霍頓房屋 (DHI) 2006 Q2 法說會逐字稿

Good morning and welcome to the second quarter 2006 earnings release conference call for D.R.

Horton, America's builder, the largest homebuilder in the United States. [OPERATOR INSTRUCTIONS] Thank you.

I would now like to turn the call over to Don Tomnitz, President and CEO.

Please go ahead, sir.

Thank you.

And joining me this morning is;

Sam Fuller, our Senior Executive Vice President of Finance, Bill Wheat, our Executive Vice President and Chief Financial Officer, and Stacey Dwyer, Executive Vice President and Treasurer.

Before we get started, Stacey.

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's 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 obligations 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.

Thank you, Stacey.

D.R.

Horton, America's builder, reported another record quarter for the second quarter of fiscal year 2006.

We once again generated double digit increases in new sales orders, backlog, revenues, net income and earnings per share.

We are pleased to announce the following highlights.

Diluted earnings per share increased 21% to $1.11 per share.

Net income increased 20% to $352.8 million.

Consolidated revenue increased 25% to $3.6 billion.

Stacey.

Homes closed increased 19% to 12,570 homes.

Our sales order backlog increased 15% to an all-time record $7.1 billion on 24,017 homes.

Our net sales orders increased 10% to 15,771 homes.

Don.

Stockholders equity increased 33% to $5.9 billion.

S&P upgraded D.R.

Horton's senior debt to an investment grade rating of BBB-.

D.R.

Horton jumped to number 162 on the Fortune 500 list.

Our second quarter net sales orders increased 10% to 15,771 homes sold for $4.4 billion, from the 14,401 homes sold for $4.1 billion on the year-ago quarter.

Net sales orders for the first six months of fiscal year 2006 increased 12% to 27,234 homes sold for $7.5 billion, compared to 24,302 homes sold for $6.8 billion in the year-ago period.

Our strong double digit sales increase contributed to a record second quarter backlog of 24,017 homes, with a sales value totaling $7.1 billion, a 15% increase over last year.

We are clearly focused on delivering this backlog while continuing our strong sales performance, to ensure our 29th consecutive year of higher revenues and higher profits in fiscal 2006.

Stacey.

We now operate an 82 markets and 27 states.

We're proud to announce our entry into the following new markets during the quarter.

In Texas, we entered Bryan & College Station and Lubbock.

And we entered Boise, Idaho, which is our entry into the state of Idaho.

Our asset concentration corresponds with our top six home building states with the following percentages by state.

California with 27%, Texas with 12%, Florida with 10%, Arizona with 9%, Nevada with 8% and Colorado with 7%.

Don.

Our total sales unit changes for the second quarter in those states are;

California up 5%, Texas up 26%, Florida down 8%, Arizona down 8%, Nevada up 14%, Colorado up 3%.

Stacey.

We would also like to mention a few additional markets where we saw sales unit increases greater than 30% in the second quarter.

In Birmingham sales were up 75%.

In Charlotte up 71%.

In Austin, 66%.

Hilton Head, 49%.

New Mexico, 47%.

Seattle, 39%.

And Atlanta, 33%.

And just as a clarification, our orders in Nevada were up 4%.

Don.

Thank you, Stacey.

In addition, we were up in sales units in all of our divisions in the Carolinas including Raleigh, Greensboro and Greenville, Columbia, which had been on our soft markets list for awhile.

Our softer markets currently in this quarter were;

Salt Lake City, Washington D.C., and the Midwest.

Bill.

Our second quarter home building revenues increased 25% to $3.5 billion from 2.8 billion in the year-ago quarter.

Home sales revenues increased 28% to $3.5 billion on 12,570 homes closed.

Home building revenues for the six months ended March 31, 2006 increased 20% to $6.4 billion on 22,461 homes closed, compared to $5.3 billion on 20,281 homes closed for the same period of fiscal year 2005.

Our gross margin on home sales revenue in the second quarter increased 50 basis points to 25.3% from 24.8% in the year-ago quarter.

For the six months ended March 31, 2006 our home sales gross margin improved 130 basis points to 26.3% from 25% in the year-ago period.

Sam.

Home building SG&A expense for the quarter was 10.3% of total home building revenues, compared to 9.4% a year ago.

For the six months ended March 31, 2006, our home building SG&A was 10.8%, compared to 9.9% a year ago.

Our goal for fiscal year 2006 SG&A continues to be below 10% of revenues.

Other income for the current quarter is primarily related to the change in the fair market value of our interest rate swaps and interest income.

As we predicted on our last conference call, interest expense this quarter relates to the call premium and unamortized discount and issuance costs associated with our 9 3/8 subordinated notes due 2011.

We called these notes in February and they were redeemed on March 15.

Bill.

Financial services revenue for the March quarter increased 43% to $71.1 million from 49.8 million in the year-ago quarter.

For the six months ended March 31, financial services revenue increased 38% to $132.4 million from 95.8 million in the year-ago period.

Financial services pretax income for the March quarter increased 39% to $27.3 million, compared to 19.6 million in the year-ago quarter.

And for six month period, increased 27% to $47.3 million, compared to 37.2 million last year.

96% of our mortgage Company revenue was captive during the quarter, reflecting our focus on profitably supporting our home builders business.

Our Company-wide capture rate improved to approximately 67% from 62% a year ago.

Our average FICO score was 718 this quarter, consistent with our average scores of 717 in fiscal 2005 and 716 in fiscal 2004.

Sam.

Our income tax rate for the quarter was 38%, down from 38.5% last year, reflecting the tax benefits we expect to realize from the American Jobs Creation Act of 2004.

For the quarter, consolidated net income increased 20% to $352.8 million, from $294 million last year.

Our diluted earnings per share for the quarter increased 21% to $1.11 per diluted share, from $0.92 per diluted share in the year-ago quarter.

For the six months ended March 31, 2006, consolidated net income increased 24% to $662.9 million from $535 million last year.

Diluted earnings per share for the six month period also increased 24% to $2.09 per diluted share from $1.68 a year ago.

Bill.

Our lot and land position is approximately 396,000 lots owned and controlled, which represents approximately a 4.5 year supply. 48% of these lots are owned and 52% are optioned.

Our home building leverage ratio, net of unrestricted cash at March 31, was 43.9%, compared to 42.5% a year ago.

Our goal for fiscal 2006 is to maintain our year-end home building debt-to-cap at investment grade levels in the low 40's.

So our current debt-to-cap level is in the heart of our target range.

In April, we accessed the capital markets and issued $250 million of 6% five-year notes and $500 million of 6.5% 10-year notes.

And we used the proceeds to repay borrowings under our revolving credit facility.

And finally, we are very pleased that S&P recognized our investment grade balance sheet recently.

Stacey.

The Company is reiterating its diluted earnings per share guidance for the year ended September 30, 2006 to be in the range of $5.25 to $5.35 based on approximately 318 million diluted shares.

