and no one is going to intimidate us, and convincing us that we have too much cash, because I can tell you at this stage in the market or the past couple of years, cash is king and we''re going to continue to maintain an extraordinarily strong cash position. We see numerous opportunities out there. Please don’t forget that we don''t have a revolving credit facility any longer and as we increase our units under construction, as we move into 2010, which we anticipate being a better year than 2009. We are funding 100% of all of our lot purchases and all of our vertical construction out of cash. So, therefore and we don''t plan on borrowing from the banks in the nearby future. So, therefore we believe we''re going to have a strong cash position. We are going to continue to grow that cash position.

Josh Levin – Citigroup

Okay. Fair enough. One follow-up, did you notice a difference in the type of home buyer profile during the quarter, with more families, less families, wealthier or less wealthy? Well, so just the same old that you saw in the first quarter, but just more of them?

Stacey H. Dwyer

Yes, it''s been consistent in terms of who we''re seeing buying homes right now and part of its driven by the product that we''re offering and our ability to achieve a very low price point. We''ve seen the percentage of first time home buyers for us continue to increase. It''s basically increased every quarter for the last four to five quarters. That''s our target group right now.

Donald J. Tomnitz

Most notably, we have several divisions, a lot of our divisions, but several divisions in particular, who have definitely redesigned their product and are offering price points that are unheard of.

In Seattle, we''re offering single family detached homes for under $200,000. In Denver, we''re offering single family detached homes, in our freedom series under $200,000. In Albuquerque, we''re offering homes for under a $100,000. So, what we''re really focused on and what we''re seeing in our models are those first time home buyers are moving out of an apartment. We are so fortunate that this company has always focused on their first time home buyer because that is the heart of the market today and we believe the heart of the market going forward for the next several years.

Operator

Your next question comes from Dan Oppenheim of Credit Suisse. Your line is now open.

Dan Oppenheim - Credit Suisse

Thanks very much. I was wondering if you can talk a little about California, what you''re doing in terms of programs to increase buyer urgency following the end of the tax credit out there.

Bill W. Wheat

We''re doing the same thing in California as a matter of fact I mentioned in Seattle and Denver, but in California, especially in our LA Central Division, we''re now offering homes under $200,000 in that market, which is unheard of and purchasing lots in the very low double-digit numbers for the first time in the history of this company.

So, in California what we continue to focus on, we continue to focus on specifically in California is offering the best product at the best price to compete with the foreclosures in that marketplace, but also to be able to provide people living in apartments an opportunity to still take advantage of the $8000 federal tax credit notwithstanding the fact the California tax credit has gone away or is going away and give them the opportunity to buy a home at extraordinarily low price and low interest rate.

Dan Oppenheim - Credit Suisse

Thanks. A quick follow-up; wondering about, as you''re looking at land, markets where you''re looking at would that be consistent where you''re seeing the better order trends, sort of Mid-Atlantic touch?

Donald J. Tomnitz

Well, we are looking for lots in all of our markets. We are not looking for raw land in any of our markets nor are we looking for partially developed lots in any of our markets. We''re specifically looking with developers and banks to provide them the opportunity to afford us the opportunity to build entry level housing on finished lots. That''s where I think our market and our business is for the next two to three years.

Operator

Your next question comes from Carl Reichardt of Wells Fargo. Your line is now open.

Carl Reichardt - Wells Fargo

Hey guys, how are you? So Don, I want to talk about your direct construction cost for a sec. I mean you mentioned that you''re going to continue to try to push them down, and then after a number of years of moving that direction and being aggressive before the market got bad. What specific trades or specific products that go into your home? Do you think you have the most leverage to push prices down on or are there regions of the country, where your directs are too high, where you think you can be more aggressive. Everyone is talking in generalities and I would just like to know of specifics.

Donald J. Tomnitz

First of all, I answer the question in a general term, and that is, it’s a market-by-market example. I will tell that DR just came out of Las Vegas in the last couple of weeks and believe it or not as much as we''ve worked our cost down on Las Vegas. After he left the market, we found opportunities and cost savings on cabinets, plumbing, insulation. As a result, it''s just every division focusing on every trade and providing ourselves the opportunity to continue to make sure that we''re getting the best price in the marketplace.

