霍頓房屋 (DHI) 2007 Q2 法說會逐字稿

Good morning, my name is Brandy, 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 homebuilder in the United States, second quarter 2007 conference call.

(OPERATOR INSTRUCTIONS)

I'd like to turn the call over to Don Tomnitz, President and CEO.

Sir, you may begin your conference.

Thank you, Brandy.

Joining me this morning is Sam Fuller, Senior Executive Vice President of Finance; Bill Wheat, Executive Vice President and CFO; and Stacey Dwyer, Executive Vice President, Treasurer, and Head of Investor Relations.

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 10-K 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 for joining D.R.

Horton, America's Builder, the largest builder in the United States, second-quarter conference call.

First, we would like to thank our people for their hard work this quarter during a time when the market conditions continue to be challenging in the homebuilding industry.

Second, we continue to operate in a very difficult homebuilding environment and, in spite of this, we are improving our already strong balance sheet while we continue to manage our business profitably.

Third, we are very proud of our positive operating cash flows which were positive for the third consecutive quarter.

Fourth, we improved our ratio of homebuilding debt-to-total-capitalization net of cash by 300 basis points year-over-year.

Bill?

As a result of the current industry conditions, our gross profit margin on home sales revenues in the second quarter before inventory impairments and land option write-offs was 17.7%, down 78O basis points from our home sales margin of 25.5% in the year ago period and down 90 basis points sequentially from our first-quarter margin of 18.6%.

These declines were due primarily to core margin compression resulting from a lack of pricing power as reflected in our 7% decrease in average sales price and increased use of sales incentives relative to last year.

During the second quarter, we recorded inventory impairments of $67.3 million as a charge to cost of sales, impacting gross profit by approximately 215 basis points.

These impairment charges are associated with projects that had a pre-impairment carrying value of approximately $256 million, and over 80% of the charges related to projects located in California.

Projects in Sacramento accounted for the majority of the California charges.

Sam?

We continue to adjust our land option contracts relative to current demand, which resulted in a $13.9 million of write-offs of earnest money deposits and pre-acquisition costs related to land option contracts.

That had an approximate 50 basis point gross profit impact.

Our supply of land and lots at March 31st is approximately 266,000 lots owned and controlled, down 33% from our peak of 396,000 lots at March 31, 2006.

Two thirds of the lots at March 31, 2007, are owned and one third are optioned.

We started the current Fiscal Year with 323,000 lots, a 6.1 year land supply based on trailing 12 months closings, and have reduced our current lot position to a 5.3 year supply.

Stacey?

Homebuilding SG&A expense for the quarter was 11.3% of total homebuilding revenues compared to 10.3% a year ago.

For the six months, our homebuilding SG&A was 10.9% compared to 10.8% a year ago.

Our ongoing SG&A goal for each fiscal year is to be at or below 10% of homebuilding revenue.

While achieving our 10% goal will likely be challenging this year, we are pleased with the progress we've made in managing our SG&A expenses relative to our revenue level.

On an absolute dollar basis, we reduced our second quarter SG&A expenses approximately $70 million or 19% from a year ago on 22% lower unit closing volume.

At our current SG&A run rate, we are on track to exceed our stated $220 million SG&A savings goal.

Included in these savings is our reduction from approximately 10,000 employees last spring to our current level of approximately 7,300.

We continue to focus on being the low cost operator in the industry, which remains one of our distinct competitive advantages and a key to our consistent profitability.

Financial Services pre-tax income was $7.3 million for the March quarter and $34.5 million for the six-month period.

Based on current conditions in the mortgage industry, we increased our loan loss reserve during the quarter by approximately $14 million to a total reserve balance of $31.2 million at March 31, 2007.

95% of our mortgage Company revenue was captive during the quarter, and our companywide capture rate improved to approximately 68% from 67% a year ago.

Our average FICO score was 716 this quarter, comparable to the year ago quarter.

Our average cumulative loan to value for the quarter was 90% compared to 89% in the year ago quarter.

Sam?

For the third consecutive quarter, we started only about one half as many homes as compared to the prior year.

Our total number of homes under construction remain flat since the first quarter at approximately 26,000 homes.

Total speculative homes declined slightly to 46% of total homes under construction compared to 48% at December 31st, and we reduced our completed spec count from the first quarter by 14% to approximately 4,300 homes at March 31st.

Our target spec percentage remains in the mid 30s.

Stacey?

Our homebuilding leverage ratio net of unrestricted cash improved 300 basis points to 40.9% at March 31st from 43.9% a year ago.

At March 31st we have $1.9 billion available on our homebuilding revolving credit facility.

On April 15th, we called $250 million of 8.5% senior notes, which will result in charges related to the early retirement of debt of approximately $12 million during our third quarter.

Our profitability and disciplined balance sheet management this quarter resulted in positive cash flows from operations for the third consecutive quarter.

Our positive operating cash flows were approximately $175 million this quarter, and our continued goal for fiscal 2007 is to generate in excess of $1 billion in free cash flow.

Don?

Thank you, Stacey.

Once again, D.R.

Horton accomplished one of its primary goals in Q2 -- remaining profitable in a difficult environment.

We are very proud of this profitability, along with the improvement in our balance sheet.

Specifically, we delevered our balance sheet, improved our liquidity, reduced our lot and land inventory, decreased our housing starts, all the while working to maximize the return in each and every community across the country.

This was made possible by our employees' superior performance relative to our competitors.

Once again, D.R.

Horton outsold, outclosed, and outearned everyone else in the industry.

Our corporate goal is to continue to outsell, outclose, and outearn all of our competitors, proving once again that D.R.

Horton is the leader in the industry.

Again, thank you to the men and women of D.R.

Horton who have helped us achieve all of these successes.

Together, we have taken D.R.

Horton from $3,000 in beginning equity to the highest equity base in the homebuilding industry.

What an accomplishment.

Thank you.

We'll now entertain any questions you may have.

[OPERATOR INSTRUCTIONS] Michael Rehaut with JPMorgan.

Hi, good morning.

Good morning, Michael.

First question I have is on inventory reduction.

You continue to move down in the right direction of completed spec, but your target goal of 30% of homes under construction is still a little bit far from being achieved, so I was wondering if you could give us some insight into how that's coming along.

And also as a percent of homes closed, can you give us an idea what cancelled resold homes represented?

Well, I can answer the first part of the question and Stacey or Bill can answer the second part of the question.

We are trying to get our specs down to that mid 30% level.

Frankly, our sales were slower in this quarter than what we had expected and anticipated.

As a result at the beginning of Q3, we're moving more aggressively toward selling more homes in Q3 and certainly in Q4, and as a result our pricing is more competitive going forward and I think that we'll clearly make a bigger dent in those 4,300 spec homes that are currently completed and available for sale.

As far as cancelled and resold homes, Mike, that's not a number we have specifically.

Clearly it continues to be at a much higher level than it had been historically as our cancellation rate remains elevated up above 30% and that's certainly something that our operators are focused on each and every month as they have homes that turn into specs after cancellations and turning them back around into sales and closings as quick as possible.

Okay, second question is on the Financial Services.

You mentioned that you increased your loan loss reserve by $14 million.

But what I'm curious about is given the concerns about liquidity and financing in the secondary markets for sub prime, did you have to take any losses on the mortgages held for -- actual losses aside from reserves or less profitability than you had anticipated, and are you getting any increases in early payment default claims?

Regarding mortgages held for sale, certainly with the tightening and liquidity in the marketplace, the price is being paid for loans -- on certain types of loans certainly has tightened a bit.

So the profitability levels on those loans have tightened versus the levels we saw a year and two years ago.

But as far as losses there have not been significant levels there.

As far as requests for repurchases on early payment default, we have certainly seen some increase there and that is what has been reflected in our reserve increases over the last several quarters including this quarter.

