Centex F1Q08 (Qtr End 6/30/07) Earnings Call Transcript

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Centex Corporation (CTX)
F1Q08 Earnings Call
July 25, 2007 10:00 am ET

Executives

Tim Eller - Chairman and CEO
Cathy Smith - CFO
Matt Moyer - IR

Analysts

Jeremy Pinchot - MCH
Kenneth Zener - Merrill Lynch
Nishu Sood - Deutsche Bank
Steven East - Payly Capital
Susan Berliner - Bear Stearns
Stephen Kim - Citigroup
Carl Reichardt - Wachovia
Michael Rehaut - JP Morgan
Rob Stevenson - Morgan Stanley
Greg Gieber - AG Edwards
Alex Barron - Agency Trading Group
Buck Horn - Raymond James
Ethan Arback - Marathon Asset Management
Dan Oppenheim - Banc of America Securities
Gary Freeman - Gem Realty Capital
Jim Wilson - JMT Securities
Joel Locker - FBN

Presentation

Operator

Good morning, and welcome to the Centex Corporation Fiscal Year 2008 First Quarter Earning Conference Call with Senior Management. Today's call will be recorded and transcribed. Today's call will also 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 that website.

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 that could cause actual results to differ materially from those discussed during the call. For further information regarding these risks and uncertainties, and Centex' forward-looking statements, please refer to the forward-looking statements disclosure in the presentation, and to Centex' 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 Management's remarks. (Operator Instructions)

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

Tim Eller

Good morning, everyone. Thanks for joining us for fiscal 2008 first quarter conference call. With me today is Cathy Smith, our Chief Financial Officer, Mark Kemp, Controller and Chief Accounting Officer and Matt Moyer, Head of Investor Relations. I'll start this morning with introductory comments on the quarter and some thoughts about the months ahead. Cathy will provide details on our financial performance and I'll offer closing comments before we take questions.

Let me start by saying the market remains difficult. I believe Centex is well positioned. We took actions early in the cycle, such as walking away from lot options and trimming inventories in order to improve our competitive position and create flexibility.

During a housing correction such as this, we're also seeing the advantages of geographic diversity. A few markets are continuing to remain fairly healthy. For example, markets in the Carolinas and mid-Atlantic reported increases in net sales for the quarter. A number of markets are reporting slower rates of decline overall. Texas, on the other hand, is slowing, primarily due to the decline in mortgage liquidity.

We know that challenges will persist for a while. Most markets continue to be hampered by over supply. And we expect widespread affordability issues to remain a problem for some time to come. The advantages of a strong balance sheet, and experienced leadership team are helping us navigate through the difficult market. And while we expect this to be a challenging summer in terms of sales activity, we are encouraged by our recent cancellation rates. Though still higher than historic levels, this quarter's cancellation rate dropped both sequentially and year over year.

At Centex we are focused on the fundamentals, with the objective of making progress toward realistic near term goals for this phase of the cycle. Those are to continue to sell homes and minimize inventory. To structure for profitability, to generate cash and enhance balance sheet flexibility, and to aggressively attack costs.

Our teams in the field have a clear focus. Sell homes, especially older inventory. Unsold inventory has reached the lowest level of the last six what you quarters.

Sales rates become more predictable in many of our neighborhoods. We are pre-selling in many markets. We have more than 3,000 homes in backlog that are pre-sold but not yet started. We are maintaining steady levels of backlog in sequential quarters and we expect to do so in the future.

Structuring for profitability is a key could focus of the Company. In the midst of a down turn that is proving deeper and longer than anyone anticipated, we are taking the steps to manage the business for profitability. This entails aggressively structuring the organization for current sales rates and selling out of older neighborhoods and opening new ones with product to meet the needs of the current environment.

Another imperative is to general rate cash. We know the importance of enhancing the flexibility of our balance sheet, for both the present and the future. We also understand that the most direct path to restoring margins is aggressive cost reduction.

As we have in recent quarters, we continue to identify savings and efficiencies in our relations with suppliers and subcontractors. And are leveraging the size of our company to drive additional cost reductions across regions and nationally. We are also continuing manage our overhead, and our head count to our current volume of business.

Our focus on selling homes, being operationally profitable, generating cash and attacking costs, is positioning Centex for the future. Our objective is to gain strength and share in the markets with the greatest potential for the highest returns.

When the time is right, we'll focus our reinvestment only in markets with strategic long-term importance and we are intent on turning assets faster and more efficiently to generate cash consistently and enhance our returns. Throughout this down turn we are working to simplify and standardize processes, to achieve permanent benefits to the business, improve cycle times and provide a better customer experience.

Our goal is to be recognized as a world-class manufacturer of homes. We believe this focus on applying world class manufacturing discipline to our business will have significant long-term benefits, including a sustainably lower cost structure.

