Meritage Homes Corp (MTH) 2005 Q3 法說會逐字稿

Good morning. My name is Mandy, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Meritage Homes Third Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a Q&A session. [Operator Instructions]..

Mr. Allen O'Sheehey, you may begin your conference.

Thank you, Operator, and good morning everyone. And welcome to the Meritage Homes conference call to discuss the operating results for the third quarter and first 9 months of 2005. During this call, you may follow along with a slide presentation, which can be accessed through the Company's website at www.meritagehomes.com. Participating on the call today from the Company's management are John Landon and Steve Hilton, Co-Chairmen and Co-CEOs, and Larry Seay, CFO.

Before we start, I would like to remind everyone that during the course of this conference call, certain projections and other forward-looking statements may be made regarding future events or the future financial performance of the Company. We refer you to the disclosures that the Company files with the SEC, specifically those contained in the Company's most recently filed form 10-K and 10-Q and its third quarter earnings press release. These documents describe important factors that may cause actual results to differ materially from those contained in any projections or forward-looking statements made during this conference call. We also refer you to Meritage's third quarter press release for the definition and discussion of the use of EBITDA and other non-GAAP financial measures.

I will now turn the call over to John Landon. John?

Thanks, Allen. Good morning, and thank you for joining us as we discuss Meritage's results for the third quarter and first 9 months of 2005. In today's presentation, we will recap our performance, review our balance sheet, return measures and liquidity, and we will also discuss our outlook for the remainder of 2005, as well as 2006. After that, we will be happy to answer your questions. We begin the presentation on Slide 4.

For the third quarter of 2005, we set all-time quarterly records for net earnings, diluted earnings per share, the dollar value of sales orders, and the dollar value of order backlog. We also set a third quarter record for home-closing revenue. Net earnings nearly doubled from the third quarter of 2005 to this year's third quarter and diluted EPS rose 85%. The dollar value of homes and backlog increased 85% to $2.5 billion and home closing gross margins advanced 311 basis points this quarter to 23.6%.

Slide 5. Home closing revenue increased 63% over last year's third quarter and the number of homes closed was up 38%. We were very pleased with our performance in the very competitive Texas housing market, where our closings increased 26% quarter over quarter to 879 homes. Though some deliveries were delayed in Houston due to Hurricane Rita. Closings continued to be strong in Arizona, as well as sales demand; however, we are still limiting sales orders in most communities there in order to match sales to production capacity.

Closings increased 37% in Arizona, while related revenue rose 68% due to rising prices in that market driven by strong demand. In California, where demand for housing remains good, along with the constrained land supply, the number of homes closed was up 11%, while the value of those homes advanced 47%. Closings in Nevada are increasing due to the addition of several new communities for sales over the past year, though some closings were delayed in Las Vegas due to postponements in electric hookups. The third quarter conversion rate, defined as home closing revenue, divided by beginning backlog, was 35%, as compared to 42% in the first quarter and 37% in the second quarter. However, we anticipate converting approximately 42% of our September 30, 2005 backlog in the fourth quarter, resulting in full-year revenue of about $3 billion, consistent with our most recent guidance.

Slide 6. We generated $1.96 billion in home closing revenue during the first 9 months of the year, up 48% from the same period a year ago, and nearly matching our home closing revenue of $2.04 billion for the full-year 2005. While the number of deliveries increased 27% to 6,192 for the same period.

Slide 7. Company-wide, the average price of homes closed during the third quarter of 2005, as compared to the third quarter of 2004, increased by 18% to approximately $326,000, somewhat the result of a greater percentage of our closings coming from Florida and Nevada, which generally have higher pricing levels than Arizona and Texas.

Slide 8. As a result of our ability to raise prices in certain markets, while effectively managing our costs, home closing gross margin rose a robust 311 basis points to 20.5% during 2004's third quarter to 23.6% in this year's third quarter. Overall, home closing gross profit advanced 88% over the year ago third quarter. Our gross margin increased 352 basis points from 19.5% in the first nine months of last year to 23% in the first 9 months of 2005. In addition, SG&A costs, net of other income, as a percentage of revenue, declined by 55 basis points in the third quarter of 2004 to the third quarter of this year. For the first 9 months, SG&A expenses, net of other income, as a percentage of revenue, declined by 42 basis points.

Slide 9. Diluted earnings per share for the third quarter reached an all time quarterly record of $2.40, rising 85% above last year's third quarter. For the first 9 months of 2005, diluted EPS reached $5.35, a 70% increase over the first 9 months of last year. Excluding the impact of the first quarter bond refinancing charge of $0.69 per diluted share, diluted EPS would have risen 92% to $6.04 for the first 9 months of this year. This bond refinancing where we repurchased $276.8 million of our 9 ¾ senior notes, 2011, and replaced them with $350 million of 6 ¼ senior notes to 2015 is expected to generate approximately $9 million of annual savings in interest payments.

I will now turn the call over to Larry Seay to discuss our balance sheet in more detail. Larry?

