霍頓房屋 (DHI) 2006 Q4 法說會逐字稿

Good morning.

My name is Crystal and I will be your conference operator today.

At this time, I would like to welcome everyone to the D.R.

Horton Inc., America's Builder, the largest home builder in the United States, fourth quarter 2006 fiscal 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] Please limit your questions to one question and one follow-up question.

Thank you.

I will now turn the conference over to Mr. Tomnitz, President and CEO.

Please go ahead, sir.

Thank you, Crystal, and good morning.

Before we get started, joining me this morning is Sam Fuller, who is our Senior Executive VP of Finance;

Bill Wheat, who is Executive Vice President and CFO; and Stacey Dwyer, Executive Vice President and Treasurer.

And before we actually 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 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 10K and the most recent Form 10-Q, both of which were filed with the Securities and Exchange Commission.

Don?

Thank you, Stacey, and thank you again for joining the fiscal year 2006 conference call of D.R.

Horton, America's Builder, the largest home builder in the United States.

We would like to start off by thanking our people for their hard work this year during a time when market conditions were more challenging in the homebuilding industry, especially in our last two quarters.

We earned more than $1.2 billion of net income and closed 53, 099 homes.

For the second consecutive year, D.R.

Horton is the only builder that has sold and closed more than 50,000 homes in a fiscal year.

Stacey?

Net sales orders for the fiscal year decreased 2% to 51,980 homes, $13.9 billion, compared to 53, 232 homes, $14.6 billion in the prior year.

Our salespeople did a great job in a challenging market, with gross sales totaling approximately 72,000 homes in fiscal year 2006.

Our net sales orders for the fourth quarter decreased 25% to 10,430 homes, $2.5 billion, compared to 13,950 homes, $3.8 billion in the year-ago quarter.

This lower net sales rate was due in part to our cancellation rate rising during the fourth quarter to 40% compared to 29% in the third quarter, 23% in the second quarter, and our historical cancellation rate of 16 to 20%.

The Company's backlog of homes under contract at September 30, 2006, decreased 6% to 18,125 homes, $5.2 billion, compared with 19,244 homes, $5.8 billion, a year ago.

Don?

Our assets are concentrated in six states.

The percentage of our assets in these states are as follows: California with 23%;

Florida with 13%;

Texas with 12%;

Arizona and Nevada each with 9%; and Colorado with 6%.

Our net unit sales changes for the fourth quarter in these six states are: California, down 39%;

Texas down 15%;

Nevada down 29%;

Arizona down 18%;

Colorado down 38%;

Florida down 51%.

Going forward, we will provide our sales and asset concentration consistent with our six reporting regions.

Sam?

Our fourth quarter homebuilding revenues decreased 4% to $4.8 billion from $5 billion in the year ago quarter, with home sales revenues decreasing 5% on 17,261 homes closed.

Our average closing price for the quarter was up 3% to $272,400 compared to $265,500 in the year-ago quarter.

Homebuilding revenues for the year ended September 30, 2006, increased 8% to $14.8 billion from $13.6 billion in the year ago period, with home sales revenues increasing 9% on 53,099 homes closed.

Bill?

Our gross profit margin on home sales revenue in the fourth quarter, before inventory impairments and land option write-offs, was 20.9%, down 450 basis points from a home sales gross margin of 25.4% in the year-ago period.

This decline was due primarily to core margin deterioration resulting from a lack of pricing power and increased use of sales incentives relative to last year.

During the fourth quarter we recorded inventory impairments of $142 million as a charge to cost of sales, which had a gross profit impact of 296 basis points.

These impairment charges are associated with projects that had a pre-impairment carrying value of $460 million and over 70% of the charges related to projects located in California.

We continued to adjust our land option contracts relative to current demand, which resulted in the cancellation of a number of option contracts during the fourth quarter.

This activity resulted in in $57.2 million of write-offs of earnest money deposits and pre acquisition costs related to land option contracts, which had a gross profit impact of 120 basis points during the fourth quarter, and these write-offs occurred across a broad cross section of our markets.

As a result of our continued efforts to adjust our land option contracts, we have reduced our supply of land and lots at September 30 to approximately 323,000 lots owned and controlled, down 18% from our peak of 396,000 lots at March 31. 59% of these lots are owned and 41% are optioned.

At September 30, the total remaining purchase price of land and lots we control under option contracts is $4 billion, down 31% from our peak of $5.8 billion at March 31.

We will continue to review our option contracts each quarter to insure that we are controlling the appropriate level of land and lots to meet our future needs.

Our reported total homebuilding gross margin, including inventory impairments and land option write-offs, was 17.2% in the fourth quarter, down 800 basis points from 25.2% in the year-ago quarter and down 500 basis points sequentially from 22.2% in the third quarter.

Our reported gross margin for the fiscal year was 22.6%, down 300 basis points from 25.6% in fiscal year 2005.

Sam?

Homebuilding SG&A expense for the quarter was 8.5% of total homebuilding revenues compared to 8% a year ago.

For the fiscal year, our homebuilding SG&A was 9.9% of total homebuilding revenues compared to 9% last year.

We're very proud of our 9.9% SG&A and our continuing goal is to maintain our SG&A at 10% or less.

Interest expense of $2.8 million in the fourth quarter represents the called premium net of the unamortized premium associated with the early redemption of our $144.8 million, 10.5% senior subnotes due 2011.

We called these notes in June and they were redeemed on July 15th.

Interest expense for the fiscal year represents the costs associated with the redemption of the 10.5% senior subnotes in July and the 9 and 3/8% subordinated notes in April, as well as expense of unamortized issuance costs from replacing our revolving credit facility in December 2005.

