Nov 20, 2007
Executives
Don Tomnitz -President and CEO Stacey Dwyer -EVP and Treasure Sam Fuller -Senior EVP of Finance Bill Wheat -EVP and CFO
Analysts
Michael Rehaut- JP Morgan Dan Oppenheim- Banc of AmericaSecurities Nishu Sood -Deutsche Bank Joel Locker -FBN Securities Ken Zener -Merrill Lynch Stephen Kim –Citigroup David Goldberg– UBS Stephen East -Pali Capital Timothy Jones- Wasserman and Associates Alex Barron -Agency Trading Group Carl Reichardt- Wachovia Securities Jim Wilson -JMP Securities Larry Taylor -Credit Suisse Mike Marburg –Ramsey Bob Thompson -Advantus Capital Susan Berliner- Bear Stearns Bob Sells -L&K Capital Management Emeril Amman -36 Capital Darren Richman- GSO
Operator
Good morning.My name is Cynthia, and I will be your conference operator today. At this time,I would like to welcome everyone to the D.R.
Horton Incorporated, America'sBuilder, the Largest Homebuilder in the United States, 2007 Year-End ConferenceCall. All lines have been placed on mute to prevent any background noise.
Afterthe speakers' remarks, there will be a question-and-answer session. (OperatorInstructions).
I would nowlike to turn the call over to Don Tomnitz, President and CEO. Sir, you maybegin your conference.
Don Tomnitz
Thank you andgood morning. Joining me this morning are Sam Fuller, our Senior Executive VicePresident of Finance, Bill Wheat, Executive Vice President and Chief FinancialOfficer, and Stacey Dwyer, Executive Vice President and Treasure.
Before we getstarted, Stacey.
Stacey Dwyer
Some commentsmade on this call may constitute forward-looking statements as defined by thePrivate Securities Litigation Reform Act of 1995. Although, D.R.
Hortonbelieves any such statements are based on reasonable assumptions, there is noassurance that actual outcomes will not be materially different. Allforward-looking statements are based upon information available to D.R.
Hortonon the date of this conference call and D.R. Horton does not undertake anyobligation to publicly update or revise any forward-looking statements.Additional information about issues that could lead to material changes inperformance is contained in D.R.
Horton's Annual Report on Form 10-K and themost recent Form 10-Q, both of which were filed with the Securities andExchange Commission. Don?
Don Tomnitz
Net salesorders for the fourth quarter was 6,374 homes, $1.3 billion, compared to 10,430homes, $2.5 billion in the year ago quarter. The slower net sales rate was duein part to our cancellation rate rising during the fourth quarter to 48%,compared to 38% in the third quarter, and 40% in the same quarter of the prioryear.
Our average sales price on net sales orders in that quarter decreasedapproximately 15% from a year ago to [$205,400]. However, our average salesprice on gross sales only decreased 8% to $231,900, as more high priced homescancelled during the quarter.
Please note,that we will no longer report our quarterly net sales orders in advance ofearnings. Beginning on the first quarter of fiscal 2008, we report net salesorders in conjunction with our quarterly earnings release.
Sam?
Sam Fuller
Our fourthquarter homebuilding revenues were $3.1 billion, compared to $4.8 billion inthe year ago quarter. Our average closing price for the quarter was down 7% to$253,000, compared to $272,400 in the year ago quarter.
Homebuilding revenuesfor the year ended September 30, 2007 were $11.1 billion, compared to $14.8billion a year ago. Homes closedfor the fiscal year totaled 41,370, and approximately 62% of our closings werefor less than $250,000 each, compared to 55% in fiscal 2006, demonstrating ourcontinued focus on providing an affordable quality entry level or first timemove-up product.
As a result, the financing for most of our customers can fitwithin conforming guidelines. Bill?
Bill Wheat
Our grossprofit margin on home sales revenues in the fourth quarter before inventoryimpairments and land option write-offs were 16%, down 490 basis points from ourhome sales margin of 20.9% in the year ago period. This was a 70 basis pointsequential decline from our third quarter gross-margin of 16.7%.
This declinewas due primarily to core margin deterioration, resulting from increased use ofsales incentives relative to last year, and the lack of pricing power, asreflected in our 7% decrease in average closing price. During ourfourth quarter impairment analysis, we reviewed all projects in the company anddetermined the projects with a combined carrying value of $2.6 billion asindicators of potential impairment.
We evaluated these projects and determined thatthe projects with a pre-impairment carrying value of $940.5 million wereimpaired. We recorded inventory impairments of $278.3 million as a charge tocost of sales to reduce the carrying value of these impaired projects.Approximately 55% of the impairment charges this quarter related to projectslocated in California.Of the remaining $1.7 billion of the projects with impairment indicators, whichwere determined not to be impaired, the majority are located in California, Florida, andArizona.Stacey?
Stacey Dwyer
The FAS 142requires that we test goodwill in each operating segment, regions in our case,for impairment, at least annually. During our fourth quarter, we completed ourannual analysis for goodwill and determined that an impairment charge of $48.5million related to our Mid-West region was warranted.
Total goodwill remainingafter impairment at September 30 is $95.3 million. Don?
Don Tomnitz
We continue toadjust our land option contracts relative to current demand, which resulted in a$40.3 million write-off of earnest money deposits in pre-acquisition costsrelated to land option contracts during the fourth quarter, across a broadcross section of our markets. Our net earnest money deposit balance atSeptember 30 was approximately $75 million or 6% of the remaining purchaseprice.
This low earnest money deposit percentage reflects our conservativeapproach to land and lot options. We’ve nounconsolidated joint ventures and we rarely use land bank arrangements.
So,deposits are typically a low percentage of the purchase price. Our supply ofland and lots at September 30, 2007 is approximately 230,000 lots owned andcontrolled, down 42% from our peak of 396,000 lots at March 31, 2006.
73% ofthese lots are owned and 27% are option. We started our fiscal year with323,000 lots, a 6.1 year supply based on trailing 12 months closings, and our230,000 lots now represent a 5.6 year supply, based on trailing 12 monthsclosings.
We continue to actively work to reduce our owned land and lot supply,through building and closing homes, as well as to opportunistic land and lotsales. For example, in November, we closed on a land sale in Phoenix, which reduced our own lot position byapproximately 20,000 lots, or about a half a year supply.
Total revenueswill be approximately $70 million on this transaction and we will recognize aprofit on the sale. There has been no impairment associated with this project.Sam?
Sam Fuller
HomebuildingSG&A expenses for the quarter was 9.9% of total homebuilding revenues,compared to 8.5% a year ago. For the fiscal year, homebuilding SG&A was10.3% of total homebuilding revenues, compared to 9.9% last year.
Our ongoing goalfor each fiscal year is to be at or below 10% of homebuilding revenues. Although,we are above our 10% goal this year by 30 basis points, we have continued toreact quickly to the market to manage our SG&A levels relative to our levelof home closings.
In fiscal 2007,we reduced total SG&A expenses approximately $315 million, up 22% fewer closings.We will continue to focus on being the low cost operator in the industry, whichremains one of our distinct competitive advantages. Bill?
Bill Wheat
Our financialservices operations remained profitable, as we have proactively adjustedexpense levels to lower volumes and adjusted product offerings to the currentrestrictive mortgage environment. Financial services pre-tax income for thequarter was $16.1 million, compared to $33.7 million in the year-ago quarter.For the fiscal year, financial services pre-tax income was $68.8 million,compared to $108.4 million last year.
96% of ourmortgage company business was captive during the quarter, reflecting ourcontinued focus on supporting our homebuilders business. Our company-widecapture rate in Q4 was approximately 64%, compared to 71% a year ago, and forthe year was 66% compared to 68% in the prior year.
Our averageFICO score this quarter was 717, comparable to the year-ago quarter. Ouraverage cumulative loan-to-value for the quarter was 90%, compared to 91% inthe year-ago quarter.
As the mortgage markets continued to change, we saw acontinued shift in the type of products that buyers utilized in the fourthquarter. Our product mix during the fourth quarter was 81% conforming, 10%agency eligible Alt-A, 2% non-agency eligible Alt-A, and 7% jumbo.
For our fullfiscal year 2007, our product mix was 57% conforming, 19% non-agency eligibleAlt-A, 13% agency eligible Alt-A, 7% jumbo, and 4% sub-prime. Sam?
Sam Fuller
The effectivetax rate related to our income tax benefit on our fiscal 2007 loss was 25.1%,because only approximately 23% of the goodwill impairment charge recorded infiscal 2007 is deductible for tax purposes. Our reported net loss for thequarter is $50.1 million or $0.16 per share.
