Centex Corporation F2Q 09 (Qtr End 9/30/08) Earnings Call Transcript

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 |  About: Centex Corp. (CTX)
by: SA Transcripts

Centex Corporation (CTX) F2Q09 Earnings Call October 29, 2008 10:00 AM ET

Operator

Good morning and welcome to the Centex Corporation fiscal year 2009 second quarter earnings conference call with senior management. Today’s call will be recorded and transcribed. Today’s call also will be simultaneously webcast at ir.centex.com.

A copy of today’s presentation was filed last night with the SEC on Form 8K. A link to that document is now available on the website. As usual, participants must download and advance their own slides during today’s conference.

Continuing on slide 2, Centex wishes to emphasize to everyone listening on the call and via the Internet that certain statements made during the course of this call are forward looking. These statements are not guarantees of future performance and are subject to significant risks and uncertainties that could cause actual results to differ materially from those discussed during the call. For further information regarding these risks and uncertainties and Centex’s forward-looking statements please refer to the forward-looking statements disclosure in the presentation and to Centex’s reports on Forms 10K and 10Q filed with the SEC.

All participants will be in a listen-only mode. There will be a question-and-answer session after managements’ remarks. (Operator Instructions). In the interest of time we will limit each person to one question and one follow-up question. If you have additional questions following today’s call please contact Matt Moyer, Vice President of Investor Relations, at 214-981-5000.

I now turn the call over to Tim Eller, Chairman and CEO. Please go ahead, Sir.

Timothy Eller

Thank you, Christy. Good morning, everyone. Thanks for joining us for our fiscal year 2009 second quarter conference call. With me today is Cathy Smith, our chief financial officer, Mark Kemp, our chief accounting officer, and Matt Moyer, head of investor relations.

I’ll start our call today with some introductory comments on the quarter, as well as a few thoughts about the months ahead. Next Cathy will provide details about our financial performance for the quarter and the year to date. Then I’ll offer some closing comments and we’ll take your questions.

Turning to slide 3, it’s an understatement to say that unprecedented economic conditions have had an increasingly negative impact on the housing industry. Last quarter our sales per neighbourhood dropped to an average 1.7 per month from 2.5 in the previous quarter. Sales may well weaken further in the December quarter.

I’ll suggest, however, that I think virtually all elements of a bottom for the housing cycle are in place. But it’s not at all possible to predict when we’ll reach bottom or how long we’ll likely bounce along there. Frankly, conditions will probably get worse before they get better, especially in light of the continuing financial and credit turmoil and increasing job losses.

The depth and duration of this housing and financial correction make this a game changer for home builders like no cycle that has come before. I believe it will dramatically alter the competitive landscape. It’s now clear that this cycle will test the best and eliminate the rest.

At Centex we have been consistent in our actions based on the current market realities at the time to effectively navigate this unprecedented cycle. We’re continuing to increase our cash position, ending the quarter with $1.3 billion cash on hand. That’s up more than $700 million since the beginning of the fiscal year and $64 million over our last quarter after having paid off $150 million of maturing senior notes in the quarter.

We’ve combined and consolidated operations around the country for efficiency. In California, for example, we now operate two divisions with a couple of satellite offices where we once operated nine separate divisions. We’ve made similar changes in Florida and the Carolinas.

We’ve shortened our land position. Only one other national builder has a lower total lot position than Centex based on the last 12-month sales. We accomplished this not through distressed sales nor forcing specs, but through an effective and practical business approach of pre-selling homes to a backlog and then building homes on a predictable schedule based on that backlog. While sales have declined, we’re carefully managing that process to optimize volumes and maintain resource efficiencies. As we do we’re retaining the capability to take advantage of the inevitable and perhaps historic opportunities as that will arise. We intend to excel on the other side of this housing cycle.

Based upon our multiple cycle experiences, I believe we’re making the right strategic choices for the current environment. We’ve established a steady monthly pattern of improving gross margins this fiscal year despite commodity price pressures and declining sales. Gross margins have increased every month for the past six months. Direct construction costs have declined 0.5% each month.

Gross margins reached 15% in the second quarter and our backlog indicates that we’ll see additional improvements. Discounts and incentives have dropped, as have financing costs and sales concessions. Further confirmation that our build-to-order transparent pricing approach is the right one.

Home building G&A combined with corporate G&A is down 39% from a year ago. However, we’re still taking actions to further reduce G&A spending in light of current sales conditions.

Our land development requirements are low. About half our lots in land under development are finished. Looking ahead, this cycle will virtually assure land and finished lots can be acquired on soft terms and a fairly asset-light basis.

We expect to continue growing our cash position. We’ll continue to reduce debt and increase cash on hand through the fiscal year. We’re confident in our abilities to generate the cash necessary to manage debt levels over the next several years, even at current levels of production.

While we continue to structure our business to weather the cycle we’re also preparing to emerge from it with strength.

Turn to slide 5. Today’s land position is sufficient for our near-term needs. With the abundance of finished lots that will be coming on the market we can supplement our existing inventory as needed.

We have the opportunity to gain market share and we’ve been steadily doing so in our key markets. Across the nation in major markets like Washington, DC, Dallas-Fort Worth, San Antonio, and Phoenix we’re gaining market share on an absolute and relative basis. This is in large part because the severity of this cycle is driving smaller and less well-capitalized players from the field. Scaled in the most attractive markets we yield further margin improvement and higher returns.

With that I’ll turn it over to Cathy to take through some of the specifics for the quarter.

Cathy R. Smith

I would characterize the quarter by good cash performance and improved gross margins, although by a macro basis the home building market continued to deteriorate. I’m on slide 6.

Our home building operations were cash flow positive for the fifth straight quarter. This reflects our keen focus on cash and the progressive changes in our business processes.

