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D.R. Horton, Inc.

F4Q07 (Qtr End 9/30/07) Earnings Call

November 20, 2007 10:00 am ET

Executives

Don Tomnitz - President and CEO

Stacey Dwyer - EVP and Treasure

Sam Fuller - Senior EVP of Finance

Bill Wheat - EVP and CFO

Analysts

Michael Rehaut - JP Morgan

Dan Oppenheim - Banc of America Securities

Nishu Sood - Deutsche Bank

Joel Locker - FBN Securities

Ken Zener - Merrill Lynch

Stephen Kim – Citigroup

David Goldberg – UBS

Stephen East - Pali Capital

Timothy Jones - Wasserman and Associates

Alex Barron - Agency Trading Group

Carl Reichardt - Wachovia Securities

Jim Wilson - JMP Securities

Larry Taylor - Credit Suisse

Mike Marburg – Ramsey

Bob Thompson - Advantus Capital

Susan Berliner - Bear Stearns

Bob Sells - L&K Capital Management

Emeril Amman - 36 Capital

Darren Richman - GSO

Operator

Good morning. My name is Cynthia, and I will be your conference operator today. At this time, I would like to welcome everyone to the D.R. Horton Incorporated, America's Builder, the Largest Homebuilder in the United States, 2007 Year-End 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. (Operator Instructions).

I would now like to turn the call over to Don Tomnitz, President and CEO. Sir, you may begin your conference.

Don Tomnitz

Thank you and good morning. Joining me this morning are Sam Fuller, our Senior Executive Vice President of Finance, Bill Wheat, Executive Vice President and Chief Financial Officer, and Stacey Dwyer, Executive Vice President and Treasure.

Before we get started, Stacey.

Stacey Dwyer

Some comments made on this call may constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although, D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in D.R. Horton's Annual Report on Form 10-K and the most recent Form 10-Q, both of which were filed with the Securities and Exchange Commission. Don?

Don Tomnitz

Net sales orders for the fourth quarter was 6,374 homes, $1.3 billion, compared to 10,430 homes, $2.5 billion in the year ago quarter. The slower net sales rate was due in part to our cancellation rate rising during the fourth quarter to 48%, compared to 38% in the third quarter, and 40% in the same quarter of the prior year. Our average sales price on net sales orders in that quarter decreased approximately 15% from a year ago to [$205,400]. However, our average sales price on gross sales only decreased 8% to $231,900, as more high priced homes cancelled during the quarter.

Please note, that we will no longer report our quarterly net sales orders in advance of earnings. Beginning on the first quarter of fiscal 2008, we report net sales orders in conjunction with our quarterly earnings release. Sam?

Sam Fuller

Our fourth quarter homebuilding revenues were $3.1 billion, compared to $4.8 billion in the year ago quarter. Our average closing price for the quarter was down 7% to $253,000, compared to $272,400 in the year ago quarter. Homebuilding revenues for the year ended September 30, 2007 were $11.1 billion, compared to $14.8 billion a year ago.

Homes closed for the fiscal year totaled 41,370, and approximately 62% of our closings were for less than $250,000 each, compared to 55% in fiscal 2006, demonstrating our continued focus on providing an affordable quality entry level or first time move-up product. As a result, the financing for most of our customers can fit within conforming guidelines. Bill?

Bill Wheat

Our gross profit margin on home sales revenues in the fourth quarter before inventory impairments and land option write-offs were 16%, down 490 basis points from our home sales margin of 20.9% in the year ago period. This was a 70 basis point sequential decline from our third quarter gross-margin of 16.7%. This decline was due primarily to core margin deterioration, resulting from increased use of sales incentives relative to last year, and the lack of pricing power, as reflected in our 7% decrease in average closing price.

During our fourth quarter impairment analysis, we reviewed all projects in the company and determined the projects with a combined carrying value of $2.6 billion as indicators of potential impairment. We evaluated these projects and determined that the projects with a pre-impairment carrying value of $940.5 million were impaired. We recorded inventory impairments of $278.3 million as a charge to cost of sales to reduce the carrying value of these impaired projects. Approximately 55% of the impairment charges this quarter related to projects located in California. Of the remaining $1.7 billion of the projects with impairment indicators, which were determined not to be impaired, the majority are located in California, Florida, and Arizona. Stacey?

Stacey Dwyer

The FAS 142 requires that we test goodwill in each operating segment, regions in our case, for impairment, at least annually. During our fourth quarter, we completed our annual analysis for goodwill and determined that an impairment charge of $48.5 million related to our Mid-West region was warranted. Total goodwill remaining after impairment at September 30 is $95.3 million. Don?

Don Tomnitz

We continue to adjust our land option contracts relative to current demand, which resulted in a $40.3 million write-off of earnest money deposits in pre-acquisition costs related to land option contracts during the fourth quarter, across a broad cross section of our markets. Our net earnest money deposit balance at September 30 was approximately $75 million or 6% of the remaining purchase price. This low earnest money deposit percentage reflects our conservative approach to land and lot options.

We’ve no unconsolidated joint ventures and we rarely use land bank arrangements. So, deposits are typically a low percentage of the purchase price. Our supply of land and lots at September 30, 2007 is approximately 230,000 lots owned and controlled, down 42% from our peak of 396,000 lots at March 31, 2006. 73% of these lots are owned and 27% are option. We started our fiscal year with 323,000 lots, a 6.1 year supply based on trailing 12 months closings, and our 230,000 lots now represent a 5.6 year supply, based on trailing 12 months closings. We continue to actively work to reduce our owned land and lot supply, through building and closing homes, as well as to opportunistic land and lot sales. For example, in November, we closed on a land sale in Phoenix, which reduced our own lot position by approximately 20,000 lots, or about a half a year supply.

Total revenues will be approximately $70 million on this transaction and we will recognize a profit on the sale. There has been no impairment associated with this project. Sam?

Sam Fuller

Homebuilding SG&A expenses for the quarter was 9.9% of total homebuilding revenues, compared to 8.5% a year ago. For the fiscal year, homebuilding SG&A was 10.3% of total homebuilding revenues, compared to 9.9% last year. Our ongoing goal for each fiscal year is to be at or below 10% of homebuilding revenues. Although, we are above our 10% goal this year by 30 basis points, we have continued to react quickly to the market to manage our SG&A levels relative to our level of home closings.

In fiscal 2007, we reduced total SG&A expenses approximately $315 million, up 22% fewer closings. We will continue to focus on being the low cost operator in the industry, which remains one of our distinct competitive advantages. Bill?

Bill Wheat

Our financial services operations remained profitable, as we have proactively adjusted expense levels to lower volumes and adjusted product offerings to the current restrictive mortgage environment. Financial services pre-tax income for the quarter was $16.1 million, compared to $33.7 million in the year-ago quarter. For the fiscal year, financial services pre-tax income was $68.8 million, compared to $108.4 million last year.

96% of our mortgage company business was captive during the quarter, reflecting our continued focus on supporting our homebuilders business. Our company-wide capture rate in Q4 was approximately 64%, compared to 71% a year ago, and for the year was 66% compared to 68% in the prior year.

Our average FICO score this quarter was 717, comparable to the year-ago quarter. Our average cumulative loan-to-value for the quarter was 90%, compared to 91% in the year-ago quarter. As the mortgage markets continued to change, we saw a continued shift in the type of products that buyers utilized in the fourth quarter. Our product mix during the fourth quarter was 81% conforming, 10% agency eligible Alt-A, 2% non-agency eligible Alt-A, and 7% jumbo.

For our full fiscal year 2007, our product mix was 57% conforming, 19% non-agency eligible Alt-A, 13% agency eligible Alt-A, 7% jumbo, and 4% sub-prime. Sam?

Sam Fuller

The effective tax rate related to our income tax benefit on our fiscal 2007 loss was 25.1%, because only approximately 23% of the goodwill impairment charge recorded in fiscal 2007 is deductible for tax purposes. Our reported net loss for the quarter is $50.1 million or $0.16 per share. However, our core operations before impairment charges and land option cost write-offs generated pre-tax profits of approximately $266.9 million.

