Apr 23, 2012
Executives
Donald J. Tomnitz - Vice Chairman, Chief Executive Officer, President and Member of Executive Committee Stacey H.
Dwyer - Executive Vice President, Treasurer and In Charge of Investor Relations Mike Murray - Bill W. Wheat - Chief Financial Officer, Principal Accounting Officer and Executive Vice President
Analysts
Adam Rudiger - Wells Fargo Securities, LLC, Research Division David Goldberg - UBS Investment Bank, Research Division Michael Rehaut - JP Morgan Chase & Co, Research Division Daniel Oppenheim - Crédit Suisse AG, Research Division Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division Nishu Sood - Deutsche Bank AG, Research Division Stephen F.
East - ISI Group Inc., Research Division Anto Savarirajan - Goldman Sachs Group Inc., Research Division Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division Joel Locker - FBN Securities, Inc., Research Division Megan McGrath - MKM Partners LLC, Research Division James McCanless - Guggenheim Securities, LLC, Research Division Michael R.
Widner - Stifel, Nicolaus & Co., Inc., Research Division Stephen Kim - Barclays Capital, Research Division Alex Barrón - Housing Research Center, LLC Unknown Analyst Timothy Jones Jack Micenko - Susquehanna Financial Group, LLLP, Research Division
Operator
Good morning, and welcome to D.R. Horton, America's Builder, the largest builder in the United States, Second Quarter 2012 Earnings Release Conference Call.
[Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr.
Donald J. Tomnitz, President and CEO.
Thank you, Mr. Tomnitz.
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.
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 statements.
Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's annual report on Form 10-K and our most recently -- recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.
Don?
Donald J. Tomnitz
Thank you. The spring selling season did arrive this year and it is still in full swing.
Our net sales orders were up 55% sequentially from the December quarter and up 19% from our second quarter last year. Our average sales price increased to $222,700 during the quarter and the value of our net sales orders increased 28% compared to the year-ago quarter.
We've also seen continued sales strength into April. Our sales this quarter resulted in a 17% year-over-year increase in our backlog units, which puts us in a strong position for increased revenue and profitability in the second half of fiscal 2012.
In response to our improving sales, we have increased our homes under construction while reducing our spec percentage to 50%, which is the lowest level in recent history. We are also evaluating and selectively investing in land acquisition and development.
We're using our strong operating position and our solid balance sheet to profitably grow our business in the current housing environment. We are demonstrating our ability to leverage our fixed costs while increasing production in response to stronger demand in our communities, even though macroeconomic and housing conditions remain soft.
We see uneven improvement across our operating markets with some markets experience in increases in demand and others remaining weak. However, we are finding opportunities to take market share and existing markets while evaluating the attractive new sub-markets.
We continue to dominate the entry-level market while expanding our product offerings for move-up buyers. We are optimistic for the remainder of fiscal year 2012, after recording net income of $68.3 million for the first 6 months.
Mike?
Mike Murray
In the second quarter, our Homebuilding operations generated pretax income of $34.6 million and our Financial Services operations generated pretax income of $7.7 million. Our net income for the quarter increased 46% to $40.6 million, or $0.13 per diluted share from $27.8 million or $0.09 per diluted share in the prior-year quarter.
Bill W. Wheat
Our second quarter home sales revenues increased 27% to $931 million on 4,240 homes closed, up from $733 million on 3,516 homes closed in the year-ago quarter. Our average closing price for the quarter was up 5% compared to the prior year and up 2% sequentially to $219,500.
Don?
Donald J. Tomnitz
Net sales orders for the second quarter were up 19% from last year to 5,899 homes on a 6% decrease in our active-selling communities. In the March quarter, our average sales price on net sales orders of $222,700 was up 7% compared to the prior quarter and up 3% sequentially.
Our cancellation rate for the second quarter was 22%, which is very close to our historical pre-downturn cancellation rate range of 17% to 21%. Our sales backlog at March 31, 2012, increased 17% from the prior year to 6,189 homes.
The value of the backlog increased 25% to $1.4 billion from $1.1 billion a year ago. Stacey?
Stacey H. Dwyer
Our gross profit margin on home sales revenue in the second quarter was 17.6%, up 140 basis points from the year-ago period. 80 basis points of the increase was due to cost improvements and decreased incentives and discounts.
50 basis points of the decrease was due to reduction in amortized interest and property taxes. Also contributing 10 basis points was a decrease in the estimated cost for warranty and construction defect claims as a percentage of home sales revenues.
Sequentially, incentives and discounts were flat. However, our gross margin improved 80 basis points from the first quarter due to the decrease in the estimated costs for warranty and construction defect claims as a percentage of home sales revenues.
This largely reflects a higher level of insurance recoveries received than in the first quarter, including a $2.4 million reimbursement of costs related to Chinese drywall. Bill?
Bill W. Wheat
Homebuilding SG&A expense for the quarter, which includes corporate overhead, was $128 million, up only 3% from the year-ago quarter on a 21% increase in homes closed. As a percentage of Homebuilding revenues, SG&A was 13.6%, down 320 basis points from 16.8% a year ago, reflecting both the improvement in volume and our continued efforts to control costs.
We also continue to see the benefits of our aggressive debt reduction over the past several years, as Homebuilding interest expense was down 63% from the year-ago quarter to $5.5 million. And our second quarter Homebuilding interest incurred decreased 17% to $28.1 million.
Our capitalized interest balance at March 31 totaled $81.1 million, which is only 3.2% of inventory. Mike?
Mike Murray
Financial Services pretax income for the quarter was $7.7 million, which included $1.1 million of recourse expense. 82% 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 60% of our homebuyers this quarter, with virtually all loans meeting eligibility requirements for sale to Fannie Mae, Freddie Mac or Ginnie Mae. FHA and VA loans accounted for 57% of our mortgage company's volume this quarter, down from 61% in the year-ago quarter.
Our mortgage company's new borrowers during the quarter had an average FICO score of 706 and an average loan-to-value ratio of 91%. First-time homebuyers represented 49% of the closings handled by our mortgage company this quarter.
Stacey?
Stacey H. Dwyer
Since December, our total inventory increased by approximately $155 million, excluding noncash items. We increased our homes and inventory by $82 million and our investment in residential land and lots by $73 million.
Our homes and inventory at the end of March totaled 11,100 homes, up 900 homes from December. As of March 31, 1,100 of our homes remodels, 5,500 were speculative homes and 2,200 of the specs were completed.
Our spec percentage improved to 50% from 56% at December 31. Don?
Donald J. Tomnitz
In our second fiscal quarter, our investments in land, lots and development costs totaled $319 million, which reflects our ability to find good opportunities to open new communities and replenish our finished lot supply. We continue to purchase our option finished lots in many markets and are also selectively investing in land acquisition and development opportunities to ensure we have adequate lots applies in desirable markets.