Our mortgage company though over the course of the past couple years have been very proactive in terms of trying to keep our tail as short as possible in terms of any exposure on EPD's so we feel comfortable we're properly reserved for any future EPD's.

Stephen Kim with Citigroup.

Hi, guys.

Good morning.

Good morning.

I was curious if you could talk a little bit about how you manage your goals for inventories, not so much on a quarter by quarter basis because I know that's affected by things like cancellations -- but rather looking more like three quarters, two or three quarters out.

For instance, would you feel comfortable sharing what your anticipated targeted level of inventories might be a year from today?

Or put it a different way, would it be unrealistic to think that under a moderate order scenario -- let's call it, orders up 10% or something like that, once you anniversary easy comps -- that you could get a level of inventory that is 20% lower than where you're currently running on inventory?

Would that be unrealistic?

First of all, I am waiting with great expectation where we can say that sales are up 10%.

We'll get there eventually.

Yes.

The answer to your question, indirectly, because we haven't disclosed where our inventory target is for the end of this fiscal year.

But rest assured, at the beginning of this fiscal year and then we readjusted it in January when we had our regional presence in a -- sequestered at our ranch for about four days -- we clearly stated and gave them goals of inventory reductions that they needed to hit by the end of this fiscal year.

That's how you achieved your free cash flow goals?

That is correct, but they have specific inventory reductions to achieve both in the combination of less land purchases as well as fewer homes under construction.

And really just on an ongoing basis, there are constant adjustments to targets on a division by division basis based on the year supply of lots that they own as compared to what their sales projections, closing projections are as well as the number of homes in inventory and specs in inventory relative to the changing estimates and projections of closing in each division.

So that's really an ongoing adjustment to the overall goals.

I'm the person approving all spec starts and also all land closings currently so we have a specific goal and Bill says he's done a spreadsheet for every regional President in every division.

And they know exactly how many starts they can have relative to how many sales they've had to justify those starts.

I have no doubt that you're going to be able to achieve free cash flow this year equivalent -- close to what you're guiding of about $1 billion.

I guess what I'm really interested in, particularly since you have September fiscal year, is how the first couple of quarters of '08 might be looking.

And to try to get a handle on that, it might help to know in your projections for let's say $1 billion in free cash flow by September, end of September, do you assume that your revised goals, and the level -- for example, you gave 30% spec ratio and what not -- should we assume that your $1 billion at the end of September assumes that you have arrived at those new comfortable levels by the end of the year?

Or should we continue to expect progress on those metrics so that we could still continue to expect additional free cash generation in the first couple of quarters of '08?

Based upon the way we see the market looking forward, we believe that there will be continued softness in '08 and I would expect that we'll continue to adjust our inventories downward in the first two quarters of '08 because we don't expect the market to turn on a dime come (multiple speakers) of '08.

Even though I'd like for it to, it's just not going to happen.

So clearly we're going to see what our sales are over the next two quarters and to the extent that they don't justify it, we're going to continue to dramatically decrease our inventory levels both WIP as well as land.

Stacey?

One thing I want to clarify, Steve, is our spec goal is to be back down into the mid 30s, not necessarily all the way back down to 30.

And in terms of our cash flow goals, I think we can continue to achieve that even with an elevated spec level because we are definitely generating positive free cash flow right now.

And if the cancellation rate remains elevated it probably will take us a little while longer to work that spec level down.

In other words '08 is going to be a year where you're going to continue to generate cash in the first few quarters?

That would certainly be our goal based upon what we see the first half of '08 today.

Great.

Thank you very much.

Yes, sir.

Margaret Whelan with UBS.

Actually, Dave Goldberg on for Margaret.

How are you doing?

Doing great.

Good morning.

Good morning.

I was wondering if you could give us some color if you have any idea approximately what percentage of your cancellations were from buyers who could no longer qualify because of tighter credit standards or couldn't sell existing homes because of tighter credit standards.

And maybe how you guys are preparing to try to get your buyers to be able to qualify in an environment where we do have tighter market for mortgages?

Well, Stacey can answer the first question, I'll answer the second question.

The way we're trying to get our buyers -- i.e., you're asking the question how are we increasing the pool of affordable buyers -- the way we're doing that clearly and have been working on that for the last 12 months is how do we drive down our average sales price.

And that's a function of how we drive down our land prices and how we drive down both our labor and materials cost which we've been working on very strongly.

So that's the key that we see in terms of increasing our pool of affordable buyers.

We face headwinds, we believe, and strong headwinds we believe, during the course of the next 6 to 12 months with the illiquidity in the mortgage industry.

So the only way that we can increase that pool of affordable buyers is to make a product more affordable and lower our average sales price.

We're already seeing some shift among products too.

In terms of a percent of our volume our government loans are up about 3% and we're seeing certainly in our application pipeline fewer people going to sub prime and Alt-A and actually going for full documentation loans.

It's a longer process which is why people are using the Alt-A products in the first place.

But now with less liquidity in those markets they are going back to the full documentation loans.

In terms of cancellations specifically related to the mortgage product, we're sure we had some, but since our cancellation rate remains flat with where we were last quarter -- while we know there were some, we don't think that was probably significantly changed from the prior quarter.

I guess the follow-up would be, how exposed do you think the backlog is currently to people who might have trouble qualifying when you actually go to deliver?

Just have you guys been able to scrub that?

Is there a way to work through that and know how clean the backlog is looking forward?

We believe our cancellation rate is not going to go down.

We think that based upon what's happened to us this quarter and the first quarter and especially as we looked at our cancellation rate in each month of this quarter, it was pretty much steady, even post the mortgage issue.

So we anticipate going forward that our cancellation rates will stay about the same and therefore we're factoring that into our projected closings relative to what our backlog should cancel out at.

And we think it will cancel out at pretty much what it has over the last two quarters.

Thank you.

Yes.

Nishu Sood with Deutsche Banc.

Thanks, good morning, guys.

Good morning to you.

First thing I wanted to ask about was California.

In your reported California division, your volumes were down worse there than they were in the other divisions.

But on the other hand, your selling price, your order price was up, I think about 5%.

I was wondering if you could just talk about your approach there recently in balancing the price versus volume trade off.

California is tough, let me use that word to be politically correct today.

And really to answer your question what are we doing in California, we are becoming more competitive on our pricing than what we were last quarter.

Because last quarter, California performed for us worse than it did in the first quarter, and we tried to hold our pricing in California in Q2 and it didn't work.

Given the fact that we have the highest operating margins in the industry, we're going to adjust -- we have already adjusted our pricing to hit our volume targets in Q3.

And the real issue out there, frankly, is that four or five years ago almost 30% of the people in California could afford a home.

And then that dropped to 11 or 12% affordability index.

And unfortunately, the 11 or 12% was being supported by a lot of unusual mortgages -- Alt-A and sub prime.

So what we're facing today in California is -- one, a very small pool of affordable buyers and that pool has been reliant largely on Alt-A and sub prime mortgages, so we must get our pricing down, must get our costs down in order to move our number of units that we want to move in California and that's what we're doing.

So was the increase in the order price, was that more of a mix issue?

I really don't know.

I think really more than anything out there, it's just most, there are several markets in California which are still good, but the northern part of California up in the Sacramento area and the San Diego area is just that we're struggling to find qualified buyers given the mortgage instruments that are available in the marketplace.

And just a second question, obviously the focus on free cash flow generation this year.

You've talked about targeting your debt levels in the low 40s as a percentage of total capital.

Now you're there, but I would wonder, in this type of environment given how difficult it continues to be, would you be considering pushing your debt-to-capital levels below -- shoring up your liquidity and pushing your debt-to-capital levels below that target range just given how difficult things continue to be out there?

Yes.

We do expect to, our leverage to drop down below our target of 40% in the current environment.

Our number one priority for our free cash flow is to reduce debt and to maintain and keep our liquidity at a maximum level so that we have maximum flexibility to make the operational decisions or take advantage of opportunities that may arise as we move through the cycle.