This guidance is based on approximately 58,000 homes closed and more than $15.5 billion in consolidated revenue.

We have 144.8 million of 10.5% senior sub notes, which become callable on July 15.

While we have not announced plans to call the notes, our guidance incorporates approximately $3 million of interest expense related to the call of those notes.

Don.

Thank you, Stacey.

We have experienced a changing market for the past four to five months.

Different than the past six to seven years.

We have anticipated this market for several years and we are positioned exactly as we want to be.

And are prepared to meet the market and our competitors head on.

This position will permit us to continue to lead the industry over the next five years.

D.R.

Horton has the most scale, the best economies of scale, the strongest balance sheet in our history, the most transparent balance sheet in the industry, and the best financial metrics.

Our operating margins continue to be the highest in the industry amongst the top five builders, strengthened by the lowest SG&A in the industry.

Our land and lot position is one of the most conservative in the industry, with 52% of our lots optioned. totaling over $6 billion with earnest money of only $280 million.

Our total lot position is approximately 400,000 lots, for which we would refuse a $10,000 profit per lot, representing to us over $4 billion in hidden value.

We are the most geographically diversified builder now, operating in 82 markets and 27 states.

Currently our Division Presidents are focused on achieving their 58,000 unit closing goal in fiscal year '06 and continuing to maximize our return to our shareholders.

We and our people have a long history of hitting our goals.

We expect to do the same in fiscal year '06.

That concludes our formal presentation.

We'll entertain any questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Joel Locker with Carlin Financial.

Hi, guys.

Good quarter.

Just wanted to say that first.

Thank you.

Looking at the 58,000 targeted closings for the year, look like you're 1,800 ahead on closings, another 2,800 in backlog.

But was that just assuming -- was that assuming another 2,500 orders in this quarter over last quarter?

Because it just -- from my angle it looks more like a 56,000 or something like that, unless the orders dramatically pick up in this quarter.

I can answer the question this way.

Last year no one expected to us hit 50,000 units, and no one's business model, I think, none of the business models.

There was one business model out there that reflected that.

Clearly our people are focused on hitting the 58,000 target and we're well positioned and focused on doing so.

Right.

And just gross margins going forward, where do you see those stabilizing?

Looks like they dropped a little bit from last quarter.

Actually, our gross margin for this quarter, they did drop some second quarter.

The first quarter, Bill?

Right.

But year-over-year they're up 50 basis points on the home seals line.

And going forward we are in the process, as I mentioned in the summary of our call, of meeting our competition head on.

We've got the best financial metrics and the highest operating margins in the industry.

We anticipate over Q3 and Q4 that our margins could soften some.

We don't know and hope that they don't but we're prepared to meet the competition head on.

Thanks a lot.

Your next question comes from Margaret Whelan with UBS.

Good morning, folks.

Good morning, Margaret.

Couple of things.

I was surprised to see that your EPS growth was lower than the rate of growth in sales.

It was the first time we've seen that from Horton for awhile.

I know you've had a couple of moving parts in the gross margin in the last six months or so.

Any FAS 66 in there?

There was no impact from FAS 66 this quarter.

And then the SG&A creeping up was a function of more discounting?

Is that it?

I think our SG&A trending upward was a function clearly, that our people are positioned, our Division Presidents are positioned to deliver the 58,000 units.

And clearly that SG&A we believe, as Sam said, will work its way down and be under 10% at the end of the fiscal year.

Can you give us the rate of growth in your communities?

Yes.

Was it a big jump maybe that led to higher SG&A?

Actually, no, Margaret, our community count was only up 3% year-over-year.

Okay.

And discounting or any incentives you're driving are going primarily in your SG&A line?

Generally incentives are recorded in two places.

And if we're offering something that's included in the house, that would actually flow through our cost of sales.

If the discounts are offered as -- and this is ongoing, there's no change in this.

If it's a discount off the actually sales price, that's reflected in the top line.

So generally, there's no impact from the discounts or incentives, if we're offering any, in the SG&A line.

And another question I had was just your delivery price, your backlog price is lower than we had expected.

Was there something -- was that a mix issue?

And the fact that your prices has come down now as well in orders?

What of that is mix verse apples to apples on the bottom line?

I think largely it's a mix issue.

As we have mentioned to you for the last three years in California, our average sales price has worked its way down and continues to work its way down.

In a number of our markets, obviously, we're increasing our offering of attached product.

Clearly that's true in the Las Vegas market, which is a big market for us, as well as the Florida market.

So more than anything --.

Is that in the Mid-Atlantic as well?

Say again.

Is that in the Mid-Atlantic as well?

Were your order prices coming down?

In the Mid-Atlantic we had stronger sales in the Carolinas, as we mentioned.

And then in New Jersey, in particular, we're offering more affordable priced product this year than we did last year.

So, there's some geographic shift in there as well as product mix.

The last question from me is just on your share count.

You said it will be about 318 million shares for the year.

Does that mean we should assume creep and no buybacks for the next six months?

We're in the process of evaluating our stock buybacks on a quarter by quarter basis.

Obviously, we funded a lot of seasonal inventory growth in the most recent quarter, and we'll evaluate that going forward.

We made ourselves a promise that we weren't going to commit to stock buybacks.

We were going to announce them after we did it.

And that's our policy going forward.

But just based on what you said, you're at 316.7 right now and you're saying 318 for the year, so there will be creep.

Assuming no buybacks, Margaret, which is what all of our forward guidance is going to assume, that is correct.

Thank you, guys.

Thank you.

Your next question comes from Ivy Zelman with Credit Suisse.

Hi, guys.

This is Justin [Sperin] for Ivy.

How are you doing?

Doing great, Justin.

I was wondering if you guys could talk to us to the trends in your market, maybe through April?

I don't know if you can do that.

But maybe recent trends in traffic, in pricing, incentives.

If you're seeing any increase in cancellations in your business or in your markets?

We can't talk about our sales in April but I can talk about sales across the country.

As we mentioned when we talked about our strong markets and our softer markets, I would say generally speaking though if you look at our top five states.

California is good this year.

We had a 46% increase in sales in Sacramento last quarter, which was very outstanding for us.

We had an increase in San Diego as well.

Our California sales being up the single digits they were, probably was more a function of new communities not being opened in several of our major divisions there.

Colorado continues to be soft.

There's no job growth in the market there.

We had an increase in sales in Colorado but clearly our profitability in Colorado is not where we want it to be.

Texas, what an extraordinary success, up 26%.

Our margins are working their way up in the state of Texas and we're very proud of all of our divisions in the state of Texas.

Arizona, there's some softness in Phoenix.

And that's been tempered some by an extraordinarily strong Tucson market, where our sales were up significantly double digits in Tucson.

The state of Florida is doing extraordinarily well.

