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Operator
At this time I'd like to welcome everyone to the D.R.
Horton Incorporated, American's Builder, the largest home builder in the United States, first quarter 2007 conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Don Tomnitz, President and CEO.
Sir, you may begin your conference.
Don Tomnitz - President, CEO
Thank you.
Joining me this morning is Sam Fuller, Senior Executive Vice President of Finance;
Bill Wheat, Executive VP and CFO; and Stacey Dwyer, Executive Vice President and Treasurer.
Before we get started, Stacey?
Stacey Dwyer - EVP, Treasurer
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 which is filed with the Securities and Exchange Commission.
Don?
Don Tomnitz - President, CEO
Thank you, Stacey.
And thank you, for joining the first quarter fiscal 2007 conference Call of D.R.
Horton, American'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 quarter, during a time when the market conditions continued to be challenging in the homebuilding industry.
Although we are operating in a very difficult homebuilding environment, we are improving our strong balance sheet and generating positive operating cash flows while we continue to manage our business profitably.
We have generated $1.2 billion of free cash flow in the last six months.
Stacey?
Stacey Dwyer - EVP, Treasurer
Net sales orders for the first quarter decreased 23% to 8771 homes sold, $2.3 billion, compared to 11,463 homes sold, $3.2 billion, in the year ago quarter.
Our cancellation rate for the quarter was 33% compared to 40 % in the fourth quarter of fiscal 2006.
We experienced a sequential improvement in our cancellation rate each month throughout the quarter, in October it was 38%, in November 33%, and in December 30%.
Although our cancellation rate improved as compared to the fourth quarter, it remains well above our historical range of 16 to 20%.
The Company's backlog of homes under contract at December 31, 2006, was 16,694 homes, $4.7 billion compared to 20,816 homes, $6.2 billion a year ago.
Don?
Don Tomnitz - President, CEO
The percentage of our assets in each of our six reporting regions at 12/31 are as follows--Northeast 15%, Southeast 17%, South Central 13%, Southwest 17%, California 22%, West 16%.
We were profitable in all of our reporting regions during the quarter, even after impairments and earnest money write-offs.
Sam?
Sam Fuller - Senior EVP-Finance
Homebuilding revenue totaled $2.8 billion in the first quarter of both fiscal 2006 and 2007.
Homes closed in the first quarter totaled 10,202 compared to 9,891 homes a year ago.
Our average closing price for the quarter was down 4% to $270,600 compared to to 282,000 in the year ago quarter reflecting the softer pricing environment over the past year.
Bill?
Bill Wheat - EVP, CFO
Our gross profit margin on home sales revenue in the first quarter before inventory impairments and land option write-offs was 18.6% down 920 basis points from our home sales margin of 27.8% in the year ago period and down 230 basis points sequentially from our fourth quarter margin of 20.9%.
These declines were due primarily to core margin compression resulting from a lack of pricing power and increased use of sales incentives relative to last year.
During the first quarter, we recorded inventory impairments of $40.9 million as a charge to cost of sales, an approximate 150 basis point gross profit impact.
These impairment charges are associated with projects that had a pre-impairment carrying value of $168 million and substantially all of the charges related to projects located in Colorado and California.
Sam?
Sam Fuller - Senior EVP-Finance
We continue to adjust our land option contracts relative to current demand, which led to the cancellation of a number of option contracts during the first quarter.
This activity resulted in $36.8 million of write-offs of earnest money deposits and pre-acquisition costs related to land option contracts, approximately 130 basis point gross profit impact during the first quarter.
These write-offs related to contracts across all six of our reporting regions with more than one half in our California and West regions.
As a result of our continued efforts to adjust our land position, we have reduced our supply of land and lots at December 31, to approximately 297,000 lots owned and controlled down 100,000 lots or 25% from our peak at March 31. 63% of these lots are owned and 37% are optioned.
At December 31, the total remaining purchase price of land and lots we control under option contracts is $3.2 billion, down 45% from our peak of $5.8 billion at March 31.
We will continue to review our option contracts each quarter to ensure that we're controlling the appropriate level of land and lots to meet our future needs.
Our reported total home building gross margin including inventory impairments and land option write-offs was 15.8% in the first quarter down 140 basis points sequentially from 17.2% in the fourth quarter of last year.
Stacey?
Stacey Dwyer - EVP, Treasurer
Homebuilding SG&A expense for the first quarter was 10.5% of total homebuilding revenues, a 100 basis point improvement from 11.5% a year ago.
Our goal for fiscal 2007 SG&A is the same as it is in every year, to be at or below 10% of revenues.
While achieving our 10% goal, we'll likely be challenging this year, we're pleased with the progress we've made in managing our SG&A expenses relative to our revenue level.
We continue to focus on being the low cost operator in the industry which remains one of our distinct competitive advantages and the key to our consistent profitability.
Bill?
Bill Wheat - EVP, CFO
Financial services revenue for the quarter increased 8% to to $66.5 million from $61.3 million in the year ago quarter.
Financial services pre-tax income for the quarter increased 36% to $27.1 million from $20 million in the year ago quarter. 94% of our mortgage company revenue was captive during the quarter reflecting our continued focus on profitably supporting our Home Builders business.
Our companywide capture rate in the first quarter improved to approximately 70% from 64% a year ago.
Our average FICO score this quarter was 715, comparable to the year ago quarter.
Sam?
Sam Fuller - Senior EVP-Finance
For the quarter, our consolidated net income was was 109.7 million compared to to $310.1 million last year.
Diluted earnings per share for the quarter were $0.35 compared to $0.98 in the year ago quarter.
Bill?
Bill Wheat - EVP, CFO
Based on controlling our level of homes under construction, we started about half as many homes in the December quarter as compared to the year ago quarter and we reduced our total number of homes under construction to approximately 26,000 homes, a 35% reduction from our peak of 40,000 homes at June 30.
We also reduced the number of speculative homes in inventory by approximately 2000 or 15% during the first quarter.
As a percentage of our total homes under construction, speculative homes declined slightly to 48% from 50% at September 30.
Our target speck percentage remains in the mid 30s.
Stacey?
Stacey Dwyer - EVP, Treasurer
Our homebuilding leverage ratio, net of unrestricted cash, improved 110 basis points to 41.2% at December 31, from 42.3% a year ago.
Our goal for fiscal year 2007 is to maintain our year-end homebuilding net debt to cap ratio in the low 40s.
At December 31, we have $1.8 billion available on our homebuilding revolving credit facility.
Our profitability and disciplined balance sheet management this quarter resulted in positive cash flows from operations for the second consecutive quarter.
Our positive operating cash flows were approximately $296 million this quarter, and over the past six months, we have generated approximately $1.2 billion of cash flows from operations.
Don?
Don Tomnitz - President, CEO
Thank you, Stacey.
In conclusion, we continue to see a very challenging industry environment for fiscal 2007; however, we are proud of our peoples performance as exemplified by our sales pace over the last 12 months continuing to lead the industry, record Q1 closings, our strong gross margins given the competitiveness in the current sales environment, our SG&A decreasing 100 basis points year-over-year and remaining on track to achieve our targeted guideline of 10% annually, permitting D.R.
Horton to continue to be the low cost operator.
D.R.
Horton and each of its reporting regions remain profitable.
Finally, I have personally visited all of our salespeople and our Senior Managers in all but three of our Markets over the past eight weeks.
We have the best people in the industry as our track record clearly reflects and the best salespeople in the industry as our sales and closing numbers reflect.