Thanks, John, and good morning everyone. As we've often said in the past, balance sheet management is very much a focus for us. We strive to maintain a low risk business model while maximizing returns to our shareholders. As you can see on Slide 10, at September 30, 2005, we had approximately $1.4 billion in real estate inventory, a 56% increase over the same time last year. This increase was caused mainly by an increase in pre-sold homes under construction, driven by our 85% rise in the dollar value of backlog. Our trailing 12-month inventory turnover ratio was 1.84 times, relatively stable as compared to 1.91 times a year ago. For the 12 months ended September 20, 2005, our after-tax return on equity was 33.6%, up 27.7% a year earlier, and our after-tax return on assets increased to 13.8% from 11.2% a year ago.

We continue to build a majority of our homes on an after sale contract has been completed basis. Spec homes under construction, as a percent of total backlog, including specs under construction, declined from 10.7% at September 30, 2004 to 8.6% at the end of this year's third quarter. Completed specs, as a percent of backlog, declined to 1.2% from 1.7% a year earlier.

On Slide 11, you can see that our net debt-to-capital ratio improved to 45% at September 30 of this year from 52% on the same date in 2004. Debt to trailing 4 quarter EBITDA ending September 30th improved from 2.2 times last year to 1.7 times this year. Our trailing 4 quarters ended September 30th EBITDA. The interest incurred ratio also improved, going from 6.7 times last year to 9.1 times this year. This improvement was caused primarily by our lower leverage and by a decrease in our average borrowing rates from our new bond issue and tender.

We believe that our balance sheet and liquidity position provides us with significant resources to further expand Meritage's business. At September 30, 2005, we had $480 million of senior notes outstanding, as compared to $417 million a year ago. We also had $151 million outstanding on our $400 million bank credit facility, leaving $168 million available to borrow after considering $81 million in outstanding letters of credit.

We are currently in the process of exercising our $200 million according feature in our revolving credit facility, which will increase our availability under the facility significantly. In addition, the Company has historically repurchased its shares when they are trading at the lower end of the typical price earnings ratio range. Accordingly, the Company is actively considering repurchasing shares under its existing $50 (ph$) million approval level.

I will now turn the call over to Steve Hilton. Steve?

Thank you, Larry, and good morning everybody. Demand for our homes remains quite strong despite the many well-publicized pressures on consumers. Contrary to investor concerns about demand trends, Meritage increased the dollar value of home orders in the third quarter by 51% to $971 million. We are pleased to report that for the quarter, our new home orders increased 64% in the very competitive Texas market, and the dollar value of those orders rose 75%. This increase reflects increased job growth in the expansion of our product lines to focus not only on move up homes but also on the entry level and semi-custom luxury markets. We continue to have pricing power in our Arizona markets, due to solid demand, and are still limiting sales in most of our communities there in order to match sales to production capacity.

As a result, orders in the third quarter of this year rose 4% over the same quarter a year ago, but the dollar value of those orders advanced 50%, primarily to a mix issue. In California, where the dollar value of sales orders increased 10%, we experienced a short-term delay in sales, due to closing out of some of our communities earlier than we anticipated. These delays have been considered in our 2005 and 2006 guidance. Sales orders in our Nevada division rose 77% over the third quarter of 2004, due to a strong market and the addition of several new actively selling communities in Las Vegas this year.

Slide 13. Our strong third quarter performance resulted in a number of new homes ordered for the 9 months of this year, advancing 22%, as compared to the first 9 months of last year, led by Texas, California and Nevada, while the value of those orders increased a greater 48%, due primarily to a large percentage of sales coming from Florida and Nevada, which have higher average sales prices than the rest of the company as a whole.

Slide 14. As a result of these strong order trends, order backlog reached an all time high of $2.5 billion at September 30, 2005, up 85% from the year ago. At September 30, 2005 we had 7,536 homes in backlog, 59% higher than the 4,747 homes in backlog at the end of the third quarter 2004. Our backlog is well diversified across all our divisions, and as we previously stated, we anticipate converting approximately 42% of our September 30, 2005 backlog in the fourth quarter, which we believe will be generating $3 billion in revenue for the full-year 2005, consistent with our most recent guidance. The value of homes in backlog at September 30, 2005 exceeds the prior year's level in all the markets by at least 47%.

Slide 15. These order and backlog trends reflect both solid demand for our housing and our success in opening more communities with the right product in the right location. The number of communities in which Meritage is actively selling was up 29% from the end of last year's third quarter, as compared to the same time this year. Supporting the robust order demand, Texas is a 13% increase in communities over the past 12 months. In Arizona, we've increased our community count 30%, from 27 to 35, and in Nevada, our actively selling community count tripled from 2 to 6. Our community count in California is up slightly, due to our closing out of some communities earlier than we anticipated. However, we expect to open 5 new communities in California in the fourth quarter of this year, and overall, we anticipate increasing our community count to approximately 180 by the end of this year, which would represent a 29% increase over the year earlier level.