However, our core operationsbefore impairment charges and land option cost write-offs generated pre-taxprofits of approximately $266.9 million. Our reportednet loss for the fiscal year was $712.5 million, or $2.27 per share.
Our coreoperations, before impairment charges and land option cost write-offs, generatedpre-tax profits of approximately $852.4 million. All of our operating regionsremain profitable for the fourth quarter and the fiscal year, beforeimpairments and write-offs.
We continue to focus on managing the core businessefficiently by controlling our costs and adjusting quickly to changing marketconditions. Don?
Don Tomnitz
Our overallinventory decreased by over $900 million, excluding impairments at 930 comparedto June 30. We reduced our total number of homes and inventory to approximately19,900 homes, down 50% from 40,000 homes of our peak in June 2006 and down 27%from 27,100 homes at June 2007.
We also reduced the absolute number of speculativehomes and inventory by more than 18% this quarter to approximately 10,600compared to approximately 13,000 at June 2007. This reducednumber of homes and inventory, combined with our earnings in the fourth quarter,allowed us to exceed our goal of $1 billion in operating cash flow for thisfiscal year by over $300 million.
We are going to further reduce both our totalnumber of homes and inventory, and our number of speculative homes in thecoming quarters, in line with current demand. Stacey?
Stacey Dwyer
Ourhomebuilding leverage ratio, net of unrestricted cash was 40.2%, an improvementof 50 basis points from a year ago, and at the low end of our target range of40% to 45%. As of September 30, we have approximately $2.3 billion available onour homebuilding revolving credit facility, and $228 million in unrestrictedhomebuilding cash for a total of approximately $2.5 billion of homebuildingliquidity.
We have reduced our homebuilding debt balances by approximately $900million, since the beginning of the fiscal year. And we have [already startedconsolidated] debt balances by approximately $1.7 billion.
As a reminder,D.R. Horton does not have any unconsolidated joint ventures, and we have noexposure to [sequential] guarantees our margin call on joint venture debt.
Wecurrently have three primary financial covenants in effect under our $2.5billion revolving credit facility, maturing in December of 2011. They aretangible net worth covenant and maximum leverage covenant in a trailing 12months EBITDA to an interest incurred coverage covenant.
All covenantcalculations are based only on our Guarantors subsidiary, which includesubstantially, all our homebuilding operations that exclude our financialservice operation. Our current tangible net worth covenant is $4.3 billion.
Andas of September 30, we have a cushion of approximately $1 billion. Our currentleverage is 42%, compared to a maximum allowable leverage of 60%.
And finally,our trailing 12 months interest coverage ratio is 3.6 times, compared to ourtwo times covenant. Bill?
Bill Wheat
Our cash flowfrom operations this quarter was over $800 million, positive for the fifthconsecutive quarter, and bringing our total for the fiscal year to over $1.3billion, exceeding our goal of $1 billion. Over the last15 months, we have generated in excess of $2.2 billion of operating cash flow.Our goal for fiscal 2008 is to generate an additional $1 billion of operatingcash flow.
Our land acquisitions spending remains limited and we continue tochallenge our land development spending in light of our current absorptions. We expect ourfiscal 2008 land acquisition and land development expenditures to total between$500 million and $1 billion for the entire fiscal year.
For comparison, ourfiscal 2007 land acquisition and land development expenditures were $2.5billion and in fiscal 2006, they were $5.2 billion. We continue to developmentsmaller phases and pace our development of new phases based on current demandin individual communities.
Don?
Don Tomnitz
In closing, D.R.Horton will continue to manage very conservatively during this housingdownturn. In fiscal 2007 by controlling our SG&A, renegotiating ourconstruction cost and reducing our inventory, we generated approximately $852million and pre-tax operating profits before impairments, with all of ourreporting regions contributing positively towards this total.
Our stated cashflow goal for fiscal 2007 was to generate $1 billion in cash flow fromoperations. We exceeded this goal, generating $1.36 billion.
We use this cashflow to reduce homebuilding debt by $900 million and consolidated debt by $1.7billion. Even though wereduced our residential inventory by 7,000 homes in the fourth quarter, we aregoing to reduce our homes under construction further, which will contribute toour goal of generating at least $1 billion in cash flow from operations infiscal 2008.
We’ll continueto focus on earning pre-tax operating profits before impairments, generatingoperating cash flow, reducing both residential and land inventories andrepaying debt. In a downturn, we believe that the builder with the strongestbalance sheet wins.
We plan to be the winner with a solid balance sheet and availableliquidity to take advantage of opportunities as they present themselves in themarketplace. Finally, wethank the entire D.R.
Horton team. This includes, especially, our field staffincluding construction, sales and mortgage.
As we know, we are all in sales andsales are the key to our future success. While it's difficult to outperform themarkets, we continue to outperform our competition.
Our model BSCM, build, sale,close homes, and make money, is most applicable today, generate free cash flowand leave no buyer behind. Thank you.
Wewill now entertain any questions that you may have.
Operator
(OperatorInstructions). Your first question comes from Michael Rehaut with JP Morgan.
Michael Rehaut - JP Morgan
Hi, goodmorning.
Bill Wheat
Good morning.
Michael Rehaut - JP Morgan
Congrats onthe cash flow generation. My first question is, if you could just, for the fullyear, give me, if possible, a breakdown of how that $1.3 billion fell across,let's say, land sales, mortgage operation, and core homebuilding and how youthink that composition will look for '08?
And then I have a follow up.
Bill Wheat
Mike, as faras the breakdown in '07, I think it's presented fairly clearly in the cash flowstatement in the press release primarily from inventory reduction,approximately $800 million of that and then we had about $500 million formortgage loans held for sale. There was a reduction during the year and of coursethat is supplemented by the pre-impairment profits from our operations, primarybreakdown in '07.
As we moveforward to '08, well, certainly our goal is to continue to generateprofitability before impairments and charges. We will see, I think, hopefully asmaller reduction in our mortgage loans held for sale during the year.
But, themajority of the billion dollars that we expect to generate in '08 is going tocome from inventory reductions and our homebuilding business, which isprimarily going to come from us building homes, from the lots that we own, and pullingdevelopment dollars out of the ground, and closing on the width that'sassociated with those houses.
Stacey Dwyer
And as wetalked about in the conference call script, we are going to be looking to sellland opportunistically. So, we have already generated some land sales revenuethat will contribute to cash flow this quarter.
Michael Rehaut - JP Morgan
Great.
Don Tomnitz
By the way,our land sales, our land and lot inventory now post that Phoenix transaction was down to about 5years, 5.1 years of land and lot supplies. So, we think that's a dramatic one-yearreduction in a 14 month period.
Michael Rehaut - JP Morgan
Now, the Phoenix sale is prettyimpressive, given what's going on in that market. The second question is justmore of an accounting question.
Last quarter, you had about $7 million of abenefit in the gross margins from selling homes of previously impairedcommunities. I was wondering if you could give that number for this quarter.
Bill Wheat
Right. Thisquarter, on the home sales gross margin line, we had $49 million flow backthrough from previous impairments, and on then land sales line, we had $10million flow back through in the fourth quarter.
Michael Rehaut - JP Morgan
Great, thankyou.
Operator
Your nextquestion comes from Dan Oppenheim with Banc of America Securities.
Dan Oppenheim - Banc of America Securities
Thanks verymuch. I was wondering if you can talk about your pricing and sales strategy.You talked about how you want to outperform others and not let any buyer'sgetaway.
Given the declines you have been reporting in orders, and what we'veseen in terms of aggressive pricing, what is that you're trying to dodifferently as you go into fiscal '08 to capture more net orders?
Bill Wheat
Well, clearlyone of the things that we are doing in a number of communities is we arecontinuing to mark our product to market. We think it's unrealistic to holdpricing which is not competitive with the market.
And in some of ourcommunities, frankly, we are having rare opportunity to raise a few prices. We'dliked to get to the point where we can have more stability in our pricing,which we have not experienced in '08.
But the real issue is the market is themarket and we are continuing to drive down our cost across the Board ondevelopment cost, on cost from our suppliers and cost from our vendors and costfrom our subcontractors, so that we can offer a more competitive product. Everythinghas to reset.
The first thing that's reset, as you know, has been the salesprice of a single family home. Now, we are in the process of resetting allthose cost.
But it's unrealistic for us to continue to expect or to offer aproduct that's higher than what the market is willing to pay.