We continue to strengthen our balance sheet and now have a home building net debt to cap ratio below 48%. This is an improvement of almost 700 basis points in the last six months.

We continue to generate cash throughout the reductions and utilizing our developed lot line. What’s more exciting, because of the longer term implications we are becoming more asset efficient and more profitable as we have almost fully completed our transition to a build-to-order production model. As Tim said, even at these depressed levels of sales and closings we can produce positive cash flow.

Another positive of the second quarter is the improvement in our gross margin. Gross margins improved 320 basis points sequentially to 15%. Our discounts and incentives came down again this quarter and in each month of the quarter as well. Specifically, our sales discounts and incentives were 7.9% of the average selling price, down from 10.5% last quarter making the third consecutive sequential decrease.

We also made good strides toward achieving operational profitability through overhead cost reductions. We reduced our home building overhead per closing by 13% year over year and lowered SG&A as a percent of revenue by 30 basis points sequentially.

Although our home building SG&A was lower, our corporate G&A increased year over year. We recognize even in these unprecedented times it’s important to continue to frugally invest in the future. We’ve been doing much to centralize, standardize, and simplify our business and some of the associated costs show up in corporate G&A. I’m confident these investments will enable Centex to have a sustainable, scalable, and efficient cost structure.

We also furthered our strategy to focus on our core home building business in the quarter. We essentially completed the wind down of our retail mortgage operation and we successfully completed the sale of two of our smaller non-core businesses. We closed on the sale of our insurance agency business and just after the end of the quarter we sold our CTX Builder Supply business. In both cases we were approached by the buyer and sold the businesses for a gain. The gain on the sale of the insurance business appears in discontinued operations on the income statement. The cash received is in investing activities on the cash flow statement.

Slide7 provides the details around the home building operations for the second quarter. We closed 3,797 homes in the quarter, 48% fewer than last year. The average price of homes closed in the quarter declined 12% to $247,534. Total home building revenues were down 55% to about $1 billion.

Sales in units were down 54% year over year. On a per-neighbourhood basis sales were down 42% as average neighbourhoods declined 21% to 523. As Tim said earlier, this level of activity was within our planning ranges and we’ll continue to adjust overhead as we have for the past several quarters.

Our cancellation rate jumped up this quarter to 40.3% versus 35.4% a year ago and 30% last quarter. The increase in cancellations was due to the elimination of the down payment assistance program, rising job losses, and tightening credit standards. We continue to believe that a return to more normal qualification standards is necessary long term, even if it causes a little bit of short-term pain.

Following the weaker sales pace and higher cancellations our backlogs fell by 28% year over year to 6,953 units valued at $1.83 billion. This is one of the strongest backlog positions in the industry and a direct result of our build-to-order model. The right level of backlog will be increasingly important to us. Creating a pre-sold backlog allows us to build to a cadence. Building to a cadence using standardized business processes yields operating efficiencies, higher margins, and more predictable results. And developing a backlog through pre-selling is essential to our asset-light business model. We’re moving rapidly in this direction.

Consistent with our strategy and early actions, we’ve done a great job reducing our total lot position. We now own 63,311 lots and control just 11,866 lots. Based on trailing 12-month sales, this is less than a four-year supply of total lots; one of the best positions in the industry.

On a pre-tax basis this quarter we recorded $103 million in land-related charges, including $77 million in land impairments, $14 million in optional walk-away costs, and $12 million of JV impairment. We impaired 28 neighbourhoods this quarter which brings the total number of neighbourhoods impaired at least once to about 280.

As I’ve said each quarter, we take a consistent, methodical approach to land valuation. We recognize this is a dynamic environment. We’ll continue to take the same disciplined approach to valuing our assets each quarter.

Along with the impairment analysis it’s essential to assess each neighbourhood for positive incremental cash flow. We evaluate every asset every quarter to make sure we have the right strategy for that particular asset. We assess whether the highest return is to sell, build through, or hold. We’re still finding that the best answer most of the time is to continue to build through our assets. You will see that our land-held category decreased slightly sequentially. Continuing to build through our assets will leave us with a leaner balance sheet and an opportunity to add faster-turning, higher-yielding assets in the future.

We also increased our valuation allowance related to our deferred tax asset by $66 million. In total, the balance of our DTA is $1 billion with a valuation allowance against it of $945 million or just over $7.50 per share. This represents over 45% of our current book value. We’ll realize this asset when we see stability, an improving environment, and a return to profitability.

Let me take a few minutes to review the regional results. Slide 8 details sales and closings by region. As you will quickly notice, we have realigned our reporting regions to better reflect the ongoing changes in our business and the industry.

In the quarter we sold 2,728 homes, down 54% year over year. Our average active neighbourhoods were down 21% in the quarter, a rate that will likely continue to accelerate through the second half of the year.

In our East Region sales were down 39%. The coastal Carolinas and DC metro were relatively stronger than the rest of the region. In the Central Region Texas and Nashville were relatively stronger than other divisions in the region. And in the West Region the Northern Pacific area and New Mexico were the stronger areas.

That said, only one division had a year-over-year increase in sales. Year-over-year closings were down across the board consistently, reflecting the soft market environment and the reductions in active neighbourhoods.

Moving to slide 9, the current conditions in the housing market highlight even more the strength of our strategic choices as they are yielding the expected positive results. Our business model emphasizes selling to a backlog and then building to a cadence. This increases our profitability and predictability. Our gross margins have now improved 730 basis points in the last six months to 15% and should continue to get better in the December quarter. Incentives and discounts were down to 7.9% this quarter, less than half of our peak levels last year.

Our sell to a backlog/build to a cadence model helps us to better know exactly where and when we need finished lots. As a result we have been able to further reduce our land acquisition and development stand for the entire fiscal year to $300 million of which $100 million of the spending remains. And given the recent volumes we expect our land spending next year to be similar to or less than this year’s $300 million.