Our reported net loss for the fiscal year was $712.5 million, or $2.27 per share. Our core operations, before impairment charges and land option cost write-offs, generated pre-tax profits of approximately $852.4 million. All of our operating regions remain profitable for the fourth quarter and the fiscal year, before impairments and write-offs. We continue to focus on managing the core business efficiently by controlling our costs and adjusting quickly to changing market conditions. Don?

Don Tomnitz

Our overall inventory decreased by over $900 million, excluding impairments at 930 compared to June 30. We reduced our total number of homes and inventory to approximately 19,900 homes, down 50% from 40,000 homes of our peak in June 2006 and down 27% from 27,100 homes at June 2007. We also reduced the absolute number of speculative homes and inventory by more than 18% this quarter to approximately 10,600 compared to approximately 13,000 at June 2007.

This reduced number of homes and inventory, combined with our earnings in the fourth quarter, allowed us to exceed our goal of $1 billion in operating cash flow for this fiscal year by over $300 million. We are going to further reduce both our total number of homes and inventory, and our number of speculative homes in the coming quarters, in line with current demand. Stacey?

Stacey Dwyer

Our homebuilding leverage ratio, net of unrestricted cash was 40.2%, an improvement of 50 basis points from a year ago, and at the low end of our target range of 40% to 45%. As of September 30, we have approximately $2.3 billion available on our homebuilding revolving credit facility, and $228 million in unrestricted homebuilding cash for a total of approximately $2.5 billion of homebuilding liquidity. We have reduced our homebuilding debt balances by approximately $900 million, since the beginning of the fiscal year. And we have [already started consolidated] debt balances by approximately $1.7 billion.

As a reminder, D.R. Horton does not have any unconsolidated joint ventures, and we have no exposure to [sequential] guarantees our margin call on joint venture debt. We currently have three primary financial covenants in effect under our $2.5 billion revolving credit facility, maturing in December of 2011. They are tangible net worth covenant and maximum leverage covenant in a trailing 12 months EBITDA to an interest incurred coverage covenant.

All covenant calculations are based only on our Guarantors subsidiary, which include substantially, all our homebuilding operations that exclude our financial service operation. Our current tangible net worth covenant is $4.3 billion. And as of September 30, we have a cushion of approximately $1 billion. Our current leverage is 42%, compared to a maximum allowable leverage of 60%.

And finally, our trailing 12 months interest coverage ratio is 3.6 times, compared to our two times covenant. Bill?

Bill Wheat

Our cash flow from operations this quarter was over $800 million, positive for the fifth consecutive quarter, and bringing our total for the fiscal year to over $1.3 billion, exceeding our goal of $1 billion.

Over the last 15 months, we have generated in excess of $2.2 billion of operating cash flow. Our goal for fiscal 2008 is to generate an additional $1 billion of operating cash flow. Our land acquisitions spending remains limited and we continue to challenge our land development spending in light of our current absorptions.

We expect our fiscal 2008 land acquisition and land development expenditures to total between $500 million and $1 billion for the entire fiscal year. For comparison, our fiscal 2007 land acquisition and land development expenditures were $2.5 billion and in fiscal 2006, they were $5.2 billion. We continue to development smaller phases and pace our development of new phases based on current demand in individual communities. Don?

Don Tomnitz

In closing, D.R. Horton will continue to manage very conservatively during this housing downturn. In fiscal 2007 by controlling our SG&A, renegotiating our construction cost and reducing our inventory, we generated approximately $852 million and pre-tax operating profits before impairments, with all of our reporting regions contributing positively towards this total. Our stated cash flow goal for fiscal 2007 was to generate $1 billion in cash flow from operations. We exceeded this goal, generating $1.36 billion. We use this cash flow to reduce homebuilding debt by $900 million and consolidated debt by $1.7 billion.

Even though we reduced our residential inventory by 7,000 homes in the fourth quarter, we are going to reduce our homes under construction further, which will contribute to our goal of generating at least $1 billion in cash flow from operations in fiscal 2008.

We’ll continue to focus on earning pre-tax operating profits before impairments, generating operating cash flow, reducing both residential and land inventories and repaying debt. In a downturn, we believe that the builder with the strongest balance sheet wins. We plan to be the winner with a solid balance sheet and available liquidity to take advantage of opportunities as they present themselves in the marketplace.

Finally, we thank the entire D.R. Horton team. This includes, especially, our field staff including construction, sales and mortgage. As we know, we are all in sales and sales are the key to our future success. While it's difficult to outperform the markets, we continue to outperform our competition. Our model BSCM, build, sale, close homes, and make money, is most applicable today, generate free cash flow and leave no buyer behind.

Thank you. We will now entertain any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Michael Rehaut with JP Morgan.

Michael Rehaut - JP Morgan

Hi, good morning.

Bill Wheat

Good morning.

Michael Rehaut - JP Morgan

Congrats on the cash flow generation. My first question is, if you could just, for the full year, give me, if possible, a breakdown of how that $1.3 billion fell across, let's say, land sales, mortgage operation, and core homebuilding and how you think that composition will look for '08? And then I have a follow up.

Bill Wheat

Mike, as far as the breakdown in '07, I think it's presented fairly clearly in the cash flow statement in the press release primarily from inventory reduction, approximately $800 million of that and then we had about $500 million for mortgage loans held for sale. There was a reduction during the year and of course that is supplemented by the pre-impairment profits from our operations, primary breakdown in '07.

As we move forward to '08, well, certainly our goal is to continue to generate profitability before impairments and charges. We will see, I think, hopefully a smaller reduction in our mortgage loans held for sale during the year. But, the majority of the billion dollars that we expect to generate in '08 is going to come from inventory reductions and our homebuilding business, which is primarily going to come from us building homes, from the lots that we own, and pulling development dollars out of the ground, and closing on the width that's associated with those houses.

Stacey Dwyer

And as we talked about in the conference call script, we are going to be looking to sell land opportunistically. So, we have already generated some land sales revenue that will contribute to cash flow this quarter.

Michael Rehaut - JP Morgan

Great.

Don Tomnitz

By the way, our land sales, our land and lot inventory now post that Phoenix transaction was down to about 5 years, 5.1 years of land and lot supplies. So, we think that's a dramatic one-year reduction in a 14 month period.

Michael Rehaut - JP Morgan

Now, the Phoenix sale is pretty impressive, given what's going on in that market. The second question is just more of an accounting question. Last quarter, you had about $7 million of a benefit in the gross margins from selling homes of previously impaired communities. I was wondering if you could give that number for this quarter.

Bill Wheat

Right. This quarter, on the home sales gross margin line, we had $49 million flow back through from previous impairments, and on then land sales line, we had $10 million flow back through in the fourth quarter.

Michael Rehaut - JP Morgan

Great, thank you.

Operator

Your next question comes from Dan Oppenheim with Banc of America Securities.

Dan Oppenheim - Banc of America Securities

Thanks very much. I was wondering if you can talk about your pricing and sales strategy. You talked about how you want to outperform others and not let any buyer's getaway. Given the declines you have been reporting in orders, and what we've seen in terms of aggressive pricing, what is that you're trying to do differently as you go into fiscal '08 to capture more net orders?

Bill Wheat

Well, clearly one of the things that we are doing in a number of communities is we are continuing to mark our product to market. We think it's unrealistic to hold pricing which is not competitive with the market. And in some of our communities, frankly, we are having rare opportunity to raise a few prices. We'd liked to get to the point where we can have more stability in our pricing, which we have not experienced in '08. But the real issue is the market is the market and we are continuing to drive down our cost across the Board on development cost, on cost from our suppliers and cost from our vendors and cost from our subcontractors, so that we can offer a more competitive product. Everything has to reset. The first thing that's reset, as you know, has been the sales price of a single family home. Now, we are in the process of resetting all those cost. But it's unrealistic for us to continue to expect or to offer a product that's higher than what the market is willing to pay.

Dan Oppenheim - Banc of America Securities

Thanks. If you can just talk, also about, I guess, if you think about, sort of spec homes here, to bring down the spec inventory environment, where some of the buyers are looking for spec homes and they didn't get the best prices--what percent of construction is spec rate now? What is your goal for next year?