Dan Oppenheim - Banc of AmericaSecurities
Thanks. If youcan just talk, also about, I guess, if you think about, sort of spec homes here,to bring down the spec inventory environment, where some of the buyers arelooking for spec homes and they didn't get the best prices--what percent ofconstruction is spec rate now?
What is your goal for next year?
Don Tomnitz
We have a verylimited spec start policy and basically its X number of specs per community. Butfrankly, we need to have, we believe in order to maximize our salesopportunities in the marketplace, unlimited number of specs in each communitysimply, because there are people out there who have existing homes or marking thoseto market and closing on those homes.
And then, they are coming in to our salesoffices and desiring to move into a new home within a very short period of time--threeto six weeks. So, therefore, we will continue to maintain limited specinventory in all of our communities such that we can appeal to those buyers.
Dan Oppenheim - Banc of AmericaSecurities
Thanks verymuch.
Don Tomnitz
Thank you.
Operator
Your nextquestion comes from Nishu Sood with Deutsche Bank.
Nishu Sood - Deutsche Bank
Thanks. Goodmorning, everyone and nice job considering the environment.
Don Tomnitz
Thank you.
Nishu Sood - Deutsche Bank
First questionI wanted to ask was, some of the harder hit markets you are beginning to seewhat you might call a limited or even a no-demand environment. I mean places likeSacramento, youare hearing about [market] falling and price inelasticity.
I wanted to ask yourthoughts on that specifically how many of your markets do you think have kindof reached that type of state? And when you consider pricing versus volumes tradeoff, how are you counseling your guys in the ground in your markets that arelike that?
Don Tomnitz
That's a greatpoint and you're exactly right. Remembering back, when we were criticized two orthree years ago about offering discounts on inventory back in December of '05,and we wished we still had that kind of pricing power as we did back inDecember of '05.
But, the way that we're countering this and we're in theprocess on a day-to-day basis, division-by-division,subcontractor-by-subcontractor is as we have to drive down the cost ofeverything that we are buying. And we have to drive down the cost of ourSG&A, because the only way to continue to meet the market and satisfy the buyer'sdesires is to have a lower cost structure than anyone else in the industry.
So,our extraordinarily [crowd] even though it is 30 basis points over our goal ofour 10.3% SG&A. So, it's a cost game right now, and I think the buyer isgoing to continue to demand competitive pricing and one who has the best cost structureis going to win.
Nishu Sood - Deutsche Bank
And I knowit's tough to quantify, I think in, roughly, 75 to 80 markets, how many ofthose do you think have reached that type as to state?
Don Tomnitz
I would lookat it more from the perspective of where our big markets are and, to be frankwith you, it's the hot markets, I think, that have reached that stage of priceinelasticity. I think Las Vegasis clearly there.
And California is clearlythere, and I think Phoenix and Florida are getting closer to being there,but they are not there yet.
Stacey Dwyer
And evenwithin those markets, Nishu, there's some differences based on locations. Asyou are further away from the job centers, you are probably experiencing alittle more pricing pressure and (inaudible) ones that are little closer in.And price points are going to make some differences based on mortgage productsthat were previously available and what's available in market today.
As Donsaid, we are working on costs whilst restructuring a lot of our product and tomake sure that what we are bringing to market meets the market demand.
Nishu Sood - Deutsche Bank
Okay, great. Oneanother quick question on the land sales.
What was the age of the 20,000 lotsthat you sold in Phoenixand generally of your, I think, $150 million on land sales, how old was thatland as well?
Don Tomnitz
I will say thePhoenix projectis a project that I believe we've owned for approximately three years, and theother sales --
Bill Wheat
We don't havethat data in front of us on all of the other sales, but it's scattered.
Nishu Sood - Deutsche Bank
Yes, great. Thanksa lot.
Operator
Your nextquestion comes from Joel Locker with FBN Securities.
Joel Locker - FBN Securities
Hi, guys. Justwanted to get a count, if you had a breakdown of our own lots, how many werefinished?
How many were under development? And how many were raw?
What is there,72% or 168,000 or so?
Bill Wheat
Yes. I think72% are owned currently.
But we have got about a 167,000 owned lots and(inaudible), so we don't have a total count or breakdown between finishedversus raw at this point.
Joel Locker - FBN Securities
Do you haveany kind of ballpark figure, I mean percentage wise? Just trying to look atcash flow going into next year, if it's just based on -- if you have a lot moredevelopmental cost depending if you choose to multiple or not to multiple, justtrying to get an idea of what's raw, what's finished?
Bill Wheat
You can restassured that virtually the mass vast majority of what we're going to be closinghomes in on '08 are already finished. And we mentioned on our conference call,our development span, projection, range for '08 is $0.5 billion to $1 billion,and we would be surely disappointment if weren't closure to the low end of thatrange.
So, we're going to be spending very, very little money on developinglots. All of our lots for '08 closings are finished and available.
Stacey Dwyer
And actually,that dollar span includes both land development and land purchases.
Joel Locker - FBN Securities
Right.
Bill Wheat
Despite, evenif it's raw land, we are slowing our development span based on and pacing ourlots, bring your lots to market based on what we expect we are going to needfor sales.
Joel Locker - FBN Securities
I got you. Andlike the impairment reversals going forward, as you know, it is big move from $7million to $49 million, or $59 million, including the land sales.
And what do youexpect on the impairment reversals in fiscal '08?
Don Tomnitz
That's a hardnumber to predict, Joel. It really depends on where we close our homes andwhether we are closing homes in any impaired projects, going forward.
Given thecumulative volume of our impairments, through June and now through September, Iwouldn't expect it to be down below $10 million in any quarter, going forward.But whether it will be around the 49 or higher or lower is little difficult topredict?
Joel Locker - FBN Securities
All right. Justone last one on your selling cost as a part of the $283 million SG&A, whatwas selling and what was G&A, if you do have that breakdown?
If you don'thave it handy, I can follow up after the call.
Stacey Dwyer
We will giveyou a ballpark number here, Joel?
Joel Locker - FBN Securities
Sure.
Don Tomnitz
Give me fiveseconds.
Joel Locker - FBN Securities
Yes.
Bill Wheat
Roughly about25% of our SG&A was selling cost during the year.
Joel Locker - FBN Securities
During theyear or during the quarter?
Bill Wheat
I am sorry,that was during the year, and we looked during the quarter, -- roughly 25%during the quarter as well.
Joel Locker - FBN Securities
Roughly 25%.All right. Thanks a lot.
Operator
Your nextquestion comes from Ken Zener with Merrill Lynch.
Ken Zener - Merrill Lynch
Good morning.
Don Tomnitz
Good morning.
Ken Zener - Merrill Lynch
Given thelower, I think, than expected impairment for this quarter, can you talk abouthow impairments that you had this quarter were influenced by your lastquarter's discussion with the auditors based upon your down pricing and betterabsorption rates? Essentially, it was like the 39% decline in orders consistentwith that type of elasticity of demand that you would have expected with downpricing, and if not, did your impairment approach with the auditors changedthis quarter relative to last quarter given the apparent lack of elasticity?
Bill Wheat
No. There wasreally no change in our approach from June to September.
We still have a verycautious outlook on the industry, on our pricing prospects and on our volume. Andcertainly, as we move through the quarter, that outlook that we had in June andas we accessed our projects in June, that certainly to a large extent wasaccurate.
And so, as we looked at the end of the projects again in September,we looked at a lot of the projects that we had previously impaired and in manycases, we had anticipated the pricing that did occur. And so, as a result of --that was inline with our previous assumptions, it did not need to be impairedagain.
Of course,naturally with the volume of impairments we've had here in the fourth quarter,we had a number of projects that had performed worse than we had projected inJune. And so, that's why they are impaired in September.
But really, theapproach was very consistent from June to September. We remain very cautious onour pricing assumptions and our models, and we will continue to do so.
Ken Zener - Merrill Lynch
Okay.
Don Tomnitz
I think youcan go back on the records and I think one thing is certain, is we've been veryconsistent on our outlook for the industry in '07, and we continue that throughthe fourth quarter.
Ken Zener - Merrill Lynch
Do you have anew Choice word Don for '08?
Don Tomnitz
No. I thoughtI would save it for someone's conference (inaudible).
Ken Zener - Merrill Lynch
Well, mysecond question--I am trying to understand your own land position which wasessentially flat q-to-q at about a 167,000 lots versus 169,000 in 3Q, despiteyour closing nearly 12,000 units. So, can you talk about kind of what percentof closings of lots are on it, do you take down in to a year and if perhapsthat ratio was shifted to '08, so as you deliver, let's say, 12,000 units,we'll see the land position declined by that amount excluding any land sales.