In March 31, 2012, we control approximately 121,000 lots, of which 86,000 are owned and 35,000 are option. Our owned lots include 23,000 finished lots and 20,000 lots to be developed within the next 12 to 18 months.
Our option lots consist of 24,000 finished lots and 11,000 lots that we generally expect to purchase and develop within 12 to 18 months, bringing our minimum pipeline of finished lots over the next 2 years to 78,000. Bill?
Bill W. Wheat
We used $79 million of cash in operations in the March quarter, primarily due to increases in homes and inventory, residential land and lots and mortgage loans held for sale, offset by net income and an increase in accounts payable. We ended the quarter with $961 million of Homebuilding unrestricted cash and marketable securities.
The balance of our public notes outstanding at March 31 was just under $1.6 billion, with no maturities until May of 2013. Mike?
Mike Murray
At March 31, our Homebuilding leverage ratio, net of cash and marketable securities, was 18.9% compared to 18.7% a year ago. Gross Homebuilding leverage at March 31 improved 580 basis points to 37.1% due to debt reductions and increased equity.
Stacey?
Stacey H. Dwyer
Before we move to Q&A, we wanted to share our expectations for some of our operating metrics. With 6,189 homes in backlog at March 31 and solid sales through the first part of April, we expect stronger closings and profits in the third and fourth quarters.
Our sales during the March quarter combined with spec inventory of 56% at the beginning of the quarter, enabled us to convert 94% of our beginning backlog into closings. With specs now at 50% of total inventory, we expect that our future backlog conversion rate will be below 90%.
Our current expectation is for home sales gross margin to remain in the mid-16% to mid-17% range. Our absolute SG&A expense in the third and fourth quarters will increase due to variable components.
However, our SG&A percentage should improve as we close more homes and leverage our fixed cost structure. We continue to analyze the need for a valuation allowance for deferred tax asset.
If our current business trends continue, we expect to be out of our 3-year cumulative loss position before the end of the fiscal year. If our business, the Homebuilding industry and the economic conditions remain stable, we may be able to significantly reduce the valuation allowance at some point in the next few quarters.
Don?
Donald J. Tomnitz
I don't have a formal closing this quarter as our strong numbers speak for themselves. However, I would like to thank all of our DHI teammates for producing an outstanding quarter.
This concludes our prepared remarks. We'll host any questions you have now.
Operator
[Operator Instructions] Our first question comes from the line of Adam Rudiger from Wells Fargo Securities.
Adam Rudiger - Wells Fargo Securities, LLC, Research Division
Don, I was wondering if you could elaborate a bit on your comments about the improvement being uneven. I was wondering if you could -- are there any themes between the markets that were improving and weren't.
And I wonder if you could explain what those were? And also in that, if you could comment on what you're seeing in the existing inventory market and how that's been affecting those trends?
Donald J. Tomnitz
Well, I'll take the second part of your question first. I noticed a lot of media coverage around foreclosures.
And frankly, one of the things that we think is that the foreclosures that are available to our buyers today are in typically poor condition requiring quite a bit of cash out of pocket to make them livable. And I think that's one of the reasons why you're consistently seeing over 1/3 or equivalent to 1/3 of existing home sales go to all-cash buyers, which means that the investors who have the money to take out of their pocket to put -- to improve those homes.
But our buyers are typically looking for a new home, obviously, with a good warranty to behind it and frankly, something that they don't have to take cash out of their pocket. So I think we're in a very, very strong position notwithstanding the fact that banks are supposedly going to increase the number of foreclosures they're putting on the market.
But again, I think these are tertiary buys compared to what the new home buy is for our customers. Now generally speaking, as I go across the country and I don't like to identify markets anymore as which ones are strong and which ones are weak, there are just several markets and primarily in the Sun Belt, in the coastal regions, that continue to be better markets for us.
And typically, those are where some job creation is taking place and if you certainly look at the state of Texas, state of Texas is generating jobs and the state of Texas continues to be a very good market for us.
Adam Rudiger - Wells Fargo Securities, LLC, Research Division
And then my second question is, if I just look at the prices you reported both in closing price and order price, it's generally, with the exception of maybe 1 or 2 regions, they were all up. I was wondering if you could comment on just how much of that is mix related versus your building to raise prices now.
Donald J. Tomnitz
Well, Bill, I think, will put some more color on this. But frankly, as you recall, probably 12 months or so ago, 18 months or so ago, we began talking about focusing more on the move-up buyer.
And we have been focusing on the move-up buyer and I certainly think that's one of the factors contributing to our increase in our ASPs.
Bill W. Wheat
And generally, we believe that the change in mix towards move-up buyers is the top primary driver behind our increase in our average selling prices right now. We do in a very limited basis see the opportunity to raise prices or reduce incentives somewhat incrementally in some areas right now.
But I think by far, the largest factors are changing product mix towards move-up.
Donald J. Tomnitz
And frankly, from a perspective of offering that move-up product with our cost structure both from the land side, as well as from the hard cost side, the direct sell side, we can develop and build a better if not equally as good a product as a custom home builders who are having difficulty getting financing and offer better product to the buyer.
Operator
Our next question comes from David Goldberg of UBS.
David Goldberg - UBS Investment Bank, Research Division
I wanted to follow-up on Adam's question about foreclosures. And do – he totally understood that concept that you're not really competing against the foreclosure home given that it's in poor condition and there's lot of out-of-pocket.
But are you worried that the foreclosures that come on the market limit the ability to raise prices simply because if an investor comes in, buys the house, prices are going up, they're more likely to flip the house than they are to rent it?
Donald J. Tomnitz
I think certainly, they're going to flip the house at some point in time. I think that clearly, they're going to take some time to fix these up, but at the same time, I think they're going to hold them for a period when the pricing improves.
So I don't see any immediate competition from the investor, who basically probably has a 2- to 3-year horizon before they flip the housing -- flip the house. Also, our pricing power is not as strong as it has been in the past in many years, so I think we're still out there facing pretty much flat pricing.
Most of where we're coming from is by being able to delete our incentives and our sales, so to speak. We don't have nearly as many event-driven sales this year as what we have in the past.
We've had more of a level sales from the beginning of the year.
David Goldberg - UBS Investment Bank, Research Division
Got it. And then just my follow-up question was on -- and I know you guys have talked about a strategy of looking at more of a move-up buyer and shift a little bit away from the first time.
And I just wondered if you -- is that really because that's where the buyer segment is now? Or is that a question more where land buying is now?
Can you talk about maybe how that kind of goes moving forward? It doesn't seem like underwriting's changing it all for buyers especially the marginal buyer.