Don Tomnitz

We have a very limited spec start policy and basically its X number of specs per community. But frankly, we need to have, we believe in order to maximize our sales opportunities in the marketplace, unlimited number of specs in each community simply, because there are people out there who have existing homes or marking those to market and closing on those homes. And then, they are coming in to our sales offices and desiring to move into a new home within a very short period of time--three to six weeks. So, therefore, we will continue to maintain limited spec inventory in all of our communities such that we can appeal to those buyers.

Dan Oppenheim - Banc of America Securities

Thanks very much.

Don Tomnitz

Thank you.

Operator

Your next question comes from Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks. Good morning, everyone and nice job considering the environment.

Don Tomnitz

Thank you.

Nishu Sood - Deutsche Bank

First question I wanted to ask was, some of the harder hit markets you are beginning to see what you might call a limited or even a no-demand environment. I mean places like Sacramento, you are hearing about [market] falling and price inelasticity. I wanted to ask your thoughts on that specifically how many of your markets do you think have kind of reached that type of state? And when you consider pricing versus volumes trade off, how are you counseling your guys in the ground in your markets that are like that?

Don Tomnitz

That's a great point and you're exactly right. Remembering back, when we were criticized two or three years ago about offering discounts on inventory back in December of '05, and we wished we still had that kind of pricing power as we did back in December of '05. But, the way that we're countering this and we're in the process on a day-to-day basis, division-by-division, subcontractor-by-subcontractor is as we have to drive down the cost of everything that we are buying. And we have to drive down the cost of our SG&A, because the only way to continue to meet the market and satisfy the buyer's desires is to have a lower cost structure than anyone else in the industry. So, our extraordinarily [crowd] even though it is 30 basis points over our goal of our 10.3% SG&A. So, it's a cost game right now, and I think the buyer is going to continue to demand competitive pricing and one who has the best cost structure is going to win.

Nishu Sood - Deutsche Bank

And I know it's tough to quantify, I think in, roughly, 75 to 80 markets, how many of those do you think have reached that type as to state?

Don Tomnitz

I would look at it more from the perspective of where our big markets are and, to be frank with you, it's the hot markets, I think, that have reached that stage of price inelasticity. I think Las Vegas is clearly there. And California is clearly there, and I think Phoenix and Florida are getting closer to being there, but they are not there yet.

Stacey Dwyer

And even within those markets, Nishu, there's some differences based on locations. As you are further away from the job centers, you are probably experiencing a little more pricing pressure and (inaudible) ones that are little closer in. And price points are going to make some differences based on mortgage products that were previously available and what's available in market today. As Don said, we are working on costs whilst restructuring a lot of our product and to make sure that what we are bringing to market meets the market demand.

Nishu Sood - Deutsche Bank

Okay, great. One another quick question on the land sales. What was the age of the 20,000 lots that you sold in Phoenix and generally of your, I think, $150 million on land sales, how old was that land as well?

Don Tomnitz

I will say the Phoenix project is a project that I believe we've owned for approximately three years, and the other sales --

Bill Wheat

We don't have that data in front of us on all of the other sales, but it's scattered.

Nishu Sood - Deutsche Bank

Yes, great. Thanks a lot.

Operator

Your next question comes from Joel Locker with FBN Securities.

Joel Locker - FBN Securities

Hi, guys. Just wanted to get a count, if you had a breakdown of our own lots, how many were finished? How many were under development? And how many were raw? What is there, 72% or 168,000 or so?

Bill Wheat

Yes. I think 72% are owned currently. But we have got about a 167,000 owned lots and (inaudible), so we don't have a total count or breakdown between finished versus raw at this point.

Joel Locker - FBN Securities

Do you have any kind of ballpark figure, I mean percentage wise? Just trying to look at cash flow going into next year, if it's just based on -- if you have a lot more developmental cost depending if you choose to multiple or not to multiple, just trying to get an idea of what's raw, what's finished?

Bill Wheat

You can rest assured that virtually the mass vast majority of what we're going to be closing homes in on '08 are already finished. And we mentioned on our conference call, our development span, projection, range for '08 is $0.5 billion to $1 billion, and we would be surely disappointment if weren't closure to the low end of that range. So, we're going to be spending very, very little money on developing lots. All of our lots for '08 closings are finished and available.

Stacey Dwyer

And actually, that dollar span includes both land development and land purchases.

Joel Locker - FBN Securities

Right.

Bill Wheat

Despite, even if it's raw land, we are slowing our development span based on and pacing our lots, bring your lots to market based on what we expect we are going to need for sales.

Joel Locker - FBN Securities

I got you. And like the impairment reversals going forward, as you know, it is big move from $7 million to $49 million, or $59 million, including the land sales. And what do you expect on the impairment reversals in fiscal '08?

Don Tomnitz

That's a hard number to predict, Joel. It really depends on where we close our homes and whether we are closing homes in any impaired projects, going forward. Given the cumulative volume of our impairments, through June and now through September, I wouldn't expect it to be down below $10 million in any quarter, going forward. But whether it will be around the 49 or higher or lower is little difficult to predict?

Joel Locker - FBN Securities

All right. Just one last one on your selling cost as a part of the $283 million SG&A, what was selling and what was G&A, if you do have that breakdown? If you don't have it handy, I can follow up after the call.

Stacey Dwyer

We will give you a ballpark number here, Joel?

Joel Locker - FBN Securities

Sure.

Don Tomnitz

Give me five seconds.

Joel Locker - FBN Securities

Yes.

Bill Wheat

Roughly about 25% of our SG&A was selling cost during the year.

Joel Locker - FBN Securities

During the year or during the quarter?

Bill Wheat

I am sorry, that was during the year, and we looked during the quarter, -- roughly 25% during the quarter as well.

Joel Locker - FBN Securities

Roughly 25%. All right. Thanks a lot.

Operator

Your next question comes from Ken Zener with Merrill Lynch.

Ken Zener - Merrill Lynch

Good morning.

Don Tomnitz

Good morning.

Ken Zener - Merrill Lynch

Given the lower, I think, than expected impairment for this quarter, can you talk about how impairments that you had this quarter were influenced by your last quarter's discussion with the auditors based upon your down pricing and better absorption rates? Essentially, it was like the 39% decline in orders consistent with that type of elasticity of demand that you would have expected with down pricing, and if not, did your impairment approach with the auditors changed this quarter relative to last quarter given the apparent lack of elasticity?

Bill Wheat

No. There was really no change in our approach from June to September. We still have a very cautious outlook on the industry, on our pricing prospects and on our volume. And certainly, as we move through the quarter, that outlook that we had in June and as we accessed our projects in June, that certainly to a large extent was accurate. And so, as we looked at the end of the projects again in September, we looked at a lot of the projects that we had previously impaired and in many cases, we had anticipated the pricing that did occur. And so, as a result of -- that was inline with our previous assumptions, it did not need to be impaired again.

Of course, naturally with the volume of impairments we've had here in the fourth quarter, we had a number of projects that had performed worse than we had projected in June. And so, that's why they are impaired in September. But really, the approach was very consistent from June to September. We remain very cautious on our pricing assumptions and our models, and we will continue to do so.

Ken Zener - Merrill Lynch

Okay.

Don Tomnitz

I think you can go back on the records and I think one thing is certain, is we've been very consistent on our outlook for the industry in '07, and we continue that through the fourth quarter.

Ken Zener - Merrill Lynch

Do you have a new Choice word Don for '08?

Don Tomnitz

No. I thought I would save it for someone's conference (inaudible).

Ken Zener - Merrill Lynch

Well, my second question--I am trying to understand your own land position which was essentially flat q-to-q at about a 167,000 lots versus 169,000 in 3Q, despite your closing nearly 12,000 units. So, can you talk about kind of what percent of closings of lots are on it, do you take down in to a year and if perhaps that ratio was shifted to '08, so as you deliver, let's say, 12,000 units, we'll see the land position declined by that amount excluding any land sales.

Don Tomnitz

Clearly one thing we are focused on in '08, and Stacey can give some more color on this, if she wishes But our goal in '08 is to close as many of our units on owned lots as we possibly can, because our primary goal and our land position is, is to pull our development dollars out of the ground, where we have already gotten finished lots. So, our goal really is to take care of Horton first and worry about the third-party developers later.

