Centex F2Q08 (Qtr End 9/30/07) Earnings Call Transcript

Centex Corporation (CTX)

F2Q08 (Qtr End 9/30/07) Earnings Call

October 24, 2007 10:00 am ET

Executives

Tim Aller - Chairman and CEO

Cathy Smith - CFO

Mark Kemp - CAO

Matt Moyer - Head of IR

Analysts

Ivy Zelman - Zelman & Associates

David Goldberg - UBS

Nishu Sood - Deutsche Bank

Michael Rehaut - J.P. Morgan

Stephen East - Pali Capital

Stephen Kim - Citigroup

Carl Reichardt - Wachovia Securities

Dan Oppenheim - Bank of America Securities.

Ken Zener - Merrill Lynch

Timothy Jones - Wasserman and Associates

Stuart Hosansky - Vanguard

Susan Berliner - Bear Stearns

Alex Barron - Agency Trading Group

Chris Brown - Banc of America Securities

Jim Wilson - JMP Securities

Keith Willey - Goldman Sachs

Michael Mogavero - Atlantic Asset Management

Randy Weisman - Burm Asset Management

Nelson Yeman - Greenlight

Jamie Canlith - Southside Analyst

Presentation

Operator

Good morning, and welcome to the Centex Corporation Fiscal Year 2008 Second 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 8-K. 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 10-K and 10-Q, 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).

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 will now turn the call over to Tim Aller, Chairman and CEO. Please go ahead, sir.

Tim Eller

Thank you, Lorain. Good morning, everyone. Thanks for joining us for our fiscal year 2008 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 the call this morning with introductory comments on the quarter and some thoughts about the months ahead. Cathy will provide details on our financial performance and then I'll offer closing comments before we take questions.

Moving to slide 3, the housing market continues to be extremely difficult as was evident with the further deterioration of pricing, traffic, and sales orders for the quarter. Rapid and unprecedented changes in mortgage liquidity over the last few months have created new challenges and affordability for homebuyers.

In August and September, we and the industry experienced a complete resetting of the mortgage products available to borrowers. Not only that many of the loan products are buyers and backlog had qualified for simply sees to exist during August, interest rates and qualifying standards and anything other than agency products became much more difficult. We responded quickly by adjusting home prices in many of our neighborhoods to levels that would enable buyers to qualify for Fannie Mae, Freddie Mac and in a number of cases, FHA mortgages.

The disruptions affected nearly every region including the relatively affordable Texas markets. We have seen this more conservative lending environment reduced the number of buyers that previously could qualify for a home mortgage. The mortgage credit issues will persist for some time to come, suppressing demand and exacerbating the current housing oversupply conditions.

But our strategy remains consistent. A balanced approach to selling homes, aggressively attacking and reducing cost, and generating cash to further strength our balance sheet. Centex also has experienced management, who know how to react in a changing environment, while also positioning the company for the future opportunities, which will inevitably come from the cycle.

I believe that we are taking the right actions in this environment. Our actions are directly aligned with our strategies for managing this business cycle. Unsold inventories in virtually all markets remain extremely high. But this quarter’s results show that we are successfully selling homes and minimizing inventories. Our net sales are down 13%. Year-over-year monthly net sales were fairly consistent to the quarter at just under 2000 homes per month. The number of finished unsold homes declined by nearly 40%, quarter-over-quarter.

We are structuring our operations for profitability. We reduced our workforce by more than 40% from the peak of this cycle, and nearly 20% in the last six months. Profit overhead is down 23% year-over-year. We are also aggressively attacking construction costs seeking and getting cost reductions that will be reflected in future closings. In addition, we are reducing our land position. This quarter, we further reduced both the number of lots we own and the number we have under option. Year-over-year, our owned lots are down 16% and options are down 70%.

We are achieving positive cash flow from operations and enhancing balance-sheet flexibility. I believe that our near-term actions in this environment will further our long-term vision. We intend to gain strength and share in the markets that offer the best opportunities for future returns, and fit with our business model. We are focused on turning assets faster.

This approach will generate free cash and higher returns more consistently. We are progressing toward our goal of applying world class manufacturing disciplines to the business of building high quality homes, and we intend to emerge from this business cycle with a sustainably lower cost structure.

Before passing the discussion to Cathy, I would like to note that J.D. Power and Associates recently recognized Centex, with its Platinum Award, for excellence in customer satisfaction, the only builder to receive the award. This is the special honor for our teams in the field, who maintained their focus on serving our customers, even in a difficult business environment. This is another example our focus on the fundamentals of home building.

With that, I will turn it over to Cathy to take us through some of the specifics for the quarter.

Cathy Smith

Thank you, Tim and Good morning everyone. I'll offer my perspective and commentary on our fiscal second quarter. First, let me reiterate that our goals and our focus remain consistent. Sell home generated cash and structure for profitability. In the quarter we did just that. We generated positive operating cash flow, reduced our inventory of unsold homes and reduced our SG&A cost significantly.

I am especially pleased with the 37% reduction in our unsold finished homes. The market remains difficult and results remained inconsistent. I was somewhat optimistic last quarter because cancellation rates have come down two quarters in a row, and two-thirds of our neighborhoods have found a predictable sales pace.

Unfortunately, the world changed quite dramatically the 1st of August. As Tim said, this quarter was marked by significant change in the mortgage market. High LTV, no-doc- dated income and lower FICO products essentially went away overnight.

With the loss of non-traditional mortgage products, the most effective way to achieve an affordable payment is to reduce prices. We acted quickly in doing that. In many markets, we reduced prices to FHA limits, and in others to Fannie Mae limits.

This allows more borrowers to qualify for mortgages. With these decisive actions, we continue to sell homes. Continuing to sell homes is key to our strategy of reducing our inventory and our lot supply areas in which we again made solid progress. Total unsold inventory is down 28%, year-over-year. Completed homes are down 50% on a per neighborhood basis.