With that, I'll turn it over to Cathy to take us through the quarter.

Cathy Smith

Thank you, Tim and good morning everyone. I'll offer my perspective and commentary on our fiscal first quarter. I'll also elaborate a little more on cost saving initiatives and provide an outlook for cash.

Let me start by saying the trends we are seeing in the housing market still lack clarity for directional guidance. Similar to last quarter, some trends give us confidence and others give us pause. However, contrary to last quarter when we started strong and finished slower, this quarter started soft but finished stronger.

The market remains difficult and results are inconsistent, which is exactly what we expected. The trend of every month being worse than the previous seems to be gone. On the other hand, we have not yet seen any consistent strength, either.

Our cancellation rate has declined for the second straight quarter sequentially. It's gone from 39% to 34 to 31. And for the first time in ten quarters, cancellation rates declined on a year over year basis. Although it remains above historical levels, you can't start a trend without a couple of quarters of improvement.

Lower cancellation rates are the first step to more predictable business patterns. Predictability helps us size our organization correctly, abates impairments, and begins the margin recovery process. More divisions are seeing some level of predictability and stability than at any point of the past two years.

In concert with some of the short-term goals Tim mentioned, we continue to reduce our assets. A majority of our divisions have reduced their un-old inventories to appropriate levels. Our unsold inventory now stands amount 4815 units, down 17% year over year, and down over 27% from last summer's peak levels. Completed unsold homes now total 1435 units, which is still a lot. But, these older homes are down 400 units or 22% since March 31st.

On the land front, we further reduced our owned and controlled position. Owned lots are down 15% year over year, to approximately 96,000 lots. Options lots now stand at about 54,000, down 68% year over year and 12% sequentially. We acted quickly and decisively to reduce our optioned and owned lot and expect our total lot position to continue to fall throughout the fiscal year.

Another important goal is remaining operationally profitable through the trough of the cycle. This quarter before impairments and option walk away costs, home building was profitable including income from JVs and land sales. However, we recognize we still have work to do in terms of restoring our gross margin to more normal levels and reducing our overhead expenses even further.

Consistent with our previous disclosures, I would like to also note this quarter we adopted FIN 48. This change in accounting resulted in a $200 million reduction in equity and a net increase -- a net $200 million increase in taxes payable. We believe our previous tax positions are appropriate and will defend them as such.

Now I'll provide some more color on the home building operations. Slide 7 provides the operational highlights of the first quarter. We closed 6095 homes in the quarter, 27% lower than last year. The average sales price declined about 5% to $291,179.

Discounts continue to be much higher than normal and are the primary reasons for the weaker margin performance. Discounts totaled 8.8% of housing revenues, up 4-percentage points year over year, and up 50 basis points sequentially.

We continue to balance our sales pace with margin on a neighborhood-by-neighborhood basis. Offering incentives in some neighborhoods and holding price in others. Sequentially our backlog of houses sold was about even with last quarter. We sold 6474 homes, down 22% year over year. Our backlog now stands at 11030 units with a total value of $3.2 billion.

We incurred additional land and related charges in the quarter. On a pre-tax basis, we had $913 million in impairments and option walk away costs. This has also come down sequentially the last two quarters. As detailed Attachment 3 of the press release, we booked impairments of $143 million reduced our JV investment by $27 million and had approximately $23 million in option walk away costs. The impairments were concentrated in southern California, Florida and Nevada.

As I said last quarter, we take a methodical approach to these adjustments, looking at all our neighborhoods. Under current business conditions our assets are appropriately valued, we'll continue to evaluate each market on a neighborhood-by-neighborhood basis.

Let's now take a few minutes to review regional results. Slide 8 details sales and closings by region. In the quarter, we closed 6095 homes, representing a lot of hard work by the men and women in the field. In Texas and the Northwest, the relative strength in closings reflected the sales strength in those areas.

Closings and sales were weakest in the Southeast, which is indicative of the prolonged softness of those markets. Looking now at strength, we see continued stability in the Washington, DC operations in Phoenix. We also had good relative sales performance in Southern Virginia, inland Carolina and the Pacific Northwest. Florida, the Midwest and southern California remain difficult.

Turning to slide 9, I'll comment on cost reductions and cash flow. We achieved a 20% reduction in SG&A expenses year over year. Even better, if you back out selling experience that increased, we were able to keep overhead per closing about flat with last year. We have made significant reductions in head count and have scaled back expenses in every year area. No cost has gone unquestioned. We have adjusted our overhead quickly and remain committed to keep our organization right-sized to the current business conditions.

We have initiatives to standardize and centralize our finance and accounting functions. This is the first step of many in our pursuit of an advantaged cost structure. These initiatives will provide building blocks to becoming a world-class manufacturer. We are addressing our G&A costs aggressively and structurally. We'll continue to see benefits of this in fiscal 2008, but the results will be even more meaningful beyond that.