Bill Wheat

One thing we should clarify, Ken, is when we state our owned lot position that does not include lots on which we are constructing a home. It includes finished lots or lots under development that we own, but we have not started a home under construction. So, actually to reduce our lots owned, we need to start a home because then it will move into our construction in progress. Since we are not starting many homes right now, we're purchasing very few as well. But since we are not starting many homes, our own lot position hasn't moved much in the last couple of quarters.

Don Tomnitz

Yeah. And that's a good point because what we are trying to do is reduce our spec inventory such that we can start additional homes.

Ken Zener - Merrill Lynch

Okay. Obviously, selling land like you did in Phoenix is going to be helpful for that. I guess that deals, you could explain on the logic behind that. While, it's good that you are selling the land and certainly at a profit relative to what you bought at in '04. I think it's going to surprise people the amount of lots, certainly me, the amount of lots, roughly 23,000, which represented 50% of the southwest lot position, as I did the calculations. So, it just seemed to be such a unique deal. Could you explain kind of a logic given what it appears to be roughly $3,000 of lot cost basis? Thank you.

Don Tomnitz

Well, we don't want to explain that too much because, obviously, we have some agreements with our buyers. But essentially, we ended up with too many lots in that market and we had a very successful project. There was essentially but the same number of lots that was north of there, that we started 7 years ago and became very, very profitable for us. As we looked at that market today, it was one of the more outlined markets in our core area and Phoenix, and we just decided we had enough lots in that market to get us through over the next two or three years. And clearly, we will be buyers of lots most likely from the gentleman and the party to whom we sold the land.

Stacey Dwyer

I think you're right on one thing, Ken. It was a unique transaction. There were certainly a larger number of lots, but it wasn't a very attractive land [dices]. And our intention there has been to sell off some piece of that land in the normal course of business. Because typically, we would not have any individual community of that is [back side].

Don Tomnitz

And just one on the same lines, we would have missed if I didn't mention Gordon Johns and Tom Davis, who were very instrumental in consummating that transaction with the buyers. So, thank you very much, gentlemen.

Bill Wheat

Next question?

Operator

Your next question comes from Stephen Kim with Citigroup.

Stephen Kim - Citigroup

Hey, guys.

Don Tomnitz

Good morning, Kim.

Stephen Kim - Citigroup

I wanted to first ask you sort of a conceptual question. Actually, yeah, that's a conceptual question. You guys just gave earlier in the call here, a development spent projection of 2008 of I think $500 million to $1 billion. I wanted to make sure I understood what that would be comparable to in 2007?

Bill Wheat

Well, clearly what we said is not only is that development span, i.e., the water, the sewer lines and the paving that's going to improve the lots, but it's also closing.

Don Tomnitz

Yeah. They are closing on land and lots as well.

Stephen Kim - Citigroup

Right. No, great. I would imagine any ongoing fees you got to pay to keep up since the lot and what not. What was that figure in 2007 for you?

Don Tomnitz

$2.5 billion.

Stephen Kim - Citigroup

Got it. Great, perfect. Okay. And then the second question I had relates to your working process, would you help finished homes and constructions in progress? Obviously, it came down nicely with a nice driver to your cash flow for the year. I think you indicated that you sort of felt that line item might be a driver again as you go forward into '08, which makes sense. My question is this, though--if you look at the number, which I think was $3.3 billion as a percentage of your backlog value, the figure was noticeably higher I believe than what we've seen in your previous quarters. And I guess I was curious as to whether or not -- and obviously that's because your backlog value dropped [previously]. I guess my question is whether or not we would expect that figure as a percentage of backlog value to come more down inline with where it's been over the last, let's say, year or so and maybe what drove the big increase in 4Q '07.

Stacey Dwyer

I think in 4Q '07, there are couple of things that come into play. Obviously, the fourth quarter is our strongest delivery and so you see the biggest drop in our backlog in a sequential quarter and the fourth quarter. The other thing is, that our speculative inventory as a percentage of our inventory is higher in the fourth quarter than it has been. And that's why we've said we want to work it down, both our absolute number of terms in inventory, as well as our speculative terms in inventory.

As our spec percentage goes back down toward our targeted 35%, we should see the percentage of residential inventory compared to our backlog coming back inline where it has been historically.

Stephen Kim - Citigroup

Right. Yeah, because those specs obviously carry a heavy dollar rate.

Stacey Dwyer

Well, they just carry a dollar rate, that's not offset by anything in the backlog number.

Stephen Kim - Citigroup

Right, right, more particularly, right. Okay. And then switching gears to your SG&A, which was obviously very good, your performance is very good this quarter, and it has been for quite a long time obviously. As I look ahead into the first quarter of next year, the way we forecast your SG&A, it looks like it is going to be quite a challenge here for you to keep your SG&A rate as percentage of [i.e.] home sale revenues, but it's not to be that much of a difference that you calculated. I have added, sort of, jumping up to a level that we have never seen in a history of company, because of some relatively weak revenues. According to my records, you have never generated an SG&A rate higher than 12%. Is it your expectation that you should be able to sort of maintain that track record and stay 12% or below in the first half of 2008?

Bill Wheat

Steve, as long as I have known you and as long as you have known Don, Horton and me, I am surprised with your question. But I will answer it for you, because obviously, you must have forgotten something about the both of us and that is we clearly reduced our SG&A inline with our closings as you noticed at rough 22% and 23%, and we'll continue to do that. We are, frankly, at this stage, waiting to see what type of spring selling season we have; to see if there is any Super Bowl party. We think we are well positioned to take advantage of it. To the extent, we are not, we'll keep our SG&A very closely inline with where it has historically been, and that's the way this company has operating and will continue to operate.

Operator

Your next question comes from David Goldberg of UBS.

David Goldberg - UBS

Hi. How are you doing?

Don Tomnitz

Hello, David.

David Goldberg - UBS

I think if we could start with the decline in unsold homes that are under construction or completed. Can you give us just an idea of what kind of price discounts you guys used to bring that down, and what's the profitability of those homes might look like having been resold?

Stacey Dwyer

Say that again please, David.

David Goldberg - UBS

Yeah. So, for the homes that were in progress or completed and unsold, that came down, if my calculations are right, from about 13,000 to about 10,600? I think that's about right? And I'm just wondering what kind of price discounts you used to move those homes?

Stacey Dwyer

So basically, the pricing differential between a spec home and a to-be built home?

David Goldberg - UBS

That's right. And then also the profitability difference?

Sam Fuller

It's all over the math. Quite frankly what we are looking is, we looking at the age of the inventory of the finished spec, and we're trying to mark that to market, as well as when we do a built job or to-be built home, we are pricing that home, I would just say rough numbers. At least 300 basis points above where we have got the spec home for sale, partially because of the fact that if we are going to take the risk of building a to-be built home for someone, we want the additional profit in order to justified that.

And we really will prefer to move the existing inventory home. So, we are trying to price that, to-be built home high enough that if the buyer wants that on that specific lot, there's a good margin home for us, as opposed to moving any existing inventory up.

David Goldberg - UBS

And then, I guess my follow up question has to do with how comfortable you guys are with the backlog right now that, everybody in the backlog is going to be able to, like if you read it out and make sure nobody can get a loan, and qualify for mortgages at the current rate. And any ideas whether that's flushed out?

Don Tomnitz

If I told you I was comfortable, I think I'd be in different business, because -- tell me what the mortgage markets is going to be like over the course of the next quarter. The answer to your question, I believe with what is in our backlog today,especially reflecting what happened in the fourth quarter, because one of the things that drove our cancellation rates so high in fourth quarter is we did review our backlog region-by-region, and division-by-division with one specific goal in mind: do we have a buyer in our backlog who is qualified in a mortgage that doesn't exist anymore or looks highly unlikely that they will be able to qualify as the mortgage market changes? So, we scrubbed our backlog, the best I think we have ever scrubbed it relative to the mortgage instruments that are available and may not be available going forward. So, while there's still cancellations to be held in our backlog, I think the vast majority of those clearly were taken as we constitute that in the fourth quarter.