On the land front, we further reduced our owned and controlled position. Owned lots are down 16%, year-over-year, to approximately 92,000 lots. Options lots now stand at about 39,500, down 70% year-over-year and 27% sequentially. We continue to aggressively reduce our optioned and owned lots, and expect our total lot position to continue to fall throughout this fiscal year.

Our cancellation rate at 35.4% increased from the June quarter but it was down year-over-year. Cleary, this past quarter’s mortgage market disruption drove the higher cancellation rate. But our sales and mortgage professionals did a good job in minimizing the increase.

Another important goal is remaining operationally profitable through the trough of the cycle. Home-building is less profitable this quarter before impairments and other land-related costs. Of the $26 million in earnings from housing operations, about $20 million is from closings and previously impaired neighborhoods.

To remain profitable, we continue to aggressively adjust our cost structure. In the last two quarters, we have realized direct construction cost reductions between 5% and 10%. This is an addition to the approximate 10% reductions we achieved in FY '07.

Further as Tim mentioned, we have made good progress in keeping our organization size to the business reality. Headcount was down 14% sequentially this quarter. We still have work to do in terms of restoring growth our gross margins to more normal levels and reducing our overhead expenses even further.

Now, I will provide more color on the home building and mortgage operation. Slide 7 provides the operational highlight of the second quarter. We closed 7,350 homes in the quarter, 14% lower than last year. The average sales price declined about 8% to [$280,800].

Discounts higher than normal had impacted record levels. They are the primary reasons for the weaker margin performance. Discounts and incentives totaled 11% of housing revenues, up 4 percentage points year-over-year, and up 220 basis points sequentially.

The increase is tied directly to the daily efforts needed to find affordable prices. At every neighborhood we drive for three sales per month. Once a neighborhood finds a predicable pace, we can then set a cost structure to be profitable of that pace.

On a year-over-year basis our backlog of houses sold was down 38% on a unit basis and 47% on a dollar basis. We sold 5,953 homes, down 13% year-over-year. Our backlog now stands at 9,633 units with the total value of $2.7 billion.

Unfortunately, the land related charges in the quarter were significant as a direct result of the new price reality. On a pretax basis, we had $983 million in impairments and other land-related costs. The total breakdown: $847 million for impairments, and write-offs of option deposits and pre-acquisition costs were $38 million. We took a goodwill impairment of $61 million and JV impairments were $37 million.

The impairments were concentrated in California, Arizona, Nevada, and Florida, markets where we experienced dramatic additional price declines and one of disclosures [around the rise]. These are the areas where affordability remains a huge issue, and we were hit hardest by the mortgage product changes.

As I said last quarter, we take a methodical approach to these adjustments, looking at all neighborhoods active and inactive under current business conditions, our assets are appropriately valued. We recognized this is a dynamic environment. We will continue to take a very consistent disciplined approach to valuing our assets.

Let’s now take a few minutes to review the regional results. Slide 8 details sales and closings by region. In the quarter, we sold 5953 homes, representing a lot of hard work by the men and women in the field. Our shelf space in the Southwest is a direct result of aggressive pricing in the Inland Empire, where sales were up 22%, and in Las Vegas, where sales were up 30%.

Unlike in previous quarters, our Texas results were weak, as areas like Houston, in particular, were especially hard hit by the disruption in the mortgage market. Conversely, our DC metro division remains on a recovery path posting a solid increase in sales, and a substantially lower cancellation rate. However, most of our markets remain challenged by affordability and oversupply condition, and could get worse with foreclosures and adjustable rate mortgage resets and buildings.

Turning to slide 9, I’ll comment on cost reductions and cash flow. It’s never easy to reduce overhead, but our operators are demonstrating impressive progress in getting our organization to the right cost structure. We achieved a 21% reduction in SG&A expenses, year-over-year. Even better, we saw a 17% decrease on a per unit basis in overhead and an 8% per unit decrease in total homebuilding SG&A. No costs have gone unquestioned.

We are encouraged by this progress and are confident that we will continue to report positive results on this front. We continue to make progress on standardizing and centralizing our finance and accounting functions. This is just one example of how we are pursuing a sustainably lower cost structure.

We are addressing our G&A cost aggressively and structurally. We will realize some benefits in fiscal 2008, but results will be even more meaningful beyond that. Consistent with management’s expectations we produced a positive operating cash flow this period. In the quarter, we generated about $220 million of cash from operations. We are buying very little land, other than from previous commitments.

We used some of the cash to make a $200 million investment in our financial services business to simplify the funding structure. We still expect to generate healthy cash flows this year and pay down our debt maturities out of operating cash. We are entering our seasonal strong period for cash generation and expect to generate approximately $5 million in cash from operations this fiscal year.

Turning to slide 10, I will comment on our financial services business in light of the past quarter’s challenges. First and foremost, we are responding to the market and simplifying our product offerings. 95% of our loans in our warehouse have a fully documented income, and have an average cycle of 735. Our combined loan to values are trending down.

As I mentioned earlier, we are also simplifying our funding structure. We are now utilizing an industry standard warehouse line and in the process of closing our old funding structure, Howard Street. Our new warehouses are of adequate size to serve the homebuilding business.

Additionally, just like in our homebuilding business, we are focused on restoring profitability of CTX mortgage. We increased our reserves and response to the loss of mortgage liquidity. The reserves increase is for the potential future losses on mortgages currently in our warehouse on products, which we stopped writing.

We do not anticipate material increases in early payment default obligation. As I mentioned earlier, our mortgage company’s early identification of tightened credit markets has helped to keep our cancellation rate reasonable. CTX mortgage is an important part of the home-selling process.

We remain focused on selling homes, generating cash and structuring for profitability. We will continue to strengthen our balance sheet and aggressively attack costs, and will never lose out on the customer. Achieving these kinds of goals differentiate great companies.