Our operators and trade partners are working hard to take advantage of the efficiencies gained in our production cadence model and this is helping offset the price increases we’re seeing due to higher commodity and energy costs. These efficiencies will be far more meaningful at higher volumes.

Furthermore, we expect to take advantage of the fully and partially developed lots in most markets using a cash-light model for the foreseeable future. In all our markets we’re actively assessing and cataloguing future potential land. For this acquisition model to be effective we’re establishing important relationships now, both with developers and capital sources.

Turning to slide 10. Starting early in this cycle we recognized our value proposition to share holders will be to consistently produce a solid home-building margin and a high asset efficiency. We’ll execute a finished-lot strategy and will be generally avert to tying up large amounts of capital in slow returning, undeveloped land. The result is that we can have lower closing volumes in a quarter and still be cash flow positive.

In the quarter we paid of $150 million of senior notes and still increased our cash balance by $64 million. We ended the quarter with a cash balance of $1.3 billion and we’re expecting our cash balance to increase by the end of the fiscal year.

With the lack of stability in price and volume it’s prudent to conserve and accumulate cash. This is a company priority. Consistent with these priorities, we’ll continue to scrutinize all uses of cash.

Another company priority is to return to operational profitability as quickly as possible. We remain highly focused on our overhead cost reductions.

Our home-building G&A was down 13% per closing in the quarter. On a combined basis with home building and corporate G&A was down 39% year over year. We expect this trend to continue throughout the rest of this year and our head count today is lower than any time in the past seven years.

Turning to slide 11. Centex financial services is now much more streamlined and straightforward. In the quarter we essentially completed the wind down of our retail operations. The associated costs were $26 million, in line with the $25 million to $35 million we previously guided. The wind down costs are primarily for severance and lease obligations.

Also, given all the pressures in the market we felt it was prudent to increase our loan-related reserves again by $16 million net of some loan sales we made at higher prices than expected. The additional reserve is not for loans repurchased, but rather our cautious stance in light of the mortgage market environment.

CTX Mortgage is now solely focused on Centex home buyers and is originating FHA and GSE loans almost exclusively. This structure is one of the keys to our industry leadership position in customer satisfaction. Finally, CTX Mortgage also has adequate, committed warehouse lines.

I’ll turn the call back over to Tim for his concluding remarks.

Timothy Eller

Thanks, Cathy. The housing industry is grappling with unprecedented economic conditions. Centex is navigating this cycle effectively. We have a strong and growing cash position of $1.3 billion on hand and have shortened our total land position to be among the shortest in the industry. We’ve steadily improved our gross margins and reduced our use of incentives and discounts despite substantial head winds. We’ll continue our G&A reductions and our need to spend on land development will remain low.

We’ll face what metaphorically and literally could be a cold, dark winter for home builders, but winter won’t last forever and nor will this downturn. A spring for the housing market will come eventually and we’re preparing to emerge with strength.

Looking ahead, we have a sufficient supply of lots for immediate needs and we foresee access to thousands of finished lots to build scale when demand improves.

We’re increasing market share in the nation’s most attractive markets which will lead benefits today and higher returns over the long term. Restoring the organization to profitability and continuing to improve our liquidity are our highest priorities.

Now, Christy, let’s address questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Nishu Sood – Deutsche Bank.

Nishu Sood – Deutsche Bank

Thanks. Good morning, everyone. First question I wanted to ask was on your reduced forecast for land spend. If I’m doing my math correctly you’re taking it down by about $100 million or $200 million for the year. I just want to understand the dynamics of that. Mostly I imagine you’re cutting your forecast for development expenditures. So is it the situation that you’re just finding that the timing has been stretched out for when you’re going to need these lots because of lower absorptions or is it more along the lines of the constant calculations you’re doing to determine whether or not you’re going to be able to get cash recovery on the development costs that you’re putting into the ground.

Cathy R. Smith

It’s really more the former. As we continue to evaluate our needs by market in our sell to a backlog and build to a cadence model we can really clearly pinpoint where the development needs to go and we’re just trying to do just-in-time development wherever we can. Fifty percent of our land in production is fully developed, so it’s really more a reflection of that.

Nishu Sood – Deutsche Bank

Got it. And the second question I wanted to ask Tim. I think you described it pretty well that this is going to test the best or eliminate the rest and that there’s going to be opportunities, of course, in terms of picking up finished lots as we come onto this. Now, when the capital markets might open up again to providing capital to the industry it might differ from when might be the best time to buy a lot of these lots. How are you going to look to fund these opportunities once you decide to go after them? Is it something you’re going to try to fund internally or would you pursue the more kind of conservative route and wait for the capital markets to open up again?

Timothy Eller

Well, we’re not going to wait for the capital markets because we’re not sure when they will open up again. We know we can acquire lots on fairly soft terms even now and do. We expect that the next calendar year, 2009, we will see many, many m ore additional opportunities as the banks sort out their capital structure now before the end of the year, given everything that the treasury is doing and the fed is doing to support the banks’ capital. So I think we’ll see a lot of activity from the banks next year.

We’re also talking to developers and other sources of private capital to align with them in terms of taking advantage of these opportunities should there be bulk sales as well and we’ll work through third parties with those.

When you think about this, we’re the logical end-user for these lots anyway. Even if private capital acquires these lots they’re going to need to be, there’s going to need to be an exit strategy for them and we are the exit strategy. There will be so few of us left that we will have, I think, a great shot at a lot of great properties.

Operator

Your next question comes from Kenneth Zener – Macquarie Capital.

Kenneth Zener – Macquarie Research

Good morning. If you could talk, obviously with the gross margins going up sequentially could you kind of break that out between your spec and non-spec sales? It certainly looks like the discounts are related to or covers a lot of the improvement in gross margins.