David Goldberg - UBS

And then, maybe I can just speak one more in here. I am just thinking about free cash flow priorities, you guys are going to generate a billion in cash flow from operations next year. Tell me, what you are seeing in the market now in terms of maybe M&A, or even land sellers (inaudible) transaction you guys did, if you are seeing that free (inaudible) in terms of cash pricing from land sellers or M&A from other builders?

Don Tomnitz

Well, I would say to you that that in terms of M&A from our perspective, i.e., us buying someone or some other major asset is certainly not at the top of our list, but rather at the bottom of our list. We are still dealing with an adjusting market. I don't know where land values are going to be three months from today, six months from today. And so, as a result for us to go out in the marketplace today and to purchase some large assets or some builder, I think the most difficult thing would be what's the value of the asset that we are buying. So, that's certainly not on the forefront of our minds. Our goal is, well, completely to reduce our land and lot inventory and to reduce our finished home inventory and reduce our spec inventory and to get our cost more inline with what the consumer is willing to pay for our product.

David Goldberg - UBS

So, you just use the cash to deliver?

Don Tomnitz

Absolutely. We are actually convinced of one thing. There is a modal risk in across all of our foreheads as we walk in this office. Homebuilder with the strongest balance sheet wins this fight and we have and we will have the strongest balance sheet.

David Goldberg - UBS

Okay, thanks.

Stacey Dwyer

Thank you.

Operator

Your next question comes from Stephen East with Pali Capital.

Stephen East - Pali Capital

Good morning, everyone. One last question on inventories and then hopefully will leave you all alone on it. Your specs in absolute came pretty down nicely as the percentage of total actually went up and I know you all are trying to focus heavily on getting that percentage back into the 30s. Can you do that with your plans that you have right now on fiscal '08? Can you do that?

Bill Wheat

I think to answer your question directly, yes, I do believe we can do that. I think it's going to be a tough goal to achieve. I think one thing that you have to remember Stephen that we did not disclose and that is that we have 299 homes that have been completed and unsold for a period greater than a year or so. So, we really don't have a significant aged inventory problem. Although, we do have more specs than we would like. That number should come down as we continue to price our built jobs, more expensively in our specs.

Stephen East - Pali Capital

Okay, all right. And then if we look at the California and West orders in this quarter, down pretty sharply--pricing down pretty sharply in California. The drivers for you, given the relative underperformance for you all in those particular areas, and sort of what your response is looking out at this quarter and into the selling season?

Don Tomnitz

Well, I would say in the West, in particular, we believe that any dollar that we don't put in the ground out there, there is a profit this year. And as a result, we're absolutely trying to decrease our investment dramatically in all of those markets out there as we speak in terms of land acquisitions, lot acquisitions, development spend, you name it. The California market, we made a lot of profit, a lot of PTI during the good times and obviously, if you look at our impairments we've given back, $0.5 billion of that in impairment so far and that's disappointing to us. But that's a very challenged market. I would say to you that the biggest issue in California today is there are a lot of people who want to own a home and there are no mortgages out there or very few mortgages out there which will permit someone to buy home in California today. So, there's got be a great reset in both cost prices as well as some additional mortgage instruments to make that market come back.

Stephen East - Pali Capital

Okay. And that sort of leads right into my next question, the news this morning with Freddie the mortgage environment in general that you are seeing. Thus the Freddie news caused you all consternation? Does it affect your business and sort of tailing onto that the performance you have seen in you markets since the end of September?

Don Tomnitz

Well, let me address everything other than post September and to answer your first two questions, yes and yes. It does impact our business. It does concern us. I am of the opinion that the best thing that's going to happen to the financial institutions including Fannie and Freddie are just exactly what the homebuilders have done. We've gone through and we have reset our basis in our properties with impairments of earnest money write-offs. The best thing, not that I am an advisor to them, but the best thing they can do is to deal with it all, get all other ways as quickly as possible so we can move on. And that will applaud our industry, because I think if you look at all the builders in the homebuilding industry, we've attempted to clean it up as quickly as we possibly can and that's what they need to do. Therefore, we'll have a whole new parameter to start with and whole new market to start with.

Stephen East - Pali Capital

Okay. What's going on with Freddie today, do you think it creates another round of tightening of lending standards and thus taking another group out of the market?

Don Tomnitz

It could very well. It really could.

Stephen East - Pali Capital

Okay. Thanks a lot.

Operator

Your next question comes from Timothy Jones with Wasserman and Associates.

Timothy Jones - Wasserman and Associates

Hello, Don.

Don Tomnitz

Good morning, Timothy Jones.

Timothy Jones - Wasserman and Associates

A couple of questions. First of all, did you say that land sale (inaudible).

Don Tomnitz

You are really breaking up there.

Timothy Jones - Wasserman and Associates

I am going to get up to you, just a second, I am sorry. Can you here me better?

Don Tomnitz

Yes, sir, it's better.

Timothy Jones - Wasserman and Associates

Okay. On the 220 -- this is a housekeeping. The 20,000 lots, did you say they generated $76 million revenues?

Stacey Dwyer

$70 million.

Timothy Jones - Wasserman and Associates

$70 million. Okay. And you didn't have any impairments given the fact you had a 45% margin in the land operations, did you?

Bill Wheat

There was no impairment on that property.

Timothy Jones - Wasserman and Associates

No, but I got one thing, Bill, because you generated 45% margins in there.

Bill Wheat

To clarify, Tim, this sale occurred after fiscal year-end. This occurred in the month of November.

Timothy Jones - Wasserman and Associates

Okay. Good. That will help first quarter.

Bill Wheat

Yes.

Timothy Jones - Wasserman and Associates

That's nice to hear. Okay. Now, can you give me the quarterly increases in sale -- monthly increases in sales this quarter and the cancellation, and maybe any comment on October?

Bill Wheat

I will tell you that our cancellation rate in each of the months of the fourth quarter increased sequentially, which led to our 48% can rate total for the fourth quarter.

Timothy Jones - Wasserman and Associates

And that was described in the backlog or what?

Sam Fuller

I would say that -- I don't have that number before me, but a lot of the increase in our can rate up to 48% over the year-ago period and especially over the third quarter, a lot of that was a function of our cans in our backlog.

Stacey Dwyer

Yes.

Timothy Jones - Wasserman and Associates

The other thing is you talked about being really working on your flyers, and I know Don well enough to know this is true. How much have reduced your material cost and labor cost per square foot in the last year or so from the peak whatever you want to say it?

Bill Wheat

We don't have an exact number on that. That's going to vary market to market. Certainly in places like California and Las Vegas, it's been more substantial than it has been in Texas, because Texas is still a good solid market for us. But I think as a good range, what we have told people over the course of the year is that that number is probably somewhere between 5% and 10%; probably closer to 10%.

Timothy Jones - Wasserman and Associates

Really, and that's sticks and bricks, that's including laboring everyday?

Bill Wheat

Yes, sir.

Timothy Jones - Wasserman and Associates

Okay. And lastly, just one another question. I just want a comment on this. One of your competitors had said they are going to built 200 homes in Southern California and hold on to them. That obviously surprised me. And you've just said that anything you can get out of California is good. Would you like to make any comment on the different tactic?

Don Tomnitz

No, sir. Frankly, we're focused on taking care of our own inventory and of houses and lots, and our goal is to try to reduce our number of homes in inventory, as well as most importantly, pull our development dollars out of the ground by building, selling and closing houses on those developed lots.

Timothy Jones - Wasserman and Associates

You said there was price inelasticity in Southern California. Yet, one of your major, major competitors said, if you can offer homes that didn't get a conforming $417,000 loan, that you can sell them quite rapidly in Southern California, I would still suspect that most of your product would fall into that category.

Bill Wheat

I would agree that most of our product would fall into that category and I think still the majority issue in California is as a fact that you have consumers. You are seeing single family home prices decline rapidly over the last 12 month to 18 months and one other things that we are fighting along with mortgage liquidity into the California market is frankly one of boosting back consumers' confidence and the only way we are going to have the confidence in the consumer is there are some pricing stability until we reach a level of inventory where it's relative to the demand out there I think that's going to be very difficult to achieve. So, clearly in California, we need some help on the mortgage side or a lot help on the mortgage side, but right now I think it's a combination of mortgage and consumer confidence.