Our income tax rate for the year was 37.9%, down from 38.2% last year, reflecting the tax benefit we realized from the American Jobs Creation Act of 2004.

Stacey?

Financial Services revenue for the quarter increased 7% to $84.1 million from $78.6 million in the year-ago quarter.

For the year, Financial Services revenue increased 24% to $290.8 million from $235.1 million in the year-ago period.

Financial Services pre-tax income for the quarter decreased 18% to to $33.7 million from $41.3 million in the same quarter a year ago.

And for the fiscal year, Financial Services pre- tax income increased 3% to $108.4 million from $105.6 million last year.

95% of our mortgage company business was captive during the quarter, reflecting our continued focus on supporting our Home Builders business.

Our companywide capture rate in Q4 improved to approximately 71% from 65% in the year-ago quarter and for the year, improved to 68% from 63% in the prior year.

Our average FICO score this quarter was 715, comparable to the year-ago quarter.

Sam?

For the quarter, our consolidated net income decreased 51 % to $277.7 million from 563.8 million last year.

Diluted earnings per share for the quarter decreased 50% to $0.88 from $1.77 in the year-ago quarter.

For the year ended September 30, 2006, consolidated net income decreased 16% to $1.2 billion from $1.5 billion last year.

Diluted earnings per share for the year of $3.90, which includes impairments and write-offs, decreased 16% from $4.62 a year ago.

Bill?

As we mentioned on our third quarter conference call, we are focused on inventory reductions.

Our inventory decreased by $662 million at September 30 compared to June 30.

We started approximately 46% fewer homes in the September quarter compared to the year ago quarter, and we reduced our total number of homes under construction to approximately 29,000 homes, a 27% reduction from 40,000 homes at June 30.

We also reduced the absolute number of speculative homes in inventory by more than 10% this quarter compared to last quarter.

However, our speculative homes as a percentage of our inventory are at 50% at September 30 as a result of our increased cancellation rate and our greater than expected closings, which lowered our total homes in inventory.

The reduced number of homes under construction and our earnings in the fourth quarter resulted in greater than $0.50 billion dollars in free cash flow from operations.

We plan to further reduce our total number of homes under construction and our number of speculative homes in the December quarter and our target spec percentage remains in the low 30s.

Stacey?

Our Homebuilding leverage ratio, net of unrestricted cash , at September 30 was 40.7%, in line with our goal of maintaining an investment grade level.

At September 30, we had $1.23 billion available on a revolving credit facility and $457.8 million in unrestricted cash, for a total of $1.7 billion of Homebuilding liquidity.

This month we added $350 million to our liquidity.

With the strong support of our bank group, we increased our current committed borrowing capacity on a revolving credit facility from $2.15 billion to $2.5 billion and extended the maturity date of the facility by one year to December, 2011.

Don?

Our sales rate has been better than anyone else in the industry.

Our unit closings have been higher than anyone else in the industry.

Our apples-to-apples operating margins continue to be the highest amongst the largest five builders; however, we continue to operate in an increasingly challenging housing environment as is evidenced by our increasing cancellation rates.

This operating environment makes it very difficult to project with any certainty our sales rate, cancellation rate , closing rate, and our fiscal year '07 EPS.

What we have done and will continue to do, we have maximized our gross margins while meeting the market price, market by market, subdivision by subdivision.

We have right sized our overhead structure relative to current and projected demand, implementing SG&A cuts totaling over $200 million.

We've renegotiated most all vendor and labor contracts downward.

We've reduced our total housing inventory by 27%; dramatically increased our liquidity and free cash flow; dramatically decreased our land spend; reduced our lot option contracts from $6 billion, approximately, to $4 billion by canceling some contracts and renegotiating numerous other lot option contracts.

We have reviewed with each of our seven regional presidents every project, one by one, and took all appropriate impairments.

We believe calendar year 2007, especially Q1 and Q2, will be more challenging than the past three quarters.

We are committed to continuing to be the leader in the Homebuilding industry while maximizing our gross margins, maximizing our volume, maximizing our liquidity, while we continue to out-sell and out-close everyone else in the industry.

We'll now entertain any questions you may have.

[OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the Q & A roster.

Your first question comes from the line of Michael Rehaut with JP Morgan.

Hi, good morning.

Good morning.

A couple questions, I guess.

The first on the spec reduction.

You know, you hit the overall -- more than hit the overall goal of total homes under construction, but as you said, came a little bit short on the spec side.

If [can] rates are to potentially stabilize around here, at what point would you be able to see that low 30% hit, and would there potentially be an incremental negative impact on gross margins?

That's the first question.

Mike, our target is to get to the target spec percentage as quickly as possible.

We are severely restricting our spec starts right now and so clearly we are focused on moving our homes in inventory, including those specs, so certainly, our target is to get there as quickly as possible at the margin that the market demands in each subdivision that we have.

So you think that would be one or two or three quarters?

Or you're just not sure at this point?

I'd say we're not sure, but Mike, clearly, we would like to be there in two quarters.

And I think that's realistic.

Your next question comes from the line of Joel Locker with FBN.

Just wanted to get the land sale, the 53 million.

That was 80% gross margin, just kind of was surprised by that and was wondering if you'd explain that a little bit.

I believe our gross margins on land sales, our revenue was about about $95 million and margins on that was about 44%.

Right, right.

Our land sales come sporadically.

They are basically as opportunities present themselves across the country.

The land sales and -- including very often commercially zoned land -- the land sales we had this quarter occurred really across the country in a number of our regions.

There's not one or two really large sales, necessarily.

Were they older pieces of land or just, I mean, I was just surprised the margins were so high versus a year ago.

