Meritage Homes Corp (MTH) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2006 Meritage Homes Corporation earnings conference call. My name is Tony, and I will be your coordinator for today. (Operator Instructions). I would now like to turn the call over to Mr. Brent Anderson, Director of Investor Relations. Please proceed, sir.

Thank you, Tony. Good morning and welcome to our conference call today to discuss Meritage Homes Corporation's operating results for the first quarter of 2006. We issued a press release announcing our results yesterday. It's available on our Website at www.MeritageHomes.com, along with the slides to accompany this Webcast.

Our statements during this call and the accompanying materials contain projections and forward-looking statements, for which I refer you to slides 2 and 3 of our presentation. Our projections and other forward-looking statements regarding the future events or future financial performance of the Company are the current opinions of management. These opinions may change, and actual results may materially be different than our expectations. We undertake no obligation to update these projections or opinions. Please refer to the discussion of risk factors in our press release and presentation as well as our Annual Report on Form 10-K, filed on March 15, 2006 with the Securities and Exchange Commission. These documents describe important factors that may cause our actual results to differ materially from those contained in our projections of forward-looking statements.

In addition, we use certain non-GAAP financial measures, such as EBITDA, to evaluate our business, and we may refer to these non-GAAP measures in our comments. Please refer to our earnings release and SEC filings mentioned previously for the definitions and discussion of EBITDA and other non-GAAP financial measures.

Participating on the call with me today are Steve Hilton and John Landon, Co-Chairman and Co-CEOs of Meritage, and Larry Seay, our Chief Financial Officer. They will discuss our results for the first quarter 2006 and our outlook for the future. At the end of our prepared remarks, we will take questions from the listening audience. I will now turn the call over to Steve Hilton and refer you to slide 5 of our presentation. Steve?

Thank you, Brent. Good morning, everyone, and thank you for joining us today. We're very pleased to report record first-quarter results in 2006. We set first-quarter records in many measures. We closed 2,528 homes in this quarter, 41% more than the first quarter of 2005. Home closing revenue increased 54% year over year to 846 million. Both of these represented first-quarter records.

On to slide 6. Net earnings increased 82% to nearly 80 million. Diluted earnings per share increased 85% to $2.86, excluding the onetime debt refinancing charge in the first quarter of 2005 for a more consistent year-over-year comparison. Both of these were also new first-quarter records. These results combined continue to reflect the carryover effects of the positive homebuilding conditions we experienced last year, which was a record for the homebuilding industry.

Slide 7. Our first-quarter 2006 results were well above our long-term business model targets for several key performance indicators and continue to be among the best in the homebuilding industry. Not only have we achieved amongst the highest revenue in earnings growth over a 5-year period, which was reported last year, but our after-tax return on assets rose to over 17%, well above our long-term target in the range of 10 to 15%. After-tax return on equity rose to nearly 41% compared to our long-term target of 25 to 35%, and our 31% ROE far exceeds the 5-year average of 22% for our peer group. We believe these metrics demonstrate the successful execution of our strategy, which is focused on high-growth markets and high returns, while maintaining what we believe to be a low-risk profile, more so than our competitors by controlling land without owning it.

On to slide 8. Our record first-quarter home closing revenue for 2006 was driven by a 41% increase in the number of homes closed, coupled with an increase in average selling price. Average prices on home closings increased 9% to approximately 335,000 as a result of strong demand for homes last year, while these orders were taken, and also reflected a greater portion of this quarter's closing coming from high-priced markets, particularly California, Nevada, and Florida.

Slide 9. Our gross margin on home closing revenue increased both year over year and on a sequential basis and was well above the target for our long-term business model. Gross margin topped 25% this quarter compared to 21.7% for the first quarter of 2005, 24.6% in the fourth quarter of 2005, and our long-term range of 19 to 21%. Again, this reflected robust market conditions in 2005 when these orders were taken, combined with effective cost management.

Pretax margin this quarter was impacted somewhat by seasonality by the implementation of FAS 123R, which was not effective in 2005, and other G&A cost increases. We booked 2.7 million of additional expense this quarter for the stock-based compensation. Our pretax margin declined slightly from last quarter. However, it grew year over year to 15.5% from 12.7% in the first quarter of 2005, excluding the onetime refinancing charge in the first quarter of 2005.