Don Tomnitz
Clearly onething we are focused on in '08, and Stacey can give some more color on this, ifshe wishes But our goal in '08 is to close as many of our units on owned lotsas we possibly can, because our primary goal and our land position is, is topull our development dollars out of the ground, where we have already gottenfinished lots. So, our goal really is to take care of Horton first and worryabout the third-party developers later.
Bill Wheat
One thing weshould clarify, Ken, is when we state our owned lot position that does notinclude lots on which we are constructing a home. It includes finished lots orlots under development that we own, but we have not started a home underconstruction.
So, actually to reduce our lots owned, we need to start a homebecause then it will move into our construction in progress. Since we are notstarting many homes right now, we're purchasing very few as well.
But since weare not starting many homes, our own lot position hasn't moved much in the lastcouple of quarters.
Don Tomnitz
Yeah. Andthat's a good point because what we are trying to do is reduce our specinventory such that we can start additional homes.
Ken Zener - Merrill Lynch
Okay. Obviously,selling land like you did in Phoenixis going to be helpful for that.
I guess that deals, you could explain on thelogic behind that. While, it's good that you are selling the land and certainlyat a profit relative to what you bought at in '04.
I think it's going tosurprise people the amount of lots, certainly me, the amount of lots, roughly23,000, which represented 50% of the southwest lot position, as I did thecalculations. So, it just seemed to be such a unique deal.
Could you explainkind of a logic given what it appears to be roughly $3,000 of lot cost basis?Thank you.
Don Tomnitz
Well, we don'twant to explain that too much because, obviously, we have some agreements withour buyers. But essentially, we ended up with too many lots in that market andwe had a very successful project.
There was essentially but the same number oflots that was north of there, that we started 7 years ago and became very, veryprofitable for us. As we looked at that market today, it was one of the moreoutlined markets in our core area and Phoenix, and we just decided we hadenough lots in that market to get us through over the next two or three years.And clearly, we will be buyers of lots most likely from the gentleman and the partyto whom we sold the land.
Stacey Dwyer
I think you'reright on one thing, Ken. It was a unique transaction.
There were certainly alarger number of lots, but it wasn't a very attractive land [dices]. And ourintention there has been to sell off some piece of that land in the normal courseof business.
Because typically, we would not have any individual community ofthat is [back side].
Don Tomnitz
And just one onthe same lines, we would have missed if I didn't mention Gordon Johns and TomDavis, who were very instrumental in consummating that transaction with thebuyers. So, thank you very much, gentlemen.
Bill Wheat
Next question?
Operator
Your nextquestion comes from Stephen Kim with Citigroup.
Stephen Kim - Citigroup
Hey, guys.
Don Tomnitz
Good morning,Kim.
Stephen Kim - Citigroup
I wanted to firstask you sort of a conceptual question. Actually, yeah, that's a conceptualquestion.
You guys just gave earlier in the call here, a development spentprojection of 2008 of I think $500 million to $1 billion. I wanted to make sureI understood what that would be comparable to in 2007?
Bill Wheat
Well, clearly whatwe said is not only is that development span, i.e., the water, the sewer linesand the paving that's going to improve the lots, but it's also closing.
Don Tomnitz
Yeah. They areclosing on land and lots as well.
Stephen Kim - Citigroup
Right. No,great.
I would imagine any ongoing fees you got to pay to keep up since the lotand what not. What was that figure in 2007 for you?
Don Tomnitz
$2.5 billion.
Stephen Kim - Citigroup
Got it. Great,perfect.
Okay. And then the second question I had relates to your workingprocess, would you help finished homes and constructions in progress?
Obviously,it came down nicely with a nice driver to your cash flow for the year. I thinkyou indicated that you sort of felt that line item might be a driver again asyou go forward into '08, which makes sense.
My question is this, though--if youlook at the number, which I think was $3.3 billion as a percentage of yourbacklog value, the figure was noticeably higher I believe than what we've seenin your previous quarters. And I guess I was curious as to whether or not --and obviously that's because your backlog value dropped [previously].
I guessmy question is whether or not we would expect that figure as a percentage ofbacklog value to come more down inline with where it's been over the last, let'ssay, year or so and maybe what drove the big increase in 4Q '07.
Stacey Dwyer
I think in 4Q'07, there are couple of things that come into play. Obviously, the fourthquarter is our strongest delivery and so you see the biggest drop in ourbacklog in a sequential quarter and the fourth quarter.
The other thing is,that our speculative inventory as a percentage of our inventory is higher inthe fourth quarter than it has been. And that's why we've said we want to workit down, both our absolute number of terms in inventory, as well as our speculativeterms in inventory.
As our specpercentage goes back down toward our targeted 35%, we should see the percentageof residential inventory compared to our backlog coming back inline where ithas been historically.
Stephen Kim - Citigroup
Right. Yeah,because those specs obviously carry a heavy dollar rate.
Stacey Dwyer
Well, theyjust carry a dollar rate, that's not offset by anything in the backlog number.
Stephen Kim - Citigroup
Right, right,more particularly, right. Okay.
And then switching gears to your SG&A,which was obviously very good, your performance is very good this quarter, andit has been for quite a long time obviously. As I look ahead into the firstquarter of next year, the way we forecast your SG&A, it looks like it isgoing to be quite a challenge here for you to keep your SG&A rate aspercentage of [i.e.]
home sale revenues, but it's not to be that much of a differencethat you calculated. I have added, sort of, jumping up to a level that we havenever seen in a history of company, because of some relatively weak revenues.According to my records, you have never generated an SG&A rate higher than12%.
Is it your expectation that you should be able to sort of maintain thattrack record and stay 12% or below in the first half of 2008?
Bill Wheat
Steve, as longas I have known you and as long as you have known Don, Horton and me, I amsurprised with your question. But I will answer it for you, because obviously,you must have forgotten something about the both of us and that is we clearlyreduced our SG&A inline with our closings as you noticed at rough 22% and 23%,and we'll continue to do that.
We are, frankly, at this stage, waiting to seewhat type of spring selling season we have; to see if there is any Super Bowlparty. We think we are well positioned to take advantage of it.
To the extent,we are not, we'll keep our SG&A very closely inline with where it hashistorically been, and that's the way this company has operating and willcontinue to operate.
Operator
Your nextquestion comes from David Goldberg of UBS.
David Goldberg - UBS
Hi. How areyou doing?
Don Tomnitz
Hello, David.
David Goldberg - UBS
I think if wecould start with the decline in unsold homes that are under construction orcompleted. Can you give us just an idea of what kind of price discounts youguys used to bring that down, and what's the profitability of those homes mightlook like having been resold?
Stacey Dwyer
Say that againplease, David.
David Goldberg - UBS
Yeah. So, forthe homes that were in progress or completed and unsold, that came down, if mycalculations are right, from about 13,000 to about 10,600?
I think that's aboutright? And I'm just wondering what kind of price discounts you used to movethose homes?
Stacey Dwyer
So basically,the pricing differential between a spec home and a to-be built home?
David Goldberg - UBS
That's right.And then also the profitability difference?
Sam Fuller
It's all overthe math. Quite frankly what we are looking is, we looking at the age of theinventory of the finished spec, and we're trying to mark that to market, aswell as when we do a built job or to-be built home, we are pricing that home, Iwould just say rough numbers.
At least 300 basis points above where we have gotthe spec home for sale, partially because of the fact that if we are going totake the risk of building a to-be built home for someone, we want theadditional profit in order to justified that. And we really willprefer to move the existing inventory home.
So, we are trying to price that, to-bebuilt home high enough that if the buyer wants that on that specific lot,there's a good margin home for us, as opposed to moving any existing inventoryup.
David Goldberg - UBS
And then, Iguess my follow up question has to do with how comfortable you guys are withthe backlog right now that, everybody in the backlog is going to be able to,like if you read it out and make sure nobody can get a loan, and qualify formortgages at the current rate. And any ideas whether that's flushed out?
Don Tomnitz
If I told youI was comfortable, I think I'd be in different business, because -- tell mewhat the mortgage markets is going to be like over the course of the nextquarter. The answer to your question, I believe with what is in our backlogtoday,especially reflecting what happened in the fourth quarter, because one ofthe things that drove our cancellation rates so high in fourth quarter is wedid review our backlog region-by-region, and division-by-division with onespecific goal in mind: do we have a buyer in our backlog who is qualified in amortgage that doesn't exist anymore or looks highly unlikely that they will beable to qualify as the mortgage market changes?