Slide 16. Meritage has also continued to be successful in expanding the lot supply required to support our growth in these communities. At September 30, 2005, we controlled approximately 54,700 lots, representing a 5 ½ year supply, based on a full-year projected 2005 closings. This represents an increase in lots of 44% over the September 30, 2004 level. Approximately 60% of this increase occurred in our newer markets of Florida and Colorado, where we are building the inventory to support our rapid growth plans. Of particular note are the 9,355 lots we now control in Florida just 9 months after we announced our strategic entry into that state. We consider our newest Florida divisions, Orlando and Fort Meyers-Naples, to be a great springboard for expansion into one of the country's top housing markets.

In addition to our startup operation in Orlando, which we announced in December, 2004, we acquired Greater Homes of Orlando in September of this year. We continue to utilize lot option contracts to purchase the majority of our lots, which we believe offers Meritage more flexibility and less land risk. At the end of the third quarter, we controlled approximately 91% of our lots through option and purchase contracts.

Slide 17. Give our closings year to date and our current backlog, we are currently projecting home closing revenue to be approximately $3 billion in 2005, up 47% over 2004. We are targeting future growth in the 20% to 25% range, including potential acquisitions, thus we anticipate reaching $6.4 to $7.2 billion in home closing revenue over the next 5 years.

Slide 18. As a result of our solid performance in the third quarter, we are reiterating our full-year diluted EPS guidance of $8.25 to $8.50, an increase of 64% to 69% over the $5.03 in 2004. This guidance includes the one-time bond refinancing charge of $0.69 for the first quarter of this year. Excluding the impact of this one-time charge, diluted EPS for the full-year 2005 would be $8.94 to $9.19, or 78 to 83% higher than 2004. Furthermore, we are reaffirming our 2006 guidance of $3.8 to $3.9 billion in revenue and $11.25 to $11.50 diluted EPS. This guidance would result in a 27% to 30% increase in revenue and approximately 35% increase in diluted EPS over our 2005 guidance.

Included in this guidance is our expectation that interest rates may rise somewhat and price appreciation in some of our more robust markets will moderate. John and I remain very positive about the state of the home building industry. We believe that recent job growth and the improving economy will more than offset any moderate interest rate increases. With our all-time record levels of sales orders and backlog, our recent margin expansion, and stable economic conditions, we believe that Meritage is poised for solid financial growth and expect 2005 and 2006 to be our 18th and 19th consecutive years of record revenue and earnings.

That ends our formal comments and we will now open the floor to questions. The conference call operator will provide you with instructions on how to register your questions.

[Operator Instructions]. [Steven Kihn] [ph], Citigroup.

Good quarter.

Kind of a question for you about your guidance. Obviously, I think you're obviously being conservative. I just want to clarify one point. At the very end there, I think you indicated that you anticipated in your guidance an assumption that pricing growth moderates in some of the hotter markets. Does that imply that you assume some degree of price appreciation from current levels in your guidance?

I would say that, Steven, it really is, depending upon some areas, let's call it Texas, where we have had some strong demand, and costs are going to increase somewhat, we will be I think able to pass on those cost increases. Whether or not we're going to be able to increase our margins in our Texas market is yet to be seen. But, overall, it's -- we're thinking that prices will move up a little bit, but not necessarily due to being able to get higher appreciation than we were over the past year, it's just moving -- passing costs on.

And can you also just talk about your outlook for your gross margin and SG&A, as you head into the fourth quarter? Is there any reason why your gross margin would necessarily deteriorate in the fourth quarter from what you saw this quarter? It's been pretty consistent on the 25 level for the last couple of quarters, moving up a little bit. Then on the SG&A side, I mean any reason why we shouldn't expect to see some improvement sequentially from 3Q?

Steven, this is Larry. On a real simplistic basis, if you just take the revenue number it's going to take us to get to our full-year guidance of $3 billion, and that's about $1 billion in the fourth quarter, and multiply that by our net margin achieved in the third quarter, and divide by our number of shares, you're pretty much right on top of the number that it takes to get to the high end of our full-year guidance number. Now, SG&A and gross margin could move around a little bit, but net-net, that's the way we're looking at it.

It just seems --

Go ahead.

It just seems to me that your guidance for QI certainly recognizes it's looking for some pretty robust improvement. It looks like it's strictly conservative on the margin front. I guess that's what I'm trying to understand. Is there anything in your backlog right now which would imply either a significant reduction in your gross margin, such as reported in 3Q, or a lack of SG&A leverage?

Well, there could be a bit more SG&A leverage in the fourth quarter because our revenues are going up, obviously.

Right.

And if we're being conservative, it's probably there. But you know, I think it's pretty reasonable to take our third quarter net margin and apply it to the fourth quarter with maybe a little bit of SG&A leverage there, that potential conservatism.

Well, I think -- I don't mean to take up so much time here, but I think I've done that. I've actually got your net margin, as a percentage of home sales, going down close to $0.20 to $0.30, and I've got your revenue for the year pretty much flat on $2 billion, and I'm coming up with a higher EPS number than you seem to be guiding to by a reasonable amount. And maybe my share count, what kind of share count are you guys giving in the fourth quarter?

Well, the 29.2 million.

Yeah.

Fully diluted.

That's not going to do it. All right. Well, I'm left to conclude you guys are being pretty conservative, but that wouldn't be anything different. But it sounds --

Good way to be, isn't it?

I would say so. No complaints here.

Good.