Consistent with my expectations, we were a net user of cash this quarter. In the quarter, we used less than $400 million in operating cash flow. We are buying very little land, other than previous commitments. Furthermore, we took the opportunity to repurchase $55 million of debt at a discount.

Even though we are not offering guidance for fiscal 2008 right now, I can say this. Moving forward we'll generate operating cash flow more consistently and more consistently return that cash to shareholders. As I guided last quarter, we were cash flow negative this quarter and will likely be cash flow negative again next quarter. But then in the back half of the year we expect to finish with about $750 million in operating cash flow. We remain focused on selling homes, structuring for profitability, generating cash, strengthening our balance sheet, and aggressively attacking costs. Achieving these kinds of goals differentiate great companies.

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

Tim Eller

Thanks, Cathy. Centex is focused on the fundamentals as we manage through a difficult market. We've established simple and direct objectives for this phase of the cycle. Sell homes, structure for profitability, generate cash, and aggressively attack costs. We are making solid progress on all fronts.

Most markets will remain challenged. Some are closer to the bottom of the cycle, several are fairly healthy. We are getting strength in share and markets with potential for higher returns.

Our goal is to turn assets faster, to consistently generate cash and higher returns. Our experienced team is using this cycle to focus on becoming a world-class manufacturer of homes, with a sustainably lower cost structure.

With that, we'll be glad to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Jeremy Pinchot with MCH.

Jeremy Pinchot - MCH

Thanks for taking my call. I was just hoping you could go through some of the details of the use of the cash in the quarter.

Cathy Smith

Sure. High level inventories about $200 million, accounts payable being down use about 150, taxes about 160, related to our CCG sale our construction sale and the debt repurchase for about 55.

Jeremy Pinchot - MCH

Right. Thanks a bunch. Appreciate it.

Cathy Smith

Sure.

Operator

Next question Kenneth Zener with Merrill Lynch.

Tim Eller

Good morning.

Cathy Smith

Good morning.

Kenneth Zener - Merrill Lynch

Since your accounting tracks closings on the unit basis can you tell us what benefits Cogs got based on prior charges through your income statement?

Cathy Smith

Yeah it was really (inaudible) just as I said last quarter. In total less than 1%.

Kenneth Zener - Merrill Lynch

Can you quantify exactly is just so we can get the sense what the core margins are adding back on a forward basis.

Cathy Smith

Yeah it was less than 1% of the total impairments we've written. So we had closings in about 75 of the neighborhoods. 75 neighborhoods had closings with impairments this quarter.

Kenneth Zener - Merrill Lynch

Okay. To me it just seems like a dollar value going forward would be useful to kind of reset the reported. But I guess what percent of your total communities have been impaired in total and what percent of this quarter's impairments were reimpairments?

Cathy Smith

We had only four that were reimpairments this quarter, and out of the total 1100 communities we look at about 1100 for impairment, we have impaired about 100 in total this quarter. We were about 29 before those were second time impairments.

Operator

Your next question come Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks. Good morning, guys.

Cathy Smith

Good morning.

Nishu Sood - Deutsche Bank

So first question I wanted to ask about your recent decision to exit the Central Coast market. I imagine that was a pretty small part of your business but just wanted to get the thought process. The thinking behind that, and maybe what that might tell us about your thoughts about your broader portfolio of where you're positioned and where you're not.

Tim Eller

Well, we are looking at all of our markets in terms of strategic importance and predictability and the ability to generate scale and share. So we have exited a couple of markets that don't meet those criteria, or where the business will not have just predictable and scalable business model. So -- but I would expect we'll continue to participate in most of the top 50 markets. 35 to 40 of the top 50 markets is really our targets.

Nishu Sood - Deutsche Bank

Right, okay. And second question I wanted to ask about the cash flow outlook. Which I think you might have lowered that from a billion you might have said last quarter to $750 million this quarter.

I was just wondering, your fundamentals relative to the other builders seem to have seen a little more stability from the calendar first quarter to the calendar second quarter. I was wondering what was the driver given your results were a little bit more consistent? What was the driver in terms of lowering your cash flow forecast?

Cathy Smith

You are correct, and really it is just the uncertainty we continue to see from the market, and our current expectations on earnings.

Operator

Your next question comes from Steven East with Payly Capital (ph).

Steven East - Payly Capital

Good morning.

Tim Eller

Good morning, Steven.

Steven East - Payly Capital

Tim, you mentioned tighter lending standards in Texas. Could you just talk a little bit about what you're seeing overall through the market? And how much you all think that's impacting demand right now? And what the trends are.

Tim Eller

Well, the liquidity I referred to is primarily at the lower FICO scores, and Texas tends to have lower FICO scores. So markets, particularly in Houston but also in Dallas, are impacted by the loss of the stated income, lower FICO score mortgage products. Texas is typically an FHA market, has been and will return to that, but there will be a transition process.