So, we scrubbed our backlog, thebest I think we have ever scrubbed it relative to the mortgage instruments thatare available and may not be available going forward. So, while there's stillcancellations to be held in our backlog, I think the vast majority of those clearlywere taken as we constitute that in the fourth quarter.
David Goldberg - UBS
And then, maybeI can just speak one more in here. I am just thinking about free cash flowpriorities, you guys are going to generate a billion in cash flow fromoperations next year.
Tell me, what you are seeing in the market now in termsof maybe M&A, or even land sellers (inaudible) transaction you guys did, ifyou are seeing that free (inaudible) in terms of cash pricing from land sellersor M&A from other builders?
Don Tomnitz
Well, I would sayto you that that in terms of M&A from our perspective, i.e., us buyingsomeone or some other major asset is certainly not at the top of our list, butrather at the bottom of our list. We are still dealing with an adjusting market.I don't know where land values are going to be three months from today, sixmonths from today.
And so, as a result for us to go out in the marketplacetoday and to purchase some large assets or some builder, I think the mostdifficult thing would be what's the value of the asset that we are buying. So, that'scertainly not on the forefront of our minds.
Our goal is, well, completely to reduceour land and lot inventory and to reduce our finished home inventory and reduceour spec inventory and to get our cost more inline with what the consumer is willingto pay for our product.
David Goldberg - UBS
So, you justuse the cash to deliver?
Don Tomnitz
Absolutely. Weare actually convinced of one thing.
There is a modal risk in across all of ourforeheads as we walk in this office. Homebuilder with the strongest balancesheet wins this fight and we have and we will have the strongest balance sheet.
David Goldberg - UBS
Okay, thanks.
Stacey Dwyer
Thank you.
Operator
Your nextquestion comes from Stephen East with Pali Capital.
Stephen East - Pali Capital
Good morning,everyone. One last question on inventories and then hopefully will leave youall alone on it.
Your specs in absolute came pretty down nicely as thepercentage of total actually went up and I know you all are trying to focusheavily on getting that percentage back into the 30s. Can you do that with yourplans that you have right now on fiscal '08?
Can you do that?
Bill Wheat
I think toanswer your question directly, yes, I do believe we can do that. I think it'sgoing to be a tough goal to achieve.
I think one thing that you have toremember Stephen that we did not disclose and that is that we have 299 homesthat have been completed and unsold for a period greater than a year or so. So,we really don't have a significant aged inventory problem.
Although, we do havemore specs than we would like. That number should come down as we continue toprice our built jobs, more expensively in our specs.
Stephen East - Pali Capital
Okay, all right.And then if we look at the California and Westorders in this quarter, down pretty sharply--pricing down pretty sharply in California. The driversfor you, given the relative underperformance for you all in those particularareas, and sort of what your response is looking out at this quarter and intothe selling season?
Don Tomnitz
Well, I wouldsay in the West, in particular, we believe that any dollar that we don't put inthe ground out there, there is a profit this year. And as a result, we'reabsolutely trying to decrease our investment dramatically in all of thosemarkets out there as we speak in terms of land acquisitions, lot acquisitions,development spend, you name it.
The Californiamarket, we made a lot of profit, a lot of PTI during the good times andobviously, if you look at our impairments we've given back, $0.5 billion ofthat in impairment so far and that's disappointing to us. But that's a verychallenged market.
I would say to you that the biggest issue in Californiatoday is there are a lot of people who want to own a home and there are no mortgagesout there or very few mortgages out there which will permit someone to buy homein California today. So, there's got be a great reset in both cost prices aswell as some additional mortgage instruments to make that market come back.
Stephen East - Pali Capital
Okay. And thatsort of leads right into my next question, the news this morning with Freddiethe mortgage environment in general that you are seeing.
Thus the Freddie newscaused you all consternation? Does it affect your business and sort of tailingonto that the performance you have seen in you markets since the end ofSeptember?
Don Tomnitz
Well, let meaddress everything other than post September and to answer your first twoquestions, yes and yes. It does impact our business.
It does concern us. I amof the opinion that the best thing that's going to happen to the financial institutionsincluding Fannie and Freddie are just exactly what the homebuilders have done.
We'vegone through and we have reset our basis in our properties with impairments of earnestmoney write-offs. The best thing, not that I am an advisor to them, but thebest thing they can do is to deal with it all, get all other ways as quickly aspossible so we can move on.
And that will applaud our industry, because I thinkif you look at all the builders in the homebuilding industry, we've attemptedto clean it up as quickly as we possibly can and that's what they need to do. Therefore,we'll have a whole new parameter to start with and whole new market to startwith.
Stephen East - Pali Capital
Okay. What'sgoing on with Freddie today, do you think it creates another round oftightening of lending standards and thus taking another group out of the market?
Don Tomnitz
It could verywell. It really could.
Stephen East - Pali Capital
Okay. Thanks alot.
Operator
Your nextquestion comes from Timothy Jones with Wasserman and Associates.
Timothy Jones - Wasserman and Associates
Hello, Don.
Don Tomnitz
Good morning,Timothy Jones.
Timothy Jones - Wasserman and Associates
A couple ofquestions. First of all, did you say that land sale (inaudible).
Don Tomnitz
You are reallybreaking up there.
Timothy Jones - Wasserman and Associates
I am going toget up to you, just a second, I am sorry. Can you here me better?
Don Tomnitz
Yes, sir, it'sbetter.
Timothy Jones - Wasserman and Associates
Okay. On the220 -- this is a housekeeping.
The 20,000 lots, did you say they generated $76million revenues?
Stacey Dwyer
$70 million.
Timothy Jones - Wasserman and Associates
$70 million.Okay. And you didn't have any impairments given the fact you had a 45% margin inthe land operations, did you?
Bill Wheat
There was noimpairment on that property.
Timothy Jones - Wasserman and Associates
No, but I gotone thing, Bill, because you generated 45% margins in there.
Bill Wheat
To clarify,Tim, this sale occurred after fiscal year-end. This occurred in the month ofNovember.
Timothy Jones - Wasserman and Associates
Okay. Good.That will help first quarter.
Bill Wheat
Yes.
Timothy Jones - Wasserman and Associates
That's nice tohear. Okay.
Now, can you give me the quarterly increases in sale -- monthlyincreases in sales this quarter and the cancellation, and maybe any comment onOctober?
Bill Wheat
I will tellyou that our cancellation rate in each of the months of the fourth quarterincreased sequentially, which led to our 48% can rate total for the fourthquarter.
Timothy Jones - Wasserman and Associates
And that wasdescribed in the backlog or what?
Sam Fuller
I would saythat -- I don't have that number before me, but a lot of the increase in ourcan rate up to 48% over the year-ago period and especially over the thirdquarter, a lot of that was a function of our cans in our backlog.
Stacey Dwyer
Yes.
Timothy Jones - Wasserman and Associates
The otherthing is you talked about being really working on your flyers, and I know Donwell enough to know this is true. How much have reduced your material cost andlabor cost per square foot in the last year or so from the peak whatever youwant to say it?
Bill Wheat
We don't havean exact number on that. That's going to vary market to market.
Certainly inplaces like California and Las Vegas, it's been more substantial than it has been in Texas, because Texasis still a good solid market for us. But I think as a good range, what we havetold people over the course of the year is that that number is probablysomewhere between 5% and 10%; probably closer to 10%.
Timothy Jones - Wasserman and Associates
Really, andthat's sticks and bricks, that's including laboring everyday?
Bill Wheat
Yes, sir.
Timothy Jones - Wasserman and Associates
Okay. Andlastly, just one another question.
I just want a comment on this. One of yourcompetitors had said they are going to built 200 homes in Southern California and hold on to them.
That obviously surprised me. Andyou've just said that anything you can get out of California is good.
Would you like to makeany comment on the different tactic?
Don Tomnitz
No, sir.Frankly, we're focused on taking care of our own inventory and of houses andlots, and our goal is to try to reduce our number of homes in inventory, aswell as most importantly, pull our development dollars out of the ground bybuilding, selling and closing houses on those developed lots.
Timothy Jones - Wasserman and Associates
You said therewas price inelasticity in Southern California.Yet, one of your major, major competitors said, if you can offer homes thatdidn't get a conforming $417,000 loan, that you can sell them quite rapidly inSouthern California, I would still suspect that most of your product would fallinto that category. Bill Wheat I would agreethat most of our product would fall into that category and I think still themajority issue in Californiais as a fact that you have consumers.