So yes, we do expect our leverage to move down below our target.

Okay.

Thanks.

Dan Oppenheim with Banc of America.

Thanks very much.

Was wondering if you can comment again on California in terms of when you've adjusted your pricing strategy with just this quarter?

And if so, if you have seen any changes in your order trends since that's taken place and if you can quantify the magnitude of the pricing changes you're implementing there?

We adjusted our pricing within the last 30 days and obviously we can't comment on order trends because we only do that once a quarter.

But we're there to meet the market and wherever the market is and thank goodness that we have the highest operating margins in the industry and we can be more competitive than anyone else and we're going to be there.

And how far below the second-quarter pricing is the pricing in terms of meeting the market today?

Well, Dan, it's going to depend upon division by division, subdivision by subdivision and frankly a house by house, week by week, day by day basis relative to how many homes do we have left to sell to hit our target at any point in time in a specific subdivision.

Okay.

I'm not trying to avoid your question but I can tell you, it's a day-to-day ground battle out there house by house.

Got it.

In terms of the impairments in California, what was the age of the land there that was being impaired?

I know this may come as a surprise to many of the analysts out there, but I believe the first, that land was purchased in 2004.

The majority of it, yes, was purchased in 2004.

And when we're looking in the total projects that we overall impaired, more than half of them are active projects and we have some that were longer term deals, but generally the land has been purchased several years ago.

As a matter of fact you can, if you don't mind, Stacey, explain the age of our land in terms so that people can understand exactly how much of our land we bought over the last three or four years as opposed to some people thinking that we bought 100% of our land in 2006 or something like that.

Yeah, we have gone through and aged our land based on the contract date because that's when the pricing was actually set, and more than two thirds of our land was contracted for in 2004 and earlier.

So we do have land that we bought in the last couple of years, but the majority of our land, the pricing was set before the peak years of 2005 and 2006.

Which one could conclude that could be one of the reasons why D.R.

Horton continues to have lesser impairments as a percentage of our total assets as some of our competitors.

Thanks very much.

Greg [Gieber] with A.G.

Edwards.

Good morning, guys.

Good morning, Mr.

Gieber.

Obviously, the orders in the second quarter came in less than you expected and you're not reducing your spec count as fast as you wanted to.

Besides reducing prices obviously you can cut back further on production.

Perhaps you could give us some idea of what you expect third-quarter production starts to be versus a year ago?

Will you cut them more than the half you did in the second quarter?

That's going to track basically with where we're seeing ongoing sales versus our ongoing inventory and really by market and by region.

We do expect our starts to continue to trend down versus a year ago, whether it will be half or a little bit less or a little bit more, that's really division by division.

As I mentioned earlier, Bill and his staff have done a great job of spreading every division and providing them with specific hard data that says, here are how many homes you can start relative to how many homes you've sold relative to how many homes we want in inventory in any specific market.

So our division presidents and our regional presidents don't really have any questions about how many homes they can start.

It's already laid out for them.

It's really relative to sales, and if our sales are less, our starts are less.

Okay, in your Press Release, you say further increases in the use of sales incentives.

What would that imply for your margins going forward?

You were about a little under 18% gross margins this quarter.

May I assume that it's going to decline over the next couple of quarters?

I think that it would simply because of the fact that clearly, we're disappointed with our level of sales in Q2.

We're happy with the ones we made but we had higher expectations and, as a result, we're marking our inventory to market across the country to hit our unit targets by the end of the Fiscal Year.

So I would say that in Q3 and Q4, we could experience and likely could experience some additional gross profit margin erosion.

However, again, I'd like to once again state that since we have the highest operating margins in the industry, we can better meet the market than anyone else out there.

Okay, and a final question, since nobody has asked it yet, could you just state, was there any difference in the year-over-year results if you went through each month during the quarter?

Really, all three of our months in terms of sales closings and cancellations were pretty level.

There wasn't any one month that was significantly worse than the other month or better than the other month.

It was just pretty much the market for us particularly as it relates to cancellations pretty much we were flat throughout the quarter.

And of course, as it is with all of our quarters, the third month of the quarter is stronger than the second month, and typically the second month is stronger than the first month in terms of closings and earnings.

Okay, thank you.

And I don't think you need to be politically correct in your statement.

Thank you.

I won't be.

Joel Locker with FBN Securities.

Hi, guys.

I was curious on how much of your land was purchased 2003 and before if you included 2004 with '05 and '06?

No good deed should go unpunished.

We gave you more information than we've ever given.

Anyway, go ahead, Stacey.

I was just going to say, Joel, I don't have that number.

I don't have the spreadsheet in front of me.

We calculated it by year but the number we put in our script notes was just for 2004 and earlier.

But I would suppose that a significant portion was in '04 just based on the capital going up about 200% in the last four years.

Would that be safe to assume over 50% is in '04, '05, and '06?

I don't want to give you an absolute answer, but that's the reason we phrased it the way we did in the contracted (inaudible).

So that's not necessarily fallowing the capital outlays but it's when the pricing was set.

Right.

I understand.

(multiple speakers) the market initially.

So we don't have a definitive answer for you on that.

And most of our tracts of land are longer entitlement periods, and it is important and I think that's what we're trying to let everyone know is the day we contracted for it relative to the day we closed it.

Right.

And just a second question on the backlog conversion rate.

So that slowed year-over-year despite backlog being 20% lower at the end of the December quarter, and just wondering if you could give me a little color on why that slowed year-over-year?

The biggest reason is as we look at our cancellation rates, that is also elevated year-over-year.

So even though we have homes available to sell, the ones that have cancelled obviously were not deliveries for us in Q1 -- or excuse me, Q2.

Right.

Just in the December quarter cancellation rate was up year-over-year also, but yet the conversion rate was higher then.

So that's just to do with cancellation rate and no other reasons?

That's really the main reason.

It's just cancellations.

It's difficult to pinpoint exactly how many cans you're going to have on a month to month and quarter to quarter basis right now.

We're happy that our can rate pretty much stayed stable in each month of the quarter.

And also, I would say to you that right now we have sort of a Catch-22.

We would like to lower our cancellation rate but we don't want to lower our cancellation rate vis-a-vis by writing fewer contracts.

As I've said to all of our salespeople, if a buyer is warm and has a pulse, we want to try to put them on paper and get them qualified right now.

So we're going to take the buyer out of the market, write the deal, and if it cans later we at least tried.

Thanks a lot.

Yes, sir.

Kenneth Zener with Merrill Lynch.

Good morning.

Good morning.

A couple questions here.

If you could talk about Texas, which is for you guys largely south central, which had order declines of 34% in 2Q versus 29% in 1Q -- can you tell us the trends within your key markets there and why it's deteriorating so much given affordability and relatively strong job growth?

I mean I hear a lot of anecdotes about pre-buying and sub prime and all those things but I'd be interested in your market analysis why orders in Texas are down so much.

I think the biggest driver is really San Antonio is much softer this year than what it was last year.

Secondly, the Dallas Fort Worth market, there's a lot of press about foreclosures and defaults and I think that's adversely affecting future buyers in the Dallas Fort Worth market.

Having said all that, we feel very strong about the fact that we have -- even though our sales were down, we had very good earnings out of the State of Texas and we're struggling with softer markets in San Antonio and softer in Dallas Fort Worth really.

I guess a follow-up to your comments are expanding among your profitability, what's really interesting about your guys' performance is how stable and strong it is amongst your segments.

You guys have last quarter about 5 to 7% operating margin, for all your divisions.

Can you kind of talk about the profitability spread by segments, before we get the Q?

We'll have the details in the Q, I don't have the details here in front of me.

I can tell you on a -- certainly on a pre-impairment write-off basis, we will show profitability again in each region.

On a post-impairment basis because of the write-offs in California, we will show a loss in this quarter in the California segment.