So do think that ship kind of continues and the first time kind of continues to decline as a percentage of the overall volumes?
Donald J. Tomnitz
Well I think that our move-up buyer segment will continue to increase as a percentage of our overall sales as we move forward. Also, as I mentioned earlier, we're very competitive with the custom builders out there who cannot get the financing.
And the second part of it is that, that second time buyer and that third time buyer basically have a lot more to put down and they don't have the challenging FICO scores, a lot of our entry-level buyers have. So the down payment and the better credit scores help us meet that buyer demand a lot easier than the entry-level buyer.
Bill W. Wheat
And David, if you go back to prior to the downturn, our historic average mix had 35% to 40% of our buyers being first time home buyers and a fairly equivalent number of move-up buyers. I think what you're seeing in this shift is a shift back closer to a more normal mix for us.
During the downturn, the first-time homebuyer was a much larger percentage. They got as high as 60% for us.
And I think we're seeing a shift back towards a more normal mix now.
Operator
Our next question comes from Michael Rehaut of JPMorgan.
Michael Rehaut - JP Morgan Chase & Co, Research Division
First question on the gross margins. I was hoping to get a little better sense for the guidance relative to what you put up this quarter, which was the best in quite some time, I guess, 2 years or so.
I would think that with better volume to the extent that there's obviously a little bit of fixed cost even in the gross margin side, you could do a little better potentially than the $17.6 million. So I just wanted to get in terms of the thought process if there were some drivers that you think might push it back to the range that you put out there?
Stacey H. Dwyer
Mike, as we talked about on the conference call, most of our sequential improvement was not necessarily from underlying strength in being able to raise sales prices. It came from a change in our estimates related to warranty and construction defects.
So when we're giving the guidance going forward, we're taking into account that sequentially, we've seen very good sales but we haven't necessarily seen a pickup in our underlying margins just yet. So we've got the range that encompasses about where we were this quarter but also allows for the core margin to remain about where it is.
In terms of volume, none of our margin is contingent on volumes. Everything is house-specific and flows-through cost of sales.
It's previously capitalized inventory until the home closes, it doesn't hit cost of sales.
Michael Rehaut - JP Morgan Chase & Co, Research Division
Okay, appreciate that. The second question, Don, you mentioned your prepared remarks that you're going to be evaluating selected land acquisition and development, maybe picking up that pace going forward.
Also, evaluating new sub-markets. So I was wondering if you could expand on that a little bit from an inventory kind of balance sheet perspective even.
I guess, a couple of questions. Where do you see to the extent that the improvement in the market backdrop continues?
Where do you see the debt to cap going? And also, the investment dollars going in terms of the inventory balance?
And if you could kind of give us at least broadly a sense of which new type of submarkets you might be evaluating?
Donald J. Tomnitz
First of all, let me emphasize that notwithstanding the fact that we are looking at some land and lot development deals, our business model still is a land light business model and our focus is very strict underwriting guidelines on our development deals. 90-plus percent of all of our deals, development deals require that we get our capital back in 2 years or less.
There are some outliers but not very many outliers. On a go-forward basis, we'll continue to -- where finished lots are not available at attractive prices.
We'll continue to evaluate those land a lot development deals. We have in the past, as you know, been a large developer and we'll continue to develop where it's optimistic for us.
Bill W. Wheat
And then Mike, in terms of our balance sheet and how we're managing that, the pace of our investments in land, land development and finished lots has increased. Over the past couple of years, we had invested around $800 million in total.
This quarter, we invested a little over $300 million. So that pace has increased, about 50% from where the pace had been.
So we are seeing the opportunities to increase that pace in response with our -- to our improved sales. But all of those investments will be done within the constraints of where we want to keep our balance sheet targets and our liquidity targets.
We still expect to maintain a strong balance sheet. Our target is to still keep our net debt to cap down below the 40% to 45% range.
Clearly, we have a lot of room on that today. And this is really just reflective of how we prepared this company for the ultimate recovery in the housing market.
We've been -- we generated a lot of cash during the downturn. We paid off a lot of debt.
And we have a lot of cash on our balance sheet. So we're in a very strong position to be able to reinvest in our business now as we see the opportunities.
Donald J. Tomnitz
I think especially relative to our peers, I think our debt to cap and our net debt to cap is extraordinary strong and permits us the opportunity to continue to aggregate market share from our competitors as well as the custom homebuilders.
Operator
Our next question comes from Dan Oppenheim of Crédit Suisse.
Daniel Oppenheim - Crédit Suisse AG, Research Division
I was wondering, Stacey, you talked about the lower backlog conversion rate going forward given the more limited spec inventory. What about the other side of that in terms of margins?
Do you think there's any positive impact on margins from having fewer spec sales coming through?
Stacey H. Dwyer
There certainly could be, going forward, which is why we give a rather wide range with the high end of the range above last quarter's margin. It essentially includes this quarter's margin.
Donald J. Tomnitz
And I would also say to you from our construction cycle perspective, we're starting and finishing homes at a much faster pace than what we have especially during the hot markets of the '04, '05, '06. And so as a result, notwithstanding the fact that we are down to 50% specs, we can build them quickly.
And a number of our buyers are coming into our models today, which is a good deal for us, and that is requesting build jobs, so that they can get the house their way. And as you evaluate our gross margins, you'll clearly find that, that's an opportunistic position for us.
Bill W. Wheat
And that's a little bit reflective of the change of the product mix as our sales mix shifts more from first-time homebuyer to move-up buyer, you see -- you're seeing our spec mix shift with that as we see more build-to-order jobs.
Daniel Oppenheim - Crédit Suisse AG, Research Division
Great. And the second question then, I'm wondering about -- you touched about looking for land and expands different submarkets.
As you think forward into '13 and '14, what do you think in terms of just what you want to be doing in terms of the aim for communicant growth through the next several years?
Donald J. Tomnitz
Our goal is to continue to grow our community count, and we are out there aggressively adding new subdivisions to each 1 of our 4 regions. I think relatively, relative to our peers, we've added more new deals and any other builder in the marketplace today.
So our game plan is to continue to grow where growth make sense. But I don't want to get focused on so much the growth because the one thing we've done is we've gotten our debt down, and we also have got -- we still have work to do on our gross margins.
And our goal is to try to get our gross margins up to the 20% levels. So we still, as you can tell from what we're -- the guidance we're giving you, which is a 16.5% to 17.5% for the second half of the year, we still have goals that exceed our current margins.
So growth is important but profitability is more important.
Bill W. Wheat
And Dan, just one clarifying point in terms of our active-selling communities. Our selling communities were flat sequentially from December.
They are down 6% year-over-year, which reflect some of the activity that we talked about in the second half of last year as far as cutting out underperforming communities. And so we've accomplished that but we are actively adding new communities today and would expect that to increase sequentially going forward.