Cathy R. Smith

The gross margins have continued to improve really for a couple of reasons. The biggest one being our focus with our trade partners on our production efficiencies. That’s coming through on brick and mortars, our direct construction costs have continued to come down. As well as our discounts and incentives; as we’ve said, they’re about half what they’ve been at their peak levels. So that’s really what’s driving the improvement in gross margins.

On specs versus pre-sold, it’s about two-thirds of our sales were pre-sold versus a third on specs.

Kenneth Zener – Macquarie Research

And how would that compare to last quarter, I guess?

Cathy R. Smith

A little bit more toward pre-sold.

Kenneth Zener – Macquarie Research

Okay. And then I guess Tim or Cathy, with another private home builder in Phoenix going bankrupt last week, do you think the banks are going too far in their tightening relative to builders that could have actually survived? How do you kind of see that in the markets, the banks’ behaviour?

Timothy Eller

Well, I think everybody’s trying to sort out the cycle and they’re trying to do the best they can but the reality is that a lot of the land that private builders are working on just doesn’t have much value anymore. So there’s no incentive for even the builder to continue. That’s the way the cycle is just working out and the banks will have to reconcile that in their capital structure, which is why I say I think next year, 2009, will have lots of opportunities.

Operator

Your next question comes from Dan Oppenheim – Credit Suisse.

Daniel Oppenheim – Credit Suisse

Thanks very much. I was wondering about your priorities. You’ve spent a lot of time talking about the improving gross margins sequentially, but then also about the production cadence, which certainly sounds a lot like even flow production where you then benefit from higher volumes. Given the order decline, which then limits their future cash flow, what are you going to focus on as you look ahead to the coming quarters: the generating more orders and cash flow in future or is it trying to continue to improve the gross margins?

Cathy R. Smith

Yeah, you know, our priorities are to accumulate and preserve the cash we have, and to structure for profitability. We know that selling to a backlog and building to a cadence helps us with that. So you’re not going to see us necessarily deviating from that model.

Timothy Eller

A couple other things we know is that we generate cash on virtually every closing. We look at this every quarter. And we also know we can generate cash at even lower levels of closings and, in fact, half of our current level of production we will be cash flow positive.

Operator

Your next question comes from Jay Mccanless – FTN Midwest.

James Mccanless – FTN Midwest Securities

Good morning. First question is on the gross margin. How much of the 15% that you earned this quarter would you say came from impairments on land?

Cathy R. Smith

The home site costs have been essentially flat over the last couple of quarters.

Timothy Eller

As a percentage of revenue.

Cathy R. Smith

Thanks. As a percentage of revenue.

Matthew G. Moyer

Jay, the way we’ve answered that in the past is about a third of our closings were in previously impaired neighbourhoods. So you can make your own assumptions around that.

James Mccanless – FTN Midwest Securities

Okay. And then my second question, I wanted to dig a little bit deeper into how much impact the build-to-order strategy that you’ve gone to now has on the closing levels. Is it a function of trying to hold price in certain areas or can you just dig into that a little bit more and explain what impact you’ve seen so far in your order rates based on this new strategy?

Timothy Eller

Well, first of all look at our backlog. Our backlog is among the strongest in the industry. So that gives us a predictable level of construction out over the next several months, couple quarters perhaps. So I think that’s the strength of the model is the predictability of the construction which allows us to create efficiencies with our trade partners and lower our costs the way we have and expect to continue to.

In terms of pricing, we moved to a transparent pricing model about a year ago. That again, we focused on the affordability of our product with our customer and, while credit standards have tightened and affordability has become a little bit more challenging, our pricing largely has stayed where it was. While we’ve reduced a bit, only a bit, and looking ahead that’s probably going to continue. We don’t see a need to lower prices at this point. Although we expect that our volumes will decline our prices may not.

Operator

Your next question comes from Ivy Zelman – Zelman & Associates.

Ivy Zelman – Zelman & Associates

Morning, guys. Good quarter. Just in terms of understanding one of the challenges we’re all trying to figure out is two things. One, you’ve got obviously a strategy that seems to be successfully turning margins around, yet at some price obviously, as you’ve indicated, you’re getting a volume. One of the things I know, Cathy, you’ve talked about sensitivities. Is there a number of units where obviously the cash flow is no longer going to be positive and the flexibility on that land spend, you know, how that sensitivity works, I guess, is any help on helping us figure out some of the sensitivity would be very incremental, I think.

And then secondly, you know, Tim, you and I spoke about finished lots. I think all of us realize that having half of your owned inventory as finished is great news because it gives you a lot of flexibility on the development, what you have to bring forward. But where are those finished lots? I mean, are they hopefully not all in the tertiary markets of the human empire and in essential valley. I think if builders provided us more transparency on where those lots actually are I think that would be very incremental in terms of getting us more confident that you guys have staying power and longevity.

And then lastly, Tim, we know you’re very involved politically or active in trying to help move forward this housing stimulus plan that the coalition has been formed by the large builders. Can you give us any of your thoughts on the success of that stimulus bill and hopefully some insight into what some impediments might be, if any?

Timothy Eller

Sure. Let’s start with your first.

Cathy R. Smith

Okay, I’ll take the first one and Tim can take the other two.

Cash generation, to help you with some sensitivities around cash generating. A high level set of assumptions that you guys could model as well would suggest that at about half of our current volumes we would still be cash flow positive on an incremental basis. As Tim has iterated and you know from your knowledge of us that we evaluate every single house we sell and close around its cash generating ability. So we have fairly good confidence there that even at fairly significantly reduced volumes we continue to generate cash. Now, obviously it’s not without, we still have to continue to reduce our overhead costs and stuff like that, but we’ve been doing that.