Operator

Your next question comes from Alex Barron with Agency Trading Group.

Alex Barron - Agency Trading Group

Hi, good morning.

Sam Fuller

Good morning. How are you doing?

Alex Barron - Agency Trading Group

Good, how are you?

Sam Fuller

Doing great.

Alex Barron - Agency Trading Group

Excellent. I wanted to ask you if you could talk about on the impairment how many communities you guys impaired this quarter and also what the breakdown was beyond California?

Don Tomnitz

Sure, we impaired 98 communities this quarter and just rough numbers we had 58% California, the next two regions kind of in the ranking there as far as volume of impairments of west region had the second largest amount and the Southeast region had the third largest amount, combined that gives the best majority of the impairments this quarter.

Alex Barron - Agency Trading Group

And of those 98, how many were re-impairments?

Don Tomnitz

23

Alex Barron - Agency Trading Group

23, okay. I guess my second question going back to the SG&A issue I am just trying to get a sense of how much of SG&A is relatively fixed versus how much is variable and I guess do you have a target for where as a percent of revenue that's going to come in next year?

Sam Fuller

Our goal has always been to keep it at 10% or less, obviously we are 10.3%, 30 bits higher than our goal. But we expect in '08 to be real close to that 10%.

Stacey Dwyer

And the only thing I would to add that Alex is, it is going to be challenging to keep that at 10% in a declining revenue environment. And we have been very proactive throughout this year and we managed to bring that in only 30 basis points of above our target. We're going to be working to do that again. A lot of our costs are variable, and over 50% probably closer to 60% of our SG&A cost, are relates to people, it's the actual salaried, commissions, bonuses and then all the related benefit cost that we pay. So as we continue to adjust our organization size to demand that we're seeing in the market, we will continue to impact a larger percentage of that SG&A number.

Alex Barron - Agency Trading Group

Got it. And any comment on the dividend; any chances that's going to get cut to save some cash?

Bill Wheat

Our dividend is stand as it is and its something that our Board of Directors reviews on a quarterly basis, clearly with our $1.36 billion of free cash flow in the past last quarter. And over $2 billion of free cash flow over the last 15 months. And our projection of $1 billion of free cash flow for fiscal year '08, to the extent that we can continue to generate the free cash flow that we expect to. We will review it on our quarter-by-quarter basis, relative to our ability to achieve those free cash flows in '08, but we certainly did that in '07 and for the past 15 months.

Alex Barron - Agency Trading Group

Thank you very much. Take care.

Operator

Your next question comes from Carl Reichardt with Wachovia.

Carl Reichardt - Wachovia Securities

Tell me guys, how are you?

Don Tomnitz

We're doing great, good morning.

Carl Reichardt - Wachovia Securities

When you choose a new word, please do it at my conference in February.

Don Tomnitz

Alright.

Carl Reichardt - Wachovia Securities

I have a question about, if you look at your budgets for absorptions over the course of fiscal '08 I don't know if you base you impairment analysis on what's you guess as to, I know you don't disclose store capital, what's your guesses is to what your store count will decline if it will in '08 versus '07?

Bill Wheat

We expect it certainly to decline if probably in the 10% range roughly, its a little bit difficult to predict, it really depends on how quickly we sell through current communities, but we expected to certainly come down at 10%, it wouldn't surprise us.

Carl Reichardt - Wachovia Securities

And that would be faster than in '07 to '06 correct?

Bill Wheat

You know that's about inline we're roughly in the 10% range for this year.

Carl Reichardt - Wachovia Securities

Okay great. And Don, can you give us any update on markets that your geographic markets where you will be there substantially consolidated divisional operations or outright pulled out off.

Don Tomnitz

I don't on the top of our heads, but not on top our heads, specifically we've not pulled out of any major markets that we were in. We have consolidated operations clearly in California. We're consolidating operations in Florida, and those are really two primary areas where we consolidated our operations significantly. And Stacey just mentioned Denver and clearly Denver were one division versus three divisions so we've consolidated those three areas the most.

Carl Reichardt - Wachovia Securities

Okay. And then just one last question, I know you are not out there if you are looking for it, but from a land price perspective could you comment on what you might be seeing from especially the third party developers and are you starting you see any of the banks that have taken stuff back from the private guys or developers start to ask you do details with them, obviously whether hanging on to it but you are actually developing outward fee has any of that started to accelerate?

Sam Fuller

No fee approach that we've been, no, we have been approached with. You are seeing very little of any come from the bank yet and it's the only thing I can say about the third party developer is they are too high and hold their prices, clearly if the homebuilders are taking the impairments that they're taking, they are going to have to decrease their prices significantly accentuate us in '08 because I can tell you they need to be impaired, just as much as we have been impaired.

Carl Reichardt - Wachovia Securities

Okay. I appreciate that. Thanks so much, guys.

Operator

Your next question comes from Jim Wilson of JMP Securities.

Jim Wilson - JMP Securities

Thanks, good morning.

Don Tomnitz

Good morning, Jim.

Jim Wilson - JMP Securities

I was wondering, Don, could you kind of go through as you discussed what you required in land in '07 and then your plans for '08, where that is? I assume you have made some material changes in what are your points in acquiring land or looking in new purchases.

Don Tomnitz

The primary place that our land acquisition is an option contracts where we are closing on lots, to either build jobs or specs in a specific community. As far as other raw land purchase, I can tell we have no plans to acquire any pieces of raw land and very little of any occurred in '07 to the extent that we did close a couple of parcels in '07. I can tell you that we've already turned those and sold them off to other people. So, we just don't have any appetite to speak-up in any market today for new land parcels, what we are doing simply is closing lots and options contracts to build homes.

Jim Wilson - JMP Securities

Okay. And I as well assume lot of that are -- that seems to have dropped options more in certain locations and executed options, [on] others. I know that there is a big difference in the geography--is that fair to say?

Don Tomnitz

Yes, very definitely.

Jim Wilson - JMP Securities

Okay and then second question, as you noted early on that your exam, I think the number was like $2.6 billion of inventory for impairments and impaired 900 of it, roughly 30%. What did you find in the large chunk there that you examined, but found no need for impairment, what were the characteristics of not requiring it? Was it geography again or just were you be able to lower cost in order to stay profitable or some combination?

Sam Fuller

The primary factor is the margin that we are seeing currently in the project and our prospects for margin going forward based on what we expect to see in pricing in that project, and at this point based on what we can see, it is still really above the line where we would not need to be impaired, similar to anything that we hadn't impaired in previous quarters.

Jim Wilson - JMP Securities

Okay, and indeed again I guess geography had a lot a with that?

Sam Fuller

Geography certainly comes into play. One indicator, one of the things that puts the project on the list is its geography, relative to perhaps other projects that have been impaired. So that will be a factor, but the primary factor is how we expect that project itself to perform based on what we are seeing and what we expect in the short-term.

Don Tomnitz

The geography is pretty much limited, I would call four states and its really still California, still Arizona primarily Phoenix, still Florida and also Las Vegas. So if you look at, as I've said before, in the homebuilding industry, everybody talked about the great ramp up in the homebuilding industry and the appreciation in all these markets. Really we had four or five hot states, and where we've got most of our impairments, and our future impairments are still going to be, I believe, in those four five hot states.

Jim Wilson - JMP Securities

Got it, okay. Alright Thanks.

Operator

Your next question comes from Larry Taylor of Credit Suisse.

Larry Taylor - Credit Suisse

Good morning, thank you.

Don Tomnitz

Good morning Larry.

Larry Taylor - Credit Suisse

A number of my questions have been answered, but I wonder if you could just provide a little more color on the use to cash flow given that you've already made substantial progress repaying the bank debt and have a limited number of maturities going forward over the next 18 months?