As Bill said, a lot of those land sales that we do make are commercial or retail pieces on which, typically, we have residential prices as our basis in the land, so hence, the margin is higher.

Right.

And then just the impairments, they've held steady -- or the, I'm sorry, goodwill has held steady for the last several years and I was wondering if that was -- any possibility of being impaired on that on the 578 million or so?

We analyze our goodwill impairments each and every quarter and we have analyzed our goodwill overall by each of our regions and at this point in time when we look at our performance in each one of our regions and our projected performance in each one of our regions, we do not have any goodwill impairments at this point in time.

That's certainly something that we will continue to monitor each and every quarter as we move forward, just as we analyze our inventory evaluations as well.

And I think to put a little bit additional on that is that, clearly, if the market stays the same or gets worse, then we could possibly have impairments.

Certainly on inventory that's project by project, and goodwill is something we'll continue to analyze as well.

All right.

And just a last question on -- I know you guys aren't giving any guidance for fiscal '07, but do you expect or can you give any kind of ballpark figure on amount of closings that you expect?

We're not giving that number currently.

Right.

Thanks a lot.

Your next question comes from the line of Margaret Whelan with UBS.

It's actually Dave [Holberg] on for Margaret.

How are you doing?

Good morning, Dave.

Wondering if you guys could talk a little bit about where the lot count, where you see it going.

Obviously it's come down sequentially and down from the peak pretty dramatically, and where you kind of see it, where is the ideal place for it?

Well, clearly, we've always had a goal of trying to keep our land and lots under five years, and ideally we would like to have it somewhere between 3 and 3.5 years, so we're going to continue to work down our lot option contracts, renegotiate those and cancel them where we see fit.

And secondly, we're purchasing a lot less land, and as we continue to close units, then we're going to make a dent in that owned land portion.

So clearly, what we would like to do, 3 to 3.5 years is a goal.

Now, how are you seeing the [landmark get] from other sellers?

Are there opportunistic opportunities for you yet from people that are under more distress in this environment?

I think there are a lot of opportunities.

Whether they are good opportunities or not, I think we're uncertain of currently, because as I say, we started this softening probably a couple of quarters ago, and the land sellers are the last ones to adjust their prices, so as a result, I think we're faced with a couple more quarters before we really get to the point where we see some great land values.

I guess the follow-up to that would be if conditions start to improve slightly in the second half of '07, are those opportunities going to materialize if land sellers aren't really being forced into position yet?

Well frankly, we're not in a position where we have to worry about when they mature right now because we're sitting on five years of land supply, so we've got plenty of time to wait for land prices to come down.

Okay, thank you.

As a reminder, please limit your question to one question and one follow-up question.

Your next question comes from the line of Nishu Sood with Deutsche Bank.

Thanks, good morning.

Good morning.

First question was, I just -- there's obviously some pretty divergent views in terms of whether or not we're seeing signs of housing market bottoming.

Some people are looking at volumes and seeing some signs of bottoming.

Others are pretty adamant that they haven't seen that yet.

Based on what you folks are seeing, what side of that do you come down on?

I'd say we're in the early stages of a declining market and, as I said on the Q3 conference call, most of these downturns are longer and deeper than we envisioned at the beginning.

Actually, I'm waiting for CNBC to call the bottom of the market, but they haven't called it yet.

Right.

So, just another question on your closing price.

Your closing price was up sequentially and so -- and I think that was a little bit different than what you had been expecting.

Was that a mix issue or was that -- what was behind that?

It really just comes down to mix.

It wasn't necessarily inconsistent with what we had seen in our backlog, but as we look at average sales prices, certainly going forward, we look at our sales, what our average sales prices are in our sales and then that really kind of gives us an indication of where our average closing prices will be in the future.

Okay.

And just one other quick question on your backlogs.

Under your new reporting structure, you had the south central and southwest were the only divisions where you saw an increase in your backlog.

The south central, I think, which has Texas in it, isn't a surprise, but where is the strength coming from in southwest?

Is that a regional issue or is that a community count issue?

What's going on there?

The southwest is primarily the Arizona market.

You also have Colorado, New Mexico, and Utah in there, so certainly, but the largest concentration is in the state of Arizona.

Our New Mexico division is doing much better over the course of the past year or two years, so a lot of the strength in that southwest is coming from New Mexico, supplemented by Phoenix.

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

Good morning, guys, and Stacey.

You said, I believe, that 46% of your -- you had 46% fewer starts in the last quarter compared to a year earlier.

Could you give us some sort of idea, in three months and in six months, what you'll say about the first and second quarter, how many starts you had less than a year ago?

I think that's going to be tied clearly to the spreadsheet which Bill and his people have worked up, which basically says if your sales are X then this is how many units you can start.

And our goal clearly to get our total inventory down into the neighborhood of the low 20,000 range, so once we get it down under that point it's going to be tied to how many sales we're making and supplementing those sales with starts.

But I'd assume it would have to be a negative number in comparison, right?

From a year ago?

Yes.

Okay, can I change the discussion here?

You've made some changes in your organizational structure, eliminating the regional VPs and increased number of regions you have.

Can you talk a little bit more about that, why you're doing it, and also talk about how that might affect your capital allocation among the various markets?

Well, just so we don't create any concern on our seven regional presidents' part currently, what we eliminated were our three COOs and the reason for that is because we are planning on going to 70,000, 80,000, 90,000, 100,000 units, and at that growth rate over the next five years we needed that level of management.

Frankly, we don't see our growth being like that today, so as a result we eliminated that layer of management and, frankly, that lets Horton and I have more touching and feeling with the actual deals that are on the ground.