You are seeing single family home pricesdecline rapidly over the last 12 month to 18 months and one other things thatwe are fighting along with mortgage liquidity into the California market isfrankly one of boosting back consumers' confidence and the only way we aregoing to have the confidence in the consumer is there are some pricingstability until we reach a level of inventory where it's relative to the demandout there I think that's going to be very difficult to achieve. So, clearly in California, we need somehelp on the mortgage side or a lot help on the mortgage side, but right now Ithink it's a combination of mortgage and consumer confidence.
Operator
Your nextquestion comes from Alex Barron with Agency Trading Group.
Alex Barron - Agency Trading Group
Hi, goodmorning.
Sam Fuller
Good morning.How are you doing?
Alex Barron - Agency Trading Group
Good, how areyou?
Sam Fuller
Doing great.
Alex Barron - Agency Trading Group
Excellent. Iwanted to ask you if you could talk about on the impairment how manycommunities you guys impaired this quarter and also what the breakdown wasbeyond California?
Don Tomnitz
Sure, weimpaired 98 communities this quarter and just rough numbers we had 58%California, the next two regions kind of in the ranking there as far as volumeof impairments of west region had the second largest amount and the Southeastregion had the third largest amount, combined that gives the best majority ofthe impairments this quarter.
Alex Barron - Agency Trading Group
And of those98, how many were re-impairments?
Don Tomnitz
23
Alex Barron - Agency Trading Group
23, okay. Iguess my second question going back to the SG&A issue I am just trying toget a sense of how much of SG&A is relatively fixed versus how much isvariable and I guess do you have a target for where as a percent of revenuethat's going to come in next year?
Sam Fuller
Our goal hasalways been to keep it at 10% or less, obviously we are 10.3%, 30 bits higherthan our goal. But we expect in '08 to be real close to that 10%.
Stacey Dwyer
And the onlything I would to add that Alex is, it is going to be challenging to keep thatat 10% in a declining revenue environment. And we have been very proactivethroughout this year and we managed to bring that in only 30 basis points ofabove our target.
We're going to be working to do that again. A lot of ourcosts are variable, and over 50% probably closer to 60% of our SG&A cost,are relates to people, it's the actual salaried, commissions, bonuses and thenall the related benefit cost that we pay.
So as we continue to adjust ourorganization size to demand that we're seeing in the market, we will continueto impact a larger percentage of that SG&A number.
Alex Barron - Agency Trading Group
Got it. Andany comment on the dividend; any chances that's going to get cut to save somecash?
Bill Wheat
Our dividendis stand as it is and its something that our Board of Directors reviews on aquarterly basis, clearly with our $1.36 billion of free cash flow in the pastlast quarter. And over $2 billion of free cash flow over the last 15 months.And our projection of $1 billion of free cash flow for fiscal year '08, to theextent that we can continue to generate the free cash flow that we expect to.We will review it on our quarter-by-quarter basis, relative to our ability toachieve those free cash flows in '08, but we certainly did that in '07 and forthe past 15 months.
Alex Barron - Agency Trading Group
Thank you verymuch. Take care.
Operator
Your nextquestion comes from Carl Reichardt with Wachovia.
Carl Reichardt - Wachovia Securities
Tell me guys,how are you?
Don Tomnitz
We're doinggreat, good morning.
Carl Reichardt - Wachovia Securities
When youchoose a new word, please do it at my conference in February.
Don Tomnitz
Alright.
Carl Reichardt - Wachovia Securities
I have aquestion about, if you look at your budgets for absorptions over the course offiscal '08 I don't know if you base you impairment analysis on what's you guessas to, I know you don't disclose store capital, what's your guesses is to whatyour store count will decline if it will in '08 versus '07?
Bill Wheat
We expect itcertainly to decline if probably in the 10% range roughly, its a little bitdifficult to predict, it really depends on how quickly we sell through currentcommunities, but we expected to certainly come down at 10%, it wouldn'tsurprise us.
Carl Reichardt - Wachovia Securities
And that wouldbe faster than in '07 to '06 correct?
Bill Wheat
You know that'sabout inline we're roughly in the 10% range for this year.
Carl Reichardt - Wachovia Securities
Okay great.And Don, can you give us any update on markets that your geographic marketswhere you will be there substantially consolidated divisional operations oroutright pulled out off.
Don Tomnitz
I don't on thetop of our heads, but not on top our heads, specifically we've not pulled outof any major markets that we were in. We have consolidated operations clearlyin California.We're consolidating operations in Florida,and those are really two primary areas where we consolidated our operationssignificantly.
And Stacey just mentioned Denverand clearly Denverwere one division versus three divisions so we've consolidated those threeareas the most.
Carl Reichardt - Wachovia Securities
Okay. And thenjust one last question, I know you are not out there if you are looking for it,but from a land price perspective could you comment on what you might be seeingfrom especially the third party developers and are you starting you see any ofthe banks that have taken stuff back from the private guys or developers startto ask you do details with them, obviously whether hanging on to it but you areactually developing outward fee has any of that started to accelerate?
Sam Fuller
No feeapproach that we've been, no, we have been approached with. You are seeing verylittle of any come from the bank yet and it's the only thing I can say aboutthe third party developer is they are too high and hold their prices, clearlyif the homebuilders are taking the impairments that they're taking, they aregoing to have to decrease their prices significantly accentuate us in '08because I can tell you they need to be impaired, just as much as we have beenimpaired.
Carl Reichardt - Wachovia Securities
Okay. Iappreciate that.
Thanks so much, guys.
Operator
Your nextquestion comes from Jim Wilson of JMP Securities.
Jim Wilson - JMP Securities
Thanks, goodmorning.
Don Tomnitz
Good morning,Jim.
Jim Wilson - JMP Securities
I waswondering, Don, could you kind of go through as you discussed what you requiredin land in '07 and then your plans for '08, where that is? I assume you havemade some material changes in what are your points in acquiring land or lookingin new purchases.
Don Tomnitz
The primaryplace that our land acquisition is an option contracts where we are closing onlots, to either build jobs or specs in a specific community. As far as otherraw land purchase, I can tell we have no plans to acquire any pieces of rawland and very little of any occurred in '07 to the extent that we did close acouple of parcels in '07.
I can tell you that we've already turned those andsold them off to other people. So, we just don't have any appetite to speak-upin any market today for new land parcels, what we are doing simply is closinglots and options contracts to build homes.
Jim Wilson - JMP Securities
Okay. And I aswell assume lot of that are -- that seems to have dropped options more incertain locations and executed options, [on] others.
I know that there is a bigdifference in the geography--is that fair to say?
Don Tomnitz
Yes, verydefinitely.
Jim Wilson - JMP Securities
Okay and thensecond question, as you noted early on that your exam, I think the number waslike $2.6 billion of inventory for impairments and impaired 900 of it, roughly30%. What did you find in the large chunk there that you examined, but found noneed for impairment, what were the characteristics of not requiring it?
Was itgeography again or just were you be able to lower cost in order to stayprofitable or some combination?
Sam Fuller
The primaryfactor is the margin that we are seeing currently in the project and ourprospects for margin going forward based on what we expect to see in pricing inthat project, and at this point based on what we can see, it is still reallyabove the line where we would not need to be impaired, similar to anything thatwe hadn't impaired in previous quarters.
Jim Wilson - JMP Securities
Okay, andindeed again I guess geography had a lot a with that?
Sam Fuller
Geographycertainly comes into play. One indicator, one of the things that puts theproject on the list is its geography, relative to perhaps other projects thathave been impaired.
So that will be a factor, but the primary factor is how weexpect that project itself to perform based on what we are seeing and what weexpect in the short-term.
Don Tomnitz
The geographyis pretty much limited, I would call four states and its really still California, still Arizonaprimarily Phoenix, still Floridaand also Las Vegas.So if you look at, as I've said before, in the homebuilding industry, everybodytalked about the great ramp up in the homebuilding industry and theappreciation in all these markets. Really we had four or five hot states, andwhere we've got most of our impairments, and our future impairments are stillgoing to be, I believe, in those four five hot states.
Jim Wilson - JMP Securities
Got it, okay.Alright Thanks.
Operator
Your nextquestion comes from Larry Taylor of Credit Suisse.
Larry Taylor - Credit Suisse
Good morning,thank you.
Don Tomnitz
Good morningLarry.
Larry Taylor - Credit Suisse
A number of myquestions have been answered, but I wonder if you could just provide a littlemore color on the use to cash flow given that you've already made substantialprogress repaying the bank debt and have a limited number of maturities goingforward over the next 18 months?
Stacey Dwyer
First thing,Larry, we had a balance of $150 million remaining on our revolver at the end ofthe year. First use of cash would be go ahead and reduce debt.