But as far as changes in the profitability by region, clearly, there will be -- it will reflect some of the overall shift in the margin from last quarter to this quarter.

And not to toot our own horn, but I guess to toot our own horn, we're very proud of the fact that pre-impairments we were profitable everywhere, and post-impairments we were only at a loss in one region in California -- and like I said earlier on the conference call, California is a challenge right now.

We're here to meet the challenge, but it's a tough market right now in California.

No, I think you guys did very well in the margins and that's clear by your results.

I guess last question about California.

Why did you guys change your philosophy of meeting the market there and try to hold price to keep margins?

This seemed to be an interesting change and obviously it didn't work, but what led you to that initial decision?

Thank you.

Well clearly, in the fourth quarter of fiscal year '06 and the first quarter of '07, we really reduced our pricing long before our competitors did out there, and we had our first program was rock bottom pricing.

And we sold a lot of homes at a lesser margin.

And then in the following quarter we went to what's called rock solid pricing, in other words we tried to take our margins up ever so slightly in California because coming off of the historical margins that we had been experiencing in California which were 30 to 40% gross margins to where we had to go with rock bottom pricing, we said well, maybe we can take our pricing up some in the next quarter and it just didn't work for us.

So I think clearly what it was is we were trying to generate a little bit more profit out of California than what we thought and the market is not ready for that today.

And we had achieved -- in Q4 and in Q1 we had reduced our homes in inventory significantly in California, so we were in a position where we weren't having to move a lot of standing inventory either so it was a good opportunity to test the market.

Don't be confused about one thing.

We're back to rock bottom pricing in California.

Right.

So it's secular issues that you're facing, not actual inventory issues.

No, sir, we're not.

That's exactly what Bill said, in the fourth quarter of '06 and the first quarter of '07 we had some inventory coming at us and we wanted to make sure we reduced that inventory.

And when we got rid of that excess inventory we saw coming at us, we said let's take our prices up, and so I said the market is not ready for that largely because it's a function in California today of one major issue -- the affordability index is at almost an all-time low and that coupled with the mortgage liquidity crisis, it's just tough sales out there right now.

Thank you.

Yes.

Timothy Jones with Wasserman & Associates.

Good morning.

Good morning, Mr.

Jones.

The first question -- I have to apologize because your Operator asked me a question just as it was asked -- but it was a very important question, so I'd like to ask it again.

That had to do with your expected continued high cancellation rates even though, one, your inventories right now, your backlogs are down 30%.

Two, you're saying you're going to lower the prices.

Both of these things should lower the cancellations relative to sales yet you're not expecting that.

And you did give an answer, but if you could give it again because I missed it.

I don't think we can expect the cancellation rates to come down because even though we're adjusting our pricing and we don't have as much completed inventory to move, we're still faced with a liquidity crisis in the mortgage industry and I think that's going to get worse over the next two to three quarters as opposed to better.

A lot of companies are having substantially lower sequential cancellation rates than you are.

Just by getting the higher margins like toward double or maybe triple some of your competitors, are you just maybe being too greedy on the margins?

I don't think we could ever be too greedy for our shareholders on the margin.

How about for your salesmen?

Well, we have a specific unit target that we want our salespeople to hit and we're adjusting our prices to help them get there.

I will also say that I don't want at this stage in the game -- it's a Catch 22.

Would I like to get back to historical 18 to 20% cancellation rate?

Yes.

But I don't want to get there until we get our units where we want them to be, so therefore, I look at a 30% cancellation rate today as a good thing.

I would you, the other thing that we tell all of our salespeople, all of our division presidents is sign people up.

They may cancel, but let's take them out of the market and let's get them committed to a house, let's get them qualified.

And if they cancel they cancel, but we're going to go through the process of taking the people out of the market and getting them in our backlog and having the opportunity to close a home to them.

And the second question, would you go a little bit more detail on your $14 million adjustment in your financial side?

Could you maybe give the main parts of it?

Did it come off of revenues to start with?

And secondly, you said early pre-payments were one of them.

Could you give me two or three or four of the other things and roughly how much each was?

Yes, as far as classification, yes.

The adjustment in the reserve does come off the revenue line in the Financial Services segment.

I thought so.

As far as how we analyze the reserve and the major components, we certainly look at any specific loans that we may have that we know we may have a potential loss on or if we have had a request to either repurchase or address a loan that we have either previously sold or we presented to an investor.

And we look at each one of those loans and estimate what we think we'll be able to get for it, and if there's a loss then we add that to a reserve.

The other major component that we do look at is we look at what our tail may be, what our risk may be overall as far as early payment default provisions on loans that we have already sold to investors.

And our mortgage company has been very proactive in working that EPD tail down over the last year, but we factor that tail in and we look at our historic repurchases because of that provision.

And then we look at the current trends in the market and where those rates may go based on the liquidity crisis on the mortgage industry and we estimate a potential reserve for future losses for loans we've already sold that may come back to us.

I'm not going to get into the details of how much is in each component but those are the major components that make up the reserve.

Okay, thank you.

Thank you.

Ivy Zelman with Credit Suisse.

Good morning, everybody.

Good morning.

Question related to goodwill.

I don't know if you've taken any charges related to goodwill for Trimark, but from what I understand you've closed down that operation this past quarter, and I was wondering if you have taken a goodwill charge or will you take a goodwill charge?

And if you can elaborate to understanding why you shut it down and actually left, from what we understand, communities that were open for sale, it was a bit of a shock to the market -- first question.

Well I would answer that question as it's been a shock to us based upon the construction defect litigation on the treble damages associated with what we think is reasonable construction on our part.

And when it gets down to the point where our losses on our units are greater than our profits then it's no longer a profitable business.

And I've debated for the last two or three years as to whether we should be out of that business and I made the decision we're out of that business and we're going to focus clearly on one thing -- single family detached homes in the Colorado market.

And in terms of the impairment?

As far as goodwill overall, we look at our overall goodwill on an annual basis and we certainly get that analysis done before our Fiscal Year End.

As far as what FAS 142 requires in actually analyzing goodwill, you analyze it at a level -- basically at a region/market level, and we have significant operations in the Denver market over and on top of our attached product operations there.

And so no, there have not been any goodwill charges yet but we'll be having our ongoing evaluation prior to our fiscal year end and if there's any that need to be taken they will be taken.

Trimark was a very small percentage of our overall Denver operation.

Or Colorado operation.

It was purchased in '96, '97.

Right.

Thank you, and my second question would relate to just generally understanding on the impairment front.

You have taken very little impairments relative to some of your peers and realizing that prices, as you've indicated, D.T., are continuing to move downward.

Given the price erosion and the uncertainty and the difficult environment that we're in today, I'm assuming you do not get audited this quarter and you get reviewed through until the last quarter of your fiscal year.

Would you anticipate that there could be further impairments and can you walk us through your process, please?

First of all -- and I'm glad you asked that question because there has been noise in the marketplace about why D.R.

Horton has had fewer impairments than other builders.

And I can tell you around this office and with our auditors E&Y out of the Fort Worth office, we are impairing everything we can impair around here.

And if you go back to our first-quarter earnings, as I tell investors, when we exceeded the consensus, one would have concluded that if we could have taken more impairments we would have liked to.

I'm not saying I'm in disagreement because I am in agreement, but I can tell you we're impairing everything we can impair around here and we still have fewer impairments than other builders.

I think that's a function of a couple of things.

One is I think that we've been more diligent in our land and lot acquisitions and I also believe that we have higher operating margins than anyone in the industry.

If you want to look at future impairments in the homebuilding industry and who should have fewer impairments than anyone else in the industry, why wouldn't you conclude that it should be the homebuilder with the highest operating margins?

Well, with all due respect, Don, with all due respect, wouldn't you look at Toll Brothers as a competitor?

Or NDR, who have higher margins than you?

Ivy, I don't look at those people as competitors.