D.R. and I recently hosted our top salespeople from each of our markets at Camp Horton in South Texas.
They, their fellow salespeople, and all of our employees clearly know and embrace our company mission, to continue to out sell, out close, and to out earn all of our competitors, so that D.R.
Horton will continue to be the leader in the homebuilding industry.
This concludes our prepared comments.
Two things, one, Shannon Brooks departed us back about a week ago.
Shannon Farell.
Her husband is being transferred to Denver and we want to just say she served five good years with the IR department and we wish her the best.
Secondly, during this Q&A period, you'll be permitted one question and one follow-up, so we can have fairness with all of our people.
We're now ready to entertain questions.
Operator
[OPERATOR INSTRUCTIONS] Your first question comes from the line of Michael Rehaut with JP Morgan.
Michael Rehaut - Analyst
Hi, good morning.
Don Tomnitz - President, CEO
Good morning, Michael.
Michael Rehaut - Analyst
I guess my first of the two questions, could you describe the -- in terms of the charges declining from the last quarter, where you've seen by contrast many other builders have a higher November or December end quarter with the charges, have you ever had any thoughts in terms of why you've been below some of the other builders?
Was it -- I think you've mentioned cutting back over the last 18 months in investment in California or just describe, has the -- do you feel that the market has stabilized over the last three months in terms of perhaps incentives that you feel more confident in the assets that you have currently?
Don Tomnitz - President, CEO
I'd say, Michael, there's a combination of two things.
Clearly, four years ago, Horton as a Company decided to slow our growth rate and as a result, we reduced our top line and our bottom line guidance which also translated into a less aggressive approach on the land and lot acquisition, and then secondly, as Don Horton likes to say, I believe that we have been very proactive in trying to decrease the risk associated with the size of our projects and as we've said before, we don't enter into joint venture agreements largely because of the fact that we prefer to do deals that are more size relative to our divisions and our regions and don't want to bet any one region or any one division on any particular land deal, so I would say it's been the conservative approach we've had on land and acquisition which we've had since inception when we started the Company in '78.
Stacey Dwyer - EVP, Treasurer
I think you see that in our gross margins too, Michael.
We're still recording an 18.6% gross margin on homes and that's only down 230 basis points from our last quarter.
So as we look at the projects that we're looking at on an individual basis on the overall Company, we're not seeing significant margin deterioration from our September quarter to our December quarter.
Don Tomnitz - President, CEO
And clearly as I mentioned to you when we were traveling around when we were in New York with you, from an operating perspective, we impaired everything we could impair in each of the last three quarters and we're following very strictly the guidelines that are set up, the accounting guidelines as we continue to beat the consensus, clearly, I hate to say this from an operators perspective.
We have room for more impairments but we're taking impairments that are appropriate.
Michael Rehaut - Analyst
That's great.
I appreciate that, and just I guess the second question or the follow-up question, and I think you hit on this, Stacey, with the gross margins being where they were, we took notice of that as well and I was wondering if you could give us color in terms of spec homes as a percent of the closing, something we've observed is that over the last quarter or two, given the high cancellation rates, the builders have had to resell a much higher percentage of spec homes in the closings during the quarter and I was wondering if you could give color on that and also what that might have been an impact in terms of the gross margins, how much lower of a gross margin those homes represent?
Stacey Dwyer - EVP, Treasurer
Michael, in terms of the percentages historically it's been about 30% of specs that are sold and closed in the same quarter.
This quarter, we were up around 40%, so we are seeing some more of that because of the higher spec count.
In terms of impact on the margin, we typically see a slightly lower margin with any spec sale than we would on a build to suit but I don't think that's something that we've got quantified at the moment.
Michael Rehaut - Analyst
Thank you.
Don Tomnitz - President, CEO
Thank you.
Operator
Your next question comes from the line of Margaret Whelan with UBS.
Margaret Whelan - Analyst
Good morning, folks.
Don Tomnitz - President, CEO
Good morning, Margaret.
Margaret Whelan - Analyst
D.T., here is what I'm struggling with, just in light of this, I believe you've given us no earnings guidance whatsoever.
You said you want to out sell, out deliver, and out earn your peers, and many of your peers continue to build specs more aggressively now than Horton is is based on what you've said today and what I've heard in the field from our contacts.
So I'm trying to figure out what is your strategy going to be this year?
If you don't start to build specs in the spring there's a risk you won't get as many closings and how are you balancing all of that out?
Don Tomnitz - President, CEO
Well, clearly right now we feel like we have more than enough specs and we're replacing those specs on a very judicious basis where we need them.
Clearly one of our issues is is that we probably have more specs in slower areas than we need and we probably have fewer specs in the areas which are higher selling areas so our game plan is is to continue to work through the specs in the slower communities as profitable a pace as we can.
Margaret Whelan - Analyst
Yes.
Don Tomnitz - President, CEO
And replace them in the stronger communities.
Margaret Whelan - Analyst
Just a follow-up to that.
Can you give us a sense for the rate of growth and the community count we should expect?
Don Tomnitz - President, CEO
Well, it's going to be up slightly over last year and clearly that's a function of the fact that we began developing sites 6, 12 months ago that are now coming to fruition and it will be up slightly over what it was at this time last year.
Margaret Whelan - Analyst
Okay.
My second question is just around the land charges.
Yours have been lower in the dollar magnitude relative to your peers but are actually much greater in the absolute change in your lock downs, so you did mention in answering Mike's question that there's potential for more charges but it sounds like you're not accelerating them so how should we think about charges for the rest of the year?
Bill Wheat - EVP, CFO
Well, first as far as the change in our lock count, most of that has come out of our option lots and so that's only been -- any charges associated with that has only been reflected in write-offs of earnest money and pre-acquisition costs.
Our owned count has not changed significantly thus far.
Stacey Dwyer - EVP, Treasurer
I think one of the reasons you're seeing lower write-off on thos amounts from D.R.
Horton is we tend to put up less earnest money than a lot of our competitors do, simply because we're doing straight option deals and they aren't contracts with either third party land banks or with joint ventures so we just have less dollars at risk for those contracts.
In terms of what we expect for the year there's really no way to quantify that and as we said before if we knew what the dollar was we would have to take it now which is something we'll continue to evaluate.
Margaret Whelan - Analyst
I missed it if you gave it, but what percent of your lots were owned versus option this quarter?
Don Tomnitz - President, CEO
63% are owned and 37% are optioned, Margaret.
Margaret Whelan - Analyst
Okay, thanks, guys.
Don Tomnitz - President, CEO
Yes.
Operator
Your next question comes from the line of Stephen Kim with Citigroup.
Stephen Kim - Analyst
Okay, great.
Thanks, guys.
I wanted to ask a question regarding cancellation rates.
I guess you gave the cancellation rates the quarter you actually gave it by month which was very helpful, thanks for that.
I triangulate in on a cancellation rate as a percentage of beginning backlog at about 24%.
What would be interesting for me would be to know, if you have any visibility on where that number, given recent trends is expected to be in 1Q or where you sort of feel it's operating now.
Did that also sort of experience a sort of a sequential decline?
Stacey Dwyer - EVP, Treasurer
Steve, that's something we don't have a lot of visibility into to try to project.
We're really waiting to get our arms around the selling season this quarter.
If we continue to see a decline in the absolute cancellation rates of our sales I think you'll see that come down as a percentage of our beginning backlog as well.