Steven, if you multiply $1 billion by 9.3% and divide by 29.2, you come up with $3.18 a share.

Yeah.

If you add that to $5.35, plus adding in the $0.69 from the first quarter, you come up with 9.2. You know, that's in real round numbers, kind of near the high end of our guidance for the year.

Yeah.

Okay?

Okay. No, I get the idea.

Okay.

Michael Novak, Frontier Capital.

Hi, good quarter. Two quick questions. John, I believe you mentioned the backlog conversion ratio that you're expecting for the fourth quarter. I didn't catch that number.

I believe it's 42%.

42%.

Is that correct, Larry?

Yes. That is going to get you to the about the $1 billion revenue number we need to get to $3 billion.

And can you talk about the -- your backlog conversion ratio has been historically low this year. Can you talk about some of the factors that are influencing that and sort of if you would expect to return to more historical backlog conversions in 2006 and 2007?

I think it's --

Primary.

It's take --

Go ahead.

It's just taking longer to build houses, particularly in a lot of our western divisions. Cycle times have increased, due to the markets being at very high levels. We expect that to begin to moderate a little bit and be able to improve our cycle times, but that's why our conversion ratio is a little bit less. You know, we have a lot of subdivisions that are on allocation and we're trying to match our production capabilities to our sales. And as we continue to do that, then we'll be able to increase that conversion ratio.

Would you expect to see moderate increases over the next couple of years?

Yeah, as the markets begin to moderate a little bit, that will certainly help those conversion ratios.

The second question is more the outlook longer term for your gross margins. As Steve mentioned before, they are at a pretty healthy level. But if you look prior to this year, they historically bounced somewhere around 20% over time and I think you used to kind of run the business to that sort of level. Two questions. Is the full 300 basis points just pricing and would you expect to give some of that back without as robust year over year pricing increases? And how much would you expect to keep, or would you expect to eventually to probably turn back toward that 20% when you renew your land at higher prices?

I think over the long term we're probably going to give a little bit of that back. I think we would be fooling people to say that we could buy land today and produce those kind of gross margins. But I do not expect it to go lower than it was previously. And I think we're going to be in a range between where we were and where we are today.

And some of that will stick because of improvements in supply chain management and SG&A leverage, so some of that will stick because of those reasons. Some of it won't because of higher lot costs.

Joel Locker, Carlin Financial.

A solid quarter. Just wanted to ask about goodwill at the end of the quarter. I know it was $114 million at the end of the second quarter. I guess you guys released it in your Q. I was just wondering how much it was with the Greater Homes acquisition or if you had a rough estimate?

The significant -- significantly, all of the purchase price, not quite all, but significantly all of it, is going to be allocated to the assets we purchased. Some of those assets are intangible assets, most of them are tangible assets, and there will be a small portion that will go to goodwill, but at this point in time, we're not disclosing what that specific number is.

So it's something like $5, $10, $15 million, but nothing major?

Yes. Certainly, the $5 or $10 million goodwill range is about the right number.

Right. And your loan-to-value FICO and just percentage of loans that were ARMs, do you have that for the quarter?

The FICO scores are remaining pretty strong. They're running into kind of 715 to 720 range for our most significant mortgage company. As far as ARMs go, see if I have that number, ARMs are running around the 35 to 40% of the largest mortgage company reduction.

And do you have a loan-to-value overall?

Loan-to-value is running around, let's see if I can find that. My memory -- oh, it's about 84%.

84%.

Yeah.

And do you have just difference in ARMs? Like what's your ARM percentage in your California market versus just your overall 35% to 40% company-wide?

It varies from -- California typically tends to have higher ARMs rates than a Texas. I don't have those specific numbers to give you.

Right. And I was just -- any comments kind of on the California market? Just assuming, statewide it's around 60% ARMs, just if the higher short-term rates are affecting that market versus the other markets that are a little more affordable?

I don't think our ARMs are as high as 60% in California. They're more in the 40% to 50%.

Right. I was just saying statewide. And California, just with a lot of people depending, or California depending on ARMs, just wondering --

We're expecting the market to moderate in California, but we have good land position at a real low basis that gives us some flexibility. And we think the right product in the right location at the right price will allow us to continue to be real successful in California, even in a moderated market.

Right. And have you seen those moderating in the last, say, 2 months versus May/June when it was red hot?

It's cooled a little bit. I mean, but our third quarter was still very positive and we'll see what this quarter brings, but we are still feeling really bullish about California.

From quarter-to-quarter and year-to-year, our ARM rates, our ARM -- the fixed ratio hasn't changed all that much. From the fourth quarter -- our third quarter of last year to third quarter of this year, it's actually gone from 36% to 38%, so it's running pretty stable. And to correct my statement about the loan-to-value, the average down payment is running around 20%, so the average loan is around 81%.

81%. All right.

Alex Baron with JMP Securities.

Great job, guys. I wanted to ask you if you could walk us through your community count, as we look forward, what you guys are expecting, and particular with all the new markets that you've entered - Reno, Florida, et cetera. And also, I think your community count dropped a little bit in California, so just kind of can you give us some expectations for maybe through end of year and maybe what you think each of those will grow next year?