The sensitivity around land spend, which is the acquisition and development cost, there is a low, low level of kind of obligatory spend that you have to do for property taxes and stuff like that. But beyond that with 50% of our lots fully finished and they’re pretty much spread across most of the markets where it will matter, we feel pretty good about the low levels of spend that we can achieve. As we said, we’ve reduced it down to 300 this year, 200 of it is already spent, about 100 in front of us, and then next year given the volumes we’re seeing we could be that low or lower as well. So again, sensitivity wise, we understand where all of our finished lots are and where our volumes are because of our selling to a backlog and building to a cadence we know right where we’re going to need them.

Timothy Eller

And that partially answers your second question, Ivy, in the sense that because our lots are in places where we’re selling houses, our finished lots are in places where we’re selling houses, we’re not having to develop as much. Certainly there’s finished lots in, I wouldn’t call them tertiary markets, but I would call them the more impacted markets in terms of sales rates. We certainly have finished lots there. But frankly, we aren’t spending much in the way of development anywhere outside of Texas right now and maybe Rawley/Durham in the Carolinas. And maybe the coastal Carolinas just a bit as well because our sales rates are still holding up relatively well. So I’d say we have pretty much of a balanced footprint of finished lots.

As to your third question, there is the talk about stimulus for the economy is everywhere now. I don’t think that talk can exclude anything around home building. I think home building has to be a part of that stimulus. Home building lead us into this – or you could argue that mortgages lead us into this – but home building has the capability of leading us out. We have the capability of trading jobs very quickly, improving buyer confidence very quickly. We have as an industry the capability of creating some urgency, if not excitement, around some economic activity.

I think there’s three things that we have to think about from a housing stimulus and this is where the industry will focus. We have to think about the roughly 2 million more arm resets that are out there that will reset over the course of the next two and a half to three years. We have to try to think about preventing those from going into foreclosure. Most of them are going to reset at higher rates and the house values for most of them are much lower than their note rates. So that’s number one.

Number two, we have to think about a stronger tax incentive to buy a new home. This was successful back in the mid-70s when it was done. The tax incentive that was passed earlier this year is proving not to be sufficient because it is not high enough and it requires repayment. We need a true tax credit for home buyers who buy a house. Not just first-time buyers, but any buyer for any house.

Thirdly, we need to have a below-market mortgage rate. Again, this was successful in the mid-70s and we think it would be successful again. That package of things we think would have a strong impact on housing demand and supply.

Operator

Your next question comes from Stephen Kim – Alpine.

Stephen Kim – Alpine Woods Capital Investors

Thanks very much, guys. Just a follow up on Ivy’s question. I wanted to push the question in the direction of what the response you’ve encountered on the Hill to this set of proposals. Obviously it sounds good and I think it makes a heck of a lot of sense, but one could also look at that with a somewhat jaundiced eye and say it’s just the builders looking out for number one. Could you talk a little bit about how you’ve seen that progress? Maybe how the resistance has changed from maybe three months ago to a proposal such as this?

Timothy Eller

Well, I think it’s really a coalition. I think that you’re right that we don’t want this to be seen as self-serving on the part of builders. We think this is actually very good for the economy, very good for lots of other industries to get this kind of economic activity working. It’s good for banks. It’s good for our trade partners. It’s good for, frankly, auto dealers who can see some economic activity improving. And it’s good for the resale market. So there’s a lot of constituencies and stakeholder sin this. It’s not just the builders. That is our message and that is the coalition that we’re building. Clearly, the little bit that we’ve been on the Hill in terms of talking to legislators and Members of Congress and Senators, there is a desire to do something. It’s just what that something is what needs to be worked out. As you might imagine, there’s a lot of constituencies kind of thinking about, because the impact now economically is so broad that there are a lot of constituencies asking for a lot of things. But we’re working on our message and we’re working on an outcome.

Stephen Kim – Alpine Woods Capital Investors

Okay. Great. All my other questions have been answered. Thanks very much guys. Good quarter.

Operator

Your next question comes from David Goldberg – UBS Securities.

David Goldberg – UBS Securities

Thanks. Good afternoon. I was wondering if we could get a little bit more clarity on a couple of questions, a line of questions that has already been asked. In terms of the sales pitch, I know you guys said at even half the current – I think closing rate is what she meant – you could still be free cash flow positive. But I look at orders per community versus closings per community the order rate, obviously, per community is lower at this point. So it seems like you’re already on the way there in terms of doing half the volume of closings looking forward. I guess if you combine that with Tim’s comments about how the December quarter could get worse I guess the question I have is, am I looking at it in the right way in terms of free cash flow, i.e. if things deteriorated in December is the potential free cash flow, neutral free cash flow negative there? And with that, and I guess as part of the question, with the gross margins improving how are you thinking about, and maybe we need to put some more incentives in to pick up volumes a little bit because of the free cash flow issue with a lot of finished lots right now.

Cathy R. Smith

You know, David, we have a really strong backlog with almost 7,000 units sitting there. So we have pretty good insight into the next quarter. Even though recent volumes could suggest that it’s going to be a little lower, as Tim said, it’s going to be a cold winter. That gives us confidence there. As we’ve guided, we fully expect to end our fiscal year with more cash than we have today. So we feel pretty good about where we’re at there.

Operator

Your next question comes from Rob Stevenson – Fox-Pitt Kelton.

Rob Stevenson – Fox-Pitt Kelton Cochran Caronia Waller

Good morning, guys. In terms of the cancellation uptake this quarter, did you see any noticeable uptake in cancellations at the closing table or very late in the process or did the vast majority of the uptake come sort of more early and towards the middle as you would expect?