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

Tim Eller

Thanks, Cathy. I will emphasize once again that the market remains extremely difficult. But at Centex, we are resolute in our approach to these challenges. The market deteriorated further over the quarter and mortgage market transformation has created significant challenges and affordability for homebuyers, with resulting pricing pressure on housing.

With all that, we have been consistent in our strategy throughout the cycle. For the strong balance sheet and experienced leadership team, we are executing our game plan, focused on the fundamentals of homebuilding, selling homes and minimizing our inventories, and reducing our land position and structuring operations for profitability. We are generating cash for balance sheet flexibility, aggressively attacking cost across the organization, and staying focused on our excellent customer service.

Our actions today will further our long-term vision. We are positioned now to gain strength, share in the markets that fit our business model, and provide the best opportunities for the highest future returns.

We intend to turn assets faster, which will allow us to generate cash and higher returns more consistently. We are bringing world class manufacturing disciplines to the business of home building. And we will emerge from the current cycle with the sustainably lower cost structure.

With that we will be glad to take your questions, Moyer.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ivy Zelman with Zelman & Associates.

Ivy Zelman - Zelman & Associates

Hey, guys, good morning.

Tim Eller

Good morning, Ivy.

Ivy Zelman - Zelman & Associates

Do I think the prices with better cash flow number for the quarter and give us your guidance seems relatively conservative going to $500 million and I know that you’ve done a great job of reducing on what owned lots you have. I’d assume that's going to continue, give us some framework of hope you can back in maybe calendar '08 or your fiscal '09 or what kind of image for reduction you setting for and what that can hopefully translate into very strong cash flow?

Cathy Smith

Yeah. So Ivy as you said, our goals are, our objective right now is $500 million in cash from operations for the year. And it is predicated the variable will be how much inventory we can continue to reduce and obviously our land spend. As you know, we probably over the hump on the land spend it is decreasing, it has been sequentially actually every year in the last three. But, we were really not prepared to get guidance because there still is no [significant] pattern out there.

Tim Eller

Let me add to that, Ivy and just say that where we’ve reduced prices. We are very transparently price that is, our incentives are modest.

Our prices reflect kind of the true value in the market. We are pre-selling homes. When we price right we are able to pre-sell homes and generate a backlog. And I see as do in more and more of that through the course of this year and next year and moving more and more towards our pre-sale model and further way from building inventory to sell.

We find our discounts are lower. Our business more predictable and it sings up nicely with the manufacturing disciplines we are trying to, we are in progress of implementing.

Ivy Zelman - Zelman & Associates

Thanks for that, Tim. I guess on a follow-up on cash flow many analysts is trying to understand is, builders are loosing money on a pre-unit basis on some of the break. Builders will get cash obviously on a gap basis it would reflective real cash. If you look at the revenues, what should we be the think is 20% to 25% a fair number assuming you are not making funny on the (inaudible)?

Cathy Smith

20% to 25% of cash that was you’re asking I’m sorry.

Tim Eller

Cash flow closing.

Ivy Zelman - Zelman & Associates

25% per unit on revenue for cash, assuming no cash margins in (inaudible).

Cathy Smith

No, it’s going to depend. As you can imagine in some areas where very low thinner and that’s part of the evaluation we do on a asset by asset basis, do we want to sell, build out or hold and as its get closer to being incrementally the cash not returning your incremental investment we were obviously choose then towards the later of that evaluation, which should be hold.

So my point of saying that, is really does depend some will be up to where you said and some will be little less.

Tim Eller

Hey Ivy, if you think about our lot costs beaten by 25% of the total revenue, that’s about right to the extend we have to develop lots in order to work out of a line position and it will be little bit less than that.

Ivy Zelman - Zelman & Associates

And just one final question, separate subject SG&A with job relative to your peers that improving with headcount reduction and you are also moving to your centralized operations [as it was] structured as. When can we really start to see efforts that using obviously coactively doing configuration in a bigger way. Do you expect that will become prevalent in more fiscal ’09 first half or where we see that sooner?

Cathy Smith

Yeah. No, you are exactly right. So, we’re seeing some results today and as we’ve always said with our cost reduction efforts, you will see some near term, but the more sustainable ones, which is all of the structural changes, we are making right now really come out in 12 to 18 months. And what again back towards our goal of having a sustainably lower cost structure, you will see at end of ’08 and into ’09.

Operator

Your next question comes from David Goldberg with UBS.

David Goldberg - UBS

Good morning, thank you.

Tim Eller

Good morning, David.

David Goldberg - UBS

My first question is, Cathy, could you give us an idea what the range on the discounts, I know, it’s about 11% incentives and discounts. But how it ranges and maybe an idea of if you are seeing any markets, where there is basically no bid kind of matter, what you are doing on the price side and if so maybe where are those markets are?

Cathy Smith

Yeah. So, the range really is all over the board. And it really as a matter of to Tim’s earlier point, if we’ve been able to get the transparent pricing because that you can actually reset to those affordability levels you bring the discounts way down. And so, in some markets, where we’ve been able to achieve kind of more transparent pricing, the discounts are really actually pretty low. And the markets, where we’re still on that transition there the higher one. So, it’s really is all over the board.

David Goldberg - UBS

And as far as where there is a no bid if you will, you are going to find that, it’s in the fringed locations -- were the fringed locations or just they shutdown, there is not a price at which they sell? And we had during the cycle a real focus on staying in A locations. So, for the most part we don’t have any of those. We’ve deferred development of some neighborhoods simply because there is no reason to add to an oversupply situation already existing in a market, but we are buy and large not in the fringe.

David Goldberg - UBS

Okay. And then the follow-up question would be about the new financing structure for the mortgage business and how that’s affecting your ability to originate loans especially on the retail side? Are there any constraints given the change?

Cathy Smith

Yes. The only constraints are really more market constraints right now, which are very traditional conforming type loans and jumbo loans that are conforming in nature with the terms but they are in larger in size. That’s the only real constraint.