You know I don't know if we'll speculate specifically by market. The California drop, as we noted in our comments, was caused by some of our communities selling out a bit more quickly without those replacement communities coming online. So I think you'll see that bounce back during the fourth quarter. By the end of the fourth quarter that that number will be back up to that 22 or 23 range. Overall, we're planning to grow our subdivision count in the range of our revenue growth, kind of in the 20% to 25%, maybe 30%, but I'm not going to comment any more specifically other than that.

So 20% to 25% is for this year?

Well, and into next year too. I mean, I think you will continue to see our revenue -- our active community growth grow somewhat in line with our revenue growth.

Oh, okay.

So, I'm generally giving you a broad range of 20% to 25% to 30%.

Okay. And then in terms of Florida specifically, I believe you guys have been working through holding back sales a little bit due to the strength in that market. When do you think you would be releasing homes for sale again in that market?

In Ft. Meyers-Naples, we had a few communities that we were planning on releasing sales the first of November, depending on what state, and let me just say that the hurricane down -- that came through the Naples area, we fared very well on it. We had a few uprooted trees, we had a loss in power, but overall damage was very minor, so we were very pleased with how the hurricane affected us. However, it could delay some closings in the fourth quarter. It's still early to tell. It really depends on the electric companies and whether they get back in business giving us meters, as opposed to going over and hooking up people's power, so we will wait on that. But, yeah, we will be increasing sales and opening some new communities up for sales in Florida really starting the first of November.

Okay, and then one last one on the gross margins, especially going into next year. Would it be fair to assume about 100 basis points in purchase accounting?

Well, the purchase accounting for Greater Homes should work its way through the income statement over the next couple of quarters with a little bit of a trailing out in the third quarter after the acquisition, so most of that is going to hit in the fourth quarter and really will mean that Greater Homes won't be contributing that much to the bottom line that first quarter.

As far as what's a basis point adjustment is overall for '06, I can't comment, but Greater Homes is not that large a percentage of our business and I haven't looked at it as what that specific purchase accounting adjustment effect would be for the whole company, Alex.

Okay, well great. Great job.

Greg Gieber, A.G. Edwards.

I have a question on your community count, just over the quarter. Were your new openings more back-end loaded or you had a fair amount of increase, which was spread evenly over the quarter?

Larry?

Yeah, I actually can't tell you that. I typically look at this stuff at the end of each quarter and I'm not in the detail enough to be able to tell you whether something opened in July or August or September. So I can't comment on that.

Okay. Because usually my impression is when community first opens on the productivity it's the highest. But if you opened late in the quarter, that would carry over well into the fourth quarter.

And that is often true, but I don't have the data to comment. We generally just look at this once a quarter and I don't get the data analyzed what point during the month or during the quarter it opened.

Okay. I joined the call a little bit late. But did you make any comment about what your sales trend was month-by-month over the course of the quarter?

We don't give monthly sales information. But I would say that throughout the summer, sales were pretty consistent.

Okay. One of your competitors talked about a noticeable cooling in the Sacramento market, or at least a cooling. Are you seeing anything there? How is your pricing and need for incentives working the Sacramento market?

It's too early to tell. The market is cooling in Sacramento. To what extent, I can't tell you yet.

Okay. If I go to Slide 17, where you give your long range projections, what should I assume about sort of the pricing that you built into that in the community count? I mean if it's -- if you're going to maintain your 20% to 25% community count that you're looking for next year of this whole period, I would assume that that's mostly relatively flat pricing.

This assumes that -- it's just a very general assumption that we've been growing at a much faster rate than 20% to 25%. And that we believe that a 25% annualized growth rate is a fairly conservative number. We have laid out a scenario where we could achieve this, but we -- as far as talking about whether there's a inherent 5% price increase assumption, or 10%, generally speaking, these are prepared on gee, we can grow our community count at a 20%, 25% rate based upon what we have coming down the pipeline and that translates into a unit growth and a revenue of this level. But it's generally prepared on more of a flat to a slight, slight inflation type pricing assumption. It's not based upon a larger pricing assumption than that range.

So it would be reasonable to assume that you're buying land or entering into land contracts at about at least 20% growth in community count?

Correct.

Okay. Very good quarter, gentlemen.

Stephen East, Susquehanna.

Quick question, follow-up question on the backlog conversion rate for next year. As Texas ramps up, both from your efforts and I guess the economy overall, does that have the ability to move the needle on your conversion rate for the corporation as a whole?

Well, Larry, what do you think?

I think the conversion rate is not necessarily a Texas issue, in fact, because Texas has been a good market, but not as hot as, say, a California or Nevada. The conversion has not -- the conversion ratio and the length to build a home has not been the problem in Texas that it has in some of those other states. So really, to me, it's more of a factor of those other states moderating a bit and us catching up versus Texas taking off. I think Texas -- or build times have extended a bit, but not nearly to the extent that they have in the more western market.

Okay. And then on the Florida, your orders for the third quarter, I know you were constraining some, but even so, I guess the level was lower than what I thought. Was there anything going on from maybe a growing pains perspective or late in getting communities open and titled, et cetera?