Our south Florida market was negative in terms of sales growth this year, or this last quarter, largely as a function of new communities not being opened but the overall state of Florida is doing very well.

And Georgia and the Carolinas is doing exceptionally well for us.

So in general, our weak markets, as I said, we pointed out; were Maryland and Salt Lake City and the Midwest, which was really a function of us having grand opened in the Midwest last year.

A huge subdivision in Chicago, which we weren't able to replicate this year.

So our sales were down in Chicago but the market is doing very well.

As I've told Ivy on number occasions, in D.R.

Horton land, we're offering an incentive 24/7/365.

Our incentives continue to be offered in the marketplace.

We have competitors who are offering incentives and we are not going to be blown out of the sky for an incentive.

We are the best positioned builder in the industry with the highest operating margins and we're there to meet the market.

What would you say your incentives are as a percentage of sales in range across markets; from the lowest markets, in terms of incentives, to the highest?

That's not a number that I've really calculated.

And we can take a look at it and get back to you but it's not something I track.

We're really just tracking our margins.

That's what our -- and our SG&A on an operating division by operating division.

Do you expect to maintain your 10 basis points of margin improvement in 2006?

That's our goal.

I think, given the present condition of the market, that's going to be a tough goal to achieve but that's our goal.

As I mentioned on the earlier question, we anticipate if the incentives continue in the marketplace as they are, that our margins could soften some in the third and fourth quarter but we're still going to have a record year.

And then lastly, just kind of a housekeeping, but your ARM and IO percentage of originations?

Stacey.

Our ARMs were 26% for the quarter.

Sorry, Bill.

And interest only, as a percentage of total originations were about 23%.

Okay.

And then on land profit, your expectations there?

It's really hard to say, Justin.

And I hate to give you a nonanswer but our land sales are really very opportunistic.

It depends on our timing of closing on a track that may have a commercial piece attached to it.

And then us having a buyer lined up to close that.

And so, the timing of those land sales really move around.

And we've done about 100 million in the first half of the year.

I think for the last three years we've done about 200 million in total.

That might not be a bad ballpark to shoot for this year.

Thanks a lot, guys.

Your next question comes from Greg Gieber with A.G. Edwards.

Good morning.

Hello, Mr. Gieber.

Let me say that I think you've had a good quarter.

And I don't normally lead off with that kind of statement.

You're right in line with most of my expectations.

The question I would have; on your closings during the quarter, how many of them, or what percentage would you estimate were actually sales that took place during the quarter?

That's not a number that we have off the top of our heads.

We'll have to call you back on that.

Okay.

Could you go into -- talk about what your vertical spec position is right now?

Our spec inventory is pretty much in line with where it was at this point last year.

You need to remember a couple of things about our specs, obviously.

One is that 90% of our specs are sold and closed before they're completed.

And most importantly, Mr. Gieber, currently we have only 52 homes that have been completed and unsold for a period greater than a year.

So, I would conclude and say we don't have a spec problem.

Why don't you just slash the price and sell them?

That's not a question. [laughter] It's a suggestion more than anything else.

Can you go a little bit more?

I didn't catch all this $10,000 that you have in profits per lot that you control.

Is that would be the profit if you were to sell them say now to another builder at retail?

How are you calculating that?

And how does that compare to where you were maybe a year or so ago?

That number is really very consistent with the conversation that Don Horton had in my office about a year ago when someone was talking about our land and lot position.

And Horton walked into my office one day and he said; "would you take $10,000 a lot profit if someone wanted to buy all your lots today?"

And I said, "heck no".

So one of the things we look at in terms of our option position in particular, but also our own lot position, if we aggregate both of them, is the fact that we are very proud of our 400,000 lots we have out there.

We are also trying to express to you that we have a lot of hidden value in those lots.

And so as a result, that's our conclusion, that our land and lot position is the most conservative in the industry.

We turned our land and lot inventory more frequently than other builders just as a function of having a lean lot inventory.

So, we want to let you know we're very focused on our land and lot position, that there's inherent value in that going forward and we believe that we'll be able to derive value out of those as we both sell and close out of those.

So, I could use that to mark your balance sheet up to market rather than book, I assume.

That was -- actually, Horton was talking to me one time about the value of our stock relative to the hidden asset on our balance sheet.

That's the way I would do it, price to book calculation.

Last question I have is, are you calculating -- what percentage of your sales or closings are coming now from what you would call satellite markets, versus the larger core metropolitan markets?

And I know it's got to be up from a year ago and probably nothing a couple of years ago.

Do you have any metrics there you can give us?

Yes, Greg.

Last year it was around 5% of our overall closings.

We expect this year to be slightly up from that but probably still in the single-digit range.

Okay.

Are the margins in those markets comparable with what you're doing as a Company as a whole?

Higher?

Lower?

Yes, they're comparable.

One of the things we focused on is not going from San Antonio to Laredo and having margin diminution.

So basically, they're down there achieving the same gross margin or higher in their satellite markets.

Thank you very much.

And again, I liked the quarter.

Thank you.

To quote one of my peers earlier in a previous quarter, we're accepting all compliments today.

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

Wondering if you can talk about cancellation rates during the quarter in terms of what you saw relative to a year ago?

Yes.

As we told you, our cancellation rates on an historical basis have run 17% to 19%.

They're running slightly higher than that in the quarter.

They're in the low 20's at current levels and we still believe that that's an industry low.

But nevertheless that's an acceptable level seeing what we're seeing in the marketplace today.

And then also if you can talk about what you're doing in terms of land investment right now, where you're looking to increase investment?

Are you -- and specifically markets like Arizona and places like Phoenix.

Are you slowing that, and also what's happening in terms of land pricing there?

Well, first of all, let me explain to you our position for our inventory growth for next year.

We're focused right now on a 10% to 15% inventory growth for fiscal year '07.

That compares to a 25% to 30% inventory growth in each of the last three years.

So we're focusing on decreasing our inventory growth, continue to increase in various markets across the country.

To answer your question specifically in Phoenix, we still believe Phoenix is a good market.

We're continuing to have extraordinarily good operating margins out of the whole city of Phoenix as well as Tucson.

We're continuing to make incremental investments there.

As I mentioned to you earlier, in terms of our weak markets, clearly in Washington D.C. and Salt Lake City, those are two markets in particular where we're not making as much investment.

But we mentioned Chicago as a weak market.

That's just a function of having not grand opened a big new subdivision this year.

We're continuing to make investments in the Chicago market.

So, most of our markets today, we're increasing our inventory at a decreasing rate in order to comply with what we want to have our inventory growth for at fiscal year '07.

Okay.

Thanks very much.

Sure.

Your next question comes from Michael Rehaut with J.P. Morgan.

Hi, good morning.

Good morning.

Just a couple of questions.

First, going back, more of a housekeeping issue, did you repurchase shares for the quarter?

No.

We had no share repurchases in Q2.