We compete with the Pultes, the Syntexes, the Lamars, and KBs.

Those are our competitors.

Those guys are not competitors of D.R.

Horton.

Okay, so anyway, I'm just saying though the price erosion that you talked about continuing -- let's assume that that continues, as you've indicated.

Are you saying that impairments will be ongoing for you?

We've impaired everything we can impair.

If the market gets worse, we've said this for --- this will be the third consecutive quarter, absolutely.

We'll have more impairments if the market continues to weaken.

And if you look at how our impairments have come about, it's been as our sales have gone down, as our absorptions have gone down, as our margins have moved, the level of impairments each quarter have moved along with it.

We started at a higher operating margin level and that's really where you start with in determining whether a project is impaired is what is your operating margin on that project.

So if you are starting at a higher level it will take more deterioration in the margin to actually trigger an impairment.

So I believe if there's more deterioration certainly there will be more impairments.

On a quarter to quarter basis, we do an analysis -- basically we screen all of our projects.

And our auditors review that process each and every quarter, and this will be disclosed in our 10-Q as it has been in our previous 10-Q's.

We keep essentially a watch list of projects that are not impaired yet, but that have lower operating margins that if further deterioration occurs could become impaired in the future.

What is that number that you guys watch if you look at gross margin and operating margin when you normalize it -- what would the margin that you use?

Well, as far as --

Are you asking the discount rate that we use?

No.

I'm not asking the discount rate.

If you're looking at your watch list, is it when it gets to a 5% net operating margin or what's your watch list for the project?

And then secondly, when you do take the impairments, what are you normalizing the margin to, in order to -- from a go forward basis?

Right.

As far as where the margins are when it hits the watch list, generally if it's hitting a single digit margin or nearing a single digit margin on an actual or a projected basis -- so there are some items on a gross margin level -- you'll see some items on the watch list that may have more than a 10% margin if we expect further deterioration in that project.

So on a gross margin level, certainly if it's single digit it's going to be on the watch list and then you then take off your SG&A expense to come down to your operating margin.

When you go through the discounted cash flow analysis to actually determine the amount of the impairment, there's a range of discount rates that are used.

And Ernst & Young is the auditor for most of the public home builders and I believe there's a fairly established range out there that I think generally is going to be in the low teens and on the low end.

And on the high end might be in the high teens, possibly on a longer term project with more uncertainty could be as high as 20%.

Right, but I was asking gross margin that you use, not the discount rate.

I understand the range on the discount rate based on the longevity of the project.

What about the range on the gross and SG&A?

Yeah, generally on a post-impairment basis you're going to wind up with a gross margin in the teens on a post-impairment basis, assuming all the assumptions come true precisely as they were modeled at the time of the charge.

Great.

Thanks a lot, guys.

Thank you.

Peter Young with In-Sink-Erator.

Good morning.

Good morning.

I had a comment or a question about what you anticipate your housing starts and closings will be or end up being for calendar '07.

Stacey?

Yeah, I was just going to say we haven't given any specific guidance on that.

As Bill talked in terms of the starts and the closing, that's going to be very dependent on our sales and then, as Don said, we're adjusting our pricing to hopefully hit the closing levels and sales levels that we're internally targeting.

But at this point that's not something we're ready to share.

So you're only projecting out through your Fiscal Year then?

Currently, yes, that's where we're projecting right now and we've got a number for '08 and we have our mid-year President's meeting next week, and we're going to get a clearer picture from them as to how many lots they actually have where they can pull permits on and start them and get them closed in fiscal year '08.

Because clearly as we've reduced our lot option contracts, we have fewer lots today than what we had a year ago, so now we want to clear the decks, take a look after these impairments -- write-offs in earnest money and due diligence, and we've reduced our land and lot supply to 5.3 months supply or -- wish it was 5.3 months -- 5.3 year supply, we want a clear picture on what we can actually produce in Fiscal Year '08.

Thank you.

Bob [Thompson] with Advantus Capital.

Hi, guys.

Just a couple questions.

You talked about getting the prices down in California.

What is -- what are the things that you can do to really bring the prices down?

Or is it things you can do in the construction process, or is it primarily a function of just lowering the margins to get those houses through the system?

Well, what we started with about three quarters ago was obviously giving up on the gross margin side, simply lowering our average selling price out there coupled with at the same point in time we were rebidding all of our labor and materials and trying to rework land contracts where we could.

As we continue to adjust our pricing downward, it means our subcontractors and our vendors and our land sellers are going to have to work more closely with us and align their prices with what the current market conditions are, so it's a function of the chicken and the egg, unfortunately.

First thing we've got to do right now, and we've already done it, is we've lowered our prices in California lower than what they were before.

So now we have to go back and recapture more on the cost side from our vendors and our subcontractors and our land sellers.

Okay.

Regarding the cancellations, has the substance of cancellations changed?

I know you had mentioned at the Home Builder Conference that a lot of them were coming in five months in.

Is that still the case or has that changed at all?

That's pretty much still the case, and we will expect it to remain the case as long as the cancellation rate's above historic norms.

Our historic cancellation rate is about 16 to 20%, generally happened pretty quickly.

That was mostly people who came in, signed a contract, then found out they couldn't qualify.

As our cancellation rate went up we really found it was because of two reasons.

People put a house under contract with a contingency to sell their existing home and then they weren't able to sell their existing home and that cancellation happens later in the process.

Or people who put a house under contract either just changed their mind and decided not to buy right now or find a better deal somewhere, and those also happened a little later in the process.

And a third thing that's happening later in the process is that as the mortgage environment changes and all of a sudden the mortgage instrument that they were qualified for when they bought -- first contracted to buy the home, by the time the home is ready for closing, that mortgage instrument may no longer be available.

So we're out searching for another mortgage instrument for them and sometimes those are not available so those are occurring later in the cycle also.

Okay.

And also, it sounds like if you generate somewhere in the vicinity of $1 billion, is your plan to use that to pay down some of your current debt or are there any other uses of that cash?

The first use is to pay down debt, and the second use will probably be to hang on to some cash to have liquidity to take advantage of opportunities, and then when we get to a point where we feel like we've got enough then we'll look at other opportunities for the cash.

Okay, do you have a target on the amount of debt you might pay down this year?

Well, first, we start with our revolving credit facility.

At the end of the March quarter, we had a $500 million balance on the facility.

We had $1.9 billion available under it so that would be our first use for the first $0.5 billion.

Okay.

And last question, just as more philosophical, but do you guys see any consolidation happening in the industry in the next year or two years as this downturn continues?

Yes.

Good enough.

Thank you.

Carl Reichardt with Wachovia Securities.

Good morning, guys, how are you?

Good morning, Carl.

I've got a question, Bill, for you on impairment reversals.

Was there any positive impact to gross margin this quarter from reversal of previously taken impairments?

Yes, there was, Carl.

I know Mike Murray is really happy to answer this question because he did the work to calculate it.

Yes, we had about a little over $22 million reverse this quarter from previously taken impairments.

Okay.

Great.

And then Don, in terms of the pricing strategies and tactics you used in California in Q1, in your other markets were you operating in a similar capacity in terms of trying to hold price at margin during the first quarter?

I assume it's not as aggressively as maybe you were in California but are there other markets where you operated a similar philosophy and now are changing that as well?

Well clearly in Florida we have for the last two quarters been trying to hold our prices, post our initial reduction, and we're not selling as many units in Florida as what we want to sell either and we're adjusting -- have already adjusted our pricing in Florida too.

So specifically, if you look at the markets where most of the price adjustment will need to take place on a going forward basis or we've already implemented it, would be -- one, California; two, Florida; and three, Arizona.

Terrific.

Thanks a lot, guys.

Thanks, Carl.

Jim Wilson With JMP Securities.

Hi, guys.

Yeah, I just had two questions.

One was cash flow, so I guess you pretty well answered that.