No, it was purely anticipated, knowing the community that we had in our acquisition of Colonial Homes back in February. The timing on when these communities would come on, we're planning on being fourth quarter openings. So we -- this is as anticipated.

Okay. And then just last question. Generally speaking, the trends in October versus say what you saw in the third quarter? Across the company. I'm sorry.

We don't really make comments on what's happened since the end of the quarter, although I will say this, we continue to reiterate that our business is good. It's very good. And we haven't seen -- everybody is so concerned about our business falling off the table, but we're very positive, as we said in our opening comments, that we like our positions, both in the markets we're in, the position in terms of the pricing and the locations we are in, and we feel very good about our going into next year.

Margaret Whelan, UBS.

Very nice quarter, and a lot of my questions have been answered already, but a couple of them had doubts about your guidance and all, your backlog and so on. I'm just wondering if you could give us an update on the costs that you're seeing relative to the efforts you're making to manage costs of your business through being more efficient and so on.

What's the question again, Margaret?

I'm just trying to get an update on the cost -- your costs of good sold. We know that all of the commodity costs are going up, and is that reflected in the conservative estimates that you have provided?

For the quarter or for the year?

For the year.

Well, in general, Margaret, I think it is kind of factored into Steven Kihn's comment earlier in that if you just take everything for the third quarter and project it out and show some SG&A leverage, you might come up with a higher number, but I think part of our conservatism lies in the fact that we don't know exactly what price increases may be coming down the pike yet, so I think our margin projections for the quarter and for next year have taken into account a bit of higher cost increases, maybe a bit of softening in the market overall, so that's why our numbers in some people's eyes may be a bit more conservative.

Okay. So that was my question. You have factored in higher commodity costs.

Correct.

Did you have higher commodity costs this quarter already?

No, we have not really seen that yet. We're just starting to monitor that and see what's going to happen there.

We had some higher costs, but our pricing power has still been so strong that we've been --

Offsetting it, yeah.

You know, offset that.

Yeah.

As we go into next year, that may not be the case. You know, we certainly have the next couple of quarters covered with our backlog. But beyond that, we may not -- in some markets we may not have the pricing power to cover the commodities increases, but we're just not going to know until we get there.

Do you have an expense for the -- on the land that you're optioning. What percent of that is profit participation?

Very little.

Very little. So then if the value of the asset has increased over the last couple of years, unless home prices were to decline, meaning so you wouldn't see margin [inaudible], right?

That's correct.

Okay. And the other question I had, John, for you, is could you give us an update on Houston and over the last couple of months? I've heard there's a lot of people migrating to that market from Louisiana. It might be below your price point.

No, we do have a value series as well as the move-up product that you guys are familiar with. And Houston feels good. You know, we were fortunate with the hurricane that blew through. We didn't have any damage to speak of. And we have seen some buyers coming from the New Orleans people moving over. And with the energy crisis where they are, and with New Orleans' effect on Houston, our sales are strong there. We see good traffic and Houston feels real good right now.

Okay. And then Steve, I also had a question for you about Phoenix. There are a lot of concerns that the wheels are coming off there. Can you just give us an update on what you're seeing?

That's not true. I mean, we still have most of our communities on allocation and we don't have campouts like we had a year ago. We're having to sell houses again, as opposed to just taking orders. But the typical community, if we release 6 or 8 houses for sale in a month, they're gone within a few days, or maybe a week at the most. So I think out of all the markets that we're in, I think Phoenix is probably still the strongest today of all of them.

Okay, that's good news.

Craig Kucera, FBR.

Thanks for all the insight today. I wanted to get your thoughts on how the expansion into Colorado is moving in and how you're seeing that market moving along right now.

It's going well. We have, I think, 3 or 4 communities open for sale there. We have several other ones that we're negotiating on and hoping to bring -- be under contract over the next year or so. It's not as robust a market as all the other markets we're in, so we're taking it a little bit slower. We don't have the pricing power in Colorado, but we think that over the long term that it's a market that we want to be in and we could be very successful there and very profitable, so we're just taking it one step at a time.

Great. And I wanted to follow up. I appreciate the insight into Phoenix. I know you said you think it's your strongest market. Have you seen any change in the level of traffic or has there been any change in the incentive environment over the last quarter or so?

I don't think we're offering any real incentives in Arizona at all. Traffic is moderating because seasonally this is not our peak selling season, so traffic is going to be less. There are more communities that we compete with open throughout the market today than there were a year ago. But like I said, Phoenix and Tucson both, there's either waiting lists in a lot of communities or buyers that are right there ready to buy, and most of the communities are on allocation and they sell out within the first couple weeks.

[Andrew Braza] with Banc of America.

I'll be really quick. Most of my questions are answered. In terms of growing the Company, are you guys happy with your current footprint? Do you have any sort of markets you would like to get in through acquisition or are you just focus on organic growth within the existing market?

John, you want to take it?