Okay.

And just going back to the question -- you mentioned this before about inventory growth decelerating in'07, would you expect along with that deceleration a deceleration in earnings growth in '07 versus '06?

We're going to have earnings growth in '07 over '06.

Our percentage increase in earnings growth in '07 over '06 may or may not be as big as what it will be between '06 and '05's.

However, if you take a look at our inventory investment, Michael, our '07 is pretty much bought.

And what we're talking about doing is probably taking our growth down in '08 and '09 more so than '07.

Okay.

Thank you.

That's helpful.

And just one last question on the incentives.

I was just wondering if could you give any more clarity in terms of as a percent of sales on a Company-wide basis if it's up year-over-year?

And a little more detail in terms of, saying if incentives continue at this rate that margin might soften.

I was wondering if you had an idea in terms of where that 25.3 might go towards?

And what you'd be able to do then in terms of SG&A, perhaps, given that SG&A subpoena year-over-year at this point?

We don't track incentives as a percentage of our revenues.

We're really focused more on our gross margins and our SG&A and our operating margins.

And the incentives vary in so different forms, so it's a difficult thing to give you a direct answer.

I would say to you clearly though, giving you a direct answer, that our incentives are up this year versus what they were last year.

And incentives are up in the second quarter versus what they were in the first quarter.

Where do I see the incentives going?

I think the incentives will probably continue industry-wide for perhaps the next couple of quarters as we work our way through to slowing demand.

The answer to your question on margins, as we've said earlier, I think that if incentives continue then our margins could soften some from the third and fourth quarter from where they were in the second quarter.

And do you see a -- from the SG&A line, an ability to reverse the trend up upward year-over-year in the first half?

The guidance was for below 10% but that could still be a nice year-over-year increase.

What type of slack do you have that you could perhaps offset a continued gross margin decline with the SG&A?

Clearly, let me say that we're very proud that we have the lowest SG&A in the industry.

And we are focused clearly on moderating demand in specific markets.

And we're in the process of adjusting our SG&A in specific markets today and been for about the last 60 days.

So, we are already adjusting those to meet the demand in the marketplace and that's really all I can say about that.

Great.

Thank you.

Your next question comes from Stephen Kim with Citigroup.

Great.

Thanks a lot.

Guys, I just had a couple of clarifying questions.

Number one, when you talk about the margin trajectory, you're talking about the back half of '06 being slightly softer, perhaps, were you talking sequentially or year-over-year?

Talking about sequentially and year-over-year.

Okay.

Well, it's sequentially that I care about mostly.

Because it seems like your gross margin at 25.3, that's pretty much where I'm expecting you to end the the year.

But heading into '07, I have a number that's lower than that.

It sounds like you guys are sort of indicating that maybe in the gross margin line in the back half of this year we might be somewhere in the high 24 range.

Would that be about right?

I don't want to get into specific numbers but it's going to be -- I would anticipate if the market conditions continue, Steve that we would be in the 24's versus the 25's.

Got it.

And then the second question related to your conversation about the inventories.

You indicated -- I thought I just heard you say that you expected to have inventory growth about 15% slower than the rate of growth that you had been running over the last couple of years.

But the current number of units which you control today is up about 15% almost exactly from where you ended '05.

So, should we presume from your commentary that maybe we should probably see very limited growth in your total number of lots controlled between now and the end of the year?

I wouldn't necessarily -- I look at them, as you know, between owned and optioned.

As I've said many times, I'd option the whole world for 5%.

Yes.

The reality of life is, is we're to cushion largely on our 400,000 plus lots that we have today.

That's about a 4.5 year supply of land and lots.

We don't feel compelled to increase that on a going forward basis.

And so as a result, we believe that '07, we've got most of our lots bought for '07.

And we're looking at '08 and '09.

And frankly, we believe that it's prudent for us to drop our inventory growth to the 10% to 15% level starting in '07 and for each year there after.

Because our inventory growth we're projecting for fiscal year '06 is going to be somewhere around the 25% level.

But we're going to drop that down to 10% or 15% starting in '07.

So, we should continue to see some growth over the next two quarters.

Yes, you should.

Okay.

Now, have you already earmarked those lots pretty much?

Are you guys, I would imagine doing feasibility analysis on those lots already.

I imagine you have a pipeline of stuff that's yet to be controlled.

And so should we presume most of the stuff that you're going to be doing over the next six months is already pretty well underway at this point?

Oh, yes, very definitely.

As you know, it takes in today's building environment two to three years to entitle most of these lands.

So, the stuff that we're going to be closing in the course of the next six months we've been working for six months to three to four years.

Got it.

With respect to negotiations, one of the things I'm interested in is your conversations that you're having with your suppliers both on the labor and the materials side.

You guys have never been very shy about talking about the benefits of your leadership position in the industry.

And one of the ways that manifests itself is your leverage over your suppliers.

Can you talk about how those conversations may have changed over the last six months and what you expect from your suppliers here over the next six to 12?

I think my best quote I can give you came from Rick Horton when he was down in one of our -- he's one of our Regional Presidents.

And he was down in one of his divisions counseling with his Division President and we were trying to work our cost structure down with a particular framer.

And we were getting a push-back from the framer and Rick said; "well, good, we're finished".

And the framer said; "what do you mean"?

And he said; "well, you're finished".

He went out and hired another framer.

So, at some point in time that's pretty much where you have to get to.

We have a lot of respect for our subcontractors and our suppliers but unfortunately, they're like land sellers in a way, their prices are sticky.

And they're slow to come down in a slowing market.

And so, as a result, no, we're not shy.

And as Horton and I were talking about in the office today, he and I had been talking to our COO's the Regional Presidents and the Division Presidents for the past two years about cost.

And we started early and we're still continuing to talk.

And to be quite frank with you, we have not seen the kind of results that we want to see yet, so we're still focusing on costs.

Got it.

And can you help me with the issue of cancellations?

One of the things that I've been sort of kicking around in my mind is the idea that cancellation rates are more of a phenomenon that sort of hits you all at once and then dissipates quickly; as opposed to being an evolving trend.

Particularly the cancellations that emanate from speculative energy.

We all know that there were a lot of speculators in the market over the last -- in the last year.

But would it seem to me that if you're going to have an elevated cancellation rate in three months time from now, then that basically means that you have to be having speculative buyers buying today, which seems rather hard to imagine.

So, I would expect your cancellation rate to ameliorate as you get into the second quarter -- second calendar quarter of this year, your third quarter.

Can you talk to me about what your expectations are for cancellations rates and whether you -- where there may be some sort of flaw in that sort of thinking?

No, I think that they should decrease in the quarters ahead.

However, there are a number of factors driving the cancellation rates, as you know.

One of them is investors.

I think most of the investors, from what we can tell, have worked their way out of the market.

Right.

But there are also issues with job layoffs, there are issues with increasing interest rates.