Stephen Kim - Analyst
Yes, I mean, and this isn't a question, but more of a statement that it seems to me that if that cancellation rate as a percentage of backlog really stays flat, your cancellation rate as a percentage of gross orders is going to come down into the very low 20s it looks like to me, so that wasn't really a question though.
Don Tomnitz - President, CEO
We're certainly hoping for that, yes.
Stephen Kim - Analyst
My second question relates to M&A activity.
There was a time, there have been a couple of times over the last 10, 15 years when the Home Builders got whacked that -- and a lot of fear came into the market that you've really had an opportunity to sort of step in and make some material acquisitions of assets and of people, personnel.
And during those previous times, I think your staff or your roster looked a little different and I know that a few, a couple years ago, you guys sort of went on and said well, you sort of de-emphasizing that initiative or that focus away from sort of M&A and you sort of indicated that was the proper thing to do.
I would think that we're starting to enter a period of time when maybe it might be time to rev that machine back up, so my question is number one, do you -- can you give us a sense for what your guys are thinking of in terms of timing for really gearing up the M&A sort of due diligence and number two, if you feel that you've got the systems and the personnel in place with existing, with your existing personnel, to do that or if we should not be surprised to see you get more active on that front both in terms of something tangible with assets and also with personnel.
Don Tomnitz - President, CEO
Well, first of all I would say that if anyone in the industry knows where land prices are going to be in the next six months I wish they would call me because I'm a little confused myself.
As you look at why we would do an acquisition certainly our foot print across the U.S. is as I like to say we have enough states that are red and we aren't really trying to color the blue states red any longer but at the same time, the only reason we would want to do that is if we felt like that we needed to add to our current land and lot inventory which at this stage in the game, we absolutely do not.
So as a result for us, we feel that our land and lot position is more than adequate today and that that would take away any reason for us to do an acquisition on that front.
As to your second question, I would say to you that we've got a complete staff at this company and we don't need to bring anyone in from the outside to do any M&A activity for us.
We're more than capable of analyzing the deals as we do on a week to week basis, but as Stacey likes to say, there's nothing out there that floats her boat right now.
Stephen Kim - Analyst
Got it.
Great.
Thanks a lot.
Operator
Your next question comes from the line of Nishu Sood with Deutsche Bank.
Nishu Sood - Analyst
Thanks, good morning, guys.
Don Tomnitz - President, CEO
Good morning.
Nishu Sood - Analyst
First question was on your cost cutting efforts.
I think it was two quarters ago you had mentioned that you had a goal of I think it was over $200 million in cost cuts.
At this stage, have most of those flowed through or are we still looking at some of those ahead and what if anything have you looked at in terms of a second phase of cost cuts?
Don Tomnitz - President, CEO
Clearly what we said a quarter or so or two quarters ago, is we said that it would take -- we had most of the -- we had all of the cost cuts identified, but it was going to take two and maybe three quarters for those to flow through our P&L and we're seeing that come through today but we've still got another quarter to two quarters to see all of those flow through.
We have identified additional cuts.
We have on the shelf as I've told our people, and those cuts are there in anticipation of our sales not materializing into what we want them to be at this point in time, they're on the shelf and that's where they are going to stay and we're going to see how our sales do in the second quarter and come probably end of March, first of April, we'll have a clearer picture on that.
Nishu Sood - Analyst
Now your SG&A ratio just in terms of where we might see the impact of these cost cuts, your SG&A ratio has obviously remained pretty impressive relative to your peers but your gross margin has also been declining at a slower rate so would you attribute any of that to the kind of cost cutting or operational initiatives you have or how do you understand that?
Don Tomnitz - President, CEO
First of all not to be critical but to be objective, I think our SG&A is the leader in the industry so just to help you correct that, and in terms of the others in terms of flowing through our gross margin, Stacey, Bill?
Stacey Dwyer - EVP, Treasurer
Definitely you're seeing some of the efforts of going back and reworking some of our contracts with our subcontractors, with our material suppliers and probably also seeing some impact from renegotiating land contracts on the option contracts where we're buying developed lots coming through.
Past that I think you're seeing the impact of our geographic diversity compared to some other builders who are operating in fewer geographic markets that may have more substantial margin declines in those markets.
Don Tomnitz - President, CEO
And I think also clearly we were criticized, not to bring up a sore point, but 12 months ago we were being criticized for being the leader in terms of sales and reducing or increasing our discounts and I think we did it at exactly the right time and that's a function of where I think our margins are today as we did it earlier as opposed to later.
Nishu Sood - Analyst
Right.
Just a final quick question.
Don, you mentioned that in looking at this next round of cost cuts that you still have on the shelf, depends on your -- how sales turn out.
I know you guys aren't providing an outlook and I respect that, forecasting less delivering more, but some of your peers have allowed themselves to be more optimistic and so just internally, in terms of looking ahead, or how you're managing things, are you also allowing yourselves a little bit more optimism or are you still looking at this as a kind of early leg of a multi-year downturn?
Don Tomnitz - President, CEO
Latter.
I think this is we're on the very early stages.
Horton and I were talking the other day.
We're about 12 months into this slowdown and we have been in business together for 23 years and this is unfortunately my fourth downturn.
But nevertheless, it's just a function of most of these downturns are longer and deeper and right now we don't see anything on the horizon that would change that opinion.
Nishu Sood - Analyst
Okay.
Thanks a lot.
Operator
Your next question comes from the line of Dan Oppenheim with Banc of America.
Dan Oppenheim - Analyst
Thanks very much.
Wondering if you can talk about the homes, goals for spec homes, the percentage of homes that are in construction, clearly the number of homes under construction has come down, both the good lower spec homes but also the bad, lower backlog as you look out to the second and third quarter of this year.
And how long do you think it will be until you get to your target of the mid 30% range for specs as a percent of homes under construction?
Don Tomnitz - President, CEO
Dan, I think that's going to be clearly two quarters and it could be three quarters.
It's just a slower process than we anticipated, but I think we clearly have two more quarters of reducing the spec percentage.
Dan Oppenheim - Analyst
Thanks, and then secondly, was just wondering if you could comment in terms of just giving a sense of the margins by region?
Don Tomnitz - President, CEO
Mr. Wheat I believe will have here, is digging for that number, those numbers.
Bill Wheat - EVP, CFO
We'll record our operating margins in our 10-Q by region so on an operating margin basis, and everything would be after impairments, we're going to range from a low of around 2% on the low end of operating margins up to a high of around 10% and that's simply for the quarter, and that is a post-impairment number.
Dan Oppenheim - Analyst
Okay.
Thanks very much.
Operator
Your next question comes from the line of Timothy Jones with Wasserman & Associates.
Timothy Jones - Analyst
What is your goal to reduce your land position to?
Don Tomnitz - President, CEO
Good morning, Mr. Jones.
Timothy Jones - Analyst
How are you?
Don Tomnitz - President, CEO
I'm doing great.
How about yourself?
Timothy Jones - Analyst
I'm doing a little better, thank you.
Don Tomnitz - President, CEO
Good.
To answer your question, we would like to get our land and lot supply closer to 3.5 to 4 years and if we could get it down to 3 we would at this stage, but I think a more realistic goal is to get it first to 4 and then try to get it under 4.
Timothy Jones - Analyst
I mean, on that question, did you have sort of, I'm sorry, back half was your deliveries, are expected to be, do you have a number on the lots for that?
Don Tomnitz - President, CEO
The total number of lots we would like to get down to?