Sure, I'll take that. You know, we will continue to expand in the Florida market, as well as we'll continue to look at some of the other markets in the southeast. You know, we've always been opportunistic and we look for companies that are in the market that would be markets we would want to be in the long term that have the right cultural fit with us, think the way we do as close as they can. And so you'll continue to see us look at new markets and we'll continue to grow through possibly some additional startups, some acquisitions, and then, obviously, once we do that, we grow more organically. I think you'll see our model, as it's been over the past years, stay the same, but you can see us definitely expanding in the southeast.

Let me just add on there. We still have a lot of room to grow in Southern California. Reno, of course, we're new in. Colorado we're new in. We've got room to grow in Phoenix. We can expand our position there. We've got room to grow our active adult business significantly. We've got room to grow significantly in San Antonio. And then, as John said, Florida, we're still in the first inning down there.

Jim Wilson, JMP Securities.

Just two quick ones. I guess, John, first in Texas, the trends, you kind of described the trends of the different cities. [Inaudible] these sales, particularly the margin, the profitability, how they're starting to trend now that Texas seems to be doing better in general?

Yeah. I'll go through a little bit. I'll start with Dallas-Ft. Worth. You know, there for a while Ft. Worth seemed stronger than Dallas, which was, historically, pretty uncommon. So we've seen Dallas firm up. With that, I hopefully see we're going to have a little bit better pricing power than we've experienced in Dallas, because it's difficult to get pricing power in Dallas over the past couple years. So I would say Dallas is sales are good, activity is good, the pricing power is still now where we want it.

Austin is the area where we've seen probably an opportunity to get some additional pricing power. In Austin, we've expanded our up brand luxury production, as well as our entry level value series, so we've really expanded our footprint in that Austin market while keeping our overhead low. Austin is a market where we've always seen where when if Austin is good, Austin is really good, and then when it's not so good, you've just got to make certain that you maintain overhead levels to continue making good margin there. So Austin, we feel real good about Austin. It's really improved over the last 6 months.

San Antonio, we're continuing a growth mode there. You're going to see large year-over-year sales increases, and we're still very -- the margins in San Antonio are above average compared to the rest of Texas for us. And we've seen Houston, as I talked earlier, we feel good about Houston and we've have a little bit better pricing power in Houston over the last several months. I think that's a combination of New Orleans. A few buyers, and I wouldn't get too excited about how many those are, as well as just overall the energy economy down in Houston. That fares well for the Houston economy.

So overall, Texas is feeling better than it had as we've spoken, it's -- it is still not -- let me be clear though, our margins in Texas are still not where the rest of the country is in terms of where we are. Where Florida, Arizona, Nevada, California, they're still not as good as there, but we're still happy with them and we've got a strong business there.

Okay, and then Steve, just one for you. I know, and I've heard several things about Phoenix losing strength, but can you even compare it to what you saw in Vegas or even a little bit in Southern California as to speculator activity. Is it less? Same?

It's less than Vegas was at the peak. I think a lot of the speculators have moved on. I think builders have done a pretty good, particularly public builders, have done a pretty good job of trying to get them out of their backlog and preventing them. So that's not a big concern for us that we've got a lot of flippers in our backlog. We've got a lot of job growth in Phoenix and it's still incredibly affordable. It's still the most affordable market in the entire western United States, even with the increase in prices down there.

[Charles Maquin], [Norman Sheather Company].

Congratulations, as usual, one good quarter after another. I was wondering just about the Texas thing. You mentioned your entry level was going to be increased and your semi-custom is going to be increased. Is that a big item throughout Texas or just in the Austin market or is that significant?

We will be increasing our entry level luxury -- and our luxury. Our entry level will have a division, or we already have a division on Houston, Austin and Dallas. So we will, as a mix, be increasing our entry level product. And then on the upper end, the luxury production brand called Monterey Homes, we right now have got that in Dallas and Austin, and then we also will be adding that component to several communities in San Antonio, probably end of next year. But, as a percentage of our overall business, the luxury production is still going to be relatively a small percentage, although it's a good piece of business for us. And it just expands our overall footprint and really leverages some of our overhead.

Yeah, and the oil and gas is obviously a positive all over the place. I was wondering on another front, the stock market suggests that housing is going to fall off the table, just to use your expression. And I wondered if -- and probably it's not true, but the people from whom you buy land, are they worried about that or are land prices holding up the way you think your market is holding up?

Land prices are really strong. People are proud of their land right now, so I don't think any land sellers are worried that there are not going to be buyers.

Okay. Well, I'm on that side, of course. Okay, good luck.

Alex Baron, JMP Securities.

Just wanted to ask you real quick on Reno. When can we expect your first orders and closings there?

Probably second quarter next year.

For orders.

For orders, and then closing is in the back half of next year.

Okay. And then this delay issue you guys mentioned in Vegas, is that resolved yet or do you expect to see so soon?

It's getting resolved, as we speak. We've gotten some of the meters here in the last several days and we're expecting to get more. Nevada Power is just having a hard time keeping up with the -- all the new hookups up here in Las Vegas. So we expect it to be resolved, but it's just taking some time.

Steven Kihn, Citigroup. Mr. Kihn, your line is open.

Hello, can you guys hear me?

Yes.

Yes.

Okay. Sorry about that. I was just on another call. My question related to your interest ratio that you project going forward. Can you give a little guidance on where we might see that in '06?