Operator

Your next question comes from Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks, good morning.

Tim Eller

Good morning.

Cathy Smith

Good morning.

Nishu Sood - Deutsche Bank

I also wanted to ask about the cash flow forecast the reduction from $750 to $500. If I look at the important drivers of your cash flows, you had pretty good orders relative to you peers, some strong backlog conversion this quarter obviously specs are down 40%. So, I’m just wondering, what's the major delta from last quarter that’s driven such a decrease in the cash flow? Is it just pricing or there is also something on the development cost side that drove that decrease?

Cathy Smith

No, big question issue. It’s really all pricing that what you’ve seen from our last outlook of $750 down to this one is really all the reduction in sales prices that’s driving that. Our land development spend hasn’t changed appreciably. It’s gone down a little bit from last quarter’s expectations.

Nishu Sood - Deutsche Bank

Okay, great. And one concept I’ve discussed with you folks in the past is just the idea of the land that you’ve in the pipeline at the moment, you are kind of budget for developing that are or just building that after completion. I was just wondering, if you could give us an update on your thoughts on that at what stage is your current pipeline fully developed and we really begin to see the true cash flow generation capability?

Cathy Smith

Yeah. It's obviously later or now as we move to the cycle where much more developed through all of that. And so you will start seeing a much more sustainable cash generation of this business as part of our goals our cash flow positive this quarter and expect to be from this point. So you should start seeing that big turn. I can't tell you off the top of my head, what percentage of our lots are actually all developed or not.

Operator

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

Michael Rehaut - J.P. Morgan

Hi, thanks. Good morning.

Tim Eller

Good morning, Michael.

Cathy Smith

Good morning.

Michael Rehaut - J.P. Morgan

First question just if you go into little bit more detail about even the Centex Mortgage business and with the $200 million investment, if you could explain exactly what that does for you and if you anticipate any further cash investment since that business in.

Now that you are moving away from the Harwood financing vehicles to I guess more just the conventional way is that is the builders are financing mortgages or making mortgages available. What that does for your company for me liability standpoint and mortgages coming back because I think that’s part of the issue in terms of the reserves that you have been taking.

Cathy Smith

Yeah. So first we do CTX mortgages critical to the selling process. So, they are a critical element and having mortgages really important to build us a home. So they start there. To your question on the $200 million investment in equity it's really a portion of the warehouse line and from the products that we’ve through there that we had to put a little bit more equity and that they wouldn’t funded at a 100% or even 90%.

So, that's really the function of the equity investment. It will go up slightly and then it will start to come down. And it’s really associated with a specific line of products. I know that little longer life construction to firm products that we had longer term that’s your question on a funding structure and our ability. Right now, we’ve outlined our [attraction] for home building business, and so it should be transparent to the rest of the world to the consumer.

Michael Rehaut - J.P. Morgan

But does it change from a liability standpoint in terms of from the Harwood Street and you are on warehouse line versus, I guess having joining on external warehouse lines..

Cathy Smith

Yeah.

Michael Rehaut - J.P. Morgan

In to the reserve that you took in and how you think about that going forward?

Cathy Smith

Yeah. There are actually two different issues, so you understand that. Liability go forward is no different than it really has been in the past. We have early payment default liability and normal reps and warranties and that's we’ve always said. The reserves we took were really around the bulk of those were for construction to prime loans. They are currently in our warehouse. These are loans; the products that we’re no longer writing. And so, they will continue to manage. So, there are actually two different issues.

Operator

Your next question comes from Stephen East with Pali Capital.

Stephen East - Pali Capital

Good morning.

Cathy Smith

Good morning, Stephen.

Stephen East - Pali Capital

First question on the specs well they are down nicely year-over-year, quarter-by-quarter they were only down it look like a couple of percent about 100 units or so. What’s going on there and should we see significant movement over the next couple of quarters on that?

Cathy Smith

Yes. You are absolutely right. In total down a couple of percent, but the aged inventory or the finished unsolds were down 37%, which is really important. So in this part of the cycle an environment really not quality at the age that we need to watch and so we are going to have to start specs unsold. We just want to finish them unsold and that’s our goal.

Stephen East - Pali Capital

Okay. And then just going back one more time to the cash flow issue, I think there was an issue that has the question. Your land and units was down pretty nicely quarter-over-quarter, if the dollars still were, as we look at that in that type of metric when do you think that starts to crossover, in other words dollars maybe potentially dropping faster than units?

Cathy Smith

It’s really probably from about this point now on forward because we tried to come through that. Typically in the past seasonally in Q2 we would have been cash negative. We’ve put a pretty good rain on our land development spend were gotten through the bulk of that so we can continue to monetize the assets.

Tim Eller

I’m talking about previous question. We generally have about a year develop lots out in front of us. So I’d just if you talked about quantifying that it would probably be about the same. So about third of our land our lot inventory today is probably developed.

Operator

Your next question comes from Stephen Kim with Citigroup.

Stephen Kim - Citigroup

Thanks very much. I was wondering if you could comment on your breakout of inventory the way you calculate, the way you talked about direct construction inventory, land under development, land held for development in sale. Do you have those numbers?

Cathy Smith

Let see what the guys can, Mark.

Mark Kemp

Yes, we have at September 30, direct construction is 2.96, land under development 4.2.

Stephen Kim - Citigroup

4.20?

Mark Kemp

Yes.

Stephen Kim - Citigroup

Okay. That included development, held for development in sale?

Mark Kemp

That’s just under development.

Stephen Kim - Citigroup

Okay. What about the held for development and sale?

Tim Eller

Held for development is $429. $429 million, Steve.

Stephen Kim - Citigroup

And can I just for comparable purposes, can I get those numbers for 4Q '07 or 1Q '08 which ever one you have handy?