Slide 10, please. We were recognized as one of the best managed companies in America by Forbes Magazine earlier in this quarter. This is the third consecutive year we appeared on the Platinum 400 list, additionally, moved up to 615 in the recently-published Forbes 1000 list, having first appeared on this list just 2 years ago.

It's very rewarding to be able to report huge results like this and receive this kind of recognition. But we recognize that market conditions can and do change. And therefore, we must keep them in perspective. We have successfully executed our growth strategy over the last several years and believe we are positioned today in some of the best housing markets in the country. Our strategy not only has allowed us to benefit from the positive homebuilding environment of recent years to deliver record results to our stockholders but today offers us greater diversification, as different housing markets are relatively stronger or weaker from period to period. We believe that our financially conservative approach to the business and our competitive advantage over smaller builders will allow us to achieve further growth in 2006.

Before I turn the call over to Larry, I would like to announce that we recently promoted [Dennis Welch] to the position of Regional President of Meritage Homes of California. Dennis brings over 20 years of homebuilding experience and will continue to serve as the President of our Colorado division until we need a replacement for him in Denver.

I will now turn the call over to Larry, our Chief Financial Officer, to review our balance sheet and liquidity. Larry?

Thanks, Steve. As Steve noted, we believe it's important to maintain our relatively low-risk management strategies as some of our markets strengthen, while others adjust to more sustainable levels. We manage our balance sheet carefully, which has enabled our growth and affords us flexibility as we face the challenges and opportunities in the dynamic marketplace.

As you look at slide 11, we reported a net debt to capital ratio of 40.5% at March 31, 2006, a 331 basis point improvement over 43.8% at March 31, 2005. We also reported significant improvements in other key metrics. Our debt to trailing four quarters' EBITDA ratio improved to 1.1 times compared to 2 times in the first quarter of '05. Our interest coverage ratio improved to 12.8 times from 6.6 times a year ago. We had approximately 131 million outstanding on our credit facility and an additional 354 million available to borrow at March 31, 2006 after considering the borrowing base and the Company's most restrictive borrowing covenants.

On slide 12, you can see our completed specs as a percentage of backlog was only 3%. Although canceled orders increased the percentage of specs under construction, our total spec inventory was only about 12% at quarter-end compared to 10% a year ago. We are working hard to limit our spec inventory. Our inventory turnover was relatively stable year over year. S&P rating service recently cited these factors along with our option strategy for controlling land in their decision to upgrade the outlook for Meritage from stable to positive.

On slide 13, you can see we believe our strategy to control land without owning it, not only reduces our exposure to the risk of land price fluctuations, but has provided us the leverage to grow and diversify more quickly than had we financed our forward supply of lots by acquiring the lots outright using our capital. We had approximately 52,000 lots under control at March 31, 2006, with 89% of them controlled through option or purchase contracts. Based on trailing 12-months' deliveries, this represents approximately a 5-year lot supply.

Slide 14. During the quarter of 2006, first quarter of 2006, we repurchased 856,000 shares of our Company's outstanding stock, representing about 3% of the total outstanding shares at an average price of $57.59 per share. The aggregate repurchase cost was 49.3 million. Approximately 86.3 million remains available for additional share repurchases under our current authorization. We will determine the level of future stock repurchases based upon evaluation of our expected capital needs for potential growth or expansion opportunities, stock values, maintaining moderate debt levels and other factors.

I will now turn the call over to John Landon to discuss market trends and our 2006 guidance. John?

Thank you, Larry. I would like to thank all of you for your interest in Meritage Homes. Since Steve and Larry covered how we did in the quarter, I will give a little insight into some market trends and our outlook going forward.

Let's go to slide 15. We now operate coast-to-coast in 14 markets and 6 states in the South and West. We believe these are some of the best markets now and in the foreseeable future for homebuilding opportunities.

Slide 16. Some markets that experience very positive homebuilding conditions last year are not quite as strong this year, while other markets that were not quite as hot are strengthening. Our diversification strategy is proving to be effective, as we are better positioned to weather the ebb and flow of housing market conditions in various markets.

Slide 17. Aggregate orders in the first quarter of 2006 nearly matched those from the first quarter of 2005. We consider this to be a solid performance, given the fact that the very strong first-quarter 2005 orders were 49% greater than those in the same period 2004. Northern California and Phoenix have been among the best homebuilding markets for the past several years. As we have previously discussed, we believe speculation contributed to the high price appreciation in these markets, which led to higher-than-normal cancellation rates. It is our opinion that this has now subsided.