Interest ratio.

Interest expense. I'm thinking as a percentage of -- as a percentage of your revenue, if you were to look at what your interest expense might be.

Well, because we have de-leveraged the company a bit, and we have lowered our rates, the interest expense number has been coming down a bit, and I think that's certainly showing up in the interest incurred to EBITDA ratio, going from 6.7 times to 9.1 times. I haven't looked at this recently as a percent of revenue, but I traditionally, and this is just a round number, we've traditionally kind of had interest expense imbedded in cost of sales of around 1.5%. And I think you'll -- that's been trending down a bit, but I think you'll see that trend down and stabilize. Because, obviously, you can't -- you're only going to benefit from the interest savings we are seeing from our bond refinancing for a one year period of time. And I don't -- I see us trying to maintain the debt-to-capital ratio in the Company in that kind of 40% to 45% range. I don't see us de-leveraging the Company significantly below that level.

[Steven Kihn]. Okay. But if you take, say, maybe you see it come down maybe 10 fifths or something like that, 20 fifths?

Yeah, something in that range.

Okay. Last question is just sort of a general question. When you have seen typically a housing market weaken from a state of being overly hot to correcting back to a normal level, that -- I mean, that's pretty much what you're sort of anticipating that you're seeing here, how does that differ from when you've historically seen markets that didn't go into a soft landing but actually had an utter collapse? I guess particularly what I'm asking is in the first few months of that transition period, were there any distinguishing characteristics of the market that completely blew up that are visibly or noticeably absent in today's situation?

Yeah, I would say a couple things, Steven. Standing inventory is one. The amount of standing inventory in markets that we just had tons of spec building and when the market softened, they just had all that -- we don't have that right now, would be one characteristic.

Lot supply too. There was an overabundance of unfinished lots in some of those downtown cycles, so land prices did actually drop, particularly in Texas and Arizona back in the late '80's.

Aside from those --

Another one would be massive layoffs. You know, like a big employer just implodes and puts a whole bunch of people, like in Southern California in the early '90's when the defense industry just imploded.

So those would be the catalysts or the drivers, as it were, to the market just completely falling apart. How about in the way you actually experience the data for your own company? The numbers coming in through the door, in terms of orders or in terms of incentives or traffic, is there anything that's different about when those markets have collapsed versus what you have been seeing recently?

Well, that's hard to say because I can't remember -- we haven't seen a collapse of a market in 15, 14, 13 years.

Yeah. Well, that's why I'm asking you guys, as opposed to some of the other guys.

Steven, what I saw was it really has to do with your communities and whether or not you really were in A locations or not. And what I've seen in -- and if you were just to grade them and say in softening markets, the C and D locations got hit harder than the guys that underwrote deals to be where there's a little bit less competition, little bit closer in communities. The A locations continue to get sales, maybe not the same pricing power, but the A locations and B's continue to do well, and the C locations really just didn't do well at all. So that's why we continue to talk about our underwriting and really not trying to speculate on a C location. We'd rather pay up and be in the right locations with the right product, so if there is a softening market, our success has gone through a softening market.

Let me try the question from a completely different angle. It would seem to me, well right now what you have are people sitting around looking at various markets. D.C. comes to mind, and some people are saying it's a market that's about ready to collapse, so the floor is going to give way. And other folks saying no, no, it's going to be fine. It would seem to me that there's a point in time where we will know, for all intents and purposes the jury will be out, will return with a verdict, and we'll know whether you engineered a soft landing or not. I first started reading about the D.C. market slowing as much as 3 or even 4 months ago. I guess I'm wondering at what point in time, how long does it take before -- the evidence should be out if the market really was going to weaken, particularly in some of these locations. Does it take 4 months? Does it take 6 months? Does it take a year?

Steven, let's use Las Vegas as an example.

Right.

I mean it was a year ago about, with the market here, it was a somewhat self-induced media slowdown.

Right.

The media was just harping on the fact that the market was overpriced and there's too many speculators and too many investors. And people just took that to heart and there was a lot of cancellations up here and the market slowed down. But 3 or 4 months later, it stabilized and business has been relatively steady in Las Vegas ever since that point in time. There was strong job growth in Vegas, strong economy, strong underpinnings in the market. In markets where that's going to be the case, continues to be the case I think, the jostle period is going to be relatively short and we're going to get back to maybe some more normal absorption levels. It could be 4, 5, 6, 7 units a month in a particular subdivision, which today are maybe 8 or 9 or 10 units a month. But we just feel so good about these markets out here. The underlying demand is still so strong and supply is so tight that we think any correction is going to be relatively short.

All right.

It seems to be a ceiling on prices, too. I think that's what a lot of markets are experiencing, like Washington, D.C., although we're not in that market. Trees don't grow to the sky, there's got to be a ceiling on price appreciation.

That was our final question for today, sir. Are there any closing comments?

Thank you for joining us today. We look forward to reviewing our fourth quarter and full-year 2005 results for you in January.

Thank you.

Thank you.

Thank you for participating in today's Meritage Homes Third Quarter Earnings Release Conference Call. You may now disconnect.