Tim Eller

Sure. March 31 '07 it was $3.041 billion of direct construction, $5.434 of land under development and $158.2 million for land held.

Operator

Your next question comes from Carl Reichardt with Wachovia Securities.

Carl Reichardt - Wachovia Securities

Good morning guys. How are you?

Cathy Smith

Good morning.

Tim Eller

Good morning, Carl.

Carl Reichardt - Wachovia Securities

You've talked, Tim and Cathy about this been a three month bogie from a sales pace perspective. I mean, you are running that now. Can give me a sense maybe on how many communities you’ve got percentage wise that are substantially exceeding that average bogie and how many are below it?

Cathy Smith

Yeah. About half of our neighborhoods have achieved that pace. But you’ve to recognize, Carl you find that pace then you might lose it next week and you’ve to go find it again. So, about half have achieved that pace and then the other half, haven’t. And so that kind of gives you that sense on they are the ones they have or the ones they achievers at this point.

Carl Reichardt - Wachovia Securities

Okay. And then as you guys look out at store count over the course of the next couple of three quarters just looking at how many lots you have left for store and at current paces, let’s say you continue to find price or looked at prices the way to maintain that pace. What's your sense of where your store count ought to be by the end of the fiscal year?

Tim Eller

Well, it’s going to be steadily declining. A lot of it’s going to be just based on sales pace. But we would expect it to be somewhere between 600 and 630.

Operator

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

Dan Oppenheim - Bank of America Securities.

Thanks very much. I was wondering if you can talk about the folks on cash flow as relates it pricing that we heard comments in terms of finding the pace on sales the folks that in terms of just maintaining sales per community, the expensive pricing. If you are doing that what are you then doing on the impairment side and think about any future price declines or using today’s current price, as you think about impairments?

Cathy Smith

Yeah, good question. You can’t really predict the future, but with regards to impairments, what I can tell you is that we have to take into account current and future market condition to the best of indicators we can look at.

Dan Oppenheim - Bank of America Securities.

Okay, thanks. Then just wondering in terms of the some comments about deferring some neighborhood in terms of opening those up and general strategy how you looking that in terms of developing now versus deferring those, what (Inaudible).

Cathy Smith

It’s really a math exercise at some point. So we evaluate every asset under our sales strategy, a build out strategy and a whole strategy and obviously there is a set of assumptions around those and then probability waiting. In most cases the economic, which should still tell you build through and so that's what we are doing in a couple of cases, that’s not the case. So we’ve actually chosen to postpone the development and not add this by.

Operator

Your next question comes from Stephen Kim with Citigroup.

Stephen Kim - Citigroup.

Okay, sorry about that. And I want to just follow-up on the inventory breakout. It looks to me like you had a pretty significant ramp in your land house of development in sale components even from the June quarter. And I was wondering if you could comment on sort of where that is, it was a particular thought process that when into allocating a lot more in that category?

Cathy Smith

Yeah. You’re absolutely right. And see we first of all or slightly cut you off, if we did that. We are also showing development and not adding to the oversupply in some areas, as you said. And it’s really around our evaluation again at every asset level of sell build out of hold. And as you can imagine, when you, as Tim mentioned, we stuck to A locations in almost all areas and on occasion that’s not the case and we had to do that evaluation.

Stephen Kim - Citigroup

And as a follow-up, I guess, I’m curious as to where amd how you perceive the appetite for buyers, and that land whether it would be an A location or non A location? Do you get the sense but there is any reason for optimism that land held for development and sale may actually resolve culminating some cash coming in the door here over the next quarter or two?

Tim Eller

Not likely. There is very little in the way of land transactions happening now, Stephen. And although, we are continuing to sell land every quarter, but it’s not in any significant quantities. The whole question about when the land pipeline start to break close and what values are still really have to be determined. So, I think, we’ve got it for a while and that’s our intent to develop out of these at the appropriate time.

Operator

Your next question comes from Ken Zener with Merrill Lynch.

Ken Zener - Merrill Lynch

Good morning.

Cathy Smith

Good morning.

Tim Eller

Good morning, Ken.

Ken Zener - Merrill Lynch

I was just wondering the impairment benefit that you got in this quarter or they are benefits you got from past impairment. Can you detail that?

Cathy Smith

Yeah. I mean, detail wise it’s about little over 600 at actual closing and then spread, we’ve impaired a total of 300 neighborhood. So, obviously it’s spread in those neighborhoods.

Ken Zener - Merrill Lynch

What was the dollar value?

Cathy Smith

$20 million.

Ken Zener - Merrill Lynch

$20 million. So I guess with your gross margin is down how should we think about your incentives – you’ve had incentives increased about 200 basis points year-over-year, your gross margin is I think were down about 90 bucks. Is that how much of benefit is occurring from the impairment benefit rolling through and is that $220 million kind of could be accelerating.

Cathy Smith

Yeah it will be accelerating.

Ken Zener - Merrill Lynch

To that degree.

Cathy Smith

Yeah, it will be accelerating. It’s again out of the 300 neighborhoods in total that we have impaired you are going to see those continue with closings. And as I said we had about 600 or closings come through that had than previously impaired. So, yes it will continue to accelerate to some degree, but then and again it was about 20 million bucks.

Operator

Your next question comes from Timothy Jones with Wasserman and Associates.

Timothy Jones - Wasserman and Associates

Good morning.

Cathy Smith

Good morning.

Timothy Jones - Wasserman and Associates

First question is, can you tell me the number of employees you have now both in the home building operation and the finance sub, and what were the numbers at the peak and when was that?

Cathy Smith

Yeah. In total were, I will give you that just a second here. For home building we are now a little over 5000 employees.

Timothy Jones - Wasserman and Associates

Good.

Cathy Smith

And the peak would have been a little over [8500] employees.

Timothy Jones - Wasserman and Associates

And how about the in financial services?