On a going forward basis, we are allocating our inventory dollars as we have in the past, where we believe we have the most growth opportunities, but clearly, what we have done in the past we will continue to do in the future largely, and that is give each region pretty much a percent increase that's the same in their inventory allocations each year, or a decrease as it may be, as we see fit.

Right now, it's pretty much a very small increase.

Right.

And that's governed largely by what we see the prospects are in each region as far as return potential, margin potential, growth potential there, as compared to where they are today.

But clearly, we manage that allocation region by region.

As we said at the end of last quarter, our goal is -- in California certainly, which at one point in time had 25% of our inventory and I think it's currently set at 23% -- our goal is to take that down to 20%.

And actually, year-over-year, we're down from 28% a year ago.

Your next question comes from the line of Ivy Zelman with Credit Suisse.

Good morning, guys.

Just with respect to two things -- on one, the spec, and secondly, strategy.

The spec inventory, if you could break it down for us in terms of what's been started, what's completed, and I guess what's in the regions, break down where it is.

The other part of the question is related to strategy.

If you're in the middle of a community, is there any reason why -- we understand like in San Diego you may have stopped building mid-stream with houses framed and several of your competitors told us in San Diego they saw that occur and I'm trying to understand why you would be willing to do that as it might upset buyers that are in the community unless it was all specked homes or cancelled units.

Well, Bill Wheat will answer the first part of the question and I'll answer the second part of the question.

To my knowledge, we're not stopping any framing in mid-stream.

If we are, it's a function of trying to adjust our cost on a going forward basis, lower in that particular project.

We have done on our podiums, we have poured the parking garages on some of those and not gone vertical above the parking garages, but we are not -- we don't have any long term intent to delay the construction of a subdivision.

With respect to the specs, if you roll forward our inventory basically this quarter, number one, we are severely restricting any spec starts, very stringent review process, basically, on starting specs right now and essentially, the only specs of any significance we're starting is when we're starting a new project and we're opening models and we may start a few specs.

If you look at our total starts for the quarter you would back into a number somewhere in the low 6,000 range during the quarter, and that's allowed us to reduce our total inventory down.

Certainly one element of the specs in this current quarter is our increased CAN rate and that is something that we're clearly focused on and wanted to make sure that we are aware of where our CAN rate is as we determine how many specs we're going to start.

And we have a total of 84 specs that have been completed and unsold for a period of more than a year.

Right.

So as always, we manage our specs in each subdivision based on the sales absorption that we're seeing, sales absorption that we're planning, and we're intently focused on any specs that become completed.

And we focus on moving those as quickly as possible.

Do you guys feel that, as you look into '07 and you weren't able to provide guidance, that there's a possibility that builders can move money in '07 and that's where a lot of the uncertainty comes from and just how deep this downturn could be, Don?

We're not focused on losing money in '07.

What we focused on with our lack of guidance or no guidance for '07 is just seeing where the cancellation rates come out and clearly our cancellation rates have increased each of the past three quarters and if that continues on a going forward basis then it's going to be a much more difficult market than I'd want to spin.

We don't see any prospects at this point for us to lose money in '07.

I can't speak to other builders.

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

Thanks very much.

I was wondering if you can give thoughts on the first quarter of fiscal '07 in that we have about six weeks left in the quarter.

I know it's tougher to give guidance for the full year.

Can you comment at all in terms of expectations for earnings for this quarter?

Dan, we have chosen at this point not to provide guidance for either the quarter or the year.

Okay, thanks.

And just separately, wondering about a little color in terms of the recent trends since the quarter ended September 30, how would you say what you're seeing in October and early November has been?

I would say that the market, we believe, in October and early November is pretty much similar to what we've seen in the fourth quarter.

Okay. [Inaudible]

Hello?

Your next question comes from the line of Stephen Kim with Citigroup.

Hi, this is Johanna Chua for Stephen Kim.

Could you comment on the trend in the cancellation rate through the quarter?

There basically wasn't a lot of change from month to month within the quarter.

Did it get better in some areas or worse in others?

You know, Johanna, there probably was some variation by local markets, but what we have really look at is on a consolidated basis and throughout the quarter there wasn't significant change, month to month.

No appreciateable change in trend overall, necessarily, or certainly no trends that we would be willing to say designates a change in a specific market or area.

Okay, and on your Other expense and income line, you actually had an expense this quarter for 2.5 million.

Could you talk about that a little bit?

Right. $1.4 million of the 2.8 relates to a change in the market value of our interest rate swaps.

The value of that went down this quarter.

The remainder of the 2.8 really is just miscellaneous small items that relate to non-operating matters that resulted in expense this quarter.

Nothing material or significant in the remainder.

Okay, thank you.

Your next question comes from the line of Kenneth Zener with Merrill Lynch.

Good morning.

Good morning.

I'm wondering if you could expand on your impairment comments.

You said it was roughly 70% in California and what I'm trying to understand with your new segment data is how that impairment concentration reflects the pricing trends that we've seen in your new segment data.

So for instance in California, it looks like your order ASP for your homes was up 3%, and now, compared to roughly a 20% decline in ASP orders for the Southeast and the Southwest, and I'm just just trying to understand with pricing in your order rates looking stable in California, why the impairments are coming from there and not from the Southeast or the Southwest?

Thank you.

Well, that's really a function of San Diego representing about 65% of the total California impairment, and so the average sales prices in the rest of the market are more positive and San Diego is where most of the impairments took place.

Okay.

And I guess related to that, is there a reason that it seems so concentrated with weakness seen in the Southwest and in Florida, perhaps why we're not seeing greater impairments?