Tucson has remained solid with an increase in orders of 4%, while the northern California sales pace has slowed and appears to have stabilized somewhat. Southern California has seen good growth with strong increases in both orders and communities. Our overall cancellation rate was 28% in the first quarter, up 20% from a year ago. Texas markets were the bright spot for Meritage this quarter, with a total order value in Texas up 48% year over year, led by especially strong sales in Houston with very nice gains in our other Texas markets -- San Antonio, Austin, and Dallas-Fort Worth. These sales gains in Texas helped to offset the sales declines in northern California and Phoenix. The change in first-quarter order average sales price from approximately 334,000 in 2005 to 321,000 in 2006 was due to the same shift toward more sales in Texas, where average sales price is lower.

Although Texas remains very competitive, conditions for housing activity there are positive. Homes are relatively affordable. The underlying economy is strong. The climate is pro-business. In our view, these factors are producing a favorable environment for relocation activity, increased demand and improved margins. Two of the four largest markets in the Meritage system are in Texas -- Dallas-Fort Worth and Houston -- and they are poised to benefit from improving conditions in Texas. We have a 20-year history of success in Texas and have broadened our product line there to better capture entry-level and luxury home markets in addition to targeting the move-up segment.

Nevada remains steady year over year with a 5% increase in order value in the first quarter. Florida was flat in terms of orders year over year. The retreat of speculators has tempered demand there recently, but Florida remains a prime state for homebuilding, with 5 of the top 20 housing markets in the country. I will point out that despite the softer conditions in certain markets, we're still making very good margins on new orders in all of our markets.

Slide 18. Our solid increase in first-quarter earnings, a healthy backlog, and the increase in active communities positions us to achieve further growth in 2006, despite a slowing pace of sales in some of our markets. We maintained our order backlog valued at approximately 2.2 billion during the quarter, which was 22% higher at quarter-end than first quarter 2005 and equates to more than 70% of our projected revenue for the remaining three quarters of 2006.

Slide 19. A good portion of our spring selling season still lies ahead. We believe we are well-positioned with our actively-selling communities up 26% and the more diversified base than we had 1 year ago. The increase in community count is helping to offset declining sales per community in the hotter markets of 2005. However, the moderation we have seen in recent order volumes will impact revenues late this year and into 2007. So, we might anticipate revenues next year to be flat or up a modest 5 to 10% absent additional acquisitions.

Slide 20. We continue to monitor and evaluate market conditions. Based on current conditions, we expect home closing revenue to be up 35 to 40% on a year-over-year basis in the second quarter this year, which contributes to reaching our 3.8 to 3.9 billion estimate for the full year and represents 27 to 30% growth over 2005. As prices moderate in certain markets and a greater mix of our sales comes from markets with lower margins, we expect our average margins to trend toward more historic levels.

Slide 21. Therefore, we currently project diluted earnings per share in the range of 2.70 to 2.80 next quarter and maintain our guidance of 11.25 to 11.50 for the year. This would translate to our nineteenth consecutive record year for revenue and net earnings in 2006. With that, we will conclude our prepared remarks and open it now for questions. Operator?

(Operator Instructions). Stephen East, SIG.

If you wouldn't mind, I guess, John, maybe talk a little bit more about your revenue outlook in '07. I guess how that has sort of built-up when you look at your orders over the last couple of quarters of this year.

Well, I think we are looking at our business and saying that you know, we've got some markets that definitely have moderated. Other markets have strengthened. When we do a bottom-up approach to all our business, look at what our community count is going to be, and we are possibly conservative. But, we're looking at the sales pace that we're currently achieving. We're thinking that without acquisitions as we said, the 5 to 10% is where we think we look like we will be for 2007. Now, having said that, things can change. But I think as we sit here today and we really don't know how long it will take the markets in let's say Florida and California to really improve over what they are now. But, if they stay kind of like where they are today, this is what we see.

Along those lines, I guess the recent tone of business as compared to earlier on in the year?

Well, I think that we definitely have seen the cancellations subsided. They were primarily due to some of the people that bought last year that were possibly -- a couple factors -- could've been people had a home to sell. They contracted for a home they showed. They couldn't sell their home they chose. Then, they canceled on our home. Some of them were speculators, who probably really didn't plan on closing the home, and the market changed so they canceled. A lot of those were orders that were taken early on in '05 before we put in the anti-investor addendums into our contracts. We think most of that is now behind us, and we will go back to more historic cancellation rates.