Why is that so important? It was important because of one major reason, as you travel around the country like DR and I have been on the road forever for the last 18 months is that we are one of the few builders starting any homes. So, when we start five or eight homes in the market, in the subdivision, we want the best price because there is just no one else starting homes.

Carl Reichardt - Wells Fargo

Okay, but then back to the question, right. So, specifically, on the trade side or specifically on the product side, as you go around and you and DR do this and I assume Bill and Stacey look at this too, where do you say, we just think these cost can come down a lot. We can negotiate better with the broad national suppliers, with local subs. I''m just trying to get those specifics because I can''t seem to figure out where we can push any harder.

Donald J. Tomnitz

Well, again, I think I answered your question, but I''ll try one more time. It''s every sub, whether it would be a national or local sub, every vendor and is taking a look at our product offerings. In many of our markets, we are putting things and houses that we haven''t historically put in houses. So, we bring in a new vendor base, our new subcontractor base. It gets back to most importantly, I think where our cost save is going to come from. The vast majority of our cost savings are going to come from our volume and to the extent that we''re starting more homes than anyone of these markets and everyone else. So, if nothing else, if volume were to stay flat with everyone else peyrepertuse, then maybe our pricing should be peyrepertuse with everyone else, but to the extent that we are starting more units then we ought to get a better price.

Carl Reichardt - Wells Fargo

Fair enough. I appreciate it, Don. Thanks.

Operator

Your next question comes from Alex Barron of Agency Trading Group. Your line is now open.

Alex Barron - Agency Trading Group

Good morning, guys. Don, I was hoping you could elaborate a little bit more on your goal to get to profitability next year. Is that going to happen more by impairing the land a lot more? Is that going to come from cutting costs, cutting SG&A, or is it more dependent on buying cheap land opportunities?

Donald J. Tomnitz

Well, we''re looking at each division and our goal is to get each division within the company profitable and then we know the company will be profitable. So, that''s the challenge that DR and I face and we are spending a lot of times in each one of our, what we call, hot divisions, which are handful of divisions, where we think we need to focus on making sure that they are profitable in 2010.

I think clearly, where we''re going to get profitable is by virtue of keeping our SG&A pretty much where it is today and then be enabled to increase our volume in each one of our divisions by having additional flags open in each one of those markets and offering product that''s ready to close to our buyers, which our competition is not doing. So, I’d say those three factors are the things that I believe truly puts us in a preeminent position to become profitable faster than anyone else.

Alex Barron - Agency Trading Group

My other question is more market-specific, was out in Las Vegas, last month, in June, and I was just doing a survey of everybody''s communities and saw that prices apparently came down about 20% to 40% versus first quarter. So, I''m trying to figure out, is that market pretty dead? I mean are you guys going to stop building there or why would you keep building?

Donald J. Tomnitz

Well, first of all, in Las Vegas, we are not going to stop building. We have the leading division in Las Vegas of all the builders. We continue to sell more homes than anyone else. Our product offerings are changing. Our pricing is changing. We''re entering into a rolling option deal just the other day, where basically we''re going to be able to provide homes, about a 3,000 square foot home for about $0.50 on the dollar, what the specs are being offered in that same subdivisions. So, what we''re looking at in Las Vegas are, those opportunities where we can come in and offer a compelling price on a compelling price per square foot in a similar location, as what the competition is.

Operator

Your next question comes from Jim Wilson of JMP Securities. Your line is now open.

Jim Wilson - JMP Securities

Thanks. Good morning, gentlemen and Stacey. I was wondering if you could give a little more color first, I guess, on impairments regionally and what you saw and then the second would be given that color and that your spec base is down, can you talk a little bit about gross margins and where they might be headed or are in backlog?

Donald J. Tomnitz

Yes, let me before Bill gets started, I want to go back and partially answer a question that was asked about impairments early in terms of -- we plan on getting profitable in 2010 by taking additional impairments. That''s not part of our plan. We''re taking impairments on projects that need to be impaired once they are put into our business model. So, the result, our focus is to get profitable based upon the three factors I discussed before. Bill?