I understand you guys have done your inventory impairments, but could you express more color around that?

Yes.

We definitely can.

We've run a very high gross margin in those markets for years, a gross margin that most people never believe when we said it was over 30%, so clearly today, given the pricing and the pace that we are working through in those Markets, we don't have any impairments to those high gross margins.

Right.

And while certainly margins have come down from their peaks they are still very healthy.

When we look at our operating margins, pre-tax operating margin by region, we still see margins in the range of 10% plus in most every region.

The Southeast particularly is up in the mid-teens, Southwest still in the mid-teens on a pre-tax operating margin basis.

So clearly we're still seeing very good profitability levels in those regions.

We do -- now, of course the impairment analysis is on a project by project basis, so we do the analysis each and every quarter project by project.

To the extent that we have an individual project that appears to be in a loss position, then we'll have an impairment charge on it.

But clearly at a high level we're still seeing very good profitability in those regions.

Thank you very much.

Your next question comes from the line of Timothy Jones with Wasserman & Associates.

I must give you congratulations.

Well, we're going to take every dern thing we can get today, Jones.

Well you're doing a great job.

I have to admit it.

I know that's hard for you to do, but we appreciate it.

When you did it, you did you did it.

Okay, I'm a little -- I'm wondering, you sort of answered this first question that you had high margins, but why didn't you take more impairment in Florida, given the fact that your orders were down 51%, and of course Fort Myers is one of the worst markets in the country?

The reason we didn't is because of the accounting rules which prohibit us from taking an impairment if we're still making money in that particular market.

And project to make money.

And project to make money.

And it's all a function, really, of the fact that we, as we've told you before, have had very high operating -- or gross margins and operating margins in the state of Florida, so even though prices are coming down, and I don't disagree with you that Fort Myers and Naples is a weak market.

We're still making higher margins down there than would permit us to have any impairments.

And clearly, that's something we will continue to monitor, every project, every quarter, based on what our sales pace is, what our average selling prices are, what our margins are on actual and projected basis, and if we see a project that appears to be heading towards a loss position, then we'll be looking at impairments.

It's project by project.

The second question is, you said that the first half is going to be tough, which is no surprise to anyone that covers the industry.

You said that you indeed were holding back on giving estimates because of cancellations.

I think you could guess cancellations, maybe not -- importers might be iffy, but isn't it maybe another thing is it's just very tough to see if you're going to have to take more impairments or not depending on what happens?

I mean, that's probably the real big unknown.

Well I'd say it's a combination of all of the things I mentioned, clearly, Tim.

Our sales rate, we believe that as other builders begin to acknowledge that there is an inventory issue and come out of denial, that they are going to be more competitive in the marketplace over the next two quarters than what they have been in the past three to four quarters.

I also -- clearly, we don't know what our cancellation rates are going.

We know where they have gone over the past three quarters and that's not a good trend, and if that continues in the next two quarters that would be a worsening condition.

And frankly, are net closing.

So all of those things coupled with the fact that you're exactly right.

If you look at Florida, down 51%, you have to ask yourself, do we have future impairments coming out of the state of Florida?

And as the ladies and gentlemen listen in Florida, they better crank up their sales because we need to because negative 51% doesn't work.

Good job.

I can just see that grin on DR's face right now.

I hope I see a happier grin!

I think it's a happy grin.

All right

Our next question comes from the line of Carl Reichardt with Wachovia Securities.

Good morning, guys.

How are you?

Good, Carl.

Two questions: First, can you tell me the percentage of deliveries this quarter that were on land that was written down either this quarter or in quarters prior and quantify the margin, I guess, benefit, if any?

Carl, I don't have that in front of me but it would be a very, very, very small percentage.

Most of the time when impairments are incurring, it is while a project is in process and so the actual homes this quarter on that -- it would be a very small percentage.

And generally, since this is the first quarter we took any significant impairments, there really wouldn't be any margin impacts this quarter.

The margin would be impacting those homes as they close going forward.

The impairments were taken essentially on the quarter-end inventory balances after closings had been recorded.

Okay, fair enough.

I kind of figured that.

And then second question, Don, in -- since you made a couple of comments about the last six weeks, did you notice any meaningful difference in either traffic or net order trends at projects irrespective of geography that were designed for entry level buyers as opposed to other types of projects?

Actually, as we've told you for many years, we don't really count traffic what we're doing -- really count our sales and -- counting cancellations much more -- we're only counting backwardly, but they're a bigger portion of it.

To answer your question directly, that's not something that we would have any direct knowledge of.

Okay.

Great.

By the way, putting Savannah in the Northeast region: Very nice.

Talk to you later, guys.

Okay.

Your next question comes from the line of Steve Fockens with Lehman Brothers.

Good morning, everyone.

Just one quick question.

As you look at your inventory, which looks like it may have peaked at around 12 billion last quarter and 11.3 or so this quarter, as you look out over the next few years, given -- without trying to forecast '07, but where you think, rationally, you might be in terms of build pace over the next few years, at what inventory dollar level would you say, wow, I feel a lot better about this?

I would say it's going to be down a similar amount as the 12 to 11.3 is, rough numbers.

We certainly do expect to reduce inventory in fiscal '07 and really, the way we measure whether we're comfortable with our inventory levels or not is when we look at our land that we own and our lots that we own as compared to what our sales and closing space is and when we're down below that five year supply and closer to that 3 to 3.5, then we feel better about it.

We can adjust our homes and inventory a lot more quickly to our current demand and it's the land that takes a bit longer to adjust downward.

But in theory, is there any reason why, again, theoretically a year from now inventory couldn't be a billion or $2 billion lower?