And even though we don't believe interest rates have a significant impact on our business, they do have an impact from time to time on buyers.

And there are markets, as the 30-year mortgage rate has hit, what, a three-year high or a four-year high, we are having some cancellation rates there.

So, I think if you believe in the scenario that I believe in, which is the investors are pretty much out of the market.

And secondly, that the rate increases are pretty much near their end, then I would anticipate in Q3 and Q4 that our cancellation rates could get back to normal.

Although if you think rates are going up over the next couple of quarters, we could have continuing cancellation rates where they are today for the next two quarters and let them slide down in the beginning of fiscal year '07.

Right.

And that would cease to be a drag on your orders, reported orders at that time.

There's no question, our cancellation rates, as you know, adversely affect our orders.

We're out there reselling every one of those that we can.

The other question I had related to inventories and speculative building.

Most of the questions have talked about what all have been doing.

But I remember back, gosh, almost 10 years ago, really was the last tame that we really add big problem industry-wide with speculative inventory.

And at that time, every builder's conference call was full of questions and answers about how many specs they have and what they're seeing out in the broader marketplace.

And everybody was pretty much saying; "well, we're trying to do the best we can to toe the line on specs, but, gosh, it's all these private guys that are killing us with all their speculative activity."

I don't really hear any builders talking about that these days.

Are you guys -- give me a sense for what you guys are seeing from your private competitors and some of the nonpublics in some of your important markets?

I don't really see them as major factor in the marketplace anymore Steve.

If you go to most of our markets, if you look at the Top 10 home builders, we have in most markets well over 50% of the market share.

I think the industry general is doing a great job controlling their spec inventory.

And so as a result, we're not seeing the kind of negative input from the small and medium-size builders.

And further, the bankers are not lending in these small, medium size builders.

They're decreasing their loans dramatically as we speak, so there's going to be less spec inventory from those.

And also most of the spec builders, frankly, are people who have gravitated because they can't get lots and they can't develop, they're more of a custom type builder, so they're not really, even though they may have spec homes out there; they're not really competing with the Top 10 home builders in their price ranges significantly like they used to.

Thanks very much.

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

Good morning.

Good morning, Tim.

How how are you?

Great.

First of all, when can you take an order -- how long can you take an order now, from scratch, and still deliver it in the fiscal year?

Are you pretty much done, or do you have a couple more months?

No, sir, we've got a number of markets where we can actually take an order and start the house an get it completed in a period of, say, 90 days.

So then on an average maybe we've got two -- for the entire Company, other markets are longer, you maybe have one or two months.

Because your backlog accounts for about 75%, as of last year, of your projected deliveries for the second half.

So my question -- second question is, you obviously know the margins in that backlog for 75% of your projected deliveries.

Could you see -- are they healthy?

They have to be sort of to get the numbers you're trying to get.

Well, I think our margin clearly -- we have a Company goal of 22% gross profit margin.

That's been our hurdle rate for our Division Presidents for years.

If you want to define healthy as greater than 22%, I'd say our margins are very healthy.

Now, that's still 300 basis points less than where we are today and I'd say our margins on our backlog are better than that.

So, our margins in our backlog are good.

They're not as great as what they were in our backlog at the end of the first quarter.

And they may not be as great at the end of the third quarter but nevertheless our margins and our backlog are healthy.

We're still going to have a very profitable year.

The SG&A, you attribute it to revving up, but you implied before that you expected it to come down dramatically and that the first quarter was an aberration.

But you were questioned by somebody else on this, too.

There appears to be something else in this SG&A other than the ramping up.

And I know Don too well.

He wouldn't be having people sitting around too long twiddling their thumbs.

Well, clearly our SG&A, as we have said -- Horton and I have said many times, when markets begin to moderate, it's difficult to adjust your overhead as quickly as you would like.

As we've been through this moderating market over the last four to five months.

And we -- over the last four to five months we've been trying to determine whether it's a moderating market.

Is it a six-month phenomenon?

Is it a longer phenomenon than that?

And currently, we're in the process, as we speak, of adjusting our SG&A market by market based upon what we see as opportunities over the next two to three years.

So yes, it's a little stickier than we would like at this point in time but you're not going to get me to apologize for the lowest SG&A in the industry.

No, you're doing great.

Last thing for either Sam or Stacey.

Two things, the call-in of those bonds, does that mean that that interest income from the interest rate swaps goes away?

And two, what was the $10.6 million of excess interest in the quarter?

The 10.6 million Tim was the actual premium plus the unamortized discount and unamortized issuance cost that we had to write off in association with the call of the 9.75 sub notes.

And the interest rate swaps are actually in conjunction with our bank revolving credit line.

So those will remain in place even after the call on the 144.8 million.

For how long?

For 2008.

Okay.

Thank you very much.

Thanks, Tim.

Your next question comes from Lawrence Horan with Janney Montgomery Scott.

Most issues I am interested in have been covered.

Again, great quarter.

One detail, when you were talking about the California market and your orders in that market, I thought you initially said you were down 5%, but then in the Q%A I thought you said you were up.

California as a state -- let me make sure -- I thought we were up 5%, but I'm -- up 5%, yes.

Thank you.

I misheard the first time.

That's it.

Your next question comes from Douglas Pratt with Mesa Capital Management.

Thanks very much.

Follow-up question to one of the earlier regarding input costs and then two other quick ones.

It appears that input costs have been increasing but still -- and accelerating a bit but at a lesser rate than cost increases.

Are you saying, though, that you're feeling that's increasing at too rapid a rate?

In other words, should we expect a further acceleration in input prices?

No, sir, we're not saying that at all.

Frankly, what we are saying is that in terms of various markets where we're continuing to negotiate with our suppliers and our trades, that we are -- as the markets moderate, that we're expecting better pricing from our trades, as well as our suppliers.

So, we expect those to moderate and frankly decrease in the quarters ahead.

Have you seen any moderation or decrease as yet today?

Absolutely.

Yes.

In which areas?

Labor?

Because I know copper has been high, and down in Arizona here we're on allocation for cement.

Right.

What areas?

Clearly lumber prices have come down dramatically, which, frankly, lumber, Stacey, represents about what?

It's about 8% to 12% of the average cost of a home.

It's the biggest cost component we have in our home except for the lot.

And clearly, in markets where prices are beginning to moderate we're seeing better land prices, and that represents 25% -- 20% to 25% of the cost of the homes.

So, on our two biggest cost components of the house, one, the land, and secondly, the lumber; we're beginning to see price moderations on both those commodities.

Okay.

And even if you don't track incentives in a strict dollar amount, can you give us a qualitative feel?

Has that -- because we kind of get the general sense in the marketplace that incentives in general throughout the industry have accelerated over the last few months.

Are you seeing an acceleration particularly as you go out through the quarter, flattening, or it has been an improvement in incentives?