Timothy Jones - Analyst
Yes.
Don Tomnitz - President, CEO
Well, I would say to you that if you assume, I know we're--.
Timothy Jones - Analyst
I'm just saying, this is hypothetical, you know that.
Don Tomnitz - President, CEO
Yes, I understand your hypothetical.
I would say to you that right now we're sitting at about 300,000 lots and I think we would be happier to be somewhere around 200,000 lots right now.
Timothy Jones - Analyst
Really, that much lower, okay.
And the second question, I just didn't quite understand, you went from 40,000 to 26,000 homes under construction and the specs you said stayed roughly at 30%, that would imply that they went from 20,000 to 13,000 yet you said something about specs being down only 2000.
I didn't understand that statement.
Bill Wheat - EVP, CFO
The change in the total inventory was compared to our peak at June.
The 2000 number on the change in specs that was just the changes this quarter.
Timothy Jones - Analyst
Oh, thank you.
Bill Wheat - EVP, CFO
Your rough numbers overall on the spec decreases are about right.
Timothy Jones - Analyst
Yes, okay.
That's why I didn't understand it.
Thank you.
Don Tomnitz - President, CEO
Yes, sir.
Operator
Your next question comes from the line of Kenneth Zener with Merrill Lynch.
Kenneth Zener - Analyst
Good morning.
Don Tomnitz - President, CEO
Good morning.
Kenneth Zener - Analyst
Can you discuss the declining orders that we saw in the South Central which I believe is mostly Texas and if there was different order rates within kind of the four key markets there, Dallas and Houston, because it seemed to be a larger drop than I would have expected.
Don Tomnitz - President, CEO
I would say to you that one of the markets that declined for us in the South Central was San Antonio which was somewhat of a surprise to us but nevertheless there was a stronger decrease in San Antonio than we had expected.
The Austin market was pretty much in line as well as the Dallas market and Houston really performed a little bit better for us than we had anticipated but largely San Antonio.
Kenneth Zener - Analyst
Okay and I guess if you could just -- if there was a particular reason for that and my second question would be the roughly 22% decline we saw in average order prices in the Southwest, wondering what type of structural changes you could put in place that would enable you to keep margins at the current level with that type of price decline.
Thank you very much.
Don Tomnitz - President, CEO
In San Antonio on your follow-up on San Antonio, I think it's a function of that the market has just gotten a little softer in San Antonio a little later than the other markets.
I still believe San Antonio is a good market but at this point in time it got softer later than the others and with respect to our average sales price decline in the Southwest, clearly the Southwest is primarily Arizona and Colorado for us.
We do continue to see a very competitive environment in Arizona, so the incentive levels certainly have increased there relative to a year ago and in Colorado, it's still a very challenging market as evidenced a bit by the charges that we had this quarter in the State of Colorado so the pricing environment there is definitely more challenging than it was a year ago as well.
Which is absolutely amazing to me, but it is and Colorado specifically, we thought Colorado would start to firm this year and that is not happening.
Next question?
Operator
Your next question comes from the line of Susan Berliner with Bear Stearns.
Susan Berliner - Analyst
Good morning.
Was just -- I think there was a little bit of a change.
I thought you guys had said prior that you would expect hitting the bottom around mid year; is that correct?
Don Tomnitz - President, CEO
What I said was and I've said this for two quarters is that it's going to take two to three quarters for the market to bottom out, and so as a result that's, I would say somewhere mid year, we expect the market to begin to bottom out, but we also said clearly that we don't expect any rapid improvement in the market thereafter.
We expect the market to remain relatively flat to slightly up commencing in '08 and that's just our feeling at this point in time.
Susan Berliner - Analyst
Great.
I appreciate that and can you just comment on your free cash flow, what your primary uses are?
Is it bank line repayment?
Bill Wheat - EVP, CFO
Yes.
Our number one use initially is to reduce our bank line so certainly reducing debt is the number one priority.
Susan Berliner - Analyst
And what is outstanding on your bank line right now?
Bill Wheat - EVP, CFO
$550 million of cash borrowings on the revolver right now so we have $1.8 billion available on a revolver.
Susan Berliner - Analyst
Great.
Just wanted to check.
Thanks so much.
Operator
Your next question comes from the line of Carl Reichardt with Wachovia Securities.
Carl Reichardt - Analyst
Guys, how are you?
Don Tomnitz - President, CEO
We're doing great, Carl.
Yourself?
Carl Reichardt - Analyst
Don, I was curious as we enter the selling season here, can you describe how your product mix, especially in new communities that you've opened that are replacing older ones has changed relative to last year?
I'm particularly interested if your focus has been apart from geography more on entry level lower price product and also just more attached versus detached or whatever it is, what the most significant changes are?
Don Tomnitz - President, CEO
The most significant change is when we're trying to get our sales prices down vis-a-vis getting our cost down both on the lot side as well as on the labor side as well as on the material side, because one of the most difficult things facing the industry as well as Horton is just a lack of affordability.
As I tell people, we've done a great job of raising our prices over the last three to four years and we've just depleted or decreased that pool of affordable buyers out there, so our focus has largely been on trying to drive down our cost on our existing products so we can offer our sales prices at lower level to have more affordability out there in the marketplace.
I would say in terms of attached product, our experience is as we move into softer markets, the attached product is less attractive than the detached product and so what our main focus has been is how do we get more detached product out there at a lower price.
Carl Reichardt - Analyst
Okay.
But just to try to drill down, if we look at maybe, because you don't provide community count, your turnover, is the percentage of communities in this year fiscal second quarter that are new, open this quarter relative to last year changed or is it down?
So you're opening more new communities I guess in this quarter than you did last year as a percentage of your total.
Don Tomnitz - President, CEO
Yes, sir, we are.
We certainly opened more communities as far as a percentage of the total, I'm not sure that that has changed significantly, hasn't moved the needle that much.
Carl Reichardt - Analyst
Great.
Thanks a lot, guys.
Operator
The next question comes from the line of Steve Fockens with Lehman Brothers.
Steve Fockens - Analyst
Good morning, guys.
Don Tomnitz - President, CEO
Good morning, Steve.
Steve Fockens - Analyst
I think last quarter you had talked about a rough goal or a hope in '07 of generating somewhere in the range of a billion in free cash or something in that range.
Is that still kind of the number you would be trying to aim for this year?
Don Tomnitz - President, CEO
Yes.
Steve Fockens - Analyst
And so following on that, if your first priority of that is to pay down what's outstanding on your revolver and it sounds like from an earlier question, I think that Steve asked, that M&A is not much of a priority, with whatever additional cash you generate this year, is your priority to let it sit on the balance sheet and wait for other opportunities or would you think about dividends or buybacks or how are you thinking about that right now?
Don Tomnitz - President, CEO
Well, clearly one of the things with we would use those funds for is we do have some debt that is callable that we--.
Stacey Dwyer - EVP, Treasurer
There's an issue that's callable in April of '07 which is at 8.5% and that's something that we'll evaluate and make a formal announcement later but that would be a potential use for cash.
As Bill mentioned the 550 on the revolving credit facility, and we have already increased our dividend, we have the highest dividend yield in the homebuilding industry, we're paying $0.60 a share right now.
Don Tomnitz - President, CEO
And as I've said before, I'll reiterate one more time, the level of our shareholders out there that don't buy our stock based upon us buying back our shares because as we've said before during a softening environment in the industry, we believe the preservation and the accumulation of additional liquidity is the right thing to do.