Operator
Our next question comes from Ken Zener of KeyBanc.
Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division
You talked about the sales trends in April being solid. Could clarify that relative to the 2Q rate we saw at 19%?
Bill W. Wheat
Very similar. That continues to be strong.
Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division
And then the -- related to the community count, which is down 6%, I mean, do you -- please feel free to give us your community count, if you have it. However, it seems that the absorption pace would've increased on the order of 20% to 25%.
Can you talk about why that's occurring, what the dynamics are, if it's better location, intentional strategy to drive volume through fewer communities and to quantify your community count increase. Is it going to be single-digit or is it a bigger round into the back half?
Donald J. Tomnitz
Well clearly, one of our focuses has been to penetrate our existing subdivisions deeper. In other words, to increase our net sales per subdivision per community because that is an optimum position for us.
The key is we called a number of subdivisions that weren't performing. But most importantly and for the majority of the instances, we've gone back and reworked our pricing and our take down schedules on our option deals to enhance the performance of those communities.
So I think it's a wonderful thing that would have increased our absorptions per community because they were a little low in our estimation.
Stacey H. Dwyer
Now the other thing I think you're seeing and I've read in several analysts reports that we kind of referred to a couple of times here, the other opportunity is for home buyers are smaller than they were. There aren't as many other builders offering new homes, so you're seeing a disconnect in terms of the national new home data and what you're actually seeing terms of the large public builders as we're taking market share.
Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division
Okay. And then your closings this quarter, obviously, there's a very different variety of ways to think about a forecast but you guys, were very specific.
What's with -- in terms of its conversion rate, was weather the factor that led to the higher volume of closings?
Bill W. Wheat
Ken, I'd say the #1 reason was our reduction in our spec count. We reduced our spec from 56 to 50 and so there was a focus.
I would say that in general, our closings exceeded our expectations for this quarter a bit. We didn't expect to convert quite as high but I think it was mainly driven by specs.
Weather in a certain point in time always does have some effect, but largely, we do it as driven by specs.
Donald J. Tomnitz
We don't like to blame weather for our lack or performance nor do we like to give weather credit for our over performance. The real issue is strongly that our people are outperforming everyone in the industry and they executed the business plan that we put forth to them 6 months ago and they're exceeded their business plan.
So no weather here.
Operator
Our next question comes from the line of Nishu Sood of Deutsche Bank.
Nishu Sood - Deutsche Bank AG, Research Division
I wanted to follow-up on some of the earlier questions about future growth plans. I know you mentioned that you would like to increase your community count and that's what you're aiming.
But if I look at the 6% year-over-year decrease, if I look at your balance sheet with the super strong 17%, I think, you said net debt to cap against kind of 40% to 45% longer-term target you have, I think you could argue that you're still taking it -- you're still taking a somewhat cautious approach. So at some stage in the future, the headroom you have in your balance sheet argues that you would put that to work and expand investment and community count growth into recovery.
So just wanted to drill in with some specificity on what do you need to see to kind of really press down the accelerator a little bit harder? You mentioned gross margins.
I mean is that what you're waiting to see? Are you waiting to see that you can consistently maintain your gross margin before you really begin to flex your balance sheet into the recovery?
Donald J. Tomnitz
Frankly, we're waiting for a lot of things. Let's not forget the -- I used to say that someone flip the switch February 1 on our buyers.
I think frankly, they just increased the real steps slightly and we've had higher traffic in our communities and we've had higher sales. I don't think that you need to worry about our community count because one thing that we can do is we certainly can increase our community count rapidly.
The thing that we are looking at in general, though, is that if you look at the macroeconomic situation in the U.S., I don't see very much of any job growth out there currently. And job growth is clearly what drives our business.
So we have country that has a tremendous amount of debt and we still have a lot of unemployed people in this country and for -- and a lot of underemployed people. So what we're looking for is a general increase in the macroeconomic conditions in the U.S.
before we start to become over-exuberant. We're 3 months into this and are we ecstatic?
Yes, but we're not over-exuberant.
Bill W. Wheat
And specifically in our business, we're on a front-edge of seeing some early indications on a number of factors that could be improving. But again, this is only 2 months into a selling season and that doesn't necessarily make a trend.
Improving absorptions, slightly improving kind of rates and some improvement in sales prices and margins, those are certainly good indications but we're on the early stages of that.
Stacey H. Dwyer
And with all that being said, if you look at our option lot positions since September, we've grown the number of lots we have under option by 8,000. We've increased our own lots by about 1,000, and we have spent more money this quarter than we have in the recent past on land and lots.
So even with all the caveats we're feeling better about our business overall.
Nishu Sood - Deutsche Bank AG, Research Division
Great, that's very helpful. And then second question, through all of the noise about the FHA last month, I think one of the interesting things that emerged was that a breakdown of that government loans figure.
I think, you said it was 57% and the VA is probably running at, let's say, 15% or 20% of that. So probably higher than what most investors have thought that VA percentage might be.
So I wanted to get your thoughts on that going forward. What does it tell us that the VA percentage is so high?
Is that a sustainable percentage as well going forward as the housing recovery continues? In other words, is the VA going to be able to support growth if that continued 15% to 20% of volumes range?
Bill W. Wheat
That's been -- the VA percentage has been fairly consistent for us over times. Whether it's sustainable, I'm not sure I know the answer to that.
But over time, that's been a fairly consistent percentage. As far as our overall business percentage in FHA and VA combined, that's actually down year-over-year.
So a 57%, that's down a bit from where we've been in the past.
Stacey H. Dwyer
And the real number on that is 20% is VA and 37% is FHA.
Operator
Our next question comes from the line of Stephen East of ISI Group.
Stephen F. East - ISI Group Inc., Research Division
If we just stayed on the FHA for a minute, we had some insurance that went into effect and then we also have sitting out there potentially, seller financing concessions. One, do you think there was any impact from the insurance going into effect?
And 2, as you look at this potential seller financing concession change, do you see that impacting your business? And if so, how much?
Mike Murray
I think we didn't see a big impact, Steve, on the mortgage insurance change coming into play. And on the seller financing limits, as they come into play, I think it may elongate the time for some buyers to accumulate more of their cash required to close the transaction.
But I think that's a 1x event that will shift some buyers to later periods. I can't tell you we'd quantify that real strongly right now.
Stacey H. Dwyer
The proposed change in state the capital and the seller contributions toward closing calls from 6% down to 3%. Our average right now is closer to the new proposed cap.
So we don't ever start offering 6% closing costs. So it might impact some of our marginal buyers but overall, it's not going to be a significant impact.
Stephen F. East - ISI Group Inc., Research Division
Okay, that's really helpful. And then if I look at 2 different issues: one, are you seeing any cost inflation out there?