Steven East - Payly Capital

Okay. Do you have any idea how much you think it's hurting overall demand?

Tim Eller

In Houston, for example, our sales are down about 30%. A year ago this time they were fairly robust.

Steven East - Payly Capital

Okay. Then the other question, Cathy you talked about the quarterly progression. Could you put a little color around that and what's going on with pricing trends and the gross margins and the new orders, that type of thing?

Cathy Smith

Well, as we said, as I shared in the comments, the average sales price has come down a little bit. And we did share that. And when we say that more of our neighborhoods seem to be finding or divisions seem to be finding some level of stability, it is really around finding a consistent sales per neighborhood type of a pace.

And now, obviously, that is at a higher discount rate as we also shared discounts were up a little bit more. And then Kansas, cancellation rates have continued to two quarters in a row at least, have continued to come down and we are seeing that again more consistently in some of our neighborhoods.

Operator

Your next question comes from Susan Berliner with Bear Stearns.

Susan Berliner - Bear Stearns

Good morning. I was curious about your comment about I guess each month and stabilizing a little bit. It seems pretty different from the other builders. So I'd love to hear any additional specifics you can give on that.

Cathy Smith

First let me say we know that no single point makes a trend and the market does remain difficult. But we are well prepared in that market. When I say the --as I mentioned, the quarter started out weaker, April and May, and then finished a little stronger June, but when I say what do we see in the markets?

How I look -- how we look at it is literally down at the neighborhood level. And the first thing we have to do is find a predictable pace and that does change. Even when we feel like we found a predictable pace it may change again the next week or something. So we have to continue to adjust. But that is really the basis of my comments around that and then that every month getting continually worse seems to -- that pattern seems to have been gone.

Susan Berliner - Bear Stearns

And my follow-up question is regarding the debt. Did you buy bonds in the open market? And is that something you would continue to do?

Cathy Smith

Yes we did buy them in the open market at a discount and will continue to pursue that opportunistically as appropriate based on the cash position.

Operator

Your next question comes from Stephen Kim with Citigroup.

Stephen Kim - Citigroup

Thanks. I was wondering if you could comment on your landowner ship position. First of all in terms of how you set your targets, or your goals, on how much land up to own at this particular in the cycle. Do you do it as a percent of you know, as a multiple of the last 12 months?

I know in the past you sort of had an anticipation for what your sales rates would be. And you would sort of try to hold a certain number of years, based on that projection. But in light of this current environment, I was wondering if you would maybe change that. Give us a sense for your methodology and what your goals are on land ownership.

Tim Eller

Steven, our goals have been consistently over the course really of many cycles, somewhere between one and a half and two years supply owned. And then about that much or perhaps more optioned. So today, whether we look at where we are, we are about three years a little over three years owned.

So our goal is to get back down below two and at this stage of the cycle I think 1.5 would be very appropriate. And as we see how the landmark is going to evolve, we expect there to be a surplus of land in various stages of development, either entitled, partially developed or fully developed that will be available to us.

And allow us to be lower on our own positioned certainly than we are now. That is one reason we are walking away from the options that we walked away from, with 3.3 years owned supply, we simply don't need to buy more land in many markets.

Stephen Kim - Citigroup

Great. And the -- I assume that three years you talked about was as a -- as a percentage of -- or as a multiple of trailing last 12 months. My second question was, related to goodwill. Some of the builders that we've observed have written off goodwill over the -- you know, over the past 6 to 12 months.

I was wondering whether or not you know your feeling was that there was any -- I know you don't have a lot. But if there was any reason to sort of scrutinize the goodwill that you currently have?

Cathy Smith

Great question on goodwill. As you said, we don't have a lot. We have a couple $100 million in total. We do as you can imagine, evaluate that goodwill and its value on a very, on a periodic basis. So at this time don't see any issue there. But we will continue to evaluate it.

Operator

Your next question comes from Carl Reichardt with Wachovia.

Carl Reichardt - Wachovia

Hi. Sorry about that.

Cathy Smith

Good morning, Carl.

Carl Reichardt - Wachovia

Sorry Cathy. I had a question about the FIN48 charge the $200 million hit the book, it is in payables now.

When do you or do you anticipate a resolution of that? When could we expect that in your mind? And then I assume what you get then is a move down in payables and an increase back in the book. Is that how it works?

Cathy Smith

Yes. You are about right. First, to answer your question on timing. That one is a little uncertain. As we disclosed in our K, our 10K, the majority of the FIN 48 adjustment is associated with an audit of our '01 through '04 tax years. So that is the vast majority of it.

That will go through the due course of settling that outstanding audit. So that will take a little time. That could be this year, late in the year. Could be into next year, and then it could be even longer. But at that point that is kind of the time frame I would expect. Once it is resolved, any difference in the resolution would come back through income.