1 last question. As you look at your capital allocation thought process with land and share repurchase, just sort of what are you all thinking about now with land, what you're seeing with the dynamics of it, the pricing terms, etc., and how that fits into your business model working forward.

Our strategy hasn't changed too much with regard to the purchase of land. We're still looking for A locations. We think land prices in peripheral locations are going to soften. But, in general, prices for land haven't changed that much. Some terms have loosened up a little bit. But, you know, we have a pretty good land position right now, so we're being relatively patient. We don't have to go out and buy a bunch of land to make our numbers for the next couple years. But we're going to continue to try to be opportunistic and grow our business organically in the markets that we are in, increase our market share and be ready to purchase good land as it becomes available.

Alex Baron.

Great job, guys. I wanted to ask you about your margins. Obviously, they were up quite substantially both year over year and sequentially. So, I was hoping you could give us some -- shed some light on what region in particular probably contributed more to this margin upside?

Alex, I think our margins generally were better than we anticipated across the board. I think the key ones were probably in Arizona and California. I think we exceeded our projections more there than we did in some of the other states. I think it's -- for particularly California, it's us being I think a bit conservative in looking at the kind of cancellation rates we're seeing and maybe thinking about some of the incentives that we may have to offer and the level of incentives. Cancellations really wasn't as maybe bad as we thought it was going to be. Therefore, our results have been a bit stronger on the margin side, particularly California and Arizona. I just think we were just a bit conservative there. But, generally across the board, our margins were a bit better than anticipated.

Now, what are you guys thinking going forward? I think obviously, discounting is having an impact on everyone's margins to some degree. But, I'm just kind of wondering to what extent or where do you guys see the margins coming out at the end of the year?

Well, you can back into those numbers from our guidance. But, generally speaking, we are thinking we see a couple 1000 basis points of margin erosion through the year. How fast that happens and how deep it really is, whether it's 200 basis points or a bit more, kind of is still being determined by us. But, you can go back in and see what our margin projections are by just taking our earnings forecast and backing into it.

Okay. One other question I wanted to ask you. I think you guys have in the past given delivery guidance by region or at least some idea of your goals there. Hoping you could update us on that.

At this point in time, Alex, I don't think we are ready to comment about that on a state-by-state basis.

Margaret Whelan.

Nice quarter, well done. My first question is, John, you mentioned in your prepared comments that the margins on the orders that you're taking, the new orders or I guess pulling into your backlog are better than you expected. Relative to the negative mix that's moving into Texas, can you just give us a sense for what's going on with your cost, your labor, your raw materials, your land, and so on?

Well, yes, I think what we are saying is that we've seen -- in the improved margins, we were talking about the -- our business in Texas. We have seen the opportunity with the market improving to having a little bit better pricing power and actually more than our increase in cost. So, we are seeing a little bit of margin improvement as the homes that we're selling, and we hopefully will see that as those homes start closing later in the year. But, let's don't get too terribly excited. You know, Texas is competitive. We're not going to see huge increases like we have last year (multiple speakers) on some of the coastal markets.

But yes, we are seeing some cost increases. Definitely concrete continues to be pretty much everywhere going up in price. We've seen a little bit -- nothing to be alarmed of a little bit of labor in some things, like in shinglers as an example and a couple other areas, where labor has been a little tight. But, it's not to a point of being concerned. Just homes are sitting a couple days longer than we would like, waiting to get roofed. But, some of the labor we think will someday go to New Orleans. We haven't seen that yet. But we anticipate that happening. But, it's -- as the demand has improved, obviously labor has gotten a little tighter. But we're not concerned that we're going to see huge price spikes. It's all manageable at this point.

Can you give us a sense relative to the [can] rates spiking? You and many of your peers had assured us that you weren't taking speculators in the backlog for the last few years. Then all of a sudden, the can rates jumped, and that's being attributed in part to more speculators. Can you just let us know what you're doing in Texas then? Because anecdotally, we're hearing that there are speculators moving into those markets. But what are you doing to keep them out of your backlog?

We've monitored that very closely, and we've only saw one -- we saw one community, where we had townhomes, where we saw some investors and we put anti-investors addendums in there. We've monitored what we've got, and we haven't seen what I have heard other people talking about, investors buying in our single-family detached product.

You have not.