Cathy R. Smith

Yeah, really kind of throughout. The difference in the cancellations this quarter were we really scrubbed our backlog with DPAs going away. I wanted to make sure that we have high confidence that everyone in our backlog could close. And then the continued concerns around job losses or people’s concerns around their job and the economy as well as the tightening of credit standards. Those three things caused the cans to go up, but when they can throughout the process was really kind of throughout the process not really late or anywhere in between.

Rob Stevenson – Fox-Pitt Kelton Cochran Caronia Waller

Okay. And then, Cathy, what’s your most restrictive covenant and where are you against that?

Cathy R. Smith

We have two covenants for our revolver. One is a tangible net worth covenant and the other is a leverage covenant that ratchets down. The most restrictive of those two would be tangible net worth and we still have fairly good room on that.

Operator

Your next question comes from Carl Reichardt – Wachovia.

Carl Reichardt – Wachovia Securities

Morning, guys. I want to go back to Nishu’s question, the first one. Have you talked before about the emergence of financial partners who you could work with long term to develop own-develop lots for you as you run the asset-like model. Obviously given what’s happening in the marketplace a lot of that capital that we thought was there isn’t going to be there. It was either levered or it’s moved to commercial. Can you give me any more colour or give me any more sense as to whether or not that capital availability, those partners are still here or still ready to go and if they’re not what can we expect your business to look like, say, over the next year as things begin to improve but that capital is not there?

Cathy R. Smith

I’ll answer and then Tim may pipe in as well. There was reportedly a tonne of capital out there, as you suggest. However, there are a number of real estate focused capital sources that are very real and are still very much well funded. Many have actually even formed their funds. So for the real ones and the ones that we would have been talking to, because we like the ones that know real estate, we think that’s a better partnership, those are still there. They’re very viable and have every intention to continue with their mission. I don’t see a wholesale change in landscape around the partners that we would have been talking to.

Timothy Eller

And what we’re finding, Carl, is that a lot of these potential partners kind of withdrew from the market at the peak. So they didn’t tie up their capital. In fact, they kind of preserved and reserved their capital for just this kind of time. So we’re finding sufficient amount of capital and sufficient amount of interest that we think it will be fine.

Carl Reichardt – Wachovia Securities

Okay. I appreciate that. And then I also have other CEOs, last question, Tim, you’re one of the few that haven’t at least this quarter talked about foreclosures impacting your order pace. I’m kind of curious, given that we have seen some improvement in some existing home sales turnover data in the few markets that have been bad, where a lot of it seems to be foreclosure activity how does that impact you and do you have any data of support that would say who’s purchasing the foreclosed properties that are turning over at a faster rate. Is it investors or is it your customers?

Timothy Eller

Just anecdotally, well, first of all, certainly foreclosures impact our volumes. The fact that they’re 50%, 60%, 70% of some of the resale markets in the country certainly have an impact on our volumes. We’re not trying to chase foreclosures in price at all. We’ve said that before. That will remain the case.

Anecdotally, what we see happening is, foreclosure buyers tend to be different than new home buyers anyway. So we are not sharing customers with foreclosures very much at all. What we’re also anecdotally hearing is that foreclosure buyers now are owner-occupants. They’re not investors, they’re just people who intend to occupy that home. So it’s a clearing process. The clearing process has to happen. It’s happening.

Operator

Your next question comes from Stephen East – Pali Capital.

Stephen East – Pali Capital

Hi. Good morning, everyone. Tim, if I could ask you about the markets. When you talk about downsizing your SG&A, etcetera, are there still some markets out there that, as you continue to shrink your business, probably make sense exiting now that maybe didn’t make sense a year ago? Something like that.

Timothy Eller

Good question. We review these every quarter. We most recently exited or are in the process of exiting Denver. We sold all of our assets in Detroit last quarter. There’s a number of other markets that we’ve exited over the course of this cycle.

For the most part the markets that we’re in right now are the markets we believe are good for us for the longer term. They’re attractive for a number of reason for the longer term. We are consolidating operations in Florida and other markets just for efficiencies and to be able to take advantage of the opportunities that are coming in those markets.

There may be one or two others, but I don’t think it would be any more than that, Stephen.

Stephen East – Pali Capital

Okay. And then sort of along those lines, while it’s outstanding to hear that you all could cut volumes by half and still be cash flow positive, is there a level looking at the income statement side where you really would say, hey, we need to stimulate some orders that’s above that drop of 50%?

Timothy Eller

I don’t think so at this point. It looks like we can execute our model at fairly low volumes. We would certainly like it to be higher, but we can execute at fairly low volumes, stick to our strategy, stick to our transparent pricing, price to our customers’ affordability. We may introduce some smaller houses at lower prices to adjust in that way, but I think that would be the extent of that.

Operator

Your next question comes from Josh Levin – Citi.

Joshua Levin – Citi Investment Research

Hi. Good morning, everybody. If the winter does in fact turn out to be as hard and cold as you mentioned or if 2009 turns out to be a dismal year for the industry, do you think there could be a meaningful reacceleration of impairment charges?

Timothy Eller

Well, impairments are more price related than volume related, so I’ll let Cathy talk about how we look at impairments.

Cathy R. Smith

You know, I don’t know that I would say meaningful. As Tim said, the biggest determinant is price and we believe our strategy is an appropriate one, which is priced to our customers’ affordability. We know that we’ve largely done that. That shouldn’t cause impairments to accelerate. The absorptions to have an impact, but we look at, you know, over the life of an asset that most of these assets are multiple year lives. So it shouldn’t have, I wouldn’t say meaningful. I think the answer’s no.

Joshua Levin – Citi Investment Research

Okay. And as you think about how you plan to manage the business over the next, say, six to 12 months, how has your thinking changed over the past two months with the credit crisis? What are you planning on doing differently compared to what your plans were two months ago?