Generally speaking I think that they're accelerating somewhat but I would tell you it's on market by market basis.

And you can't even look at California as a market, because there are some markets like Sacramento or San Diego where the incentives are higher than what they are in Riverside, Orange County and the Inland Empire and Ventura County.

Where those markets are much stronger than the other markets in California.

So in -- generally speaking across the country I would say that they've increased slightly but not significantly.

Okay.

And then finally, just to make sure I heard correctly, you weren't suggesting that Tucson is offsetting Phoenix?

You just meant Tucson is still somewhat strong, whereas Phoenix has weakened?

Is that correct?

That is correct.

Tucson is not big enough to offset Phoenix but we're glad to have Tucson and their contribution at this stage but it's not big enough to offset Phoenix.

As someone who lives in Tucson, we're very glad for that.

Well, actually, we'd like to build more homes in Tucson, but I'm sure you don't want to us do that.

Well, we don't, but the Federal Government lands kind of prohibit it.

Thank you.

Yes, sir.

Your next question comes from Jim Wilson with JMP Securities.

Most of them have been answered.

But one general one, Don, is you haven't repurchased shares recently and obviously you're going to slow your land investment.

So that suggests, at a minimum, keeping your powder dry.

But I'd love to know your sort of thoughts as to general capital deployment?

Because it suggests obviously you'll be building up -- potentially building up more cash than you might have thought you would have six months ago.

I want to make Stacey feel really squeamish right now but I can tell you my personal feeling is right now is that we need to be buying back our stock, with our multiple word is, and that's what we're really focusing on.

Don Horton has been pushing for slower inventory growth longer than I have and I agree with him today.

And so as a result, we want to be in a position where we can have a lot of dry powder for general corporate purposes.

As well as have the opportunity to buy back more stock than what we have in the past.

Stacey.

Stacey have another answer?

No, actually, Jim, I was just going to follow up with Don's comment, because when we look at our inventory growth in the current year we are looking at 25%.

So, the cash inflows that you're talking about will really happen more in fiscal year '07.

What about historically, and I know you've been focused on growing organically more recently.

But acquisition, acquisition prices, that's obviously another way you can spend your money.

But any thoughts on that, how pricing is looking?

Might you step back in if opportunities start to show up in the weakening markets?

As you know, we constantly look at every deal that comes past.

Right now we're hard-pressed to find anything that makes any sense.

And so as a result, we're focusing on internal growth 100% currently.

I'll backtrack one more time on the stock.

Given where we are today, with our multiple, with the great record this Company has had, and how much we have pushed growth over the years and the fact that we are not getting any credit for it;

I would say to you that my big vote amongst all the group here is that we focus on other things.

Primarily, stock repurchases in the years ahead.

Okay.

Great.

Just final question.

Your sales results obviously, particularly, I'd say in California and Florida relative to just what we keep seeing, hearing from people as to the market conditions are particularly outstanding.

Can you -- besides, obviously, the basic act of being able to work and operate and generate margins at lower prices than others, can you differentiate anything else you think you're able to do in those weakest markets to show such excellent results?

Well, first of all, Horton and I have been together for 23 years and we've lived through several up and down markets, Jim.

And I can tell you that we're focused on moving through our inventory with the highest possible return we can achieve on it.

But yet at the same time we're focused on hitting our 58,000-unit target for one primary reason.

And that is that we've always wanted to turn our inventory as quickly as we possibly can, especially our land inventory.

And so as a result, what we're focused on out there; is meeting the market and meeting the market conditions, such that we can achieve our business plan.

And being in a position to reinvest at hopefully moderating land prices on a going forward basis.

Okay.

Very good.

Thanks.

Yes, sir.

Your next question comes from Steve Fockens with Lehman Brothers.

Hi, good morning, all.

Good morning.

Just two quick questions.

First, if not in terms of specific numbers, Don, can you give us an idea of where incentives might be relative to the range of the last five or 10 years as opposed to just the last few?

I think -- I don't have an exact percentage to give you, and we don't have an exact percentage around.

But I would say to you, over the last four or five years we've had a lot of pricing power in virtually all of our market across the country.

We've characteristically had some weaker markets, as usual.

But our incentives are greater today than they have been at any point in the last four or five years.

But they're still producing phenomenally great gross margins.

And as I've said before, given our operating margins being superior to everyone in the industry, we're in a more powerful position to meet the market than anyone else.

Fair enough.

I get the feeling that some investors may feel that the sort incentives that you guys are putting out there may be akin to autos post-9/11 where all of a sudden they were giving the store away.

And so, what I'm really getting at is do you see the ability or the need to incentivize dramatically different than in past periods over a long period of time?

No.

Great.

And then secondly, any -- in terms of the land buying market, I know in the past few years, I believe you've been raising hurdle rates in some of your formerly hot markets to in effect, protect margins there.

Do you continue to maintain above average hurdle rates in some markets or have you continued to raise hurdle rates in terms of additional land buying?

Absolutely.

And it's on a market by market basis.

We just approved a number of deals in California recently because we can't get our hurdle rates where we want them to be.

We've gone back to the sellers, we've asked them to reduce their land prices.

If they don't reduce their land prices we're passing on the deal.

So clearly, we are pushing forward and making certain that our hurdle rates relative to the specific market and the yield that we can get in that marketplace today.

And what we're looking at is;

What are our current prices for that house in that market today and where do we think it the's going to be a year to two years from today?

And I can tell you that's a difficult call today.

We believe the prices will be hopefully equal to or better, but we're being -- if we're going to err, we're going to err on the conservative side today when we buy a piece of land.

Great.

Thanks very much.

Your next question comes from Alex [Band] with JMP Securities.

Thank you.

Again, great job on the quarter.

Thank you.

I wanted to ask, generally speaking, what percentage of the homes you guys start with at a buyer?

It's generally going to be somewhere between 25% and 35%, Alex.

There's some seasonality in there, so at different times of the year we'll be at the high end of that range, maybe slightly above.

But that's generally what our traditional mix has been.

Great.

And then you guys said something about -- that a lot of people were offering discounting or incentives and that you guys weren't going to get beat by that.

I'm just just kind of wondering what that means.

How low are you guys willing to go to compete?

We're moving forward to hit our business plan of 58,000 units closed and to generate the growth that we -- EPS growth that we have given you, the 5.25 to 5.35.

We are going to hit that number.

That's what our goal is and we're out there striving on a daily basis to do it.

To the extent that someone, as I said before, is trying to blow us out of the air, like Southwest Airlines back in their formative days, for $15, it's not going to happen.

We've got the highest operating margins in the industry and we're decreasing our costs on a daily basis.

And we're going to be better prepared one month, three months and six months from today to meet the competition.

So, we're going to do what's necessary to achieve our business plan.

If you got somebody like Centex offering $100,000 off, does that mean you're going to match it?