That's what I implied, yes.

I think we would look at our inventory being down similar or greater than the 12 to 11.3.

2 billion may be aggressive, but certainly close to a billion is possible.

Great.

Thank you very much.

Your next question comes from the line of Jim Wilson with JMP Securities.

Good morning.

A couple questions, I guess, Don, could you characterize, looking at the options that you walked away from and obviously then also those that you have not walked away from, can you characterize what it is that you've looked for when walking away from options?

Is it in geography?

Is it then timing of acquisition?

What are some of the characteristics?

And in turn, as you've looked through all of your inventory, what is the nature of the inventory you're sure certainly leads to this point that you want to keep your hands on?

Well, three good questions.

Basically, what we look at primarily is first of all, what's our lot and land inventory in that particular market coupled within what's our gross margin on that project.

And as you know, the purpose of these lot option contracts is for us to readjust our pricing down to try to preserve and protect our gross margin.

So we're looking at how many lots do we have in that market and then what kind of gross margin are we achieving on it, and we're sending the regional presidents back to renegotiate the land deals and the lot deals.

As we calculate them now, we know when we get ready to close X number of lots in a subdivision what our trailing 12-months gross margin is and our trailing 3-months gross margin is, and if it's not where we want to be then we send them back to reset them.

What was the second part of the question?

I'd add one other thing, because the other thing we're looking at with our option contracts is simply our overall capital allocation because we do intend to spend significantly fewer dollars on land this year than last year, and so as Don said, we're evaluating and basically choosing the best returns of the contracts we have out there, regardless of the geography.

What was the second part of your question?

Well, I was saying, why did you focus on keeping, but I guess Steve pretty much answered that, which is return driven.

I was wondering if there's products or geography nature to that, but I guess maybe it's just return driven?

No.

I can tell you the other thing that is, that Horton and I have emphasized with our regional presidents and our division presidents and that is if it's a piece of land that is difficult to replace, then we need to protect that deal because even if we're realizing a slightly lower gross margin than we want to today, in certain markets, like we just came out of Virginia and we stopped all the sales in a particular subdivision for awhile and then set a different sales goal for that subdivision because Horton and I know that you can't replace that subdivision.

So as a result we don't want to move through anything at a lower margin than we think that we can achieve on a return on capital over the course of the next two to three years.

Okay.

Very good.

Good job.

Yes.

Your next question comes from the line of Treacy Gaffney with GoldenTree Assets.

Hi.

Can you walk through the vintage of your land and options by the year they were negotiated?

Yes, we can, and you asked me that question on Margaret's conference and I'll let Bill Wheat give you our breakdown real quickly.

Certainly.

We've looked at our total inventory based on the date on which we contracted it and based on that analysis, about 65% of our inventory that we have today was contracted in fiscal 2004 and prior.

So about 2/3, basically, of our inventory was contracted in fiscal '04 and prior.

Can you break out how much was '04?

No, I don't have that here in front of me, but basically 2/3 was '04 and prior.

Okay.

And what about your options?

That's on everything that we own.

On our options, really, the original contract date isn't as relevant because we are constantly reworking those option contracts.

We have cancelled a number that don't particularly work right now for us and we've reworked a whole lot of other deals.

So really, the most recent negotiated price and negotiated date is a constantly changing thing on our option contracts and changing to reflect where the market is going.

Okay.

And the land that you bought this year, when did you -- did you renegotiate those prices from the original options and when did you enter those options?

Yes.

The land that we bought in '06 and the land that we're currently buying, not all of it, but the vast majority of it, especially in the last two quarters, three quarters of this fiscal year '06 which we just completed, we have been in the process of renegotiating the sales price downward or we just weren't going to close.

Your next question comes from the line of Alex Barron with JMP Securities.

Yes, thanks, guys.

I was hoping you could expand a little bit on your inventory and your balance sheet.

In terms of land, can you tell me how much of of the 6.7 billion is land owned versus options?

And in terms of the homes, how much is like spec inventory versus work in progress?

Alex, on our balance sheet, all of the $6.5 billion of land, we own all of that.

And in our homes in inventory, as we talked about, about 50% of our homes in inventory are spec right now.

And that's total homes under construction from the time we start turning dirt to start the foundation, set the form boards, all the way through completion.

I'm sorry, that was 50% you said?

50%, yes, sir.

And that's in terms of units.

Right.

And in terms of focusing on '07, what would you say is your primary goal?

Is it generating free cash flow?

Generating flat orders?

Stay profitable?

I mean, what would you say is your number one goal for '07?

Our number one goal is to sell as many homes as we can, close as many homes as we can, at the highest possible gross profit margin.

Which will generate free cash flow and continue to reduce our inventory and will strengthen our balance sheet.

Any chance you'll start paying down debt?

Absolutely.

We paid down a lot of debt this quarter and certainly we had still a balance on our revolver at fiscal year end, and typically that's where the first dollars go.

And the last thing that we really want to focus on in '07 is that any new land deals that we purchase we're underwriting with a 30%-plus gross profit margin such that we can make sure that we are protected in case there's any land adjustment -- or adjustment in land prices going forward.

Okay.

Your next question comes from the line of William Mack with Standard and Poor's.

Thanks for taking my question.

Just wanted to get one accounting thing on just the percentage of owned versus optioned land and my real question is in some markets, I see you're in 84 markets now.

Does it make sense to rather than slow your sales as you described because you don't have a community to replace it, then does it make more sense to just get out of the market altogether or does your very presence, whether you're making a large profit margin or not, justify itself?

Any place that we're slowing sales because the land is irreplaceable is a market that we definitely want to stay in, so any place that is like you're characterizing, it's a long term market force.