Steve Fockens - Analyst
Fair enough thanks and just one quick follow-up.
As you look forward to the spring selling season, how would you -- or what would have to come about for you to consider actually a good spring selling season?
Don Tomnitz - President, CEO
Well, one of the things that we are focusing on is how do we get on a year-over-year basis, Steve, positive on our sales comps and I would say to you if we can end the second quarter and the third quarter, get positive year-over-year, we would look upon that as a successful sales season.
Bill Wheat - EVP, CFO
And certainly if we saw some stability in pricing as well.
Steve Fockens - Analyst
Great.
Thanks.
Don Tomnitz - President, CEO
Yes.
Operator
Your next question comes from the line of Ivy Zelman with Credit Suisse.
Ivy Zelman - Analyst
Good morning, guys, hi.
Don Tomnitz - President, CEO
Good morning.
Ivy Zelman - Analyst
I wanted to understand with respect to your orders that you took this quarter, what percent would you say were coming from speculative inventory, and then assuming that you're selling a majority of spec because you want to work through that spec as you try to do so, has it been more challenging to sell dirt and as you look into the spring selling season and hopefully work through the inventories, can you say with confidence that can't, possibly can't go back up again if you're selling dirt?
Is that something that you would worry about?
That's my first question.
Don Tomnitz - President, CEO
Well, I would say in terms of the dirt as we're selling more dirt, certainly we're getting higher deposits, Ivy, earnest money deposits on the dirt sales so we would anticipate those numbers, or cancellation rates going down.
Our focus from our sales perspective clearly has been you've got the specs.
Sell them to close this month or sell them to close next quarter so we can reduce our number of specs.
And dirt is really a low priority for us right now, but again, as we sell dirt even today, we're getting a higher deposit so that could translate into a lower cancellation rate going forward.
Ivy Zelman - Analyst
Okay.
And my second question relates to some statements that you've made within the last several months at my housing conference in September, there were clients in a breakout that said that historically, you've looked at what homes have been under construction and that a good rule of thumb you would double that and that would give you your closings expectations for '07 and this was in September, and then also, recently in your New York meetings, you held with Michael Rehaut, analysts that told me they were at the meeting said that you said you could, this year, you expect to do 50,000 units or you were projecting that you could meet or exceed 50,000 for '07 closings and I'm wondering as you reduce your spec and the number of homes in backlog, obviously are very low relative to that goal, wondering how you're going to to achieve that?
Don Tomnitz - President, CEO
Clearly what we said, maybe I'll let Stacey say clearly what we said in New York and Boston.
Stacey Dwyer - EVP, Treasurer
Well, and we actually talked about it in our conference cal.
In terms of positioning going into this year, we had about 25,000 homes in inventory and typically, yes, what we have in inventory is what we can generally deliver in terms of closings over the next six months so you basically double that to get to 12 month, so if sales supported it with the current inventory levels we could have delivered 50,000 homes that would be flat and that's how we were going into this year positioned with our overhead structure as well.
So those have been the conversations around our inventory levels.
Ivy Zelman - Analyst
I'm sorry, I was just going to say that your goal to reduce spec historically you've also been the mid 30% target range for specs would mean that you're starting more and now that you're not starting as much, it just seems like that historic rule of thumb might not be as able to come to fruition.
Don Tomnitz - President, CEO
I don't think there's any question that that's going to be a difficult number to achieve and that's why we didn't give it as guidance.
I think we were asking this, what we would look upon as a successful year and we said our goal is to try to do the same thing that we did last year and as we see our sales materialize, certainly in the first quarter, it doesn't support that 50,000 unit number, but as our salespeople tell us in the field, we are not going to know anything about fiscal year '07 until we get to about April the 10th, when we count our sales for the second quarter and then we're going to pretty much know exactly where we're going to close in the fiscal year.
But at this time I would agree with you, 50,000 looks aggressive and that's why we did not give it as guidance.
Ivy Zelman - Analyst
Well, that's very -- I appreciate your comments, Don, and just sneaking one in and then I'll let the next question.
Your write-offs and what you said I thought was really fair on the impairments.
It looked like so far if I'm correct there hasn't been impairments in Nevada; is that correct?
Bill Wheat - EVP, CFO
That is correct.
Ivy Zelman - Analyst
Okay, thank you.
Operator
Your next question comes from the line of Jim Wilson with JMP Securities.
Jim Wilson - Analyst
Hi, thanks, good morning, everyone.
Was wondering, I'll make it kind of one question, two parts, if you could describe how the product that you're successfully selling might be shifting, is it lower price points, smaller homes, anything that might be interesting or useful and if it varies at all by region, how that pattern is taking place?
Don Tomnitz - President, CEO
Well, you may not like this answer, but as clearly, we've got as I think we disclosed, we've got right at 5,000 specs that are available to close immediately and our focus is how do we move those that we've already got under construction.
As we move forward as I mentioned, we're trying to drive down our price points across-the-board and recover our gross margins by driving down all of our cost components because clearly, we've got affordability issues in the industry.
I do think one of the things that has helped us with our sales and us being down less than everybody else is Horton and I have always said, we focused on that first time home buyer and the second time home buyer which is the biggest segment of the home building -- or home buying market and that still is true today, but we're trying to focus on the 5,000 we've got available to close and thereafter, we're trying to drive down the cost on those units so we can drive down the sales price on those units.
Jim Wilson - Analyst
And obviously, just one other thing.
What do you see or what do you hear as it relates to private companies, smaller companies, I mean obviously we can all see and hear the public builders, but what do you see as to the suffering going on within private companies, might be more leveraged than all you public players.
Don Tomnitz - President, CEO
Actually, Horton and I were talking about that the other day and I think clearly right now, I don't think they're suffering nearly as much as they are going to be suffering in the next 12 months because the large home builders are just now beginning to put back the lots to the developers, and I don't believe the banks have cut back nearly as much as they're going to on those small and medium sized builders so I think they are sort of operating in a period of euphoria currently and I think that's about to change because clearly, as we drive down our prices and drive down our incentives and so forth I think we're going to make the market much more competitive on them and as you know, they don't have the staying power and I think at some point in time the commercial bank has got to say you're not going to get the next loan and it's going to happen but it just hasn't happened on a large scale yet.
Jim Wilson - Analyst
That makes sense.
Thanks.
Operator
Your next question comes from the line of [Ricardo Klinebaum] with [DNT].
Ricardo Klinebaum - Analys
Hello, good morning.
Just had a question about Moody's report.
I assume you saw that several weeks ago.
They published a report on the homebuilding industry in which they put out some projections on interest coverage that various home builders can support relative to their covenants, and Moody's identified your company as being one having a weaker position relative to the industry that you could sustain a much lower decline in EBITDA in order to cover your interest costs.
They also signal, I think this may be erroneous, that your negative cash flow as of September 30, was 1.2 billion and as you pointed out today that you are positive cash flow to a significantly higher number.
I just was wondering what has been, what's your take on Moody's view and if there are -- on the bond side can you give us any comfort that we're not going to see a downgrade in your outlook or rating as a result of the agency's concerns?
Don Tomnitz - President, CEO
Well, I'd love to answer that question and Bill and Stacey have talked to Joe and we all have a lot of respect for Joe, and as I said, I haven't talked to him.