We have not. We've seen -- we do look and we see some relocation buyers coming from California and elsewhere. But, it's at a pretty normal rate when we talk about more healthy relocation market. They are coming here for jobs, and they are not speculating. So, I don't -- as of right now. I do believe that if people come to Texas and things, they are going to see the wild price appreciation that we saw in other markets. With the way the land is here and the availability to bring it on fairly quick, I just don't see we're going to -- we've never seen it. I would be surprised if we see the kind of price appreciation now. I do think we can sustain high single-digit appreciation but that's fairly normal.

Another question I had was just relative to the cancellation rate. I think you are saying that you feel like it's starting to trickle down now that it peaked around 28%. Would that be accurate?

Yes. I think we've -- we looked at where we historically have been and we take into account that we think it was more of a moment in time when we had to flesh out some of these cancellations that we then anticipated. Most of those, as the homes got ready to deliver, have canceled. We've cleaned the backlog up, and we think that if not all of that -- most of that is behind us.

Then, a question for Steve, just about the management changes in California and how do you make the decision to double up a regional president to monitor such a big market?

Do you mean because he is doing Denver and California?

Yes. I know Denver is smaller for you, but, California --

Well, we're very small in Denver. He is originally from California. Actually, he was formerly going back several years the Treasurer for KB Home. He was a regional president in Denver. You know, we're actively looking for somebody. We're going to have somebody on board within the next 30 to 60 days. So, it's a very short period of time he's going to have --

For Denver.

For Denver. So, it's a very short period of time he's going to have -- will be wearing two hats.

Then, for you Steve, what do you see -- what are the trends that you're seeing in the market at the moment into April?

You know, I would just echo what John said. The one thing that I would clarify a little bit was that when we talk about the margins in his prepared remarks, he said that the margins on new orders are very good. I think what we meant by that was that even after the incentives, the margins on new orders in California and Arizona and the West in particular are still better than our historical average. So, --

But they are probably going down year over year.

They are going year over year, but they are still much better than the 5-year average.

One thing too, there is really kind of three things going on. There is the Texas market improving, so margins are improving there. In other markets, they are going down. Then you have the shift in mix, where we're going to have more deliveries in Texas than say California, which has -- California has traditionally been a higher margin market and Texas a lower margin. So, the combination of all those factors makes a little different -- a little difficult to zero on exactly how that's going to all kind of shake out throughout the year. But, overall, they are going down.

Just finally, what is your appetite for M&A here and for land? I know you said you're buying it opportunistically. Have you seen land prices change at all?

Land prices haven't come down to where we would like them to be, particularly in outlying locations. We are waiting for that. But, if we can get an A location and a good close in location, we're going to take advantage of it today and we're going to buy it because of the tight supply. There hasn't been much happening on the M&A front. I think there's still -- people are still trying to adjust their expectations. But, we're opportunistic if the right opportunity comes around in a place where we want to be with the right management team that is culturally accretive to what we're doing. At the right price, we're going to take advantage of it. But I think we're going to have a few quarters, where people need to kind of get in sync.

Relative to multiples, relative to what they think they are worth.

Yes, look at what the public multiples are relative to what people want for their businesses.

We aren't completely focused on growth. We on the top-line side we can, as we generate free cash flow if we don't find the right acquisition or organic growth opportunity, still grow the bottom-line earnings per share number by buying shares back. So, rather than see us continue to delever the Company down in the 35 or 30% debt to capital range, you'll probably see us being more aggressive if we don't find growth opportunities to redeploy the capital we're generating more aggressively, buying shares back to keep the EPS number growth up a bit.

Good. We like that strategy. Thank you very much.

Dan Oppenheim, Banc of America securities.

Wonder if you can talk about that a little bit more in terms of the share repurchase, in terms of how you are looking at that right now, in terms of just price sensitivity and just how you evaluate that versus current land opportunities?

Well, obviously, the price recently has been attractive, and we've been out buying. We won't comment specifically on how much we plan to buy going forward. That is still an opportunistic deal. In fact, our guidance hasn't factored in much in the way of additional share repurchases. So, we could see a little upside to the extent we're more aggressive there. But, you know, we still want to grow the Company. So, to the extent we can find organic growth or an acquisition at a reasonable price, we will still pursue that. If those opportunities are not available that we would be more aggressive in share repurchases.

Great. And then, one question in terms of the cancellation rate. Was wondering with just the increase in mortgage rates recently, what percentage of your home buyers are locking in mortgage rates at the time of signing a contract if there's any just risk for some of those just with the recent increase that we could see cancellations stemming from that?