Stacey Dwyer

First thing, Larry, we had a balance of $150 million remaining on our revolver at the end of the year. First use of cash would be go ahead and reduce debt. We also have $215 million of senior notes that mature in December and that will be redeeming, and in fact that we will basically look at opportunistic ways to repurchase our debt and we may also achieve more cash on the balance sheet than we have historically, and simply until we see market conditions stabilize a little bit we want to make sure that we have sufficient liquidity.

Larry Taylor - Credit Suisse

Okay, great. That's helpful. And then I wonder if you comment as you look into 2008 and think about the competitive landscape and I realize this is sort of a general question, but how you anticipate pricing strategies to evolve from some of your competitors, I mean we've seen price cuts, we've seen a pause in pricing cuts in some markets. And I guess just sort of trying to get some benefit from your view as the housing demand falls in '08 from a pricing standpoint?

Sam Fuller

I believe '08 is going to be considerably more competitive than '07, both in terms of volume as well as price, and we are prepared to meet the market in each one of our markets and we think that this is going to be little more painful for us in '08 than it was in '07 in terms of trying to meet that limited market, because the market is -- there is less volume and the volume that is there is demanding better pricing which is couples with our focus on decreasing our cost as rapidly as we possibly can.

Stacey Dwyer

And the other thing that Don talked about is just to continue changes and tightening that we're seeing in the mortgage market and tightening at the lending standards and changes in the products that are available to our buyers to allow them to get into houses.

Larry Taylor - Credit Suisse

Great, that's very helpful. Thank you.

Operator

Your next question comes from Mike Marburg with Ramsey.

Mike Marburg - Ramsey

Hi guys. Two questions. One, around the gross margin, so as you look over the past four quarters, that the margin change its track with some difference, but its track somewhat with the decline in average selling prices. And I guess starting next quarter, we're really start to see this filters through with the flow through of the big declines in the last two quarters on ASPs for sold homes, which we have not seen yet, because ASPs on our closed homes have been pretty good, all things considered in this environment.

So, do you expect the gross margins to really start to change, take a step function change, early next year, or are you able to really make up for that, with these cost cutting efforts? So, it would be different than what we have seen in last four quarters?

Bill Wheat

Realistically speaking, I believe our gross margins will come under continued pressure in '08. I am not certain we're going to be able to offset that decrease in gross margins a 100% by our SG&A cuts as you can tell. But clearly, we anticipate '08 to be more difficult than '07 and we have taken the proactive steps to be prepared for that.

Mike Marburg - Ramsey

Okay.

Sam Fuller

One thing we probably should clarify is in the sale ASP in the current quarter's sales. A product mix did impact, especially product mix on our cancellation rates, did impact our ASP quite a bit, while our net sales order ASP did decline by 15%, our ASP on our gross sales orders only declined 8% because we did have more cancellations coming out of the higher products as the jumbo market was in flux. But, certainly an 8% decline, we do expect that impact margins going forward.

Bill Wheat

But 8% versus 15%, and one of the factors that we continue to work on, is how do we hold those units and backlog and prevent them from canning even if it takes us a little bit more negotiation to hold those in; because we can see the difference between 8% and 15%, we have got a little bit, we've got quite a bit a leeway to work with the buyers within backlog and to hold them in the backlog to get them to close.

Mike Marburg - Ramsey

Yes, okay, thank you. And then as it relates to the SG&A comments you are making early about a roughly 25% of selling. So for this year that would put on just on a quarterly basis your G&A cost at around 200, below 200 per quarter. So if next quarter we've a big drop in homebuilding revenues, which I think is to be expected given the recent trends. The G&A, you assume, roughly 25% stays for selling. The G&A needs to go down to about a 150 from, say, 210 per quarter. Are you prepared to make such a dramatic change in G&A in one quarter, it did happen last quarter, in the fourth quarter of last year you went from maybe 300 down to somewhere in the mid-200s per quarter using the ratio you have given us, but are you prepared to do that again?

Sam Fuller

Yes, we are. I am not sure that we'll get it all done in the first quarter, or all in the second quarter, but we're waiting for even though we're leaned today. We're waiting to see what happens in terms of the spring selling season Specifically, Super Bowl in February of calendar year '08. We're I think as lean as we can possibly get right now in anticipation of what we think we're going to do. We've run the numbers based upon how many units we believe that we'll close in '08 and the number that we're running on based upon what we believe we can close in'08. Our SG&A is close to be in line where we want it to be, to the extent that the number of units that we think can close are eroded than we are prepared to make the SG&A cut, just as we have done over the past 24 months?

Mike Marburg - Ramsey

Thank you very much.

Operator

Your next question comes from Susan Berliner with Bear Stearns.

Susan Berliner - Bear Stearns

Good morning. Just two quick questions, one, is I was wondering if you could talk about which are your best markets, right now?

Bill Wheat

That's a limited list today.

Sam Fuller

I still believe the California. I thought you asked the different question. Clearly, Texas continues to be a very good market for us. It's weakened some in '07 and we expect it to weaken some in '08. But the all the markets in Texas from Dallas to Boston, to Houston, to a lesser extent San Antonio are all good markets for us. Our acquisition in Baton Rouge, Louisiana continues to perform very well for us. The Chicago market, we had a very good year in Chicago.

We anticipate it would be a softer market in Chicago next year, but it will be still good solid year for us in Chicago. And if you take a look at the Coastal Carolinas and even interior parts of Carolinas with Durham/Raleigh and Charlotte, we expect those to be good markets for us in '08. I believe that rest of the markets are going to continue to be as marginal as they were in '07 or even to decline some in '08.

Susan Berliner - Bear Stearns

And is that true for Atlanta as well?

Sam Fuller

I think Atlanta is just a -- it's a pretty much a flat market. It's a great market for us. We get good sales and closings in Atlanta. But it's just not as active as what it once was, and it's very competitive market which is influenced largely by a large number of small and medium sized builders, who we don't wish a (inaudible), but during this downturn, we hope they go away because it will get back into the larger builders who are working for higher profit than the smaller or medium sized builders on the line.

Susan Berliner - Bear Stearns

And then my last question is, can you just talk about your philosophy and what kind of levels are you giving for incentives versus actual price declines?

Sam Fuller

Well, in terms of the incentives, where we are, it's really out of one pocket or the other pocket. Frankly, we've tried to preserve as much of our sales prices as we possibly can in our communities and offer incentives as opposed to marking to market permanently vis-à-vis the sales price. But clearly, whatever it takes to get the product, that's already produced and available, sold and cleared the market with that, we are willing to that both with price incentives as well as price cuts as well as incentives.

Susan Berliner - Bear Stearns

Great, thank you very much.

Operator

Your next question comes from Bob Thompson with Advantus Capital.

Bob Thompson - Advantus Capital

Hi, guys. Going back to that, were the average incentives and discounts in the fourth quarter, did you give that amount?

Sam Fuller

We didn't give that amount, but I think we are pretty much dealt with I believe when we talked about our core margins and it's fully reflected our entire deterioration in our margin is wholly the result of the incentives and price adjustments that we have made during the quarter. We talk about it because it does hit both lines.

Bob Thompson - Advantus Capital

Okay.

Sam Fuller

Incentives hit cost whereas price reductions come up revenue line.

Bob Thompson - Advantus Capital

Okay, and also, going back to the 20,000 lots--did you say, did you sell them for $70 million?

Sam Fuller

It was a raw piece of land that was entitled for as many as 20,000 units.

Bob Thompson - Advantus Capital

Okay.

Sam Fuller

Both single family as well as multi-family, and the revenue associated with that was approximately $70 million.

Bob Thompson - Advantus Capital

Okay. And then do you anticipate any further -- are you actively seeking lot sales going forward?

Sam Fuller

Whether we have -- to answer your question directly, yes, we have excess lots, and it's going to vary market-to-market.

Bob Thompson - Advantus Capital

Okay. And then the last question is as the year unfolds, as the covenants gets closer, I mean do you anticipate needing to amend your covenants in '08?

Bill Wheat

At this point, we certainly have sufficient cushion at 930. As we go into '08, we will evaluate where we think we're going to be and will be in active conversations with our banks if necessary.

Bob Thompson - Advantus Capital

Okay.