But I was wondering is it implied that you really are planning on making virtually no win acquisitions or is there done nothing that's starting to entice you out there in the land acquisition market that looked too good to pass up?

No, Jim, we are making land acquisitions and they are at a reduced rate.

As we mentioned at the beginning of the fiscal year, we anticipate closing on about $0.5 billion to $0.75 billion worth of new land in fiscal year '07.

And that will be driven largely by deals where we can achieve a 30% or higher gross margin return.

And so therefore, by setting that high hurdle rate, there just are not a lot of deals that are coming across our desk up here, but they're increasing at a certain rate but not to a large extent.

So basically, $0.5 billion to $0.75 billion we're going to buy but it's basically high margin deals where we also need lots because some of our divisions -- notwithstanding the fact that we had a high inventory of lots given a year ago, we had certain divisions that had a limited supply of lots which needed to buy lots.

Got it.

And then my other question, you mentioned at least what was, well I guess particularly weak in Texas and California, but could you give a little color further of good and bad in other parts of the country?

Well, first of all let me say in Texas, our sales were down, but they're off and one of the things we're facing as a Company, not to wind anybody, but we're coming off some more difficult comps.

And if you remember, a year ago, or the past several two or three quarters, we were the only one producing positive sales gains quarter, year-over-year, and so as a result we've got more difficult comps than the rest.

Another thing I would add on the South central in particular is even though the sales year-over-year comparisons have been difficult and negative, our year-over-year comparisons on our operating margin have actually been improving.

So while the volume of houses is down, the profits from those houses is up.

And I think clearly you see that in our higher than industry gross margins.

We clearly have focused on -- we don't like selling homes for practice, we've said that for a number of years and we said in California last quarter we tried to raise our prices, we weren't successful.

And in Texas, we basically -- we've tried to keep our margins up.

So we understand internally where we need to get to by fiscal year end and we're adjusting our pricing where it needs to be, but I say we're in a very fortunate position.

And I don't want to beat this dead horse to death, but we have the highest operating margins in the industry and we can meet the market better than anyone out there and we're going to do it.

Again, sorry -- in regional color, all that being said, in other parts of the country, could you give a little color on what's good and what's bad that you'd like to highlight?

Let me say first of all I think Seattle and Portland and the Pacific Northwest are very good markets for us, continue to be.

In California, I think if you get around the Ventura County, Oxnard area, that kind of area, we have two division Presidents there who are doing extraordinarily great jobs for us in those two areas.

When you go down to San Diego, that's a tough market for us and the Corona Riverside market in California is tough and Sacramento is tough.

So we've got two really central operators there around the Thousand Oaks area that are doing very well for us in California.

Phoenix is a good market.

It's gotten tougher with the mortgage illiquidity, but we've got good margins in Phoenix and we're continuing to outperform in the industry in Phoenix, we're not outperforming our expectations in Phoenix.

If you look at Chicago, we're doing well in Chicago.

Minneapolis has been a tougher market for us.

We've adjusted our pricing there.

The Northeast is beginning to see some recovery but it's slow.

Washington D.C.

is still slow.

Atlanta area is doing well for us, but Florida is weak for us.

And the coastal Carolinas, especially some of the Charlotte area and so forth, is a good market for us today.

Okay, great.

Thanks.

Steve Fockens with Lehman Brothers.

Hi, guys.

Good morning.

Good morning.

Two quick questions.

What were incentives as a percentage of sales price this quarter versus say a year ago?

Higher.

Any idea of the magnitude?

Yes.

What we usually talk about is our core margins, Steve, because we don't try to break it down between actually giving up dollars on the actual sales price versus an incentive, and --

Basically the entire reduction in our margins year-over-year and also sequentially is driven by more incentives and reductions in prices.

Okay, so that kind of leads to the second question -- on a longer term basis, presumably at some point you'll be returning to normal -- long term average normal or above.

Is that the first thing you should see in terms of a snap back?

If you get to the point across your markets where you have some better stability in supply and demand that you can bring down those incentives fairly quickly and margins begin to snap back quickly or is it a much more slow progress over time?

I think as the inventory nationwide and market by market gets more back to an equilibrium level that gives all of the home builders an opportunity to decrease their incentives and increase their margins.

And that's as quickly as flipping a switch tomorrow and saying gee, we -- all of a sudden we've sold more units than we desired in this subdivision or in this market and we need to raise our prices.

And we did that in California in Q2, we sold a lot of units in the fourth quarter of '06 and also we decided to raise our margins in Q1 and it didn't work, so we can adjust the pricing immediately.

And again, I don't want to draw too much distinction between incentives and pricing because if people get used to certain incentives in a market those incentives may have to stay.

So you might not see a free washer and dryer go away, but you can incrementally raise your base price which would then flow through to your gross margin.

So when you see some stabilization, you would start to see some margin improvement, but generally speaking you don't anticipate any significant snap back in any particular area?

Not right now.

I think that across the country with especially couple -- we still have high inventory levels across the country and coupled with the mortgage liquidity issue, I believe it's going to become more challenging, certainly in the next nine to 12 months.

And I think over the course of the next six months, hopefully we'll have sorted through most of the mortgage issues, but we're not sorted through the mortgage issues yet.

Sure.

Okay, thanks very much.

You're welcome.

Robert [Fatoe] with Votech.

Hi, guys.

I just wanted to ask a couple questions.

First of all on stock repurchases, activity there expected for '07?

Well, sir, I don't know if I've met you before, but for the last couple years I have been very forthright with our investors and that is that, one, please don't buy our stock if you're expecting us to buy back our stock because our goal right now is to maintain maximum liquidity.

And until such time as we get our debt paid down to where we want to get it paid down to and we haven't -- and we always have a desire to continue to try to increase our dividend, we want to use our cash for those two primary purposes.

Okay, and also you alluded to, I think earlier in the conference call, consolidation within the industry.

Any plans at the -- let's say over the next six months to 12 months in terms of M&A for you guys specifically?

Anything you're looking at, anything you could talk about in terms of over the next year or so going forward?

Obviously I cannot comment on M&A activity, but I will say that it's difficult to assign any value to any other builder, certainly for the next 6 months, maybe the next 12 months until we see where land prices sort out.

As I've said before, the main reason that you would do an acquisition is to take advantage of some other builder's land situation.

Because clearly we have enough flags and we have enough markets and we have enough cities so we're not really trying to significantly expand our geographic foot print since it's so large and well distributed today.

So for us to be able to assign some value to somebody else's land, we're focusing on trying to assign value to our land right now and that would be a very difficult deal.

Yeah, that's why I asked that question, because previously I remember you saying you would only make an acquisition if you needed more land and right now you had too much I believe was your comment last time.

Last question is on price expectations in terms of average selling price into 2007.

Can you give us some kind of indication in terms of percent increase-decrease where you think 2007 will net out?

Down.

I clearly am not trying to be wise.

We're working very diligently on trying to get our ASP's down market by market by market because one of the biggest issues we face as an industry and as a company in each one of our markets is, how do we increase our pool of affordable buyers?

And that pool of affordable buyers has been decreased over the last four or five years as the industry has raised its prices significantly.

And now, with the mortgage situation the way it is, our pool of affordable buyers is being depleted even more simply because we can't qualify as many buyers as we once could because the mortgage instruments are not out there.

So clearly, what our focus is on how do we drive down our cost and how do we drive down our sales prices.

Unfortunately, as I tell investors, we're really good at driving down our ASP's and you can see that in our margins although they are good but they're not as good as they once were.

Now we have to focus on how do we get our costs down and get our margins back up, but it's going to be a continuing cycle I believe over the course of the next 12 to 24 months in terms of how do we get our ASP's down market by market across the country so we can sell more homes to more home buyers.

Understood.

Actually if I could slip through one more question.

In terms of walk through traffic, I know seasonally this is a better season for you, but can you comment a little bit and give us some color on year-over-year traffic trends and maybe closing rates?