Bill W. Wheat

In terms of our current quarter impairments Jim, of the $102.9 million of impairments we took during the quarter, $32 million of that was in our West region. So, that was the largest portion of the overall impairments. Second, was the Southeast region at 20 and third was the Midwest at 18. So, it was really spread around the regions this quarter with the largest portion being in the West.

As we look at margin expectations going forward, clearly, that’s largely dependent on market conditions overall. We did see the sequential effect on margins, this quarter was largely driven by the large number of older homes that we moved through our closings. As our inventory of completed specs is more inline with where we would expect them to be, we would not expect that drag to be quite as big going forward.

So, certainly, our goal and our expectation would be that we start seeing some sequential improvement in margins going forward. Nailing down exactly what that’s going to be, will be difficult. We won''t be guiding any specific improvement, but we would expect to see improvement from here.

Jim Wilson - JMP Securities

Okay, great. Thanks.

Operator

Your next question comes from Jay McCanless of FTN Equity. Your line is now open.

Jay McCanless - FTN Equity Capital Markets

Good morning. I wanted to ask first about the negative effect on gross margin from the increased warranty reserve. Is that from the aggressive growth you''re planning next year, or does that have to do with some of the drywall issues we have been hearing about?

Stacey H. Dwyer

You are right. A portion of that, approximately half of that increase in our warranty reserve is related to about 75 homes, we have identified that have indicators that they have the Chinese drywall. Right now those homes are located in Florida and Louisiana. We have screened through our subcontractors and our supply chain, all of our markets and right now those are the only two areas, where we are aware that we have any Chinese drywall installed in our homes. Our reserve for that this quarter was about $4 million and our total reserve for Chinese drywall right now is about $6 million.

Jay McCanless - FTN Equity Capital Markets

Then wanted to get a little more color on the East expansion and could you talk about what the neighborhoods are going to look like? Are you going to be mostly entry level or mix of entry level and move up and if the first time buyer credit does sunset at the beginning of December how does that affect your neighborhood mix on that Eastern expansion?

Donald J. Tomnitz

Let''s not get confused because the South also has done an extraordinary job on in renewable, in option deals. To answer your question the focus in all of our markets is to be the preeminent entry-level builder in each one of those markets.

To the extent that the $8000 Federal tax credit goes away at the end of November, we''re still going to be focused on that first time home buyer largely because of one important fact. They do not have an existing home to sell. So, as a result, we believe that our pricing, the interest rates, as well as the fact that we''re taking all of our apartment and putting them into a single family home that has good tax consequences for us, will put us in a good position going forward. Not much focus on the second or any focus hardly at all on the third-time buyer, so first-time home buyer, where our focus is.

Operator

Your next question comes from Bose George of KBW. Your line is now open.

Jade Rahmani – KBW

Yes, this is Jade Rahmani from KBW on for Bose George. Can you tell us the percentage of your home sales that are coming from first-time home buyers and what that percentage was last year?

Stacey H. Dwyer

Last year we were in the 40% range. This year we are a little bit over 50% in terms of first-time home buyers. I actually clarified, the way we can track that best is through our mortgage company, which currently captures close to 70% of our business and so, I''m giving the mix that''s actually being financed through our financial services.

Jade Rahmani – KBW

So, the 50% is what''s financed through your financial services?

Stacey H. Dwyer

Right, but we think that''s a pretty good representation since we''re capturing 70% of our company''s business.

Jade Rahmani – KBW

Okay and then secondly, have you quantified the impact of the federal tax credit and what percentage of your current demand you''re seeing as a result of the tax credit?

Stacey H. Dwyer

We have not and I don''t really know any way to do that. We certainly have seen an increase in our first-time home buyers. That may or may not be a factor though, because there is income limitations associated with that. So, people who are buying first-time home in a higher platform market may not qualify for that tax credit. It certainly has had some impact on our sales, but we are not able to quantify definitively.

Operator

Your next question comes from Stephen East of Pali Research. Your line is now open.