And if so, what type of impact is it going to have this year on your gross margin? And then 2, your Texas growth was modest relative to the overall growth.
Could you just talk a little bit about what's going on there?
Donald J. Tomnitz
I think Texas obviously, has been -- I don't think, I know it's been a strong market for us for even all through the downturn. And frankly, as we have some of our other markets kick in, it's less of a percentage in terms of our growth on a go-forward basis.
But Texas, let me assure you, is strong and we're continuing to expand our footprint in all of our Texas markets. I would say to you on the cost side, clearly, we are receiving cost pressures.
We're negotiating those as strongly as we can. One of the difficult things is, obviously as we began to begin to report a profit then all of a sudden, our suppliers and vendors began to realize that we are making money.
But bottom line is we're still not as profitable as we'd like and we are also starting more homes than anybody else in the country so as a result, we are very, very competitively pricing and bidding everything that we've got going forward. And we want to work with our suppliers and our vendors.
But we still have a lot more to accomplish in the quarter.
Stephen F. East - ISI Group Inc., Research Division
All right. If I could ask one other, on the DTA that you talked about.
You talked about moving into a profitability on 3 year. If I look at the trailing 12 quarters, you're already there.
Is there something else you're looking at before you bring the DTA back onto the balance sheet?
Bill W. Wheat
On a simple pretax income basis, all in pretax, consolidated pretax income basis, we're not quite there yet. We're at about $200 million loss on a 3-year trailing basis right now.
So -- but we do see that -- we do see as getting out of that position sometime before the end of the fiscal year. That is one of the major factors, clearly, that goes into the evaluation.
But it's one factor. Obviously, we want to see ourselves deliver our backlog strongly the rest of this year.
We want to see our sales continue to be strong and our pricing to remain stable, our margins remain strong profitability levels and remains as good as well. And then we also then look at the rest of the industry conditions, as well as general economic conditions and the mortgage markets.
So all of those things will go into the mix and evaluating when we feel confident that, that asset can come back onto the box. Ultimately -- but it's just a matter of timing and ultimately, it's just a general entry.
It's just the balance sheet entry. It's not -- it will not change our cash position one bit and so when that happens, it will happen.
Whether that happens before the end of fiscal year or not, it changes a few metrics but ultimately, it doesn't change our business one bit.
Operator
[Operator Instructions] Our next question comes from Joshua Pollard with Goldman Sachs.
Anto Savarirajan - Goldman Sachs Group Inc., Research Division
This is Anto for Joshua. With higher share of your late 2009, early 2000 land being delivered and the early '10, early '11 share increasing, how different are the margins here versus what is rolling off?
Bill W. Wheat
Yes, clearly, the margins on more recent land purchases will typically be a bit higher than land that we purchased earlier. In '09, the market was still struggling some, and so some purchases, we would've made in '09 may not have performed at the levels that we expected if conditions deteriorated, and the more recent purchases are more in line with where the market conditions are today.
I don't have numbers in front of me to be able to quantify the difference. But clearly, more recent purchases that we've been able to evaluate with our current cost structures and with the current market conditions would have better margins.
Anto Savarirajan - Goldman Sachs Group Inc., Research Division
Okay. What is any changes in orders or cancellation did you see during the first week of April than that was neither on the FHA requirements?
And could you also talk about how the mortgage company is planning for -- when the things are again re-implemented come July?
Bill W. Wheat
We haven't seen any real changes in our cancellation trends here in April. And I'm sorry, I didn't quite pick up the second half.
Stacey H. Dwyer
Yes, the second part how would we prepared to respond to the FHA changes. And it's going to be business as usual, and we'll just be working with each customer with the available loan guidelines that are out there.
One benefit we have at D.R. Horton is we have what we our Home Buyers Club.
And we work very specifically with people who have credit challenges and help them plan for homeownership, whether it is cleaning up collection items on their credit report, establish a payment plan for that, improving their credit score, just to establishing a savings plan for their down payment.
Donald J. Tomnitz
And frankly, over the last 4 or 5 years, we worked through a lot of changes in underwriting guidelines increases in FICO scores. So our job is to go build a product and adjust to the market whatever the financing is.
Operator
Our next question comes from the line of Jade Rahmani of KBW.
Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division
Just a clarification on the gross margin. Was about 30 basis points and a sequential improvement related to the 2.4 million Chinese drywall and then the rest of the variance was on lower construction warranty estimates?
And then regarding those lower estimates, was any of that a true-up that would impact future periods? Or is this just going to -- is this what explains the higher margin guidance you gave for coming quarters?
Bill W. Wheat
The $2.4 million reimbursement does equate to around 30 basis points. We did have some additional insurance recoveries during the quarter as well that contributed to that.
So the remainder of the 80 bps is an entirely due to changes in estimates. I believe it's about 60 basis points were based on total insurance recoveries and 20 basis points were from a change in estimate.
And the changes in estimate relative from quarter to quarter do fluctuate somewhat, but the largest contributor this quarter was our insurance recoveries.
Donald J. Tomnitz
And frankly, as reflective of our attitude in our process of the corporate office of pursuing insurance recoveries based upon our insurance policies and the drywall Chinese drywall, I know that we told you in previous conference calls over the years that we're going to aggressively pursue that, and we have. And we've had some nice the accomplishments.
Bill W. Wheat
And we do continue to pursue additional reimbursements.
Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division
Okay. And then just when we think about your incremental margins, if you look at the improvement in growth in operating margins that we saw this quarter versus the 5% sequential revenue change, is there a rule to think about or some way you could help us formulate what potential operating leverage is going forward on an incremental revenue growth?
Bill W. Wheat
Generally, when we look at our incremented revenue growth, at least in the short term, we look at SG&A as a variable component. And typically, our SG&A variable component will be somewhere in the 4% to 5% range of the increase in revenues.
So in the short run, that's probably a rule of thumb to use. Over the longer term, there'll be some additional SG&A that would need to be built to support a much larger volume level.
But that's the SG&A leverage is the biggest portion of any leverage that we get from our growth.
Donald J. Tomnitz
And frankly, we're controlling our SG&A very nicely and we're very judicious in our new hires. We want to make sure that the business, the earnings are growing before we add the overhead.
Operator
Our next question comes from the line of Joel Locker, FBN Securities.
Joel Locker - FBN Securities, Inc., Research Division
Just first of all, I guess, in the Midwest orders up almost 50%. I know it's a kind of odd reason for you, but was that base mostly on absorptions or just maybe arising community count are counter trending the company?
Bill W. Wheat
That's primarily based on absorptions off of a fairly low base a year ago.