Cathy Smith

I’m getting you that right now. We don’t have it. Okay, we have to get that back and Matt can give you that detail?

Timothy Jones - Wasserman and Associates

I have to hear them on that. Thank you. When was that peak by the way?

Cathy Smith

About fourth quarter of '06.

Timothy Jones - Wasserman and Associates

Okay. Second question I’m not quite sure of this $200 million in financial service in business. Has this to do with the changing over from your prior warehousing facility to the current once with the banks, I don’t. But could you give me a more light on the terms still not quite sure what’s going on there?

Cathy Smith

No, that exactly because transitioning out of our previous asset-backed securities funding structure Harwood Street and into more conventional warehouse line and in combination with the changes in the mortgage market that we couldn’t fund those at 100%. So, we’ve to keep still on the balance sheet. So, that's different, you got it.

Operator

Your next question comes from Stuart Hosansky with Vanguard.

Stuart Hosansky - Vanguard

Yes, good morning.

Cathy Smith

Good morning.

Stuart Hosansky - Vanguard

A quick question for you. On your impairments, how many lots that you actually impair?

Cathy Smith

Well, this quarter about a 140 not of lots in the neighborhood. I don’t think I have a lot count.

Stuart Hosansky - Vanguard

And do you provide the number of lots that you impaired?

Cathy Smith

No. It could be, the answer is no. We don’t typically look at that way. I look at them by neighborhood.

Stuart Hosansky - Vanguard

All right. Thank you.

Operator

Your next question comes from Susan Berliner with Bear Stearns.

Susan Berliner - Bear Stearns

Cathy, I’m sorry, I’m still not understanding the cash flow because it just seems like it typically in the fourth quarter is obviously when you generate a lot of cash. So, if you generate $220 this quarter, I might missing something that we should add back 200 for the contribution to the financial services or how do I look at that?

Cathy Smith

Yeah. First of all, good morning, Susan.

Susan Berliner - Bear Stearns

Good morning.

Cathy Smith

It’s that the change is really you’re right that typically we’ll continue to generate from this point forward. But the change really is just loss of revenue from the sales price reduction.

Susan Berliner - Bear Stearns

So, I guess why would it be so much higher this quarter than it would be in the fourth quarter?

Cathy Smith

Yeah.

Tim Eller

No, no. It’s not going to be higher. It will be higher in the fourth quarter than this quarter because…

Cathy Smith

Remember we are negative from cash from opts in the first quarter.

Susan Berliner - Bear Stearns

Okay. Remind me what that number was?

Cathy Smith

Oh, Gosh.

Tim Eller

It was about minus 500.

Cathy Smith

I think it 5 or 6.

Susan Berliner - Bear Stearns

Okay.

Tim Eller

So, we are talking cash flow. Remember we are talking on the cash flow statement, cash flow from operations.

Susan Berliner - Bear Stearns

Okay.

Tim Eller

That improved by about 220 and should finish a positive 500 by 331.

Susan Berliner - Bear Stearns

Okay. That’s helpful. And my second question is I’m just curious in California what kind of mortgages are you using now to sell homes?

Cathy Smith

Pretty conventional that we are writing through CTX Mortgage just little fashion, Fannie Mae, Freddie Mac, type GSC type loan. We are finding though that we can local broker with some alternatives still. So there are some local brokered opportunities that we can find that we are using in California still.

Tim Eller

And Jumbo are still available to high quality buyers with down payments and good FICO scores.

Operator

Your next question comes from Alex Barron with Agency Trading Group

Alex Barron - Agency Trading Group

Good morning.

Tim Eller

Good morning, Alex.

Alex Barron - Agency Trading Group

I was hoping you could go through the impairments a little bit more, like how many dollars per region and I just wanted to go over the community count a little bit again on how many community do you impaired there?

Cathy Smith

Yes. So kind of one of the attachment we gave you with our 8-K has the profitability were regions that will help you understand, where the impairments are. As I said in the early comments, the really some of the West California, Arizona and Nevada were hit and Florida.

We really the dominant regions for those impairments and again as about a 140 neighborhoods impaired this quarter. We actually detailed that pretty extensively in the Q, which will be filing here shortly.

Alex Barron - Agency Trading Group

Oh okay. Yes, I guess last quarter that you guys impaired about 29 and about 83 and pervious fiscal year. So, I was just trying out get through the 300 you mentioned?

Cathy Smith

Yeah. So all the up through this last quarter, we had impaired about 160 neighborhoods. In this last quarter, we impaired another 140. So, this last quarter was almost equal to everything we've done in the previous quarter and in previous quarters.

Alex Barron - Agency Trading Group

Okay and thanks. Can you just talk about going forward as you do look at the impairments or may be just the company overall. How do you view sort of the sales pace and prices sort of playing out, I guess over the next few years?

Tim Eller

It’s hard, impossible to determine how that’s all going to play out here, Alex. But we feel good about where we are priced now. We’ve literally looked at what buyers can afford on neighborhood-by-neighborhood and adjusted our prices to the mortgage products that are available, and their ability to afford the houses with those mortgage products. So, I feel very good about our pricing right now.

Operator

Your next question comes from Chris Brown with Banc of America Securities.

Chris Brown - Banc of America Securities

Thank you. I know your ratings credit ratings were recently lowered and you renegotiate your bank alliance. Can you just talk generally about where you stand versus some of the bank covenants because I know in particular some of them depending on interest coverage, where your kind of overall leverage caps are?

Cathy Smith

Yeah. Obviously [tangible and that work] is the one covenant to be mindful of and we are. But we still have quite of room under that covenant.

Chris Brown - Banc of America Securities

All right. And then when you, Duke, start generating some cash flow about $300 million in maturities over the next couple of months. The excess cash is there any thoughts of use of that yet?

Cathy Smith

Yeah, right now it's just prudent to hold the cash. So, generate it first and then let’s hold, as you did say we’ve $300 million in maturities at January, I believe.