Carl Reichardt - Wachovia

Okay.

Cathy Smith

So therefore go back to equity.

Carl Reichardt - Wachovia

Perfect, all right. Just on the finished inventory count, the move down in it, can you tell me, you may or may not have this, what the additions to that were versus the subtractions? In other words did you sell 800 finish and then add 400 through the pipe? Or was it all in that reduction is that.

Cathy Smith

Just a second. We are going to see if we can get that you detail. Let us get back to you in a minute.

Carl Reichardt - Wachovia

Fine. Okay guys, thanks a lot. Appreciate it.

Tim Eller

Okay, Carl.

Operator

Your next question from Michael Rehaut with JP Morgan.

Michael Rehaut - JP Morgan

Thanks, everyone. The first question, you discussed June being a little bit better. I want to circle back to that and certainly one month doesn't make a trend. But I was hoping you could give a little bit more in terms of quantification, either through orders or traffic or CAN rates or you know, and just how much better June was. And what, in your opinion, might have driven that. And then I have a second question.

Cathy Smith

Yes. Let me provide a little color first and Tim may want to give a bigger picture. Just to kind of understand, traffic was about flat. Kind of consistent through the three months. So that one wasn't any better or worse in the month of June.

CAN rates, dropped throughout the quarter, and so they -- June was the low point, the average for the quarter was 31. But June was a little lower than that. So CANs had continued to come down. Discounts, you know, pretty much flat through the quarter, through the three months.

Michael Rehaut - JP Morgan

Excuse me. Chris Brown has a question.

Cathy Smith

Okay. I'm sorry. Not sure what that was. So you can see that there was, you know, nothing in particular stood out as being why June was any better than the other months. But just it was pretty much the two that we saw were the consistency and sales pace in the neighborhoods and then the cancellation rates coming down.

Tim Eller

Michael, I'll just offer it still remains choppy out there. Sales are choppy. We focus on really selling our inventory as it ages. So we had a push to do that in June and perhaps that's what it was. But I guess the best way to characterize it is the market, the sales remain choppy. The market remains difficult.

Operator

Your next question comes from Rob Stevenson with Morgan Stanley.

Rob Stevenson - Morgan Stanley

Good morning, guys. Are you seeing any signs that of the land sellers capitulating, more willing to reprice or extend the terms of your options today than they were a couple months ago?

Tim Eller

Yes, we are. In fact, the options that we have outstanding were very, very much kind of in the money, because we took a very aggressive look at options last fiscal year and we are actively renegotiating those options today. So, both in terms of terms, and in terms of price. So we're seeing a lot more flexibility on terms, some flexibility on price.

Rob Stevenson - Morgan Stanley

Okay. And then as a follow-up, Cathy, is there anything, you know, surety bond or JV related that is going to require a meaningful amount of cash expenditures over the next six months that isn't immediately evident looking at the financials today.

Cathy Smith

No. Nothing. The answer is no.

Rob Stevenson - Morgan Stanley

Okay. Thanks, guys.

Operator

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

Greg Gieber - Edwards

Good morning. Just as a point of clay clarification, Cathy. That 750 you mention in cash flow. Was that for the full year or what you expect to have just in the second half?

Cathy Smith

That's cash flow from operations for the full year.

Greg Gieber - Edwards

Full year? Okay.

Cathy Smith

So as you know, we're down about $400 million in operations this quarter. So it will be the latter half of the year will be stronger than that.

Greg Gieber - Edwards

Obviously. I just want to make sure it was for the year. Question is really I have is for Tim. Could you just tell us what markets you have pulled out of? Or have decided to pull out of because they lack strategic importance to you, longer term?

And give us an approximate estimate or actual number if you have it of the number of closings you did in 2005? You know sort of the peak year in those towns those cities?

Tim Eller

Well, really, we've only announced two markets, Greg, which is Columbus Ohio and the Triad area of North Carolina. We continue to evaluate our other options. We may continue to participate in some markets but at a lower level than we have in the past. So in those markets less than 500 closings.

Greg Gieber - Edwards

Do you worry that you don't have enough volume if you reduce your presence in a market to get economies of scale at the local level?

Tim Eller

No, we don't. In fact that is what this is all about. This is all about positioning for the future so we can gain share in those markets that will provide the best returns and the best benefit of scale.

Operator

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

Alex Barron - Agency Trading Group

Yes. Thank you. Wanted to go circle back to the impairments. I know you mentioned the top three areas. But can you give us kind of a dollar breakdown or percentage breakdown by area of your impairments this quarter?

Cathy Smith

Yes. You know, you'll get the segment detail by region in the Q. That is really the best way to get it at this point. Other than I gave you the top three. And the Q will be filed fairly shortly.