Joel Locker - FBN Securities, Inc., Research Division
Right. And just on a percentage of buyers in the second quarter that were -- had experienced some king of short sale or foreclosure in the last 2 or 3 years, what percentage or do you have a rough number on that?
Donald J. Tomnitz
We don't have an exact number but I can tell you, as with visit with our salespeople across the country, there are more and more of those people who are becoming available. That's the -- I believe is a 3-year span.
And those buyers are coming back into the market.
Joel Locker - FBN Securities, Inc., Research Division
Right. Would you say that's significantly more than a year ago on a percentage basis?
Donald J. Tomnitz
Yes, I would.
Operator
Our next question comes from the line of Megan McGrath of MKM Partners.
Megan McGrath - MKM Partners LLC, Research Division
Don, just to sort of try to summarize, listening to your opening comments and then your answers to the Q&A. Is it fair to say your view of the overall market is that the housing market in the U.S.
is sort of flattish to stabilizing and most of your growth is coming from market share gains?
Donald J. Tomnitz
Yes.
Megan McGrath - MKM Partners LLC, Research Division
Okay. And is there anything you're kind of looking for?
You've had a great read on the market in the last couple of years. Are you still expecting overall U.S.
housing to be flattish this year? Or do you think that we're a little bit better than that now?
Donald J. Tomnitz
I think, we'll be a little bit better than that but not significantly. And again, you're right, basically, we continue to aggregate market share across the country, as well as to drive down our directs as well as our keep our SG&A low so that we can offer a quality, very competitively priced product in the market.
And then also, I want to continue to emphasize is that, that move-up buyer is helping us grow our market share.
Megan McGrath - MKM Partners LLC, Research Division
Great. And then just a quick follow-up on the DTA.
It sounds like from your comments that, I don't know if this is what your account have told you that the DTA could come back on to the books in pieces gradually?
Bill W. Wheat
By and large, it will come on in one piece. When you get to the level of confidence that you believe the asset is recoverable, by and large, it should come on in one piece.
The only exception to that will be to the extent that a portion of our NOLs that we're carrying forward relate to certain states in which the carryforward periods maybe rather short. There may be some portions of our state NOLs that we may not feel that we will fully recover.
So there could be some portion that could be left in the balance sheet or the valuation allowance could be remaining for those portions.
Operator
Our next question comes from James McCanless with Guggenheim Partners.
James McCanless - Guggenheim Securities, LLC, Research Division
First question I had, just going back to the FHA's seller concessions. Can you all discuss how easy or how difficult it would be to transition somebody who might qualify under the old concession rule over the, say, a conforming mortgage with mortgage insurance behind it?
Stacey H. Dwyer
The challenge there is and if you're looking at simply the seller concessions, if you're looking at contributing 6%, you're probably working with a buyer who doesn't have a significant amount of cash at closing and the FHA down payment is 3.5% whereas conventional mortgages is going to at least 5%. So I'm not sure that trying to transition that person to conventional mortgage fully addresses the cash situation of that buyer.
And that's where we would work with the buyer then to help them understand exactly what's required in terms of cash at the point of closing.
James McCanless - Guggenheim Securities, LLC, Research Division
Okay. And then my second question, just was wondering with the decline on the cam rate year-to-year, is that a function of scrubbing potential buyers more closely now than you may have in the past?
Or is that a function of the shift in the more move-up, housing and move-up buyers who are bringing more cash and more equity at the table? If you could discuss that, I would appreciate that?
Donald J. Tomnitz
I think clearly, the shift into the move-up buyers we are experiencing more buyers who are bringing more down payment to the table, especially in markets like California where a number of our buyers have 20% down payments. I think generally, the answer to your question specifically on whether we're changing the way we're scrubbing our backlog, absolutely not.
Standard procedure basically, no changes whatsoever.
Operator
Our next question comes from Mike Widner of Stifel, Nicolaus.
Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division
I'm not the smartest guy on the block, I was just hoping you could clarify once again for me on some of the 1x or kind of things that are included in the margins. And if I understood you correctly, it was about $2.4 million or 30 basis points in a drywall settlement.
And then you mentioned 60 basis points insured in insurance recovery, so roughly, $5 million or so. So is it fair to say that between the 2 of them, you have 90 basis points, give or take, that was kind of 1x in nature?
And then I would presume that the changes in estimates that you talked about would be sort of an ongoing thing?
Bill W. Wheat
Yes, when we've been talking about the recoveries, we've been speaking about the sequential change. And so of our sequential change you have 80 basis points from Q1 to Q2, about 60 basis points of that is coming from the reimbursements, which it is around $5 million in total, of which $2.4 million related to Chinese drywall.
The remaining 20 basis points, the remaining change is something that's just ongoing. There's always some fluctuation from quarter-to-quarter based on activity in terms of our costs, activity in terms of just the way some of our costs settle out and the way we have to adjust our estimates.
Donald J. Tomnitz
And frankly, that's one of the reasons why we're indicating to you that we don't see a lot of pricing power available in any of our markets out there today. There are few but not many.
And secondly, why we led you to our 16.5% to 17.5% gross margin expectation for the second half of the year.
Bill W. Wheat
Clearly, our forward expectations are to continue to improve gross profit, but we don't want to mislead anybody as to what caused the sequential increase this quarter.
Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division
Great. So you guys have been through cycle or 2 here and you built a few houses over the past 4 decades or so.
I just wondering if you could talk not about what's going on right now but sort of from your experience, both on a regional basis and now on a national basis you had this big pullback that just happened in the past again on sort of a regional basis. I was just wondering if you've experienced the phenomenon before where at the bottom, where a lot of private guys are still kind of reeling and they don't have access to the balance sheet capital that you guys do.
Did you have that opportunity to kind of -- you've the land, you've got the capital, you've got the ability to store or steal share at the bottom. But as things progressed, as those guys watched you stealing their market share, I'm wondering how the challenge of them wanting to get back into the market and then watching what you're doing and figuring that hey, it's time to start up in communities ourselves.
I mean, how does that play out with your simultaneous hope to increase margins? And it seems like it would be very difficult to both increase margins as you hope to do, as well as continue to increase market share as those guys are seeing that demand is coming back and trying harder to get back into the game themselves.
Just wondering if you could talk about how that's played out in the pass on a local basis?
Donald J. Tomnitz
Well, I think, frankly, this time around, the private builders have been devastated more than they've been devastated. Any previous downturn in this is for the nice fourth downturn in the industry.
I don't see the banks stepping up to lend money to those people today. As a matter of fact, I see just the opposite.
So I look at our markets and our submarkets across the country and the one thing that is consistent amongst almost all of those markets is that there are fewer and fewer public builders out builders who, one, are live and 2, if they are alive, they actually can get a loan from bank who doesn't want to loan them any money. So I think this is a unique downturn.