When I'm in New York the next time I'm going to schedule a visit and visit with him, but as Horton and I would tell you and the comfort we can give you is it's all about the E and when we take a look at our earnings relative to the other home builders, notwithstanding the fact that we might have a slightly different coverage metric in our revolver, clearly, as we have said here and as you look at our top competitors report over the course of the next week or so, you'll find out that we have out earned all of them, so in terms of the comfort that I would give you is about earnings and we've got positive earnings and certainly, I think it would be difficult for anyone to put us on watch or downgrade us with us outperforming the rest of the industry.
Bill Wheat - EVP, CFO
That earnings has translated to major cash flow over the last six months, because over the last six months, we have turned cash flow positive to the tune of $1.2 billion so certainly that points in the right direction as well, and then our prioritization of the cash that we do generate, first priority is to debt reduction, and so debt reduction over time certainly improves your interest incurred which is then the denominator of the coverage calculation.
So all the things we are doing point to maintaining and supporting as strong a coverage as we can.
Sam Fuller - Senior EVP-Finance
The cash flow number in Moody's report was for the entire fiscal year too, Ricardo, that may be where the confusion came.
We're saying that the last six months have been positive by 1.2 billion.
Don Tomnitz - President, CEO
And as we mentioned, our debt to cap is down year-over-year and we continue to -- we plan on continuing to improve that and maintain it, just exactly where we told Moody's and all of the other rating agencies in the low 40s.
Bill Wheat - EVP, CFO
Our debt to cap of 41.2 is the lowest debt to cap we have ever had at the end of a first quarter so we are certainly in a good position and going the right direction as well.
Ricardo Klinebaum - Analys
And you look forward into the year, I don't know if you can comment on this, what kind of assumptions are you making about deliveries, and the revenues that you generate from them relative to what effort they might be looking for.
Don Tomnitz - President, CEO
Well, go ahead, Stacey.
Stacey Dwyer - EVP, Treasurer
I was just -- we haven't really given any guidance in terms of what we're looking for for deliveries, or revenue, or earnings, so that's really not a question we can answer right now.
Ricardo Klinebaum - Analys
Thank you very much.
Stacey Dwyer - EVP, Treasurer
Thank you.
Don Tomnitz - President, CEO
Notwithstanding that, we've out sold, out closed, and out earned everybody else, so move on.
Operator
Your next question comes from the line of Stephen East with SIG.
Stephen East - Analyst
Good morning, everyone.
Don Tomnitz - President, CEO
Good morning, Stephen.
Stephen East - Analyst
A couple of quick questions.
First, on gross margin and then one about write-offs.
If you look at incentives as a percentage of the selling price, what's it look like, the quarter just ended versus last quarter and a year ago?
And then also, given your trajectory on costs with writing down land, et cetera, If pricing was stable, moving forward, incentives and pricing were stable moving forward, what would your gross margin look like versus your just ended quarter?
Stacey Dwyer - EVP, Treasurer
I'll take the first part, Steve, in terms of the incentives as a percentage impact on our gross margin.
Basically we look at the incentives combined with just overall sales softness and that was the 920 basis points decline that we saw in our margin year-over-year.
Just for historical perspective, that 920 basis points is about a third of the margin that we were running last year, so in terms of incentives, we're giving up about a third of what we earned last year.
Bill Wheat - EVP, CFO
And then certainly looking forward, if pricing remains stable at current levels and the impact on gross margin, we have analyzed the impact of land cost can as a percentage of our cost of sales and that has remained very steady over the last year, so we would actually, if pricing were to stabilize, if incentive levels were to stabilize, we would expect margins to start to stabilize at or near where we currently are.
On an overall basis.
Don Tomnitz - President, CEO
And as I've said over the last couple of quarters, and I've told our salespeople, really what's happening is that we're returning to a more normalized homebuilding gross margin environment.
It's been wonderful over the last four or five years when we've had 25% gross margin as high as that as the Company average and we've had markets where we've had 30, 35%, 40% gross profit margins and I tell people we've been in Disneyland the last four or five years, that's not what Horton and I have experienced in our number of years in the business together so we're going back to a more normalized homebuilding gross margin environment and that's why it's so key to being profitable in this environment.
The key is how do you keep your SG&A extraordinarily low, and that's I believe the key to us continuing to report earnings is because we've been able to absorb those lower gross margins with a lesser SG&A.
Stephen East - Analyst
Okay.
And just on the other part of it, I think Ivy was the one who asked about write-offs and Las Vegas.
I guess I'm a little bit more curious about Arizona.
No one, except for Meritage is really taking charges for Arizona and yet we're seeing significant price declines in housing, it looks like further out land is dropping quite a bit.
What do you all think is going on in there and why aren't we seeing write-offs from others and yourself in that market?
Don Tomnitz - President, CEO
Well, I know that people have been talking about the Arizona market it seems like for the last three or four quarters.
Are prices coming -- are more incentives being offered in the marketplace, to remain competitive in the marketplace?
Absolutely, but I will say to you as a company, we were north of 30% on our gross margins in Arizona over the course of the past two, three, four years and now we're going back to a more normalized gross profit margin and clearly, we've got higher price land working our way through, but we're also in the process of renegotiating land prices that we're closing on in that market today, so I feel like that one, we entered the market with high gross margins.
We're going back to lower gross margins and now we're working land that we're now closing that will be coming through the P&L over the course of the next 12 to 24 months and we've reworked those deals and renegotiated those deals so we feel good about the Arizona market.
Stephen East - Analyst
Okay, so it sounds like just the sheer starting level is a big part of it then?
Don Tomnitz - President, CEO
Yes, absolutely.
Stephen East - Analyst
Okay.
Don Tomnitz - President, CEO
And I get back to Steve, All of these write-offs are a function of how big a land bill you did and how good you were when you bought the land, and not a lot of builders like to hear this, but I can tell you that you make your money in this business when you buy the land and I think that we have been more conservative in both the size and the prices that we paid for our land than most and I think that's -- you're seeing that in our lower level of impairments and earnest money write-off.
Stephen East - Analyst
Okay.
Don Tomnitz - President, CEO
Not bragging, it's just stating a fact.
Stephen East - Analyst
All right thanks a lot.
Operator
Your next question comes from the line of Alex Barron with JMP Securities.
Alex Barron - Analyst
Yes, thanks, guys.
Wanted to see if you could quantify for us how many communities were impaired this quarter and how many lots were written off?
Don Tomnitz - President, CEO
See if I've got that list here, Alex.
As far as number of communities, it wasn't more than about 10 or 12 in total.
It's somewhere in that ballpark, and again, they were focused in the states of Colorado and California.
Virtually all of the impairments were in Colorado and California, and number of lots, I'm not sure if I have that handy right here, Alex.
But we can get back to you on that.
We can get that number for you.
Alex Barron - Analyst
Okay.
I guess I also wanted to know the number of your finished specs.
You mentioned it was about 5,000?
Don Tomnitz - President, CEO
That's correct.
Alex Barron - Analyst
Does that include your models or no?
Don Tomnitz - President, CEO
No, it does not include our models and I think when we say finished, that's, Bill, from what stage to what stage?
Bill Wheat - EVP, CFO
That would be from carpet flooring to absolutely complete.
Alex Barron - Analyst
Okay.
And how many models do you guys actually have approximately?
Bill Wheat - EVP, CFO
Right around 2000 models.
Alex Barron - Analyst
Okay.
And are both, okay, so the models are included in the count you gave for total homes under construction; is that correct ?
Bill Wheat - EVP, CFO
That's correct.