Operator

Your next question comes from Jim Wilson with JMP Securities.

Jim Wilson - JMP Securities

Thanks. Good morning. Could you describe a little bit of I know you’ve talked a lot about price Tim. But when it starts to drive the sales particularly where you mentioned, they were pretty strong in Inland Empire, and Las Vegas it’s like give or take, what it took, what you think price gets more from three or four months ago.

And the second question is could you give a little more color on the other regions in the Southwest, where obviously in total you were up, but other parts of California may be Phoenix what sales may look like for you, they are during the quarter?

Cathy Smith

Yeah. So in order to move or the price cuts that we took it, to your question really about 15% to 20% pricing reductions in some areas. And that's what it took to find that affordability level and to get two mortgages will buyers and qualify.

Tim Eller

The same that we are able to do was, move very fast on that again we had the data. We knew what our buyers could qualify for. Once the mortgage products we set, we are able move very quickly and adjust prices very quickly, which we did.

Operator

Your next question comes [Keith Willey with Goldman Sachs]

Keith Willey - Goldman Sachs

Yes, I’m just trying to understand the cash implications of the reduction of the loan held for sale and the debt with that business. So is that essentially sold the loans that because you didn’t, you are shrinking your business, used the cash got to paid debt and is that, am I interpreting that right and is that number included in the cash flow.

Cathy Smith

No, that's not. Yeah, you are interpreting that correctly and I believe that comes from financing business. Yeah, so doesn’t come through in cash from, comes through in the financing line.

Keith Willey - Goldman Sachs

Okay great. And then did you indicate that the investment the $200 million investment in financial services that's going to go up a bit. Is that what you have said and its still, I’m just wondering why, should I think of that as a percentage of the business or percentage of the first 5% loss on a loan or how should I think about that?

Cathy Smith

Yeah, no, sort of good question for clarification. It’s really associated with the amount of money we’ve to contribute or fund on the construction to prime loans. So, think of it as there is around $350 million, $400 million of originations there that through the construction sites. Well, as those finished then we can protect the loan and modify it and sell it out.

So, it’s really just going through that pace of that progress right now of those loans it will go up to slightly a little bit more, and then it will start coming down from that point forward down to eventually zero. But it’s really because it dictated more on the construction cycle of the home.

Operator

Your next question comes from Michael Mogavero with Atlantic Asset Management.

Michael Mogavero - Atlantic Asset Management

Hi, just a little more clarification on the provisions that you took on those mortgage loan originations. Now how much in total do you have on the book that is, is it plus 50 million in provisions?

Cathy Smith

Yes.

Michael Mogavero - Atlantic Asset Management

Correctly? How much is the loan is that balance?

Cathy Smith

Well, you are correct about 50 million in provision and is that what you are asking?

Michael Mogavero - Atlantic Asset Management

Well, that, what is the 50 million of provisions on what balance of loans. What’s the outstanding?

Cathy Smith

Yeah. The bulk of it’s for the construction to prime loans and there is $350 to $400 million in total.

Michael Mogavero - Atlantic Asset Management

At September 30, it was $271 million balance of construction loans?

Cathy Smith

Yes.

Michael Mogavero - Atlantic Asset Management

This $271 million balance yes, I guess, it was 2 points of provisioning for loss and when is this expected to I guess, go off the books?

Cathy Smith

It will be over the course of the next year and a half. And to clarify the 271 the current balance that we in our provision we did look at total commitments and that’s the 350 to 400 million.

Operator

Your next question comes from [Randy Weisman] with [Burm Asset Management].

Randy Weisman - Burm Asset Management

Hey, just a few questions. One is you guys are talking about cost savings, and I wanted to get a sense for the cost of sort of materials and labor for building house, just on your average house count. What were the costs of material and labor maybe at the peak when home prices were much higher and when things were going very well relative to now, that sort of how much of they come down?

Cathy Smith

Yeah. So that how much they have come down about 5% to 10% in brick and water are the direct construction cost just last two quarters and about 10% the previous fiscal year as kind of the efforts there on the SG&A or the overhead costs further we continue to make very good progress. I couldn’t give you a total reduction to, from peak to now, but every quarter we are getting a good reduction there.

Randy Weisman - Burm Asset Management

How about just in terms of dollars I mean roughly what are the costs in materials and labor for building home it sells for $280,000 like that your average price for the quarter?

Tim Eller

Well, the way to think about it is roughly 50% of the revenue will be the cost of constructing the house. It’s help the bricks and water if you will. Another way to think about that is the peak it was close to 45%. Now today it’s closer to 53% cost lag or sales prices a bit our cost reductions are going to apply the future closings, but our price reductions happened today.

Operator

Your next question comes from [Nelson Yeman] with [Greenlight].

Nelson Yeman - Greenlight

I was just wondering from the statements can you clarify as you went through the quarter, you are required to take some further price increases to move to keep the houses moving, does that correct.

Tim Eller

Price decreases.

Nelson Yeman - Greenlight

Price decreases right. And can you comment into October you still being forced to do that?

Tim Eller

We’ve made most of our price adjustments in August and early September. And in fact, most of them in August.

Nelson Yeman - Greenlight

Thank you.

Operator

Your next question comes from Michael Mogavero with Atlantic Asset Management.

Michael Mogavero - Atlantic Asset Management

Yeah hi, I got cut off, I didn’t get quite a complete answer on the risks that you are retaining on the mortgage loans is that credit risks or interest rate risks that you are provisioning for. And my understanding that you sold off products and I guess, what was in the warehouse would be sold off. So, there wouldn’t really be much credit risks there?

Cathy Smith

Yeah. It’s really a market risk; it’s not credit risk or interest rate risk. It’s really just where can we price (inaudible) and so we obviously saw a disruption in August for that and that’s part of what’s coming through in the financials.

Michael Mogavero - Atlantic Asset Management

And that would be not confirming product or confirming product or?