(multiple speakers) I don't think we have those numbers about what percentage are getting locks.

Most don't lock at the time they sign. They get closer to the closing date and maybe lock 90, 120, 150 days out. So, most are not signing at -- or are not locking at signing.

Stephen Kim, Citigroup.

Congratulations, good quarter. I guess I have a few questions if I could. First, I want to touch on this issue of the cancellation rate because this is something that I think there has been a fair amount of confusion in the marketplace on. What you are telling us is a little different from some of the other builders. So, I just want to drill down on it a little bit more. As you mentioned, there are basically two drivers of the cancellation rate. One is speculation, and the other one is an inability to sell a house when you have a mortgage contingency -- or I mean a home sale that is basically contingent upon selling your other house. It has been our view for a while that the speculator issue was a one-hit wonder, and it was going to come in all at once and then it goes away. It's not a trend. But, the second -- it is something that is a little harder to say is sort of a onetime deal. It's a little harder to say that it can get a little worse.

So, I'm very intrigued by your commentary that overall, you think both factors seem to be ameliorating. Can you explain in a little bit greater detail why you believe that the second factor, the inability to sell a house in a tougher market, is not going to be something that's going to lead to greater cancellations -- or a continued elevated level of cancellations in the future?

I think let me, let me -- do you want to go ahead and take that Steve or I?

Either one.

Go ahead.

I think a lot of it is because the people that are buying over the last few months -- as we move more into -- deeper into this year, the people are buying over the last few months have already kind of predicated the change in marketing conditions into their thinking and into their sort of analysis on selling their own home. You know, these markets didn't all change on the same day. California started first -- actually Vegas started over a year ago. They changed, then northern California, then Florida, then Phoenix. I think you know, markets change pretty quickly, and there's a lot of momentum that happens over a couple month period. Then, things sort of seem to stabilize I believe to some degree. I think we saw that in Vegas, and I think we're seeing that in California. There is good traffic in a lot of communities, and there are people out there looking to buy houses. Of course, they want to know what the incentive is. Because they want to take advantage of the changing market conditions. That encourages us in good locations, there's still a lot of demand. You want to add onto that, John?

Add on a little bit on the one I'm talking about -- the people with homes to sell. What some of them chose to do is they have their home and they said, you know, maybe we will move up. They put a contract in on a home to move up. It's not that they couldn't sell their home. But, they got a little uncomfortable with the price of the new home that they put under contract, and they chose to stay in their existing home. They were kind of speculating if you will a little bit by saying, wow, if I can sell my existing home for this kind of profit, why don't I take that profit and move it into toward a bigger home, even though it will be a more expensive home? Some of the people, their minds changed and their thinking changed that they say, you know what? Maybe we really can't afford that other bigger home. We don't need the bigger home. Let's just stay where we are. So they were kind of moving up, taking opportunity to move up into a bigger home due to market conditions. They rethought that as the market conditions changed.

I think the key is that the buyers today realize that they can't sell their house in 2 weeks and wait until 2 weeks to closing on the new home to sell it. They realize they have got to put it on the market right away as soon as they sign a sales contract. It may take 2 or 3 months to sell, and it may not be getting top dollar. They may be getting something a little less than what they might have gotten 6 months ago. That thinking is already factored into the buyers we're dealing with today.

Got it. That all makes a lot of sense. I appreciate that. So, it really sounds like sort of the sentiment behind the cancellation rate has sort of hit its point of maximum negativity if you will. Now at this point, we're just basically [nuking] to start normalizing.

We believe that's what we're seeing and in the markets where we have already had that correction, yes.

It will take a lot of people by surprise if and when that happens. A few questions if I could additionally. Number one, just to triangulate a little bit more on what you're looking for on -- sorry closings and average price. You've given us the revenue. I'm trying to get a sense for whether or not you are anticipating a nice year-over-year increase in your backlog conversion ratio in the second quarter and for the remainder of the year. You didn't achieve a better conversion rate here in the March quarter. So, I was wondering if that's part of the story here in your second-quarter guidance and your year guidance.

We certainly believe that the conversion rate will start to improve and trend towards more normal conversion rates. You are right. We didn't see it this quarter. We probably thought we would, but we still came out okay with our results. But, you know, you should see as we are able to work through the backlog that improve.

Okay. So, I have in my notes somewhere here about 12,000, 12,500 incentive paid at closings in '06. Is that still a pretty decent range or lower end of the range, higher end of the range?