We also have$215 million of senior notes that mature in December and that will beredeeming, and in fact that we will basically look at opportunistic ways torepurchase our debt and we may also achieve more cash on the balance sheet thanwe have historically, and simply until we see market conditions stabilize alittle bit we want to make sure that we have sufficient liquidity.
Larry Taylor - Credit Suisse
Okay, great.That's helpful. And then I wonder if you comment as you look into 2008 andthink about the competitive landscape and I realize this is sort of a generalquestion, but how you anticipate pricing strategies to evolve from some of yourcompetitors, I mean we've seen price cuts, we've seen a pause in pricing cutsin some markets.
And I guess just sort of trying to get some benefit from yourview as the housing demand falls in '08 from a pricing standpoint?
Sam Fuller
I believe '08is going to be considerably more competitive than '07, both in terms of volumeas well as price, and we are prepared to meet the market in each one of ourmarkets and we think that this is going to be little more painful for us in '08than it was in '07 in terms of trying to meet that limited market, because themarket is -- there is less volume and the volume that is there is demandingbetter pricing which is couples with our focus on decreasing our cost asrapidly as we possibly can.
Stacey Dwyer
And the otherthing that Don talked about is just to continue changes and tightening thatwe're seeing in the mortgage market and tightening at the lending standards andchanges in the products that are available to our buyers to allow them to getinto houses.
Larry Taylor - Credit Suisse
Great, that'svery helpful. Thank you.
Operator
Your nextquestion comes from Mike Marburg with Ramsey.
Mike Marburg - Ramsey
Hi guys. Twoquestions.
One, around the gross margin, so as you look over the past fourquarters, that the margin change its track with some difference, but its tracksomewhat with the decline in average selling prices. And I guess starting nextquarter, we're really start to see this filters through with the flow throughof the big declines in the last two quarters on ASPs for sold homes, which wehave not seen yet, because ASPs on our closed homes have been pretty good, allthings considered in this environment.
So, do youexpect the gross margins to really start to change, take a step functionchange, early next year, or are you able to really make up for that, with thesecost cutting efforts? So, it would be different than what we have seen in lastfour quarters?
Bill Wheat
Realisticallyspeaking, I believe our gross margins will come under continued pressure in'08. I am not certain we're going to be able to offset that decrease in grossmargins a 100% by our SG&A cuts as you can tell.
But clearly, we anticipate'08 to be more difficult than '07 and we have taken the proactive steps to beprepared for that.
Mike Marburg - Ramsey
Okay.
Sam Fuller
One thing weprobably should clarify is in the sale ASP in the current quarter's sales. Aproduct mix did impact, especially product mix on our cancellation rates, didimpact our ASP quite a bit, while our net sales order ASP did decline by 15%,our ASP on our gross sales orders only declined 8% because we did have morecancellations coming out of the higher products as the jumbo market was influx.
But, certainly an 8% decline, we do expect that impact margins goingforward.
Bill Wheat
But 8% versus15%, and one of the factors that we continue to work on, is how do we holdthose units and backlog and prevent them from canning even if it takes us alittle bit more negotiation to hold those in; because we can see the differencebetween 8% and 15%, we have got a little bit, we've got quite a bit a leeway towork with the buyers within backlog and to hold them in the backlog to get themto close.
Mike Marburg - Ramsey
Yes, okay,thank you. And then as it relates to the SG&A comments you are making earlyabout a roughly 25% of selling.
So for this year that would put on just on aquarterly basis your G&A cost at around 200, below 200 per quarter. So ifnext quarter we've a big drop in homebuilding revenues, which I think is to beexpected given the recent trends.
The G&A, you assume, roughly 25% staysfor selling. The G&A needs to go down to about a 150 from, say, 210 perquarter.
Are you prepared to make such a dramatic change in G&A in onequarter, it did happen last quarter, in the fourth quarter of last year youwent from maybe 300 down to somewhere in the mid-200s per quarter using theratio you have given us, but are you prepared to do that again?
Sam Fuller
Yes, we are. Iam not sure that we'll get it all done in the first quarter, or all in thesecond quarter, but we're waiting for even though we're leaned today.
We'rewaiting to see what happens in terms of the spring selling season Specifically,Super Bowl in February of calendar year '08. We're I think as lean as we canpossibly get right now in anticipation of what we think we're going to do.We've run the numbers based upon how many units we believe that we'll close in'08 and the number that we're running on based upon what we believe we canclose in'08.
Our SG&A is close to be in line where we want it to be, to theextent that the number of units that we think can close are eroded than we areprepared to make the SG&A cut, just as we have done over the past 24months?
Mike Marburg - Ramsey
Thank you verymuch.
Operator
Your nextquestion comes from Susan Berliner with Bear Stearns.
Susan Berliner - Bear Stearns
Good morning.Just two quick questions, one, is I was wondering if you could talk about whichare your best markets, right now?
Bill Wheat
That's alimited list today.
Sam Fuller
I stillbelieve the California.I thought you asked the different question. Clearly, Texas continues to be a very good market forus.
It's weakened some in '07 and we expect it to weaken some in '08. But theall the markets in Texas from Dallasto Boston, to Houston,to a lesser extent San Antonioare all good markets for us.
Our acquisition in Baton Rouge, Louisianacontinues to perform very well for us. The Chicagomarket, we had a very good year in Chicago.
We anticipateit would be a softer market in Chicago nextyear, but it will be still good solid year for us in Chicago. And if you take a look at theCoastal Carolinas and even interior parts of Carolinas with Durham/Raleigh and Charlotte, we expectthose to be good markets for us in '08.
I believe that rest of the markets aregoing to continue to be as marginal as they were in '07 or even to decline somein '08.
Susan Berliner - Bear Stearns
And is thattrue for Atlantaas well?
Sam Fuller
I think Atlanta is just a -- it'sa pretty much a flat market. It's a great market for us.
We get good sales andclosings in Atlanta.But it's just not as active as what it once was, and it's very competitivemarket which is influenced largely by a large number of small and medium sizedbuilders, who we don't wish a (inaudible), but during this downturn, we hopethey go away because it will get back into the larger builders who are workingfor higher profit than the smaller or medium sized builders on the line.
Susan Berliner - Bear Stearns
And then mylast question is, can you just talk about your philosophy and what kind oflevels are you giving for incentives versus actual price declines?
Sam Fuller
Well, in termsof the incentives, where we are, it's really out of one pocket or the otherpocket. Frankly, we've tried to preserve as much of our sales prices as wepossibly can in our communities and offer incentives as opposed to marking tomarket permanently vis-à-vis the sales price.
But clearly, whatever it takes toget the product, that's already produced and available, sold and cleared themarket with that, we are willing to that both with price incentives as well asprice cuts as well as incentives.
Susan Berliner - Bear Stearns
Great, thankyou very much.
Operator
Your nextquestion comes from Bob Thompson with Advantus Capital.
Bob Thompson - Advantus Capital
Hi, guys.Going back to that, were the average incentives and discounts in the fourthquarter, did you give that amount?
Sam Fuller
We didn't givethat amount, but I think we are pretty much dealt with I believe when we talkedabout our core margins and it's fully reflected our entire deterioration in ourmargin is wholly the result of the incentives and price adjustments that wehave made during the quarter. We talk about it because it does hit both lines.
Bob Thompson - Advantus Capital
Okay.
Sam Fuller
Incentives hitcost whereas price reductions come up revenue line.
Bob Thompson - Advantus Capital
Okay, and also,going back to the 20,000 lots--did you say, did you sell them for $70 million?
Sam Fuller
It was a rawpiece of land that was entitled for as many as 20,000 units.
Bob Thompson - Advantus Capital
Okay.
Sam Fuller
Both singlefamily as well as multi-family, and the revenue associated with that wasapproximately $70 million.
Bob Thompson - Advantus Capital
Okay. And thendo you anticipate any further -- are you actively seeking lot sales goingforward?
Sam Fuller
Whether wehave -- to answer your question directly, yes, we have excess lots, and it'sgoing to vary market-to-market.
Bob Thompson - Advantus Capital
Okay. And thenthe last question is as the year unfolds, as the covenants gets closer, I meando you anticipate needing to amend your covenants in '08?
Bill Wheat
At this point,we certainly have sufficient cushion at 930. As we go into '08, we willevaluate where we think we're going to be and will be in active conversationswith our banks if necessary.
Bob Thompson - Advantus Capital
Okay.
Sam Fuller
Frankly, weare very proud of where we are today relative to those covenants. We have moreroom I think than most everyone else in the industry.