Alex Barron - Analyst
Great.
Thanks a lot.
Don Tomnitz - President, CEO
You're welcome.
Operator
Your next question comes from the line of Joel Locker with FBN Securities.
Joel Locker - Analyst
Hi, guys, just had a couple of inventory questions.
I'm just looking at the actual dollar backlog increase over the last two or three years versus the land under development, so you just kick out all of the specs and it's just pretty much raw land or finished lots and was looking at it and noticed dollar backlog was up 31% in the last three years versus 137% for land under development and on a two year rate, it was -- dollar backlogs were actually down 2.5% versus a 72% increase in land under development and was wondering, when you thought those two demand versus supply was going to get more in lined?
Stacey Dwyer - EVP, Treasurer
That's an ongoing process for us right now.
You're seeing that in our land spending and over the last couple of years we were building our land supplies to match the demand we were seeing and that's why you saw the inventories growing as the backlogs grew.
As our backlogs are coming now, we're spending significantly fewer dollars on land.
So you should start to see our inventory dollars even on the land side begin to decline, probably in fiscal year 2007, and hopefully, while you're seeing that decline, you also see backlog dollars come back up as we go into the spring selling season.
Joel Locker - Analyst
Do you think the gap will lessen to using that ratio of maybe 30% or less by the end of the fiscal '07?
Stacey Dwyer - EVP, Treasurer
We will see what happens with our sales.
That's going to be the real key driver for us, but Don was talking about wanting to reduce our lot supply from 300,000 lots down to 200,000 lots so really what you should see over a longer period of time and not just over fiscal year '07 is that inventory dollars will stay flat or actually go down while our backlog continues to grow.
Joel Locker - Analyst
Right.
I guess just the real capital side up in the owned lots which hasn't decreased much at all so it's just -- now that you've gone through a lot of the options it's just a matter of just closing owned lots without exercising anymore land options.
Don Tomnitz - President, CEO
You must have been on Horton and I's meeting last night because that is the real key right now is to the extent that even as we have more option lots coming to us, we probably don't need as many option lots coming at us as we've got coming at us, we'll determine that based upon our sales but clearly the initiative is now how we build through our own lot position and reduce that.
Joel Locker - Analyst
Right.
And just on the option lots which looks like about 100,000, what is your -- what's the actual dollars you have invested in those for acquisition costs and option deposits that you can't walk away from?
Don Tomnitz - President, CEO
We've got about about $140 million and that's all earnest money including a certain portion that is refundable.
Joel Locker - Analyst
Right so that's only $1,400 per option lot?
Don Tomnitz - President, CEO
We're down to about 4%.
Joel Locker - Analyst
Right.
Don Tomnitz - President, CEO
I think we've got about $40 million worth of pre acq. costs. 40 to 50?
Somewhere in that range.
Joel Locker - Analyst
Right.
And just last question, have you guys changed your percentage on a current or demand for orders that you're currently getting from customers, has that changed any in the last year?
Don Tomnitz - President, CEO
I would say yes, it has.
I don't mean to laugh about it but I'd say our earnest money deposit on spec sales is probably, probably, it has declined some, but on the dirt deals that Ivy was talking about earlier, we're clearly increasing those because we want to make that a less of a -- we want to make it a more challenging buy for the buyer, we want to move the existing inventory.
Joel Locker - Analyst
So as a percentage of -- as a purchase price it's actually going up on the dirt that's maybe closing six to nine months out or so?
Don Tomnitz - President, CEO
Yes.
Stacey Dwyer - EVP, Treasurer
Well, actually, I think we're talking about -- I want to clarify with you, Joel.
The earnest money that we're putting up to buy dirt is not increasing at all.
In fact that is probably trending down a little bit.
Joel Locker - Analyst
Right.
Stacey Dwyer - EVP, Treasurer
What we're getting from deposits from buyers on the specs that we have, that's probably coming down a little bit.
If it's a to be built home we're asking them to put more dollars at risk for us to take that contract.
Joel Locker - Analyst
Thanks a lot, guys.
Operator
Your next question comes from the line of Margaret Whelan.
Margaret Whelan - Analyst
Just want to clarify two things.
The first one is you want to see this dramatic reduction in your lot count, and you're saying that if you had any more charges that were kind of immediate, you would have taken them already and you think there's a lot of equity in land even in some of these markets, I think the most in the Southwest, so I'm trying to reconcile all of that with the fact that you're saying that D.T. and you have talked about this and you think it could be a multi-year correction.
Don Tomnitz - President, CEO
Well, we do think that it's a multi-year correction.
In terms of our lot count, I don't know if I understood your question, but basically we do believe we would like to see our lot count come down just as a number that we're throwing around, it's about 100,000 lots largely because of the fact that we would like to get our owned -- we would like to get our lot inventory both owned and option closer to a three year versus a four and a five year, such that we can then be more opportunistic purchasers of land assuming land prices come down.
If the land prices don't come down, we don't feel like we've hurt ourselves, but I don't believe that land prices are going to be more expensive going forward.
Bill Wheat - EVP, CFO
And that's a goal that won't be accomplished overnight and it's one that we'll evaluate project by project as we evaluate sales and where pricing is in each market to determine whether or not we're going to go forward with some of our option deals.
So while we have a goal to reduce our lot significantly, that doesn't mean that we're not still going to do some deals along the way.
So that's why we still have lots under option and earnest money outstanding on certain deals.
Margaret Whelan - Analyst
I understand that.
I guess where I'm confused is that D.T. in answering one of the questions, you said that you believe that a lot of the land developers, the smaller builders, private builders maybe are going to be more financially constrained, and if that's the case in the next 12, 18 months then we're going to see another whole area of distress and prices will fall, so it seems like you should be cleaning up your lot count earlier rather than later.
Assuming that I heard you right and that's what you were saying.
Don Tomnitz - President, CEO
Well, believe me, Margaret, I think you're exactly right.
We would love to clean it up a lot faster than what we are even cleaning it up right now.
It's just a function of how quickly we can clean it up and when you say clean it up we have got 100,000 lots that we have under option, we have got about 200,000 lots that we own.
The issue is as we got -- as those option lots come to us, there are attractive option lots that we're going to want do close.
We've got an owned section of 200,000 lots that unfortunately the only way we can work through those is for our sales to increase at a faster pace than what they are increasing and that's the only way we can clean up the problem faster.
So we're doing as much as we can do and have been doing it longer than everyone else trying to clean up the lot position vis-a-vis sales.
Bill Wheat - EVP, CFO
We've already taken 100,000 lots out of our option position already.
Some of the lots under option are '08, '09 closings and so there's certainly no need to address those today.
We can continue to evaluate the market and then to take action later on.
Don Tomnitz - President, CEO
That's an excellent point.
Margaret Whelan - Analyst
Okay, so relative to the sales, the deliveries, whether or not it's 50,000, that seems pretty aggressive but whatever that number ends up being, it seems to me that buyers at your price point are going to be more focused on price than anything else and if you have peers who are carrying more specs or homes that are closer to being finished, that those peers are going to gain the sales because we all know these first time buyers that their credit isn't always great, often in the time it takes you to buildout a house, they 're gone.
They've wiped out their credit and so I just -- I don't really understand this, what your strategy in terms of not building the specs, trying to have the discipline there but you think it's going to be another couple years of a down market.
Stacey Dwyer - EVP, Treasurer
Margaret, I want to make sure that we're clear we're not saying we're not building any specs.