You know, I think that that's not a bad number. Certainly, it could be a little bit different, but (multiple speakers) --

Probably closer to the low end of that. You know, getting above 12,000 might be tough.

Great. You know, if we take your -- you said I think 3.8 billion or something like that in revs, right, this year?

Yes.

Yes.

Okay, so that assumes an average price somewhere considerably about $20,000 lower than what you actually delivered this quarter -- I'm sorry -- then you delivered this quarter. It seems to suggest a mid, like 315-ish type $1,000 average price. Is that -- so should we expect a pretty significant reduction in your closing price going forward, as Texas comes in as a bigger part of the mix?

I think the --

I think the average price on the homes we sold this quarter was 321, right Larry?

Right, that's what I got.

Right.

So, I think it's going to be closer to that 315, 320.

Good, that's good.

And it's being caused by mix more than anything else.

Yes, no, I know. Then lastly, your tax rate -- I noticed your tax rate was a touch higher than what we anticipated. Any reason why your tax rate would continue at 39, or do you think maybe 38 is still a good number?

Well, that's being caused this quarter because we had a new executive compensation plan up for vote with the shareholders this year for '06. Until that is approved, executive compensation over $1 million is not deductible. So, we are factoring in, just to be conservative that that is not deductible. Once we get that approval, the tax rate should trend back towards more the historic range. For all the investors on the call, I would encourage you to vote for that proposal. Because, otherwise, it hurts the Company. Because those costs are nondeductible, and it's just more money you paid out to the IRS.

I appreciate it; good job. Thanks.

Joel Locker, Carlin Financial.

Strong quarter, I just wanted to say that first. Larry, I just wanted to ask you about just the I guess first of all, just the order trends through the quarter and how that broke down if you have some kind of an explanation on January, February, March year over year.

I've actually -- John or Steve, do you want to comment on that? You are probably closer to the market than I am.

Sure. I think that from the new orders netting out cancellations, we saw in most of the markets that I oversee -- I'll break them down even more -- Texas, solid all 3 months. In Florida, as we look at it, kind of different. The Fort Myers/Naples market seems to be a little softer than the Orlando market. You know, I think that has a lot to do with some existing for sale inventory that's on the ground. So, the competition is a little bit tougher. So, we think it's going to take some time for that to improve. Orlando, as prices have adjusted there, still with very good margins, we see in that market stabilize. Phoenix, we're kind of seeing an area of -- some of the prices of homes that have moved up the most seems to be where there is some softness. At the lower-priced ends, we're still doing good sales. We see the trends throughout the quarter being pretty consistent, except for the cancellation rates were a little bit stronger earlier on. We see that slowing down a little bit.

So, cancellation rates were even stronger in January, February say versus March?

Yes, I would say on balance. Steve, would you say that's true?

Yes, I think they were a little higher in Phoenix as you went into March than they were in January, February. I think the correction in Phoenix didn't kick in until late -- didn't really start until late February. So we got in February and in March and we're getting some in April. I think California is certainly -- the correction started earlier. So, as we got later into the quarter, you know, this has firmed up a little bit.

Right, but just I guess the net orders including the cancellations, would you say they are around that -2% on a unit basis throughout the quarter? Or was it including the cancellations a little higher or lower in the March period?

I actually think due to cancellations and I think I would say I agree with Steve's comment on the Phoenix market and having higher cancellation rates in a couple of our outlying subdivisions that have been softer, that that caused the cancellation rates to be higher in March and caused the trend for the quarter to be a little less strong in March than throughout the quarter.

Right, and then just on -- when you mentioned your declining margin is back to historical level, you are talking about the 20% historical and gross margins?

Correct.

Yes.

And how -- I mean how quickly do you expect that to happen? Is that a couple quarter phenomenon, or would that take six quarters or so?

I think it's over four to six quarter, maybe longer.

Four or so? Maybe by the end of '07 or something like that?

Yes, yes.

And then, what about the -- have you not exercised or written off any of your land options in the first quarter? Did that pick up at all, just based on some of these slowing markets?

We are exercising all the time, but we're not writing off any deposits or walking on any deals.

All right, so you guys have not walked on any of the deals yet?

No.

We are still making, as Steve and John had said, good margins in all of our communities and even in California, where there is -- in Sacramento, where there's been the most softness. We're making good, good margins. So, there's no reason for us to be walking on any projects.