It may just be one community out of several communities that we're operating in in an individual market where we choose to take that approach too, William.

Okay.

And percent -- thank you -- and the percentage breakout, owned versus optioned?

Of our total of the 323,000 models?

Yes.

Yes. 59% of those lots are owned and 41% are optioned.

Okay.

Thanks again.

Yes.

Your next question comes from the line of [William Nobler with Adalana Fosnov].

Good morning, everybody.

Good morning.

Hi, Don.

You said, if my notes are correct, that 50% of your homes are spec and your goal would be to get that down to 30% as quickly as possible, I think you said.

Low 30s.

Low 30s.

And this would therefore mean -- what I understand, you would just stop building other than where you have a purchase contract, almost stop building?

Well, we've slowed our starts dramatically, just simply because we don't need the additional inventory, and that's really helping us also, big time, with renegotiating our vendor and our labor with our subcontractors, because one thing that clearly gets their attention is reduced our no starts in a particular area.

Right.

And I think another thing, if my notes are correct, you said you have, you're sitting on a five year supply, 323,000 lots , and your goal, ultimately, could be to go to 3 to 3.5 years.

Would that be true?

That is correct.

And to be accurate, if you take our 53,000 units that we closed in '06, basically, that's about a six year supply, a six and a quarter year supply of lots and we're trying to take that down to 3 to 3.5, ideally.

Right.

I guess that's a long term goal, assuming the current conditions were to continue.

Well, you know, I wouldn't call it a long term goal.

It's going to probably take us longer to get there than we would like, but as -- obviously as our absorptions and our sales and our closing have declined and all of a sudden that year supply becomes larger and larger, so we're hopeful of two things.

We're hopeful that, one, we are going to control our new land acquisitions and underwrite them to higher guidelines, but also as we move forward into, certainly, '08, we believe that the unit closings will go up, so that will also mitigate that year supply.

Right.

So your current thinking is in '08, I think you're suggesting that closings might increase from '07?

To answer your question directly, yes.

I believe that what's happening, going to happen in '07 is we're going to deal with a hangover, overhang, whatever you call it, as an industry, of too many homes available in the marketplace.

I think over the first two quarters of calendar year '07 the industry will do a good job of selling that inventory and decreasing their starts and also, ironically, as we continue to liquidate our inventory at the highest profitable margin, we're also increasing our incentives and discounts, so I believe what's happening and what will happen during '07, there's a pool of pent-up demand that's being created over here because buyers are unsure whether today is the right price or not.

So I think we end up at the end of '07 -- I call it the perfect scenario -- where basically we have pent-up demand and lower inventory as an industry and then I think we get pricing stability, which is fewer discounts and fewer incentives.

Your next question comes from the line of Jay McCanless with FTN Midwest.

Hi.

Thanks for taking my call.

Don't know if you've addressed it yet, but what in the fourth quarter were your incentive levels versus last year's fourth quarter, on average?

Clearly, our incentives have increased significantly and really that's really reflected in our gross profit.

Gross profit on home sales were down 450 basis points year-over-year in the fourth quarter, and that's really entirely due to increased incentive levels.

And softer pricing.

And one of the reasons that we haven't tracked incentives specifically, because you could both reduce the sales price without offering incentives, or you could just offer an incentive and then basically have the same impact on your gross margins.

They both flow through gross margin.

Exactly.

So we're really more focused on the gross margin rather than tracking an incentive level.

Okay.

And then, one follow-up.

Are you still seeing a lot of buyers trying to pit one builder against another in terms of getting incentives or getting a price reduction?

Is that still very prevalent in the market you all serve?

Yes.

Okay, thank you.

Your next question comes from the line of Jeremy Pinchot with MCH.

Hi, everybody.

Thanks for taking the question.

Nice quarter.

Actually my question was on the incentives so you guys already answered it.

I appreciate it.

All right, Jeremy.

Thank you.

Have a good one.

Take care.

Thanks.

You have a follow-up question from the line of Michael Rehaut with JP Morgan.

Hi.

Thanks.

On the backlog conversion, last quarter you kind of -- slightly less than 3Q '05, this quarter, at about 69%, it looks like it returns to that more normal pace, looks like 4Q '05 was the outlier on the positive end.

It looks like historically you've done about 70% or so.

Given the change in environment and your focus on reducing the backlog, will we expect that to, in the first half of '07, improve against the year-ago numbers?

Well, first of all, Mike, we're not focused on reducing our backlog.

We would like to increase our backlog but decrease our inventory.

And in terms of what we expect for the backlog conversion, that's going to be a function of our sales and our cancellation rates going forward.

Obviously, as we talked about on Q3, we were a little uncertain what our backlog conversion rate in Q4 would be, simply because we didn't know what to expect in the current market conditions.

And right now we're not really ready to say whether we expect that to be higher or lower than last year.

But I think we are in a strong position, given our current inventory, and as we've readily admitted, with a 50% spec count out there I think we're in a strong position to have perhaps a higher than normal backlog conversion as it relates to the first quarter.

To the extent that the sales are able to be generated and the CAN rates remain under control.

Great.

Thank you.

And then one follow-up.

You mentioned in the beginning of the call that, I believe, you had achieved your 200 million-plus run rate of -- was it SG&A costs or just cost savings overall?

Total SG&A cost cuts of 220 million, yes.

We've made those cuts and they are implemented beginning Q1.

That's great to hear.

And just in that -- you'd also mentioned that you're aggressively pursuing lower costs across labor and materials.

Can you give us any idea, either on a dollar or basis point basis, what you expect that to be in terms of the gross margin contribution?