We're saying that right now our spec percentage is at 48 and we want to get that back down to our historical percentage of 35%.
So, while we are certainly starting fewer specs and we want to bring that down as a percentage of our inventory, I'm not sure that that's going to impact our sales going forward, kind of circling back to the conversation we had before, if we look at our inventory that basically indicates homes that we can deliver over the next six months and we still have approximately 25,000 homes in inventory.
So I don't think that we're going to be constrained in terms of having product on the ground to sell versus the competition.
Don Tomnitz - President, CEO
And really, I think to put it succinctly we're looking at our trailing six-month sales and we're saying, all right, we started off the year thinking well, gee, we would like to do 50,000 in '07.
We're not giving you that number but if we had our desires that's what we would like to have given our inventory levels, now we're down to 25,000 units, 26,000 units under construction and so that would imply that we would be closing 52,000 units, but if that doesn't keep pace and all of a sudden our sales are slower in Q2, then that number is going to probably translate down to somewhere around 23 or 24,000 units under construction and would translate into a 48,000.
Stacey Dwyer - EVP, Treasurer
But even at that number, we're not constrained in terms of being able to sell against the competition.
Don Tomnitz - President, CEO
Absolutely not.
Margaret Whelan - Analyst
Just seems the competition that's building the houses now and relative to all of the vacant houses in the system that you are going to be constrained because you won't be able to build them quickly enough.
Don Tomnitz - President, CEO
We're still building specs today.
While we started one half the number of homes this quarter as a year ago, we still started a significant number of homes this quarter.
We're just balancing the supply we have versus the sales volume.
Right now we have more specs than we would like compared to the sales volume, but we're just simply getting it in balance.
Stacey Dwyer - EVP, Treasurer
From that perspective, Margaret, I would tell you we have a lot of homes that we can sell against the competition in the upcoming quarter.
We're going to be in a very good sales position.
Do you see a situation where some of the move up builders who do carry a lot of specs are now selling bigger homes, on bigger lots for the same price you're offering or lower price?
Don Tomnitz - President, CEO
Every market is different and to answer your question directly, I'm not seeing that, what we're really focusing on is we're trying to focus on driving down every cost in the system such that we can sell the house that we were selling a year ago for less but have a higher margin in it than what we have today.
And I think that's the real key to going forth to the industry, dealing with the affordability issue is we have all experienced cost increases over the last four or five years as the business has gotten very good, and as a result, not only have we gotten those cost increases back vis-a-vis raising prices but we've also had a lot of pricing power so we've raised prices and I think that's clearly sucked a lot of affordability out of every market and the only way the industry can get back to being in a stronger position is to get our costs down and increase the pool of affordable buyers.
Margaret Whelan - Analyst
And having less expensive land will help.
Don Tomnitz - President, CEO
Yes.
And I remember many years ago, I was riding around in a car with one of your competitors and he was talking about writing a piece and he did about the pool of affordable buyers decreasing.
It didn't happen to happen, it didn't happen in the time period that he thought it was going to happen but it definitely has happened in the last year or two years and that's the biggest challenge facing the industry is how do we get our costs down so we can get our sales price down.
But we are going to be, we are currently in a phenomenal position in terms of product available to sell for this quarter and the next quarter and as Bill said, we are replacing not all of the specs that we're selling because we're selling some specs in markets where we don't -- or in subdivisions where we don't need anymore specs, where we've got too many, but in those markets and those subdivisions where we need more specs, we're starting the specs.
Margaret Whelan - Analyst
I'm not saying that you should build specs.
I'm just trying to reconcile everything that you've said relative to what our model should be for '07 and to be clear.
And given your view that there are going to be more distressed land developers over the next whatever period, 6, 12 months, do you have a team set up now that's going in and starting to look at those assets?
Don Tomnitz - President, CEO
Well, we constantly have teams in every one of our markets from our regional teams to our corporate team that analyzes all possible investments for us and as you know, Stacey heads up our M&A activity so where we get our feedback the best is not from us sitting up here in the ivory tower, saying gee, we ought to be buying lots, distressed lots in Orlando.
We expect Rob Lawson and David Alt to tell us, hey, there's a great opportunity to buy distressed lots in Orlando and that's one of the reasons that we, Horton and I have concluded that we want to drive down our current inventory of lots is because we believe there are going to be opportunistic purchases available at lower costs than the future.
Operator
Your next question comes from the line of Michael Rehaut with JP Morgan.
Michael Rehaut - Analyst
Yes, hi.
I would agree with you in terms of lowering the specs that that is still a pretty prudent strategy given that there's still excess inventory out there and you have your full array of model homes out there, so I think in terms of this industry getting better, the most discipline on the supply side is a key thing.
On that topic, I was wondering if you could comment in some of the key markets that you're in, California, Florida, in particular, also Vegas and Arizona, what you're seeing in terms of the inventory situation over the last -- during your first quarter, trends within the quarter, if you have seen any encouraging, any declines in inventory or any of those markets on the margin stabilize, get better, get worse?
Don Tomnitz - President, CEO
Well, clearly I believe California, Mike, entered the downturn earlier than everyone else, and so as a result, we're beginning to see better sales in California as a company and we're seeing less inventory on the ground in that market as we move through more of a more normalized, it's not a normalized market but the market is stabilizing some.
In Florida, I think we've got as an industry too much inventory on the ground in Florida.
In Arizona I think we've got too much industry on the ground in Arizona and I think the same is in Las Vegas and I think if you look at those three markets, they entered into a softening later than California, so we still have excess inventory in those latter three markets to work through.
Michael Rehaut - Analyst
And in California, I mean certainly in the order trends on a regional basis, California was down 18% versus down almost 40% last quarter.
Did you come out of the quarter on a month by month basis?
Was there improvement throughout that trend if you're seeing beginning to see better sales, did that finally reach a positive year-over-year number or where are we within that context?
Don Tomnitz - President, CEO
We don't like to comment on a month to month sales based upon even our own company, about our region, but I'll say this about California.
They clearly nail their budget in terms of sales and closings, their internal budget for the Company and I thought that was a major accomplishment for our California region.
So that would indicate to me that we found the market and -- because we hit the sales in the closing and now that we found the market, our goal in California is to take our margins up.
And any description North versus -- Northern versus Southern?
Any particular areas of relative one being ahead of the other?
Michael Rehaut - Analyst
Well, actually, I believe one is Sacramento made a major accomplishment in terms of moving through excess inventory and I believe clearly that central market if you look at the Ventura area, Oxnard area, that area is still a good -- has always been a good solid market for us.
We saw some more weakening in the inland empire than we've seen in the past and San Diego is still weak So I look at Northern California as being slightly stronger than Southern California right now.
Operator
Thank you, Ladies and gentlemen.
We have reached our allotted time for questions and answers.
Mr. Tomnitz, are there any closing remarks?
Don Tomnitz - President, CEO
Yes, there are.
I want to thank everyone for joining our conference call.
Most importantly, I want to thank all of our salespeople who we've seen over the course of the past eight weeks as well as our Senior Management.
We've made a lot of major strides in this company.
We're very proud of the success that you had in the first quarter and it makes us proud that you're going to continue that tradition in the quarters ahead.
We all know we've got a tough mission ahead of us but to report the earnings that we did relative to the competition or relative to what we think the competition is going to report you did an outstanding job so thank you very much and we look forward to talking to you at the end of Q2.
Operator
This concludes today's conference call.
You may now disconnect.