Alex Barron - Agency Trading Group

Okay. Got it. And just I guess associated with that, I had here in my notes that you guys had previously impaired something like 87 communities. So I just want to reconcile that with your 100 counts, since I guess it is a net 25 addition. Was that just a round number?

Cathy Smith

I think the actual number is 83 previously impaired and then 29. But 24 were new or 25 new. And I just -- I rounded.

Operator

Your next question comes from Buck Horn with Raymond James.

Buck Horn - Raymond James

Good afternoon. Just curious about the inventory purchases again in the quarter. Was wondering for those inventory purchases how much of that was, you know, voluntary strategic versus maybe option counter parties putting back to you? Forcing you to exercise options?

Cathy Smith

In that quarter we had inventory like I said a couple $100 million. And of that, it was a little bit in the markets where we are short or growth markets. They are still performing very well. That would be probably about a third of that. Then the remainder would have been JV commitments that we have that still make sense.

Buck Horn - Raymond James

Did you have to make any other capital contributions to the JVs in the period and how much?

Cathy Smith

We had no margin calls. We will make an equity contribution to a JV in the 25 to $27 million range.

Operator

Your next question comes from Ethan Arback (ph) with Marathon Asset Management.

Ethan Arback - Marathon Asset Management

I was wondering if you could quantify in your expectation for $750 million in cash this year, what portion of that is from net income and what portion is from changes in inventory?

Cathy Smith

We are not providing guidance this year at this point, given the uncertainty in the market. The reason why we have confidence in that cash generation amount is because of the amount of our balance sheet. And that we are you know continuing to sell homes.

Tim Eller

That would imply that we would generate more, you know because we were cash flow negative this quarter, it would generate between now and the in the end of the year we will generate in excess of $1 billion between now and the end of the year.

Ethan Arback - Marathon Asset Management

Right. I mean is there some kind of -- what are the key drivers you are using to come up with that? Are you going on a community-by-community basis and trying to figure out home homes you think you're going to sell?

Or more of a big picture you are going to try to decrease the number of finished homes in inventory by a certain amount? I'm trying to understand how you are arriving at that number.

Cathy Smith

You know it's based on our understanding of our forecast, our internal forecasts, home we're going to sell so inventory reductions. And we know where we are going to continue to want to buy land that we are light and the markets that make sense, so we factor that in as well.

Operator

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

Dan Oppenheim - Banc of America Securities

Thanks. Tim, in October of '05, you were out there before many others in the industry, talking about how the conditions we'll see in the coming quarters and years could be a lot tougher than what we see in the past and responded appropriately in terms of focusing more in cash flow.

Little bit concerned hearing the comments in terms of stabilization here. Seems a little bit more optimistic. How is that changing if at all your strategy in terms of running the business and thoughts on cash flow here?

Tim Eller

Well, it's really not change it go from even October of '05. We are really focused on the fundamentals, Dan. And let me just reiterate that the market remains difficult. And I don't see any change in that for some time.

So, while I might have observed that some markets seem to be stabilizing, overall, we have chronic over supply issue and a chronic affordability issue that we are going to have to deal with for quite some time.

So for us, it's just focusing on the fundamentals right now. Selling homes in a very tough environment, minimizing our inventory, structuring for profitability at volume levels far less than they were a couple of years ago. Continuing generate cash so we have balance sheet flexibility for now and in the future. And aggressively attack all of our costs.

Dan Oppenheim - Banc of America Securities

Okay. Thanks very much.

Operator

Your next question comes from Kenneth Zener with Merrill Lynch.

Kenneth Zener - Merrill Lynch

Morning again. You guys recently amended your covenants to include debt to cap measures in your revolver.

Tim Eller

Yes.

Kenneth Zener - Merrill Lynch

I was wondering if you could talk about the willingness of banks to work with you know smaller, private builders. And how you think that will play out during the cycle, since it looks like there is a lot more capital available to both large and small builders this time.

Cathy Smith

Yeah I can't comment on the willingness of the banks to work with others. We have a very supportive bank group, as you know it is in the filing of our 8K, we did just amend our covenant -- our credit agreement.

Tim Eller

It will be interesting, Ken, to see how this really plays out in terms of the private sector and -- and the development sector. So far there's been a lot of patience.

We don't see much distress, although we're seeing now, as I mentioned earlier, a lot more flexibility in terms of land sellers in terms, and in some cases, prices.

Kenneth Zener - Merrill Lynch

Do you think the availability of capital is going to kind of disrupt things, because Terra (ph) Homes, for example, had received funds from a hedge fund? Do you think the interest in capital is going to really kind of amplify the supply issues?

Tim Eller

I don't know. I'm not sure quite how it's going to play out. I think it's good for the industry there is a fair amount of patient capital in the industry right now. So -- but it will play out.