Well, you probably won't appreciate this comment, but we don't really track traffic.

We track our sales and clearly our sales are not where we wanted them to be in the second quarter.

So one of two things is happening, since we don't track the traffic -- either there's not as much traffic there or we're not having as high a kill ratio as we need to have on the traffic that is coming through the door.

So generally speaking and not having any numbers to back this up, I'd say to you that the traffic is slower than what it has been relative to our first quarter of '07.

And again, just anecdotally what we've heard from several people is that since there are more inventory of home choices available for people, they are actually viewing more houses before they make the purchase decision.

So your closing rate on your traffic probably is down.

And a unit of traffic may not be what a unit of traffic used to be because, as Stacey said, [inaudible] one or two model complexes people are going to six or seven model complexes.

Perfect.

Thank you, guys.

I appreciate the insight.

Thank you.

Alex Barron with JMP Securities.

Thanks, guys.

Good morning, Alex.

Wondered if you can discuss how many communities you guys impaired and then you also said some of them were not actively selling communities?

Yes.

The projects we impaired this quarter, we impaired 16 and over half of those we had, we did have active closings in.

Okay.

And you mentioned 80% was in California.

What was the other 20%?

It was really across several regions.

You'll see some in the Northeast which would probably the next biggest number that you'll see and we'll put the details on our Q.

Got it and what was that reversal you discussed?

How does that work and what market was that in?

Well that's actually across-the-board.

All of the projects that we previously impaired in a previous quarter, when you impair a project you write down the book value.

And so therefore, the book value is less than what you actually paid for it in cash.

So when you actually then either sell that inventory through either selling lots or selling and closing homes, then you actually have a reversal effect from that impairment.

And so what we do is we track all of our previous impairments by project.

We look at when we sell those assets, and we know what our impairment per lot or per home was, and that's really the reversal.

And that's something we want to see internally, because we're really focused on our cash on cash returns, and we want to be able to see beyond what we're reporting in our financial statements to what we actually got in cash back so we can really see what the impact of those impairments are on our forward margins.

How much do your starts front this quarter over last year?

We started about half of what we started last year.

And community count growth roughly?

Never give that, Alex.

Okay, and lastly, I missed how many homes you guys got under construction.

26,000.

That's flat with previous quarter.

And one last quick one.

Are you guys kind of thinking the environment right now looks more challenging I guess than what you thought it was six months ago or more stabilized or how are you guys feeling about that?

I think the market is -- I don't think the market is stabilizing because of the fact that clearly California is a tougher road than what it was a quarter or two ago, and I also believe that Florida and Arizona are becoming tougher as we move forward, so I believe that -- I don't see stabilization in very many markets currently.

Got it.

Thank you very much, Don.

Thanks.

You're welcome.

Richard Paoli with ABP Investments.

Good morning, everyone.

I appreciate you taking my call and all the detail that you've provided this morning.

I just have a couple questions and they are more clarifications, excuse me if they are a bit mundane.

But the cancellation rate that you guys refer to, is that based off of sales or is it based off of the backlog?

Because as an industry I guess some calculated one versus the other.

The rate that we're referring to is calculated as cancellations divided by gross sales.

What has the trend been if you looked at it based off of backlog?

Because obviously if you have more in the pipeline, you have more potential cancellations versus less.

Has that number been stable also or has it changed in any way?

Well, that number, if you follow somewhat the trends we've seen on the sales side, it would have been highest in the September quarter because that's when our absolute cancellations were the highest.

I haven't actually read it for the last two quarters because we do typically look at sales.

I don't think you're going to see -- it went up this last quarter but not significantly.

And then my next question is sort of related to this, with respect to your backlog, have you tracked how many of the buyers -- and not necessarily from your mortgage division but in general -- would be considered Alt-A buyers and/or sub prime buyers?

And I know the definition is a little squishy but if you could help me out on that?

On the Alt-A side and really all we can speak to is our originated loans through our captive mortgage company and our capture rate is running about 68%.

Alt-A for us is running about 40%.

That's trended down from 50% and we expect to see that to continue to trend down.

For sub prime, if you define sub prime as a FICO score of 620 or less, that's running about 2% of our business.

Sub prime on a broader scale, though, is a combination of both FICO scores and a debt to income level, and on the broader definition, our sub prime is running about 5% of our business.

Okay.

So combined it's about 45%, is that right, of the backlog?

Well, again, (multiple speakers) backlog because we expect the Alt-A and the sub prime both to be trending down so those will be coming down as a percentage of our backlog.

And then one other question -- and then I have two other points but one other question.

On the impairments, I know it's done on a prospective basis, is that off of -- especially in California -- this new rock bottom pricing or was the impairment taken and then the strategy shifted again?

I'm just trying to understand if there's continued exposure, obviously if things deteriorate further, but based on your comments on you moving to rock bottom?

Right.

Go ahead, Bill.

Certainly, as deterioration furthers, there is further exposure and certainly any time you adjust pricing lower in a project on a prospective basis there is some risk.

The analysis on impairments are done on a project by project basis so as our operators in each market make the changes in pricing on a prospective basis then we'll revise our impairment analysis to reflect that as well.

But certainly, there is risk for further impairment in markets where pricing is still going down.

But based on the current view -- so, the current thinking is in conjunction with those impairments, is that right?

Am I interpreting that -- what happened correctly?

You realized you tried to hold on to margins too much, had to backpedal and that's what precipitated the impairments for this quarter?

Well, certainly the impairments as sales go down as absorptions go down, that does impact your impairment analysis.

Okay.

And then my last question, and obviously you guys know the business much better than somebody like myself, but I'm sitting back from 30,000 feet, and I understand your point where with respect to margins, that if you're throwing in some extras or lowering price, it impacts margin.

But isn't there some point where tactically you have to look at it and say, we've got an affordability issue and maybe not throwing in the granite counter top is helpful to the guy that can't afford it?

Maybe we should just have the lower priced product on the face?

Instead of giving $250,000 worth of value for 200,000, wouldn't it be better just to sell the $200,000 house at $150,000?

See what I'm €"- my point?

(multiple speakers) we've been doing.

That's exactly what we've been doing for the past 12 months.

As a matter of fact, we have subdivisions where we completed our models and not opened for sales and we've said wrong product, we're going to mothball these models and we're going to introduce new models before we ever start to sell because we've got to, as I call, take features out of the home and get it back down to a more affordable home and that's exactly what we have been doing.

So I misunderstood your earlier comments then.

Thank you for getting me on.

I appreciate it.

You're welcome.

[OPERATOR INSTRUCTIONS] Stuart Hosansky with Vanguard.

Thank you very much for taking my question.

You're welcome.

A couple questions.

One, you keep on talking about how the affordability levels are still too high and that certainly seems to be the case.

What's your view of how much further pricing has to go?

And I realize this is regional, but how much further pricing has to go given the constraints in the lending market and the probably unlikely situation of much lower interest rates before we get to a level where affordability is going to allow you to maintain your pricing?

Your own pricing?

It is on a market by market basis and I couldn't answer your question directly because I think that we're in a fluid market, and we thought we were in a more stabilizing market as we adjusted our prices downward relative to our level of inventory -- excess inventory as an industry and as a Company.

And then we hit another hurdle when we had the change in the mortgage industry.

So as a result, I don't know where all the mortgage industry is going to fall out.

I just know there are going to be fewer buyers being able to qualify with the new mortgage underwriting guidelines as they adjust out over the course of the next three to six months.

So, it's market by market, and right now the best thing we can say about D.R.

Horton is once again we have the highest operating margins in the industry and we can meet the market better than anyone else and still produce a profit.

And on a second question, if I can try to understand your strategy here.

You have been talking about how the inventory is too high industry wide and probably yourself as well, and at the same time you are indicating that you are willing to accept a high cancellation rate and you want your salespeople to take new orders and you'll live with the cancellation rates.