It has been unique for D.R. Horton and myself.
This has been the worst downturn in our almost 29 years together. I see an opportunity for us to continue to take market share not only away from those small and medium-sized undercapitalized private builders, but I also believe and know for the very first time in our company's history, that we have an excellent opportunity to continue market share away from our public competitors, who I perceive are way overleveraged to us and permits us an opportunity to continue to aggressively take market share away from them.
Operator
Our next question comes from Stephen Kim of Barclays.
Stephen Kim - Barclays Capital, Research Division
It's Steve Kim from Barclays. A question I had for you relates to your comment about not putting to price increases in most of your communities.
And then also -- but then also, talking about positive mix shift. I was curious as to whether or not the land that you are building your move-up product on is substantially the same as the land that you may have been building more of the entry-level type product on, let's say, last year or the year before.
Because it would seem to me that if you're able to put a richer mix on a similar land base, that would be almost as good as the price increase but if you could just answer that broadly, that will be great.
Donald J. Tomnitz
To answer your question directly, we are not putting a more expensive house on the same price as the -- our entry-level lot prices, so there's no real benefit there. As we continue to expand into that entry-level market, we're paying more for those lots than what we're paying for our entry-level products so there's really no enhancement there.
And I would say the other thing about the pricing that we can't forget in terms of pricing power is that one of still our major issues facing our industry are appraisals. And notwithstanding the fact that we believe that we have a justification to raise prices in a number of our markets, those pricing increases are slow simply because of competitive appraisals throughout the U.S.
Stephen Kim - Barclays Capital, Research Division
Got it. The second question I have for you relates to your comments about margin.
If you could share with us a little bit -- I'm sorry, not margin, but community count. If you could share with us a little bit your view of how the community count is going to likely trend as we head into next year?
You were talking about down 6% today but your sales have also been better-than-expected and so I'm actually been closing out on more communities that you would've otherwise have expected, let's say, late last year. Today, given that you're looking at a better sales profile and you have the balance sheet with which to grow, would it be unrealistic of us to expect that if sales trends continue and you burn out of the same kind of rate that you're burning out today, that your sales count could be -- you're selling community count could be up double digits next year?
Donald J. Tomnitz
Well I hate to put a number on that, Steve, because really, what we've done and what we’re going to do, we have a division president's meeting here in Las Vegas next week and we've expressed to our divisions in our 4 regions, our growth expectations for them in '13, '14 and '15. So basically, what they're going to be doing is going out and finding lots and land positions in order to meet their respective growth expectations that we have here.
So I don't see -- it could be a double-digit, it could to be a single digit. But let's remember one thing, the best thing that could happen to us is to continue to achieve higher sales and higher closings of our existing communities because certainly, we have enough lots in our communities.
We have enough lots on our books. And to the extent that we can penetrate those existing communities deeper, and that's better for us on a SG&A component and the gross margin component.
Bill W. Wheat
And as we look to invest and as we look to grow, certainly, we want to grow incrementally but as long as we also stay disciplined as far as how we invest, stay disciplined on our land supply and on our return thresholds on a project-by-project basis, that's what will improve our company, not simply focusing on the top line growth.
Donald J. Tomnitz
As I said earlier, our focus is on growth but our bigger focus is on profitability. We need to continue to grow our gross margin and our pretax income percentages.
Operator
Our next question comes from Alex Barrón of Housing Research Center.
Alex Barrón - Housing Research Center, LLC
My question is we've seen, I guess, a strong improvement in the orders in the last 2, 3 months, as you mentioned, or 2.5 months. And so my view is that a lot of communities have started to perhaps sell-out earlier than expected, which I guess, is a good problem to have.
But my question is, are you guys starting to also see some cost pressures and perhaps are you thinking you should accelerate your land purchases earlier? And are you starting to see cost pressures from materials and labor and land prices?
Donald J. Tomnitz
Well, we've consistently seen cost pressures from the land and lot side, as well as most importantly, our subcontractor and our vendor base. So it's a division-by-division, as we call it, release-by-release bidding process, an aggressive bidding process.
As I said earlier, we are building more homes and starting more homes than anybody in the U.S. We bid every release.
And we want to make certain that we have the most competitive pricing at that point in time. We're going to have commodities going up, and we're going to have labor going up but the bottom line goal has always been at this company is how we balance those with increases and decreases such that we end up with the most competitive direction in the market.
Again, our size and our number of starts, I think, leads us to a very competitive position relative to our peers. As I travel the country, I just don't see a lot of our peers even today starting a lot of houses.
So we're the preponderance of starts in most of our markets.
Alex Barrón - Housing Research Center, LLC
Great, absolutely. My other question was if you start to see the number of buyers remain at a strong phase, is your view more towards just taking the volume on a per community basis?
Or is it more to raise the price and kind of put an upside on the sales per community? And related to that, what are your views on selling homes investors?
Donald J. Tomnitz
Well, frankly, over the last 5 years, we'll sell homes to anyone. Frankly, what we're focusing on is selling homes to families who are not investors, basically people who are buying homes for a good place to raise their children and send their children to school.
Bill W. Wheat
And we're always looking to try to strike the best balance community by community between driving additional volume and improving our prices or reducing our incentives. Sometimes we're constrained by appraisals in the submarket but in general, we're trying to strike that best balance.
Right now, we clearly would love to see more absorptions per community. But we want to see that with some improving dynamics in terms of our incentives and our pricing as well.
Donald J. Tomnitz
Clearly, we can grow the business from a number of different aspects, whether adding new communities, whether of rolling options, whether we're penetrating our existing communities deeper or whether we're developing land and lots. We've got the whole wide expanse out there of opportunities.
We just hope that the sales and the closings continue to be what they have been since the 1st of February because that will provide this company really the preeminent opportunity in the industry to continue to grow profitably.
Operator
Our next question comes from Bob Wetenhall with RBC Capital Markets.
Unknown Analyst
This is Dezi [ph] filling in for Bob. You said your capture rate was 60% for the quarter.
Can you talk about your experiences with home buyers who chose to go with a different mortgage lender? And how that impacted cancellation rate in the quarter?
And whether you expect the capture rate to increase going forward?
Bill W. Wheat
Since we have very strong capture rate with our captive mortgage company, we really haven't noticed a substantial impact on our aggregated closings in any given quarter because of any follow-up from other mortgage companies. Typically, if we're not working with DHI Mortgage in a given market, that division will be working with other preferred lenders and have a tight working relationship to manage the backlog through.
So we haven't really had that kind of a fall-off in our business.
Donald J. Tomnitz
And I think as Stacey mentioned earlier, as I asked the same question in our pre-conference call, our 60% capture rate has a lot to do with the fact that our mortgage company is also pursuing non-captive business. So sometimes those numbers are skewed slightly by the number of non-captive buyers they solicit and are able to garner in a specific quarter.