So we are very proud ofour financial performance relative to those covenants. But to the extend thatour financial performance should adjust going forward, and as we said earlier,we think '08 is going to be more difficult than '07, then we'll be, if we needto, actively discussing with our banks adjusting those covenants.
Bob Thompson - Advantus Capital
Great. Thankyou very much.
Don Tomnitz
Yes, sir.
Operator
Your nextquestion comes from Bob Sells with L&K Capital Management.
Bob Sells - L&K Capital Management
Threequestions. First question is, looking at the spring '08, as you call itseparable selling season, why not make the overhead cuts now assuming the direct-- given the direction of the credit markets rather than waiting to see theresults of spring '08?
Don Tomnitz
I believe --first of all, let me say that from an SG&A perspective, we are the leanestbuilder in the industry. We believe we're properly positioned for what weenvision is going to happen in '08.
And to the extent that that doesn'tmaterialize according to our spreadsheets that we have done for each month ofthe fiscal year, we're going to make those adjustments as it does not meet ourexpectations.
Bob Sells - L&K Capital Management
When you lookat those assumptions, where do you assume the low watermark is for orders?
Sam Fuller
Typically, ifyou look at our first quarter, our first quarter of sales is our weakest andsecond quarter it usually starts to pick up, and third quarter is little bitbetter, and the fourth quarter is little bit less. So if you fuse this, thefourth and the first quarter are our lowest points and the second and the thirdquarter are our highest points.
So, today, with where the mortgage market isand the constant evolution of the mortgage markets, I couldn't say which isgoing to be our best quarter at this point.
Bob Sells - L&K Capital Management
But it soundslike you will wait until the second quarter, kind of the beginning of thesecond quarter of '08, over at that point before making the further decisionson SG&A cuts?
Sam Fuller
Well. Let meclearly say, and maybe I misstated this earlier, we're not holding excessSG&A in anticipation of unrealistic fiscal year '08 sales and closingsnumber.
We are frankly looking at it. We're positioned exactly where we want tobe relative to our projections, which are internal for '08 and will adjustthose as we move forth accordingly.
The one thingthat I will remind everyone of is we have had the lowest SG&A in theindustry and will continue to have the lowest SG&A in the industry, andwe're going to adjust our business just as we've done over the last 24 monthsto meet the market.
Bob Sells - L&K Capital Management
Secondquestion. With the lack of further impairments, the implication is that yourpricing assumption for orders doesn't drop radically going forward, although Iunderstand you're doing good job on costs.
Help me help reconcile thatimplication with the statements that you made and I believe is your philosophythat you will price as it takes to move inventory. I guess myassumption had been that pricing will continue to move down more quickly thanyou are able to cut costs as we look into the fourth quarter and the firstquarter.
Sam Fuller
Ourassumptions are that our prices will continue to drop in most cases. There isno implication with regard to the amount of impairments that are taking in anyone quarter.
The assumptions that go into the impairment evaluation areconsistent and do assume flat to lower pricing in virtually all projects thatwe're evaluating. This is thesecond largest quarter on record for us in terms of dollar amount ofimpairments.
So it certainly is a substantial amount of impairments from ourstandpoint and really there is no implication regarding assuming the pricing isgoing to be better. We assume that the pricing will continue to be challenged.
Operator
You nextquestion comes from [Emeril Amman] with 36 Capital.
Emeril Amman - 36 Capital
Hi, guys.Thanks for taking my question. You guys have done a great job kind of assessingthe situation for what it is.
I just kind of wanted some color on a higherlevel question. There has been a lot of talk lately about that given the stateof buyer confidence in some of the more troubled states that the cost of homeownership is going to have come down to the point where it's competitive withthe rest, which means anywhere from between another 10% to 20% drop in prices.Is that kind of theory you subscribed to or is that kind of analysis missingsomething?
Sam Fuller
Absolutelynot. Each market is adjusting on its own and some markets are adjusting moreand some markets are adjusting less.
And I would not attach the percentage ofdecline to any of it, because frankly, I would say to you and I would say tothe homebuyers in America that if we're not at bottom in terms of our pricing,we're really close to it and to the extent that you are waiting to buy a homebecause you think prices are going come down, you're going to do the same thingyou do on interest rates most of the time and that is you're going to say, gee,we missed the bottom of the market. So I think weare very close to the bottom of the market.
And most of our markets, some stillhave some additional deterioration, but it's difficult to determine where thoseare at this stage.
Emeril Amman - 36 Capital
Okay. Great.Thanks, guys.
Operator
Your nextquestion comes from Darren Richman with GSO.
Darren Richman - GSO
Hi there,everybody. Thanks for taking the time today.
On the topic of impairments, I waswondering once you make the determination to impair a property, can you walk methrough exactly the methodology used. What type of margins you are trying totarget?
What discount rates you may use in the process just to add some morelight to that process? Thanks.
Don Tomnitz
Certainly, theassumptions are set project-by-project. In order to determine that a project isimpaired, we must determine that the project will not essentially make moneyfrom an accounting standpoint after covering direct overhead cost.
Once we havemade that determination, then we'll perform a fair value analysis, which inmost cases will be a discounted cash flow analysis of all of the future cashused or cash flows from that project in the future. That will be discountedback.
The discountrate assumed in each project will vary, and it will vary basically based on therelative risk of the project. The closer that we are to delivering homes in aproject, the lower the discount rate will be.
If it's raw land, and we stillhave developments, and will not deliver homes for some period in the future,the discount rate will be higher. Butessentially, we discount those cash flows back, determine the fair value basedon that compared to the current carrying value of inventory and record theimpairment accordingly by choosing different discount rates based on therelative risk.
Generally, theassumed gross profit that would result from an impairment charge would be loweron a project that's closer to delivering homes; again, lower-risk project. Andit would be higher on a project that we would be delivering homes further intothe future.
The range can vary quite a bit. I'm not state necessarily specificranges of gross profits or discount rates, but it's project-by-project.
Darren Richman - GSO
I'm justwondering, I mean is it -- some of your competitors have put out some discountsrates. I was wondering if at the very least you could bracket it.
I mean arethey in the double digits or are they closer to 20% really, just to get abetter sense for it?
Don Tomnitz
The numbersthat you've seen kind of bracketed for the other builders out there have beenvery consistent with what we have used, as well. There is basically one auditfirm that audits majority of the industry.
And overall, I believe that thebuilders and the audit firms have worked together to make sure that we arekeeping the assumptions on the impairments as consistent as we possibly cangiven that it is a project-by-project analysis.
Darren Richman - GSO
Sure. And thenwhat do you do on a raw land basis?
Is that something that you'll discount aswell, because I think the methodology there differs from builder to builder?
Don Tomnitz
We willdiscount that. Of course, it depends on what our intent is for that land.
Ifour intend is to build it out, then that's one set of assumptions. If theintent is to sell the land, that's another assumption and that would be basedmore on the market price of the land, but that will vary based on the intent ofour use of the land.
Operator
Ladies andgentlemen, we have reached the end of the allotted time for thequestion-and-answer segment. I would now like to turn back over to Mr.
Tomnitzfor any closing remarks.
Don Tomnitz
Thank you verymuch. As I sit here around the conference table and I look at our 2006 21stAnnual Builder 100 Single Family D.R.
Horton number one trophy, I would say toall of our employees and our investors that we entered this downturn in themarket as the largest and the most profitable builder. Clearly, as we gothrough this market downturn, we are shrinking the size of our organization tomeet the demand.
And as I tell our employees and I tell our investors, on theother side of this, we will come out as the largest and the most profitablebuilder. We are themost transparent financials in the industry.
We have the least -- we have noone consolidated joint ventures. And the bottom line is, as I said, D.R Hortonentered this with the strongest balance sheet and will come out of thisdownturn with the strongest balance sheet.
We have been, we will be, and we'llcontinue to be, the survivor and the leader in our industry, and we lookforward to great opportunities in years ahead. As I tell oursalespeople, it's all about sales.
We're all in sales-- regardless of whetheryou are construction superintendent or whether you are a field person, awarranty person or whoever--we are all in sale and it's all about sales. So, aswe have told all of our regional presidents and division presidents, and I hopea lot of salespeople are listening to us today, the future of the company andhow well we do is based upon how many homes you sell throughout there.
Leave nobuyer behind; sell and close homes. Thank you very much.
Operator
Ladies andgentlemen, this concludes today's D.R. Horton Incorporated America's Builder, the largest homebuilder inthe United States,2007 year-end conference call.
You may now disconnect.