Cathy R. Smith

You know, we continue to be focused on the two priorities, which is to preserve and accumulate cash. We think that’s one of the most prudent things we could be doing right now. And then continue to structure for profitability. There’s not a day that goes by that we don’t focus on both those priorities.

Operator

Your next question comes from Chris Hussey – Goldman Sachs.

Chris Hussey – Goldman Sachs & Co.

Thank you. Good morning. Just trying to delve in a little more in the cash flow dynamics. I wasn’t sure if you had provided this information yet, but on the inventory a number of finished specs that you might have in inventory at this point. Maybe you could just give us a little bit of characterization around how much cash flow per closing you guys are getting currently.

Then the last question would just be around October. What have you seen specifically in October? Could you characterize the sales per neighbourhood per month in October seeing as we’re only a couple days away from the end.

Cathy R. Smith

Yeah, Chris, Matt’s looking up finished specs for you right now.

Matthew G. Moyer

I think it’s about 1,390, something like that.

Timothy Eller

The total specs, Chris, were 1,396, of which 600 were characterized as finished.

Cathy R. Smith

Your middle question was, I’m sorry?

Chris Hussey – Goldman Sachs & Co.

I was asking about cash flow per closing. If you guys wanted to characterize that at this point.

Cathy R. Smith

Yeah, you know, it is highly variable depending on which market you’re in. Essentially it’s about the investment in land. So that would be about your cash flow per closing and that’s going to vary depending on which market. Texas still, obviously, and a couple of the other markets would have, beyond that you’d still have some greater-than-replacement costs type cash as well. So you decide what an average lot is. I don’t know, Matt, usually it’s an average of what? Seventy or eighty? Average finished lot.

Matthew G. Moyer

Per lot?

Cathy R. Smith

Yeah.

Matthew G. Moyer

Yeah, it’s a little lower than that. You can take our land held, or land under development divided by lots and that will give you –

Cathy R. Smith

That will give you about a cash per closing.

Matthew G. Moyer

Right.

Timothy Eller

And as far as October, we don’t comment on the current month in these calls, but I will say that generally in the second quarter sales deteriorated throughout the quarter given the increasing financial and credit turmoil that were going on. A lot depends right now on external factors and job losses, and we continue to hear about job losses. Announcements are coming out almost daily on those. It’s just causing consumers and reflected itself in consumer confidence recently, you see how the consumers are thinking. So that can turn around with some positive news. Hopefully we’ll at some point begin to hear some positive news.

Operator

Your next question comes from Susan Berliner – J. P. Morgan.

Susan Berliner – J. P. Morgan

Thank you. Good morning. Just a couple questions. One is, Cathy, can you tell us what your availability is on your bank line now?

Cathy R. Smith

Yeah, the borrowing base capacity would have it almost fully available and then because of our cash (inaudible) feature we have about half of that we could actually take down. Is that what you wanted to know?

Susan Berliner – J. P. Morgan

Yeah. Exactly. And then, I guess, you guys were talking about cash flow and obviously it sounds like you’re going to be generating cash throughout this fiscal year. Can you comment at all about the, I know your land spend going forward is also going to be pretty small, so can we expect that you will continue to generate cash flow in the next fiscal year?

Cathy R. Smith

We haven’t really given that guidance, Susan, so we do know that we’re going to say the end of this fiscal year will be higher than what we have on our balance sheet today. We know that at lower volumes we continue to generate cash.

Timothy Eller

We have very low compulsory levels of land spend moving forward. At lower volumes we can be cash flow positive, although we just can’t give guidance at this point for something that’s 18 months away.

Operator

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

Michael Rehaut – J. P. Morgan

Yes. Good morning. Thanks for taking my question. First question is just, I guess, I know, I don’t want to beat a dead horse, but in terms of the absorption pace, and hats off in terms of the ability to generate cash flow with half of the production. I don’t think I’ve heard that from other home builders. With the absorption pace now at your lowest level in the last few years, it’s been down dramatically, and this quarter you took in 1,000 fewer orders and closings, so you’re talking about working your backlog off by about 1,000 a quarter. If that continues and you do get to that production level, 50% from current, at that point would you be considering, what would you do in order to improve your order intake and how would you go about the market at that point?

Timothy Eller

Well, Michael, we’ll continue to adjust just like we’ve adjusted since the beginning of this cycle and this downturn. We have a strategy, we have a model, we’ve been consistent about that. There is nothing that would cause me to think that we shouldn’t continue to be consistent about that. We would continue to adjust.

Michael Rehaut – J. P. Morgan

Okay. The second question, just on the prebuilt or presold model, and certainly it appears that’s had great success on the gross margin, but I was surprised to hear you say that you still had about a third of your closings in spec. I wanted to know if that’s just as that model continues to get implemented if that number would go down and do you have a target for spec as a percent of homes closed. Or is that just kind of a function of being in certain markets that that’s just how those markets are predicated, like a Texas market.

Cathy R. Smith

Now, our model is absolutely to sell to a backlog and build to a cadence. That balance of closings and sales to a backlog is going to continue to go up and specs will continue to come down. We do still have some specs that we need to sell through and often times in a multi-family unit you sell six but start two specs, get the building started, and hopefully have them sold before it completes. You’ll always have a few natural specs because of that. And then just by definition you’re always going to have a couple of natural specs because of cancellations. Other than that we’re not intentionally generating specs.

Operator

Your next question comes from Alex Barron – Agency Trading Group.

Alex Barron – Agency Trading Group

Hey, good morning, guys. I wanted to ask you if you could help me understand. As I’m looking at the balance sheet and it’s, you know, I’m looking at the relationship between inventory revenues and payables. It seems like your inventory end revenues are down 50% or so, but your accounts payable year over year are down about 18%. I’m just trying to understand, is this just a seasonal or temporary thing or is there something more structural there?