Sam Fuller

Frankly, we are very proud of where we are today relative to those covenants. We have more room I think than most everyone else in the industry. So we are very proud of our financial performance relative to those covenants. But to the extend that our financial performance should adjust going forward, and as we said earlier, we think '08 is going to be more difficult than '07, then we'll be, if we need to, actively discussing with our banks adjusting those covenants.

Bob Thompson - Advantus Capital

Great. Thank you very much.

Don Tomnitz

Yes, sir.

Operator

Your next question comes from Bob Sells with L&K Capital Management.

Bob Sells - L&K Capital Management

Three questions. First question is, looking at the spring '08, as you call it separable selling season, why not make the overhead cuts now assuming the direct -- given the direction of the credit markets rather than waiting to see the results of spring '08?

Don Tomnitz

I believe -- first of all, let me say that from an SG&A perspective, we are the leanest builder in the industry. We believe we're properly positioned for what we envision is going to happen in '08. And to the extent that that doesn't materialize according to our spreadsheets that we have done for each month of the fiscal year, we're going to make those adjustments as it does not meet our expectations.

Bob Sells - L&K Capital Management

When you look at those assumptions, where do you assume the low watermark is for orders?

Sam Fuller

Typically, if you look at our first quarter, our first quarter of sales is our weakest and second quarter it usually starts to pick up, and third quarter is little bit better, and the fourth quarter is little bit less. So if you fuse this, the fourth and the first quarter are our lowest points and the second and the third quarter are our highest points. So, today, with where the mortgage market is and the constant evolution of the mortgage markets, I couldn't say which is going to be our best quarter at this point.

Bob Sells - L&K Capital Management

But it sounds like you will wait until the second quarter, kind of the beginning of the second quarter of '08, over at that point before making the further decisions on SG&A cuts?

Sam Fuller

Well. Let me clearly say, and maybe I misstated this earlier, we're not holding excess SG&A in anticipation of unrealistic fiscal year '08 sales and closings number. We are frankly looking at it. We're positioned exactly where we want to be relative to our projections, which are internal for '08 and will adjust those as we move forth accordingly.

The one thing that I will remind everyone of is we have had the lowest SG&A in the industry and will continue to have the lowest SG&A in the industry, and we're going to adjust our business just as we've done over the last 24 months to meet the market.

Bob Sells - L&K Capital Management

Second question. With the lack of further impairments, the implication is that your pricing assumption for orders doesn't drop radically going forward, although I understand you're doing good job on costs. Help me help reconcile that implication with the statements that you made and I believe is your philosophy that you will price as it takes to move inventory.

I guess my assumption had been that pricing will continue to move down more quickly than you are able to cut costs as we look into the fourth quarter and the first quarter.

Sam Fuller

Our assumptions are that our prices will continue to drop in most cases. There is no implication with regard to the amount of impairments that are taking in any one quarter. The assumptions that go into the impairment evaluation are consistent and do assume flat to lower pricing in virtually all projects that we're evaluating.

This is the second largest quarter on record for us in terms of dollar amount of impairments. So it certainly is a substantial amount of impairments from our standpoint and really there is no implication regarding assuming the pricing is going to be better. We assume that the pricing will continue to be challenged.

Operator

You next question comes from [Emeril Amman] with 36 Capital.

Emeril Amman - 36 Capital

Hi, guys. Thanks for taking my question. You guys have done a great job kind of assessing the situation for what it is. I just kind of wanted some color on a higher level question. There has been a lot of talk lately about that given the state of buyer confidence in some of the more troubled states that the cost of home ownership is going to have come down to the point where it's competitive with the rest, which means anywhere from between another 10% to 20% drop in prices. Is that kind of theory you subscribed to or is that kind of analysis missing something?

Sam Fuller

Absolutely not. Each market is adjusting on its own and some markets are adjusting more and some markets are adjusting less. And I would not attach the percentage of decline to any of it, because frankly, I would say to you and I would say to the homebuyers in America that if we're not at bottom in terms of our pricing, we're really close to it and to the extent that you are waiting to buy a home because you think prices are going come down, you're going to do the same thing you do on interest rates most of the time and that is you're going to say, gee, we missed the bottom of the market.

So I think we are very close to the bottom of the market. And most of our markets, some still have some additional deterioration, but it's difficult to determine where those are at this stage.

Emeril Amman - 36 Capital

Okay. Great. Thanks, guys.

Operator

Your next question comes from Darren Richman with GSO.

Darren Richman - GSO

Hi there, everybody. Thanks for taking the time today. On the topic of impairments, I was wondering once you make the determination to impair a property, can you walk me through exactly the methodology used. What type of margins you are trying to target? What discount rates you may use in the process just to add some more light to that process? Thanks.

Don Tomnitz

Certainly, the assumptions are set project-by-project. In order to determine that a project is impaired, we must determine that the project will not essentially make money from an accounting standpoint after covering direct overhead cost. Once we have made that determination, then we'll perform a fair value analysis, which in most cases will be a discounted cash flow analysis of all of the future cash used or cash flows from that project in the future. That will be discounted back.

The discount rate assumed in each project will vary, and it will vary basically based on the relative risk of the project. The closer that we are to delivering homes in a project, the lower the discount rate will be. If it's raw land, and we still have developments, and will not deliver homes for some period in the future, the discount rate will be higher.

But essentially, we discount those cash flows back, determine the fair value based on that compared to the current carrying value of inventory and record the impairment accordingly by choosing different discount rates based on the relative risk.

Generally, the assumed gross profit that would result from an impairment charge would be lower on a project that's closer to delivering homes; again, lower-risk project. And it would be higher on a project that we would be delivering homes further into the future. The range can vary quite a bit. I'm not state necessarily specific ranges of gross profits or discount rates, but it's project-by-project.

Darren Richman - GSO

I'm just wondering, I mean is it -- some of your competitors have put out some discounts rates. I was wondering if at the very least you could bracket it. I mean are they in the double digits or are they closer to 20% really, just to get a better sense for it?

Don Tomnitz

The numbers that you've seen kind of bracketed for the other builders out there have been very consistent with what we have used, as well. There is basically one audit firm that audits majority of the industry. And overall, I believe that the builders and the audit firms have worked together to make sure that we are keeping the assumptions on the impairments as consistent as we possibly can given that it is a project-by-project analysis.

Darren Richman - GSO

Sure. And then what do you do on a raw land basis? Is that something that you'll discount as well, because I think the methodology there differs from builder to builder?

Don Tomnitz

We will discount that. Of course, it depends on what our intent is for that land. If our intend is to build it out, then that's one set of assumptions. If the intent is to sell the land, that's another assumption and that would be based more on the market price of the land, but that will vary based on the intent of our use of the land.

Operator

Ladies and gentlemen, we have reached the end of the allotted time for the question-and-answer segment. I would now like to turn back over to Mr. Tomnitz for any closing remarks.

Don Tomnitz

Thank you very much. As I sit here around the conference table and I look at our 2006 21st Annual Builder 100 Single Family D.R. Horton number one trophy, I would say to all of our employees and our investors that we entered this downturn in the market as the largest and the most profitable builder. Clearly, as we go through this market downturn, we are shrinking the size of our organization to meet the demand. And as I tell our employees and I tell our investors, on the other side of this, we will come out as the largest and the most profitable builder.

We are the most transparent financials in the industry. We have the least -- we have no one consolidated joint ventures. And the bottom line is, as I said, D.R Horton entered this with the strongest balance sheet and will come out of this downturn with the strongest balance sheet. We have been, we will be, and we'll continue to be, the survivor and the leader in our industry, and we look forward to great opportunities in years ahead.

As I tell our salespeople, it's all about sales. We're all in sales-- regardless of whether you are construction superintendent or whether you are a field person, a warranty person or whoever--we are all in sale and it's all about sales. So, as we have told all of our regional presidents and division presidents, and I hope a lot of salespeople are listening to us today, the future of the company and how well we do is based upon how many homes you sell throughout there. Leave no buyer behind; sell and close homes. Thank you very much.

Operator

Ladies and gentlemen, this concludes today's D.R. Horton Incorporated America's Builder, the largest homebuilder in the United States, 2007 year-end conference call. You may now disconnect.

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