There seems to be an inconsistency there, that if you're going to be taking the orders knowing that there might be a high cancellation rate, that's just going to keep the inventory levels high.

So is there something that I'm missing there?

Yes.

Well, first of all, we're adjusting our starts relative to real sales versus just backlog sales.

So the result to the extent a unit cancels and it doesn't close, then we're adjusting the starts downward to reflect that.

On the other hand, as Stacey said earlier, our real goal is to take the buyer out of the marketplace and that's the goal of our sales persons such that we can then, if the buyer wants a home our goal is to put them in that home and try to qualify them or find a mortgage company that will loan them the money to qualify for that home.

So as a result, even in the event that buyer doesn't qualify even after two or three or four different types of mortgage applications, then at least we tried.

But we haven't started a home just simply because we had that home sold but not closed.

Our starts are based upon closings and not sales.

Alok Makhija with Ore Hill Partners.

Hi.

Just had a follow-up question on one of the questions that somebody asked about gross margins falling and impairment.

You mentioned gross margins -- you model gross margins in teens on a post-impairment basis.

Can you specify -- is it mid teens you're talking about or low teens?

It actually will range depending on the discount rate used, the uncertainty or the risk involved in the project, the time frame involved in the project.

So actually, it can range from the low teens to the high teens, depending on the individual nature of each project.

So does that mean this is the kind of gross margin that you are anticipating going forward or -- you guys are booking gross margins way north of 20%, 22%.

So I'm just trying to understand the strategy, what does that reflect on your going forward strategy?

Our historic margin range has typically been from 18 to 22%.

In the short-term we are below that level, but we expect on an ongoing basis, once stabilization is reached in the market, that we should be able to get back up in the 18 to 22% gross margin level.

And the second question I had was the comment you made about affordability index which is low right now and you expect prices to come down.

If that is really the case, shouldn't we be expecting more impairments coming from you and the other home builders also?

I can't speak for the other home builders.

I can only speak for D.R.

Horton.

And as we've said clearly, this will be our third quarter, is that we've taken everything impairment wise we can take.

We've impaired everything that can be impaired and, as Bill Wheat said, it's reviewed every quarter by E&Y, our auditors, and approved.

As to the market going forward, if the market weakens, then yes, we'll be subject to additional impairments.

Thanks.

Yes, sir.

Bev [Hausbeck] with AllianceBernstein.

Good morning.

Thanks for staying on.

Good morning, Bev.

Out of the owned lots, and I think based on Sam's comments about 170,000 or so, could you give any sort of color as to how many of those are ready to be built versus those that are still in need of significant development spending?

Well, to answer your question directly, we're asking that same question of our division presidents, because what we're interested in is they're in the process, we spent quite a few development dollars in Q1, slightly less in Q2, and so we're bringing projects into the final completion stages.

We have our President's meeting next week and we're going to tie down the exact number of lots that we can build on for fiscal year '08 that are 100% complete and we can go pull permit on and start the house vertical construction.

To answer your question directly, we don't have a field specifically for that number right now but we will and by the end of next week.

And I guess the follow-up question and I know we've danced around it so just let me throw it out and you can do with it what you want.

I know for the closings for the year, you don't know yet, you're not going to know, but is it fair to say that it's going to start with a four?

That it's what?

Will start with the number four?

Certainly -- Stacey loves me and she hates me and certainly that's our goal.

Thank you very much.

Mike Shrekgast with Longacre.

Hi, guys.

Was just wondering -- with regards to your impairments, usually how long after you take an impairment are those lots or homes sold.

Maybe if you could break down, if you do break this down, lots versus lots without homes on them to lots that have homes on them?

You know, it will range from one month to four or five years depending on the size of the project, how many lots you're talking about -- whether it's already actively delivering homes, closing homes or whether we're still in the development stage, so it's really just based on each individual project.

As we've talked about in the ones we've taken this quarter, over half of them were already actively delivering homes.

So of this quarter's impairments, over half of them are delivering homes, so you're going to start seeing some reversals as we deliver those homes.

Because I think we just want to be clear as going forward as we estimate margins that if you take the writedowns in the quarter before you sell the homes, then the margin comes in at a decent margin.

And not saying that you're not interpreting, just thinking of modeling it out as the year goes on.

Right.

And it's going to be a mix.

We do look at where we expect it to be.

As we said we had $23 million, a little over $22 million reversed this quarter and that is the biggest reversal of previous impairment charges that we have seen in any single quarter to date.

And it's just reflective of some assets that we have sold that we had previously impaired over the last six to nine months.

And just with regards to -- you mentioned that this strategy is to continue lower ASP's to make the homes more affordable.

The writedowns that you have taken, you say are based on what average selling prices I believe are in the current regional market.

So if you're projecting at the end of this year average selling prices coming down 10%, is your writedown already factoring that in?

On a project by project basis to the extent we know what the pricing plan is for that project, yes.

But please don't get confused.

We're not sitting here in a normalized mode to the extent that we're reducing prices or to the extent that we anticipated reducing prices, believe me.

We're going back to our trade partners and saying, we're not there yet, and we need more concessions.

And are they giving all the concessions we want?

No, but we're all in this together.

Oh, no, I think you guys have been very forthright, just thinking about the next -- the end of the year and what that could look like.

Just because -- I want to be clear about this, it's an interesting point that you make.

Just because we reduced our prices in California and we're in the process of reducing our prices in Florida and some other markets doesn't necessarily translate into there are going to be more impairments because of those price reductions.

Because we've been focused on how do we get our cost reductions in line so we don't have to have those impairments.

Well, and how can we adjust our product as well.

All of it comes into play.

Thanks very much.

Thank you.

Scott O'Shea with Deutsche Bank.

Yes, good morning.

I was wondering if I could get the dollar amount of home builder interest incurred for the quarter.

Interest incurred for the quarter is $85.2 million.

Is that just home builder or does that include total interest incurred for the companywide?

That's a good point, thank you.

The $85.2 is consolidated and that would include $6.8 from Financial Services.

Okay, great.

My second question has to do with your existing selling subdivisions.

What percentage, and maybe you tracked this -- what percentage of the existing homes have been sold are currently back on the market for sale?

Is that something you track and follow?

Well, I'm sure we do at the division level.

At the corporate level we just track how many homes are completed and available for sale and how many homes are under construction and available for sale and it's not something that we generate a report on, to answer your question.

But that certainly would factor into the pricing in a local community.

Right, but I would imagine that those homes would represent kind of the first order of competition for your own backlog.

Okay.

Thanks again.

Thank you.

At this time, I would like to turn the call back over to Mr.

Tomnitz.

Do you have any closing remarks?

Yes, I do.

Thank you for joining this Q2 Conference Call.

I want to reemphasize that we're striving to do better.

We're proud of our accomplishments in Q2 relative to the current operating environments that we see in the industry.

Most importantly, and I do this every quarter and every time I'm in the divisions where I spend 75% of my time, I want to thank all the men and women of the Company who have helped us get to where we are.

Unfortunately, we've reduced our employee count from 10,000 to 7,300.

It's been a tough thing for us to do.

We owe it to our shareholders to align our SG&A in line with the number of homes that we're going to sell and close.

We believe we have the 7,300 best employees left in the Company.

You clearly outperformed everyone else in the industry and I want to take my hat off to you and applaud you for a great, great performance.

And finally, I know that D.R.'s listening, and it is quite an incredible accomplishment for anyone to have started with $3,000 of equity in 1978 and now to have the highest shareholder equity in the industry.

And our people have gotten us there and I know D.R.

joins me in thanking them very much for quite an accomplishment.

So thank you, and we commit once again that D.R.

Horton will outsell, outclose, and outearn everyone else in the industry.

Thank you.

This concludes today's D.R.

Horton, Inc.

second-quarter 2007 conference call.

You may now disconnect.