Cathy R. Smith

Yeah, I don’t think there’s anything more structural. We watch our DPO, our days payable outstanding, and it’s actually slightly improved, which is not necessarily consistent with all of our cash, but it has. So it’s not, we know it’s not in a DPO metric and I would have to assume that it’s just really timing of the inventory spent when we built it. Nothing structural is shaping it.

Timothy Eller

And I should say, we’re very consistent on our DPOs and we have, as part of our model we’ve standardized our payable terms, payment terms across the entire country. We’re looking for very predictable cash flows in and cash flows out.

Alex Barron – Agency Trading Group

Okay. Thanks. My other question has to do with, again related to the current sales pace, if this current sales pace remains going forward what further efforts can you do on the SG&A front to prevent that from going up meaningfully?

Timothy Eller

Well, we think quite a bit and we continue to work on that. We still have a strong backlog. We have to close the backlog, so we have G&A in place to do that. But we have continued to reduce G&A really every month and almost every week in response to the current conditions. We believe there is still quite a bit to go if volumes continue to decline.

Operator

Your next question comes from Buck Horne – Raymond James.

Buck Horne – Raymond James

Hey. Thanks, guys. Just some housekeeping things. Do you have the number of homes under construction at quarter end? And secondly, can you give us the capitalized interest balance both at the end of the quarter and the start of the quarter? I guess related to that, are you comfortable that you’re allocating enough interest expense per closing such that we might not see another big write off of capitalized interest later?

Cathy R. Smith

Matt and Mark are going to get those numbers.

Matthew G. Moyer

Yeah. The homes under construction are 6,967.

Cathy R. Smith

Just a second. They’re getting capitalized. We may have to get back to you on capital.

Timothy Eller

Let me call you back on the cap-I balance.

Buck Horne – Raymond James

Okay. Thanks guys.

Operator

Your next question comes from Eric Landry – Morningstar.

Eric Landry – Morningstar

Morning. Thanks. Outstanding quarter. Really good work. Congratulations. The strategies look like they’re starting to show through.

Cathy R. Smith

Thank you.

Timothy Eller

And you’re right. They are.

Eric Landry – Morningstar

Yeah. I agree. Your backlog conversion was the lowest it’s been in years, if I calculate the numbers right here. Is this a function of the building to the cadence? If so, are we going to see a less volatile conversion rate going forward? What should we look for?

Cathy R. Smith

Yeah, that’s really –

Timothy Eller

Yeah, you should see lower backlog conversion and it’s really a function of no spec, not closing a lot of spec. Probably March of last year, last fiscal year, earlier this March was probably our high point for backlog conversion and from then on it’s going to really kind of come down. You should actually see it become, when volumes start to steady you should see it become much more consistent at a pretty low level. You may see, if it is higher in any one quarter it would probably be the March quarter, but you should see a pretty consistent low level in every quarter other than that.

Eric Landry – Morningstar

It should stabilize somewhere between 40% and 60%.

Timothy Eller

Probably on the lower end of that range.

Operator

Your next question comes from Joel Walker – SBN Securities

Joel Walker – SBN Securities

Yes. Just wanted to follow up on the accounts payable and accrued liabilities. I guess the accounts payable there was roughly around $130 million, if it’s similar to last quarter. I just wanted to see if you had a breakdown of the accrued liabilities, the $1.7 billion or so.

Cathy R. Smith

I think I would tell you wait for the Q to come out. It’s going to come out shortly and that will help you with all that.

Joel Walker – SBN Securities

Even the accrued liabilities will be broken down in there?

Timothy Eller

Certain aspects. Some of the bigger accrued liabilities are disclosed in the footnotes.

Joel Walker – SBN Securities

In the footnotes.

Timothy Eller

Yes.

Joel Walker – SBN Securities

And is there, I guess, just going as a percentage of inventories on the accrued liabilities/accounts payable say around close to 40% versus some of the other builders, or most of them are in the 20% to 30% range. Is there anything you guys do different, at least that you know about, that’s different than the other home builders?

Cathy R. Smith

Nothing sticks out in my mind. Things are pretty typical when we go to our balance sheet. I will take a look at that, but nothing sticks out in my mind.

Operator

And our last question comes from the line of Jim Wilson – JMP Securities.

Jim Wilson – Jolson Merchant Partners LLC

Let’s see. Can we go back to the land spend? I know you’re looking at probably a number $300 million or less kind of in line with this year. Can you give a little colour, though I can guess on the answers, where you’re targeting that spend and is it mostly out of options already in place? I assume not too much new deals. Are you primarily concentrating on Texas and Carolinas where things are a little better?

Cathy R. Smith

No. Actually, it’s a little bit, I would characterize it as probably about two-thirds development type spending and a third into acquisition type spending. I would have said that is really more concentrated on a little bit of what’s sitting in options, but more new acquisition.

Jim Wilson – Jolson Merchant Partners LLC

More into new? Okay.

Cathy R. Smith

Yeah.

Jim Wilson – Jolson Merchant Partners LLC

And again, geographically where, can you give me colour where they might be on the margin?

Cathy R. Smith

It’s going to be in the markets that have continued to perform well and the land’s priced appropriately.

Timothy Eller

Yeah. And we would look at every market for any locations at this point. Again, these are our key markets. These are the markets that we’re going to focus on for the future. We are buyers of A locations.

Operator

We have now reached the end of our allotted time for questions. I know turn the call back over to Tim Eller for his closing remarks.

Timothy Eller

Thanks, Christy. I want to thank all of you for joining us today. We look forward to discussing our results with you again during our third quarter conference call in January 2009.

Operator

This concludes our Centex’s fiscal year 2009 second quarter earnings conference call. Thank you for your participation today.

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