Operator

Your next question comes from Gary Freeman with Gem Realty Capital.

Gary Freeman - Gem Realty Capital

Thank you. Cathy, I apologize, if you gave color on this earlier in the call. But I think you mentioned that your quarter got better or strengthened toward the end of June.

Cathy Smith

I assume you meant that from an absorption standpoint? Yes. In a couple of places, cancellation rates continue to improve throughout the quarter and in two quarters sequentially as well as absorption rates or the pace and predictability in the neighborhoods.

Gary Freeman - Gem Realty Capital

Were you cutting priests more aggressively toward the end of the quarter to improve that absorption?

Cathy Smith

Not anywhere in particular. Now, discounts were up a little bit, 50 basis points, 8.8% in the quarter.

Operator

Your next question comes from Jim Wilson, JMT Securities.

Jim Wilson - JMT Securities

Was wondering, in your markets that you think had been weaker and have stabilized, sounded like particularly Phoenix and DC, could you give a little color on how much you think they've dropped from the peak and kind of a what you think it's taken to reach stabilization or relative stabilization of markets?

Tim Eller

In terms of what, Jim?

Jim Wilson - JMT Securities

Price through discounts, price from the peak things of that nature.

Tim Eller

That varies significantly by neighborhood and product position. But it is substantial. I'll just say it's a substantial difference and a lot of that is just affordability. It is the market's need to adjust to become more in balance with our buyer's capability to purchase.

And, to the realities of the mortgage markets, but having said that, both our Phoenix and D.C. markets cancellation rates are back to normal. We are seeing predictable sales paces. And those are the first steps to this recovery, basically.

Jim Wilson - JMT Securities

And I guess one other, I know you mentioned southern California being weak a couple of times. But what does northern California look like for you guys?

Tim Eller

Pretty good is relative. I think the issues in southern California are more around -- it was a heavy, alt-A stated income market and prices rose very quickly. Beyond the kind of the agency threshold of $417,000 for a Fanny Mae, Freddie Mack mortgage product.

So the average price is over $500,000. In that market southern California, I'm speaking about, prices really need to get back down to the area of agency affordability. So that's why that one's going to be impacted more than northern California.

Operator

Next question from Michael Rehaut with JP Morgan.

Michael Rehaut - JP Morgan

Thanks. I think I was cut off from there my second question.

Tim Eller

Sorry.

Michael Rehaut - JP Morgan

Not your fault. Maybe I can get a couple in here. Just you know going back to my line of questioning before about the trends during the corner and again month-to-month understand a lot of variability and still inconsistency. But how have you seen what you saw in June continuing to July? If you are able to offer any insight there.

Tim Eller

We're not. I mean, July isn't even finished yet. So -- but again, the best characterization I can give of our sales environment is choppy.

Michael Rehaut - JP Morgan

Okay. And you know, in terms of pricing, you know, Cathy, you mentioned that incentives were up 50 basis points, but I assume that that is more -- that is stat is more on closed homes, not the orders that you're taking? Is that correct?

Cathy Smith

Yes.

Michael Rehaut - JP Morgan

Okay. So on -- on the pricing trends during the quarter, as it relates more to orders, you know, I was wondering if you could comment on that, and you know, even by market, where you've been you know more aggressive and how you see, pricing, where the worst markets where the best markets. And where have you seen better success with your own is pricing positioning?

Tim Eller

It's a very dynamic environment, Michael. I mean, it changes all the time. So I think, you know, the characterization I gave of Phoenix and D.C. is maybe one of the best, which is these markets needs to reach a level of stabilization and predictability and we are seeing more of that in more places. But we are not seeing it across the board.

We are not seeing strength, really predictable strength, anywhere. It still remains choppy. And I think it's really no different than our comments even last quarter. Florida remains highly impacted. Southern California remains highly impacted. Texas is slowing because of the mortgage liquidity. And we are seeing signs of stabilization in a few places.

Operator

Your next question comes from Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks. I also had a follow-up question on the can rates. A lot of your peers, public and private, seeing a tick up in the can rates, due to mortgage disqualifications. So I mentioned that would have probably had an effect on your can rates as well.

You already mentioned pricing wasn't the offset that would have kept your can rates more stable. I was wondering if you could help us understand what is helping you keep your can rates down in the face of the mortgage situation?

Well, I don't know -- I don't know that there is anything. It may just be mix and where we are. The cancellation rates today are much more around the mortgage issues, than they are around buyers reselling their houses. That is still an issue. Mortgage issues over the past three, four months have l a higher impact on the cancellations. But I can't explain why ours is different than somebody else's.

Matt Moyer

This is Matt. You know, keep in mind, at 31%, there is still a good 5, 6, 7 percentage points above kind of historical levels. They've come down quite nicely for us and as a presented backlog they've come down. But they still remain above historical levels.