Stacey H. Dwyer
And since our cancellation rate actually improved in this quarter, down 22%, we're not running into any significant hurdles even with our outside lenders right now.
Operator
Our next question comes from Timothy Jones of Moloney.
Timothy Jones
Okay, other than orders, D.R.' s favorite number is SG&A in sales, I believe.
And you did keep your SG&A flat with $200 billion increase in sales and brought your margins down 4%. But there's still 13.7% [ph], which is even for this quarter probably 250 basis points of I think your norm.
Is it that your -- is it still high because you're expecting a further improvement in upcoming months? Or are you getting hit with that normal amount of sales by realtors, which are where are -- where the margin would cost you about 3% versus 1.5% internally?
Donald J. Tomnitz
We haven't talked in a while and I guess, as just -- as Todd Horton [ph] says so eloquently, "No good deed should go unpunished." We continue to have the lowest -- some of the lowest SG&A in the industry and we include our corporate overhead in our overall.
But we still get questions about our SG&A. But to answer your question directly, yes, that is a focus of the D.R.'
s. But I'll let Bill perhaps explain or answer your question since I really just didn't answer your question.
Bill W. Wheat
Year-to-date our SG&A expense is 13.5% of revenues. That is higher than our long-term target.
Our long-term target is to have it as close to 10% as we can. There's a lot of targets that we're not quite at today.
We're not at normal margin rate either. So we have certainly kept our some level of SG&A infrastructure that will support some higher volume as evidenced this quarter when our closings were up 21% and SG&A was only up 3%.
We've also maintained our footprint across the United States. We haven't exited a lot of markets.
And so we are in well-positioned to be able to grow and leverage that SG&A. We expect as we're able to reinvest in the business, use some of our cash to grow our business and we would leverage that SG&A and it will drop as we grow.
And hopefully we can get it back closer to that long-term target of 10%.
Donald J. Tomnitz
And I think Bill makes an excellent point there. If you look at everyone else's footprint, most people have shrunk their footprint much more dramatically then we.
And our goal all along was keep our footprint the same but then take down our multiple divisions in each one of our various markets to the lowest common denominator that we could get to. And they're ready to grow.
Stacey H. Dwyer
One clarification to you to, Tim. For D.R.
Horton, the external sales commissions are actually in our cost of sales not in our SG&A. and I just want to know if D.R.
put you up to that question.
Timothy Jones
No comment. But I am in contact with your company quite often.
Secondly, where is your warrants? I mean, they're still outstanding, aren't they?
Where are they on the balance sheet?
Bill W. Wheat
Convertible debt? Yes, it is in our debt and the current carrying value is around $432 million.
Timothy Jones
Still your debt?
Bill W. Wheat
Yes, $432 million is in our debt. The face value of those notes is $500 million.
So the remainder of $68 million is equity today, and that's the value of associated with the convert. And that is being accreted each quarter out of equity and into debt.
So by the time that debt matures in 2014, we'll be at $500 million debt on the balance sheet.
Timothy Jones
You could turn it to cash tomorrow. It's in the money.
Bill W. Wheat
Well it's not callable in advance of the maturity date. So we can't make that decision or let transaction until 2014.
But clearly, yes, the price is 1306 [ph] the strike price of 1306 [ph] so as long as we take care of business here then we should be in good shape.
Timothy Jones
What's the interest on it?
Bill W. Wheat
2%.
Timothy Jones
I'll take it.
Bill W. Wheat
I think you can buy it in the open new market.
Timothy Jones
I'll take it from your side not my side.
Bill W. Wheat
It is trading at a significant premium.
Operator
Our next question comes from the line of Michael Rehaut of JPMorgan.
Michael Rehaut - JP Morgan Chase & Co, Research Division
Just wanted to go back to the idea of expecting a little less in your backlog, I believe, than previously. Is that just purely driven by the shift a little bit more towards move-up?
Because I would think all else equal, you wouldn't necessarily be moving away in any regard from your spec approach in the market?
Donald J. Tomnitz
Actually, it's interesting you ask that question because it's really due to our more conservative nature. We had -- we started the quarter with 56% specs.
Our goal was to try to get that number reduced back down to closer to 50% and we did. So it's just a function, I believe, of largely not having started as many homes as we could've started simply because our spec ratio was a little high and we wanted to see those specs come down.
And frankly what happened was the spring selling season materialized and that caused our primarily our reduction in our specs. But as I said before, construction cycles are currently some of the shortest in the history of the company since I've been here.
And our ability to put a house on the ground and get it ready for a buyer is the best we've ever had.
Bill W. Wheat
We do typically see our spec percentage sequentially from December to March because we do have home started prior to the selling season but then we sell during the March quarter. But I think, we did a little bit better job of selling-through that this quarter than we have in the last 3 years.
Donald J. Tomnitz
And frankly, that has been a focus of both Bill Wheat and Mike Murray with our division presence and our regional presence clearly identifying who needed to move, what age inventory or what point in time. And they actually, over the last quarter, did an excellent job on that.
Operator
Our next question comes from the line of Jack Micenko of SIG.
Jack Micenko - Susquehanna Financial Group, LLLP, Research Division
I did want to get your thoughts on land pricing maybe quarter-to-quarter year-to-year in the markets that are working. And wondering how much moving on this option increasing the option mix over the last couple of quarters, moving to a higher trade up mix over the last couple of quarters?
How much of that strategy is tied to land pricing that you're seeing in the better markets?
Donald J. Tomnitz
Basically, I think that all of the lots that we're buying are more competitively priced than what they have been in the past. In other words, I think that the land sellers are trying to get more for their lots than what they had 2 years ago and 3 years ago because there has been some months of improvement in the industry.
So I think we're going to continue to fight that on a go-forward basis.
Stacey H. Dwyer
One of the things that helps keep the lid on that though is the land prices are constrained by what we can sell the home for. And so when we’re targeting a specific gross margin and return on our investment and we know what our fixed cost are, they basically use a residual that we're not willing to pay about a certain dollar for the land.
Donald J. Tomnitz
And it's further constrained by the fact that we still have appraisal issues across the country. So again, I say, there's not a lot of pricing power in the industry today.
Operator
There are no further questions at this time. I'd like to hand the floor back over to management for closing comments.
Donald J. Tomnitz
Thank you very much. Again, I thank all the DHI employees who quarterly turned in an outstanding quarter.
You continue to outperform all of your peers, market by market, subdivision by subdivision, and we look forward to a very successful second half of fiscal year '12 and look forward to a profitable years ahead. Thank you very much.
Operator
This concludes today's teleconference. You may disconnect your lines at this time.
Thank you for your participation.