Stephen East - Pali Research

Thank you. Good morning, everyone. Don, you''ve talked a lot about resetting your product in size and price point, etc. Could you talk about where you are in the process and maybe from a community perspective what percentage you''re in now, where you want to go with that and then also, the relative velocity of sales with that type of product versus your communities that don''t have that in there?

Donald J. Tomnitz

I would say virtually every one of our divisions has got some new product offering, some more than others. Certainly, in our divisions, where we had a high ASP or median price there was a huge focus on (inaudible) become more affordable, specifically in Denver, where most of our product offerings were in the $300,000 to $400,000 price range. In Seattle, it was in the $300,000 to $400,000 price range, same in California primarily over $400,000.

So, what we''ve really focused on is not retooling by the way our task products. We’ve been focus simply retooling our detached product to the extent that we''ve got a whole group of different series of names based upon what the division President wants to name them from the Freedom Series to the Medallion Series to the Cottage Series, and the real essence of that is how do we get the smallest single family home that is marketable, and in some markets that''s less than a 1000 square feet, some markets has 1200 square feet, but the real essence has been to get a smaller and also to get all the amenities out of the house that we can get out of the house.

I just came out of Denver last week. We actually have a game room above the garage. That is sheet rocked only, no carpeting, no trim, no nothing in it and if you want it finished you can pay an extra $6,000. The buyer that we''re attracting is somebody, who can''t afford that extra $6,000. So, as a result, that price point, that home is selling for $166,000.

So, as a result, that''s in essence where we are. I think we''re very far along and its relative division by division, but as a company, we are very far along in terms of having retooled our product. That''s largely as a result of DR walking into my office probably about 18 months ago and saying, we just got to get back down to entry-level housing because a lot of these home buyers could be buried in their mortgages and they''re not going to be candidates for move up products. So, as a result we made a major effort and I think we have accomplished a lot at this stage of the cycle.

Stephen East - Pali Research

Where would you like to target? What percentage of your total volume would you like to have at first time?

Donald J. Tomnitz

It''s relative to the market and you define first-time home buyer market-by-market because you can''t do it by sales price because it depends upon what the lot price is. It depends upon what the permits are. Even in a market like Denver, we’ve got one market, where we got a $43,000 building permit and we got another market, where in that same MSA area in Denver, where we got an $18,000 permit. So, really it’s just a function of location and subdivision and what that buyer profile is in that particular subdivision. We would like to have as we are right now. I think approaching 60% first-time home buyer and certainly that''s seen in our sales and we''d like to continue to keep it that or raise it.

Operator

Your next question comes from Megan McGrath of Barclays Capital. Your line is now open.

Megan McGrath - Barclays Capital

Thanks. Just two quick follow-ups, do you have the deferred tax valuation allowances as of the end of the quarter?

Stacey H. Dwyer

It''s a $1.067 billion.

Megan McGrath - Barclays Capital

Then just wanted to get a little bit more color on the land market and the competition there that you''re seeing for these finished option lots, I wonder if you have any sense of what percentage of the bids that you''re putting out there that you''re actually winning?

Donald J. Tomnitz

Well, that''s going to be on a market-by-market basis and then to answer your question, it''s a long, laborious process, a lot of markets for a couple of reasons. One is that we''re offering to purchase the lots at typically significantly less than what the bank or the developer has in those lots i.e. at a buy in that market, where we can put a house on it and hopefully make it. Our goal is make an 18% plus gross margin on the vast majority of those option deals. So, as a result I’d say to you that the competition in those markets sometimes is more with the developer than it is with other builders.

Megan McGrath - Barclays Capital

Great. Thanks a lot.

Operator

There are no further questions at this time. Now I will turn the call over back to you, Mr. Tomnitz for closing remarks.

Donald J. Tomnitz

Thank you. We appreciate you listening to our third quarter conference call. Once again, I would like to thank all the DHI team members because without you, we would not be where we are. We have made massive SG&A cuts over the last couple of years. We have repositioned the company with solid new product offerings and price points. We want to also thank our subcontractors and our vendors, who helped us, get to this point. We absolutely believe that we are the leader in the industry with our sales and our financial performance and it is our intent to continue to lead the home building industry into the recovery. Thank you very much.

Operator

This concludes today''s conference call. You may now disconnect.