Nishu Sood - Deutsche Bank

Right. One other quick question. Cathy, you mentioned ex-selling expenses you have been pretty successful in holding your overhead costs down. Wondering if you could help us understand, maybe quantify, what the trends have been in your selling year over year?
Cathy Smith

Yeah, I don't have that off the top of my head. We can look it up. Maybe we can pull it here real quick.

Tim Eller

They are up a bit.

Cathy Smith

Yes, as you would expect in a difficult market. But I don't have a trend for you. We'll have to get back to you on that one.

Operator

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

Dan Oppenheim - Banc of America Securities

Thanks, just a quick follow-up. Was just wondering and thinking about some of the credit issues. What would you say the trend has been in some of the, let's call it the credit constrained markets, out there, we are typically seeing the lower FICO scores, lower down payments? If you can just comment on what the trends were over the course of the quarter.

Cathy Smith

Yes. We are seeing actually a reversion back to a more traditional product. So even in the more challenged markets, now, as Tim mentioned, southern California has an affordability issue. Houston, we are actually seeing more of a reversion to more traditional products.

Tim Eller

FHA, particularly.

Dan Oppenheim - Banc of America Securities

Not so much in terms of that, but in terms of your orders in those markets as the quarter went on.

Just given the, I imagine you are seeing a reversion back to those products, but that doesn't mean you have 100% of the people that is just the whatever percent of the people are still using it and the sub prime people aren't getting the mortgages.

Tim Eller

We did have some shift. But again our sales in Houston are down 30%, our cancellations are up. Or cancellations in southern California are fairly high, still continuing fairly high, as some buyers can't find alternatives can't qualify for the mortgages. So in those markets, more of those southern California/Texas markets that be typically hit.

Operator

Next question from Greg Gieber with AG Edwards.

Greg Gieber - Edwards

Tim, you mentioned the markets we are seeing stabilization. I assume that is on orders. Could you give us an idea at what operating margin these markets are stabilizing at? Compared to historical norms for the markets?

Tim Eller

You know, in some cases, we are profitable and fairly profitable. Even at current levels. And in some cases we are much more challenged. It really is very market specific.

Cathy Smith

And neighborhood specific.

Greg Gieber - Edwards

Okay. Second question I had, I mean you hit quite well what the nature of the problem of the market is. You said chronic over supply, chronic affordability. I want to is ask you how you are addressing the affordability issue.

If you look down the road say to you know, new product, you'll start bringing out in '08 or '09 whenever, just how much lower do you think you'll have to go with your ASPs to the point that you have product that people aren't stretching to get into and where affordability ceases to be an issue?

Tim Eller

That is a good question, Greg. We have done some work on that. Actually, what we are doing is looking at what the markets can afford from a mortgage standpoint, given the current level, given the current mortgage products that are out there.

The incomes that we know are out there and just backing into a sales price, based on conventional underwriting standards. What that is giving us is targeted sales prices by neighborhood, actually, in those markets. And in some cases, in many cases we are able to recraft our neighborhoods and our products in order to meet those.

And that is the exact process we are going through in southern California. Southern California we have had a Fox and Jacobs brand for several years and that is proving to be a big benefit to us as we kind of convert most of our neighborhoods to a Fox and Jacobs-type product. Very value-oriented. Very efficient product with very good turns and good affordability.

Operator

Your final question from Joel Locker with FBN.

Joel Locker - FBN

Hi, guys. Kind of just wanted to get my hands around inventory a little better. Just you know, with the 49% drop in lock counts, that is great in the last five quarters. I look at it more on a dollar-wise versus backlog. If you look at backlog over the last four years it is down 8% versus 136% increase in inventory.

And you know, so that is about 156% differential, I think. Was wondering if anytime in the last four years, if you switched your operating schedule or you know, just your whole business plan because that just seems like it's pretty outside.

Tim Eller

Well, we look at it slightly different, we look at it as a percentage of work in process. So our unsold inventory as a percentage of work in process. We like to keep at a 15 to 20% range.

We are higher than that now, primarily because of the cancellation issues that we have had. But our target continues to be 15 to 20% of work in process. That really hasn't changed.

Joel Locker - FBN

Right. Just when you impair the -- impair communities, do you look at future communities that are not open yet?

Cathy Smith

Yes, we sure do. We look at everybody neighborhood both active and inactive. So we have 670 roughly active neighborhoods and we look at 1100 neighborhoods.

Joel Locker - FBN

Total? So that is you know for the most part that is those impairments you look at them every quarter? Every single community?

Cathy Smith

Absolutely.

Joel Locker - FBN

All right, thanks a lot.

Cathy Smith

Thank you.

Operator

I'll turn the call back to management for any closing remarks.

Tim Eller

Thank you. Thanks everyone for joining us today. We look forward to sharing our second quarter results and continued improvements in our operations during our next call in October.

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