Or how that might play out on the gross margin line?

Well, Bill, we gave the answer about, I don't know, a quarter ago, and I followed it up about two weeks later and we gave two independent numbers and we were pretty close.

He said around 5% and I said 5 to 10%.

He's the accountant and I'm the operator, so somewhere in between there and that's what we're really focused on.

As an example, I just came out of one of our markets last week and -- just a little bit of humor, but the framing contractor showed up with his calculator for the first time in a couple of years, he was bidding our next project, and prior to that he would just come in and sit around and chew the fat and say, here is the price, take it or leave it.

So we've definitely got their attention now.

So that 5 to 10% or so, that's incremental to the 220?

The 220 was simply SG&A, so yes, that would be incremental to the 220.

That's just the cost of goods sold.

Right.

Just wanted to be 100% clear.

Just a little additional color on that too, Mike, because I don't want you to take that 5 to 10 basis points and assume that that's going to be margin improvement going forward.

In today's environment it is still a tough selling environment and I just want to make sure that you understand we're using those to stabilize our margins, not necessarily to improve our margins right now.

No, understood, but certainly, given headwinds with higher land costs and incentives to have some type of visibility in terms of what you can do is certainly helpful.

Yes, as someone just said, it could very well be eaten up by incentives, depending upon how competitive the marketplace is.

Right.

Great.

Thank you.

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

Thanks very much.

I noticed that the cost of goods per home delivered, as is the case for a lot of builders, continues to climate at a high single-digit rate.

For you it was about 9% year-over-year.

Could you give us a feel for how much of that is land related and how much is material and labor?

It sounds like, from what you're saying, you're actually having some success on the labor material side, so if that's the case maybe give us a sense of where that increase is coming from?

When we look at our total cost of sales, land as a percentage of our cost of sales is flat with where it was a year ago, so any increase is on a per home basis and our cost would have come from the materials and labor side.

And certainly, in the hot markets that we have seen over the last few years, certainly there had been increases in materials and in labor costs and that's what we're actively working to reduce right now as we head into '07.

Does that mean we should expect to see that slow dramatically then?

Because obviously land is not going up and you're saying you're starting to get some impact with your subcontractors.

Should we see that slow significantly?

We're in the process of trying to reset every cost in our supply chain, so that we can adjust our revenues to meet a higher affordability index, because clearly what's happened over the last four or five years is the pool of affordable buyers has shrunk.

So I think that we're going to gain some here and we're going to give it up someplace else because our game plan is how do we produce a product which appeals to the largest percentage of buyers?

In other words, we've got the largest pool of affordable buyers possible.

Part of that, too, will depend on the geographies where we're delivering our product.

As we've seen in the last couple of quarters, we've delivered more homes in the Texas and in the Southwest and the cost of constructing a home in Texas is significantly less than it is to construct a home in California.

So depending on where our sales come from, we could see some geographic impact to our cost her home.

But I guess my question is the rate of increase in the cost of goods per home has actually accelerated, so if it's more homes in the Southwest and Texas, I would think that your increase in cost of goods per home would actually be decelerating, in other words, going up at a lesser rate, but it seems to be going up at a faster rate.

So I'm just trying to get a sense of, going forward, should we expect costs per home to be more like a 5% or closer to the 9 it's been running at?

I would expect it to not accelerate as fast, simply because we are adjusting our labor and materials right now.

The costs that you've seen in the last couple of quarters of '06 would have been more reflective of the cost of labor and materials as they were increasing in the hotter markets.

And one clarification on the land piece.

Land as a percentage of overall cost of sales has been consistent from quarter to quarter, which would mean that on a per unit basis, land would have increased consistently with all of our other costs in the home at the same time.

So certainly our per lot cost is higher but it's increased at the same rate as the rest of our costs.

I see.

So the increase has been labor -- it's been materials, land, and labor?

Okay, thank you.

Your next question comes from the line of Steve Fockens with Lehman Brothers.

Hi.

Just two quick follow-ups.

One, what was the outstanding on your short-term revolvers or lines of credit or whatever it is at the end of the quarter?

We had cash borrowings at September 30 of $800 million.

800 million.

Great.

And then secondly, on the earlier question, that 65% of your inventory is from '04 or earlier.

Is that in units or dollars?

That's in terms of dollars.

Dollars.

Because along those lines if you have 12% of your assets in Texas, and I'd guess that that stuff turns fairly quickly, is it generally fair to say that, given your geographies in any given year, you may have anywhere from 10 to 20% of your assets purchased within the last year, merely because those are parts of the country where assets turn a lot faster?

That's a fair characterization.

Certainly. in the markets -- certainly in Texas and throughout the South, where you're buying finished lots on a finished lot take-down, very often that land span, that land inventory turns within the same year to a closing.

So that's fair.

Texas, Georgia, Alabama, places like that.

Carolinas.

Great.

Thanks very much.

Yes.

At this time there are no further questions.

Do you have any closing remarks?

Yes.

Again, I'd like to thank all of the D.R.

Horton employees for a very strong effort in our fourth quarter, and once again, it's put Horton in a position of being the only builder for two consecutive years to close and sell more than 50,000 homes.

As we look forward to 2007, we will have a more challenging year but there's one thing that I'm convinced of: With have been a leader in the home building industry for a number of years, particularly the last five years, and it's because of one thing.

We have the best people in the industry and the best people in the industry will continue to put Horton in a position to be the leader in the industry.

So thank you and have a good day.

This concludes today's D.R.

Horton Inc., America's Builder, the largest home builder in the United States, fourth quarter 2006 fiscal year-end conference call.

You may now disconnect.