Well, in the first place I would say to you I don't know specifically about that offer.

But I do know that from time to time, all builders offer a large incentive like that on a limited number of units in order to drive traffic into a specific community.

So, there may be only one or two homes at that particular discount.

And then the rest of the people are buying homes with a significantly lesser discount.

So, to the extent that other builders are doing that, and we do that from time to time, it's not an across the board discount at that level.

It's basically something to drive sales.

And we wouldn't be doing it if we didn't think that it was driving traffic and creating a profitable environment for us to continue to sell homes in.

Okay.

Lastly, have you guys seen any pickup in cancellations in Vegas lately?

Bill shakes his head no.

Okay.

Thanks a lot.

Okay.

Your next question comes from Susan Berliner with Bear Stearns.

I was just wondering if you could go over two things.

One is the percent of attached housing?

And secondly, if you could give us a target range for your free cash flow for this year?

Our attached is running pretty much in line with where it was last year.

We ended the fiscal year last year at about 16% attached.

And we expect that to be equal to or slightly above that for fiscal year '07.

Our fiscal year '06 not a significant change one way or the other.

In our free cash flow, we won't have any free cash flow this year.

So just basically be flat?

Or neutral?

No, there will be cash used in operations.

Last year was around 600 million used, and I'd expect it to be a number in the same ballpark.

Okay.

Thank you.

Your next question comes from Bob [Beutner] with [Elmrich] Capital.

I've got a question for you regarding a comment that was made earlier in the call, which is that speculators have worked their way out of the market.

My sense would be that might be from the order side.

However, isn't -- if the -- isn't the right way to look at that it the speculators still in large part hold these units.

And if the price begins to soften, they're much more likely just to hit whatever bid is out there and drive down prices, which obviously has an impact obviously on ASP's?

So, can you give me a better sense as to whether speculators, in terms of how you're viewing it, still own a significant amount of this inventory and are somewhat limbo as prices have come down?

And now we're nearing the point at which they're going to have to start unloading some of these properties because of the negative cash flows?

Clearly, I do believe that the investors are still holding properties out there.

Although, I think that the home building industry has done a very admirable job over the last three or four years of excluding a lot of investors out of their subdivisions.

Prohibiting them from directly competing with our current ongoing sales process.

To the extent they are holding inventory in other subdivisions or even our own subdivision, I would only suggest to you that we, one, sold the house to them at a profit with a good margin.

Two, that we are constantly adjusting our cost, such that we can adjust our sales price in accordance with what the market.

So I would say to that you they'd better hope that they really bought at a discount price, because we're in a better position to compete with them than they are with us.

Sir?

Yes.

Thank you.

Your next question comes from David Knott with Knott Partners.

My question was asked awhile ago.

Thanks.

Okay.

Thank you.

Your next question comes from Scott [Ravine] with Shankman Capital Management.

Hi.

Have you seen any meaningful differences in absorption rates for attached versus detached homes?

Well, the main reason that we're going into detached homes, to answer your question directly, yes.

Especially, in certain areas like California and certain parts of Florida.

We're even doing an infill areas in Atlanta.

And basically -- and up in the Northeast.

And the reason that we entered into that segment of the market was to appeal to a higher percentage of the buyers out there.

In other words, to strive toward affordability.

So to answer your question; yes, especially in higher priced markets, where the median price of a home, like in California, certain parts of California, are $400 and $500,000.

Clearly, our ability to offer an attached product, which would put someone in a for-sale unit, ownership unit, for anywhere from 0.75 to 0.5 of what they could purchase a single family detached home for, definitely drives the demand, yes sir.

But have you noticed any weakness?

Has there been some decrease in demand within those markets?

Has there been a greater decline in the demand for attached versus detached or has there really not been a difference?

We haven't noticed in our price range.

And I think clearly, there have been a lot of articles written about the high-rise and mid-rise condos along the Florida coast and so forth like that.

And we've just never been in that market.

Most of our attached product, maximum stories is five or six stories over a couple of underground parking.

So, we're focused on not the high-end buyer.

We've always been focused on the entry-level buyer.

And so we have not noticed any significant decline in our demand.

Okay.

Fair enough.

And then just one other question.

On the metro D.C. market, throughout the quarter would you characterize that market as stable, or has it improved throughout the quarter?

Has it gotten a little bit worse?

Washington D.C.?

Yes.

I'd say it's declined.

Thank you very much.

Your next question comes from Joel Locker with Carlin Financial.

Just a quick follow-up on actually wallboard prices.

I noticed they were up around 40% to 45% in the last year.

And I wondering if you had any negotiating plans with that?

Just because it seems like they're almost price gouging.

Well, I assure you that on a daily basis our Head of National Accounts and our regional purchasing people are working on that.

It's -- you're right.

I wouldn't call it price gouging, but it's a supply and demand issue, and obviously the cards are on their side of the table right now.

But we went through this about four or five years ago.

As a matter of fact, there was a critical shortage of it.

The good thing about --.

Well, that's with the housing starts being lower today and it looks like it's going to tailor off.

And the bigger builders taking share with the price increases, it's even 30% in the last six months, I think.

It just seems like it goes straight up and straight down.

And I'm just kind of wondering --?

Same thing happens in the lumber prices to a large extent.

Lumber prices have a tendency to work their way up just prior to the big selling season, then they work their way down.

You probably don't like my answer but I tell investors; we have prices going up every day and we've got prices going down every day.

And we're out there battling on the front lines every day to make sure we've got more going down than we've got going up.

Right.

But you don't -- do you see any -- like further price hikes, would that fly with you guys, or kind of be shut down?

Sir, at this point in time, I really couldn't answer that question.

Right.

All right.

Thanks a lot.

Your next question comes from John Emerich with Iron Works Capital.

A couple of unrelated questions if I could ask them separately.

First is, what's the -- you talked about median home prices in California as an example.

What's the median home price for the Company overall in the current period?

We'll have to look that up.

I'd say it's somewhere around $450,000.

That's fine.

I'm looking to order of magnitude.

Are you asking for the entire Company, John, or are you --?

I'm sorry, yes, ma'am, the entire Company.

For the entire Company our median price is going to be below 250.

Below 2-5-0?

Yes, sir.

I thought you asked about California.

I just referenced the example you used earlier.

Excuse me.

Thank you, Stacey.

Say that one more time.

It is below $250,000.

When we look at our closings, about 60% are under 250, so it's going to be probably in the 245 to 250 range.

And the IO percentage you referred to earlier of 23% on originations is that disproportionately California or a couple of your total markets?

California probably runs a slightly higher interest-only than most of our other states that we do see interest-only product being used across the country.

And last question.

And I hate to ask you to speak for the industry overall, but would the IO's be disproportionately utilized by your typical -- by the entry level buyer, if will you?

Generally not.

Generally what we find on interest-only loans is a higher FICO score than our other buyers.