Cathy Smith

Yeah. So that was previously it was not more non confirming product. Now, where as I said 95% of the loans we’re writing are confirming.

Michael Mogavero - Atlantic Asset Management

Okay. Is there, could be a composition of this somewhere, where we could see what those loans are. It would be very instructive to see what the make up of the loans are?

Cathy Smith

Yeah, there will be pretty extensive discussion in our MD&A and our 10-Q, as we filed out.

Michael Mogavero - Atlantic Asset Management

All right. Thank you.

Cathy Smith

Sure.

Operator

Your next question comes from [Jamie Canlith] with [Southside Analyst].

Jamie Canlith - Southside Analyst

Hi good morning. Two quick questions. I apologize, if you have already addressed this. The decline in the closings for the Southeast and also for the backlog in the Southeast, can you give more color on that market?

Cathy Smith

Southeast.

Jamie Canlith - Southside Analyst

Yeah, your segments Southeast are you talking about?

Tim Eller

Yes.

Jamie Canlith - Southside Analyst

Primarily Florida.

Tim Eller

Is that the reason is it all Florida or is that …

Jamie Canlith - Southside Analyst

Particularly Florida

Tim Eller

Yeah, absolutely.

Jamie Canlith - Southside Analyst

Okay.

Tim Eller

Florida is maybe the hottest hit market in the country.

Jamie Canlith - Southside Analyst

Okay. And then one other question I had with the announcement, we have seen in the press about new refinance programs, the banks coming out trying to get more aggressive on refinancing some of their sub-prime customers. Are you seeing any beneficial effects in terms of lower existing home inventories in your market as a result of those?

Tim Eller

Yet, in fact we are seeing foreclosures continuing to rise. So hopefully those efforts keep for closures and check and that would be a big benefit.

Operator

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

Michael Rehaut - J.P. Morgan

Thanks. A couple of questions here on the write downs if I could, you had mentioned that in the assumptions you were obviously taking to account what you’ve had to do, but also what future conductions might hold. and I’m just wondering if you could review what's baked in going forward if there is some builders have try to anticipate maybe pricing falling bit further over the next three to six months and so the write-off that you have taken that they assume further price reduction and if so can you gives us some color on is it on half the communities that you written off that maybe that’s case we’ve assume that?

Cathy Smith

Yeah. So it’s really kind of an independent answer. So we always will evaluate current and future market condition in our impairment analysis and we’re trying to base that as best we can on so some more objective data where we can. But the answer is yes, we do include current and future market conditions in our impairment analysis.

Michael Rehaut - J.P. Morgan

And so is it fair to say that in some of those then that you would be assuming further price declines?

Cathy Smith

Yeah, in some markets.

Michael Rehaut - J.P. Morgan

Okay. And of the 140 neighborhoods that you impaired this quarter how many of those, were those all first time or were some of those second time or even may be third time?

Cathy Smith

Yeah, some are third time. We’ve about 30 in total in this quarter that we’ve reimpaired, a little less than 30 that we reimpaired than the 140.

Operator

Your next question comes from Dan Oppenheim with Banc of America Securities. I am sorry that question has been withdrawn. Your next question comes from Ken Zener with Merrill Lynch.

Ken Zener - Merrill Lynch

Okay. I’m trying to understand how the decline in the units under production to a let’s more normalized level given the depressed housing is going to be kind of a onetime benefits. So, as you look at the $500 million for this year how much of that is associated with decline in units under production, if you could give that would be useful. But for example, they are going from 25,000 down to 12,000. How much would that account to the $500 million?

Tim Eller

Maybe you are talking about just a decline in working process in general, Ken.

Ken Zener - Merrill Lynch

Exactly the vertical because the land is that expires as you sell houses. I think the builders are getting a benefit as the units under production decline, which is an event that’s happening this year, but it won’t be present next year?

Tim Eller

We’ve already had a pretty dramatic decrease in number of homes under construction. Again, the focus is really on how long they are under construction more than before they are sold more than the actual number. I mean we, I think that Centex and the industry this time did a really good job reacting to the slowdown and we’ve cut homes under production from the peak close to 50%. So, probably it has some room to come down a little more. But really it’s at a level; it’s getting closer to a level of more normal amount.

Operator

Your final question comes from Stephen East with Pali Capital.

Stephen East - Pali Capital

If I calculate this way to get to $500 million of free cash flow basically everything that’s coming out of inventory for the next two quarters on the land side does not get replaced. In other words, your inventory absent, those costs stay the same. Is that the trend that will accelerate in the next fiscal year?

Cathy Smith

Yeah. In total, we still have sufficient amount of land to substantiate the business for a while. And our goal is to be under a little less than two years of owned land and we’re still over that, little over three. So, the answer is yeah. We are going to continue to bring that down, don’t need to replenish. When the opportunities start to present themselves and we will evaluate that on an instrumental basis. But the answer is, it’s going to continue to come down.

Tim Eller

And Stephen I would add that the land spend and the land development that does occur, although much smaller than in previous years, usually occurs in the first two quarters for us.

Stephen East - Pali Capital

Yeah.

Tim Eller

So, in the back two quarters cash, every closing is a direct reduction in inventory.

Stephen East - Pali Capital

Okay. All right, that's what I was trying to get at. Thanks.

Operator

Mr. Eller, do you have any closing remarks.

Tim Eller

Thank you, Lorain. Yes, just very briefly, I want to thank you everyone for joining us today. Well the housing market is extremely difficult, Centex remain resolute. Our actions align with our near term strategy of selling homes, generating cash and structuring for profitability. These actions will also further our long-term vision to gain strength and share in those markets that will provide the highest future returns. We look forward to showing our third quarter results during our next call in January. Thank you all. And, thank you Lorain.

Operator

This concludes Centex’s fiscal year 2008 second quarter earnings conference call. Thank you for your participation.

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