And it's people who are just managing their cash flows.

Not necessarily our first-time buyers or people who are struggling.

It's people who have made the investment decision that that's a reasonable way to finance their house investment.

As a matter of fact, as we travel around the country, it's sort of interesting, yes, we're sometimes being criticized as an industry for having IO loans.

And the people criticizing us happen to be the portfolio managers or the analysts.

And we ask them what their last mortgage was and they say it's an I0.

I think of the -- to sum up what Stacey said, I think a lot of it is clearly highly FICO score people and people who are more financially sophisticated.

As a matter of fact, I'm looking at Mike [Murray] who's our controller sitting in the corner over here.

I think he got an IO loan just recently.

So, it's more financially sophisticated people are doing it.

Okay.

And even folks who I would suspect over $1 million, even close to a $1.5 million in a home, real high end, that folks might not have any mortgage at all but what you might telling me is some of those folks might be making a personal financial decision to leave their cash where it is and borrow as cheaply as they can for a short time frames and things like that?

That one is hard for us to answer because we don't generally sell at that price point.

I apologize.

Thank you very much.

Your next question comes from Margaret Whelan with UBS.

Can I just try and understand all the different moving parts in terms of use of the capital going forward?

The impression that I'm getting is that going into fiscal '07 your free cash flow is going to turn positive and you're going to do a lot of buybacks.

Am I totally way off on that?

Well clearly -- I'm going to answer your question very directly.

I know you appreciate it.

Don't curse at me please. [Laughter]

Now, Margaret.

First time for everything. [Laughter]

All right.

To answer your question, yes, if we slow our inventory growth to 10% to 15% in '07 as what we are planning to do currently we will generate free cash flow.

And secondly, we're not going to promise that we're going buy back stock.

But clearly, that's going to afford us a much better opportunity to buy it back than what we're currently living through right now.

Okay.

That was the impression I had.

And then the second question is, you answered different questions about your input costs and raw materials components, labor and so on.

But can you give us an idea of how far your dollars are going now as you're securing land?

Are you getting better turns on the options?

More flexibility or less risk from the sellers?

In certain markets we are.

And especially in the markets that you all have perceived as the hotter markets, as those markets cool and moderate, demand in those markets, the sellers are some of the last people to decrease their prices.

But I also -- one thing I was talking about Tom [Noonan] about, who you know; is that the sellers in California this time around are much more aware that even if we're asking for a discount on something that's in escrow; that they're better off to take the discounted price and close and move forward.

Because a number of them have been to the movie before in California, where they didn't do that.

And so as a result, we're finding that land prices are moderating in certain hot markets.

Not as fast what is we'd like but they're definitely coming down, especially if you're pushing it.

And we have a tendency to push it.

And I've also -- I've heard from some of the smaller builders that they're selling finished lots to free up capital to meet their bank debt.

Have you taken advantage of that at all?

We haven't really run across that of any significance.

In a couple of markets, we've had some smaller builders.

As a matter of fact, Stacey is looking where we have had a couple markets where that's happened.

And as the bank put more pressure on those smaller builders perhaps that will continue to increase.

Well, I'll look forward to the buybacks next year.

I know, Margaret.

We're working on it for you.

Thank you.

Your next question comes from Michael Rehaut with J.P. Morgan.

Just a clarification.

Before you had mentioned I think, Stacey, lumber is 8% to 10% of costs.

I think the way we had always looked at it, it was more like 35% to 40% of raw -- total raw materials.

And if raw materials are a 0.25 of the sales price, that they -- the lumber is more 8% to 10% of sales prices.

Am I wrong on that, or could you explain what that number was?

The way we look at it, Mike, is we take it as a percentage of cost and it's generally 8% to 12% for us.

Now, your metrics are going to change because land prices vary so much as a percentage of cost of sales from state to state.

For us on average it's 20% to 25%.

Materials and labor are equally split, about 35% each.

And then the balance is going to be closing costs.

Permits.

Permits, that type of softer cost.

So, when we're looking at it internally for our business it's running 8% to 12%.

Part of it depends if you're building single story or two-story homes.

And that's 8% to 10% of costs inclusive of labor and land?

Yes.

Okay.

All right.

Thank you.

Thanks.

[OPERATOR INSTRUCTIONS] Your next question comes from Timothy Jones with Wasserman and Associates.

Yes, your cancellations have gone from roughly 18% to 22%, up roughly 4%.

Can you tell me, is that at the bank level because of higher interest rates, or them getting more strict on hybrid loans?

Or is it at the -- once a home is started, due to either job losses or lower prices perceived or anything else?

I think it's a combination primarily of two things, Tim.

One is, I think it's a function of interest rates eking their way up a little bit.

As you know, 30-year mortgages are at their peak for the last three to four years.

But secondly, incentives are driving some buyers to cancel.

And I think as we work our way through these incentives over the next couple of quarters and they decrease, I think you'll see the cancellation rate decrease.

But clearly, if you have one builder offering this discount today and another builder offering a slightly higher discount tomorrow, sometimes -- I think we've forced some of the buyers to be sitting on the sidelines or going to the sidelines saying; "well gee, let's let the industry work its way through this over the next couple of quarters.

I don't have to buy today, so maybe I'll just cancel and wait."

On the 18% or 22%, either one, what percentage is done at the bank level, and what percentage is done after the person has gotten the financing?

Is it 50/50, or 30/70, or what is it?

Yes, actually, Tim, we don't have an exact breakdown for you but a high majority would be from people who don't qualify.

And it's not necessarily that banks are tightening their lending standards.

It's just that people have over committed for the house.

And generally what we try to do in those situations is find them another house.

You have nothing under -- anything to -- any money put in, really, because you haven't started the house in those cases.

Right.

Okay.

So the vast -- 70% or so or plus is at the bank level because of them not qualifying.

Rough number, yes.

Thank you very much.

At this time, there are no further questions.

I would like to turn the call back over to Mr. Don Tomnitz for closing remarks.

Thank you.

I'd like to congratulate all of the D.R.

Horton people on the line including our mortgage and finance people.

We had one heck of a quarter.

We sold more homes than anyone else in the industry in terms of our percentage increase and was very proud to release that we add 10% sales increase.

And thank you very much for all of our sales people out there.

Many times I forget to thank our construction people and all the construction superintendents and construction employees that delivered all the homes they need to deliver, typically in the third month of the quarter.

We're very appreciative of that.

We have a fantastic year going and we have a lot to do in this last two quarters of the year.

We're looking forward to our Presidents' meeting in Tahoe next week, to hear about all the great things that our Division Presidents are going to do in the second half of the year.

So again, thank you to our investors who own our stock.

And thank you to all of our employees who have made all of this possible.

This concludes our call.

Thank you for participating in today's D.R.

Horton, America's largest homebuilder, second quarter 2006 earnings release conference call.

You may now disconnect.