Right. And are you guys -- the takedowns just kind of delaying those, where the absorption rates are slowing, say like in a Sacramento and just renegotiating with the developer?

We are putting some lots on our books. Some lots we're delaying; we're renegotiating. You know, it's either one of those two.

Nick Yulico, Street.com.

Could you just repeat what you said about your 2007 guidance for revenues?

We gave revenue guidance of up 5 to 10%.

Okay, that was all you said about that? I got on a little late for the call.

Is that right, Larry?

Yes, well, it's a fairly broad range. We've said it might be as low as flat, and it could be up 5 to 10. It kind of just depends, and we really don't give guidance. We don't typically give guidance for next year this early in the year. So, we're giving a fairly broad range.

Okay, and you said right that the average selling price for orders this year would be 315,000 to 320,000? Is that what you said (multiple speakers) --

Approximately, approximately correct, yes.

How much does that -- I know you said some of that is makeshift. But how much is that [singularly awarded]? What is that really assuming about pricing in Texas and Arizona?

Well, it would actually assume that we've been able to raise prices in Texas, starting with an average sales price in Texas in the -- I think it's in the $230,000 range. And so, we've actually been able to raise prices in Texas. In Arizona, if you're just talking Arizona, we haven't been able to raise prices. In some cases, we've had to give incentives. But, we're still -- even with incentives, as Steve I think said, our margins are still very strong and way above Company average.

And as far as California and Florida, I mean, is there anything -- the average selling price on new orders there? What are you looking at there? Because I just noticed both of those went down from the fourth quarter.

I'm sorry; what are we looking at for prices?

Yes.

Relatively flat. I mean, we're giving incentives in California and Florida. So, I mean prices are not going to go up there this year, other than mix issues.

You know, in Florida, we can talk -- we are operating in Orlando and Fort Myers/Naples. The Orlando price product for us is less expensive. Depending upon the mix of homes that we expect we're going to get a greater percentage of our homes sales this way in Orlando. So, the 350 is probably a good number. As the Fort Myers/Naples markets improve, where the homes are more expensive, you could see that go up. But, that may not be till definitely probably '07 or later.

I would emphasize that the change in average sales price is again more due to mix than prices going up so that they can later going down significantly. It's individual subdivisions that have higher or lower prices selling out or starting up.

Right, so I'm just wondering if it's better to use for the current quarter contract based on the average selling price for California and Florida, which were lower in the fourth quarter. I mean, is it going to continue going lower as we get closer to it?

Yes, I mean, I think using a good trend would be to use the average sales price for this quarter in projections going forward. They may trend downward a bit more or upward a bit more. But, that's a pretty good number to use if you are doing kind of forecasting or your own modeling.

[Jeff Bernstein], [Schroders].

Just a question on leverage and how you think about it and what's the optimal leverage. If you could comment on that, I would appreciate it.

Well, we are kind of a striving forward BB flat across-the-board ratings. We think that the leverage we are at now should get us there. I don't think we perceive that decreasing our leverage significantly and going for a BBB investment grade in the near-term is something we want to do that the cost of doing that as it relates to being able to leverage our equity in keeping our returns on equity up would be too much. So, I think you'll see us try to maintain the 40 to 45% target range we have had. As we said earlier in the call, to the extent we're generating free cash flow and that starts to drop us down below that target, we could buy shares back. We could look more aggressively if we had acquisitions -- in order to keep our debt to capital ratio in that range and keep our equity capital fully levered.

[Brian Shanahan], [Norman Shelter].

Congratulations on a good quarter. I was wondering on basically specifically if you knew which markets that you would plan to do any type of acquisitions. One other question, I know that you guys have this buyback plan going on. I was wondering at what stock price do you decide to M&A instead of buyback shares.

We really don't give out that detailed of information. But, I will talk about what we said in the past and we still feel that the area for us to look for acquisitions is in the Southeast. We've made a comment that we really want to be $1 million business in Florida within the next 4 to 5 years. That's still our plan. We feel like we can be patient and grow our business there, either organically or through acquisitions or probably a combination of both. We are currently in the process of doing a greenfield startup in the Tampa market. And, we are also continuing to look at other markets, not only in Florida but in the Carolina's and Georgia. We've looked at those for some time. As Steve said, when the price is right and we can find the right opportunity, you would see us enter more markets in the Southeast. So, I would say that would be our primary area. As far as the balance on what we would do an acquisition for versus stock price, I think we're not prepared to comment on what our strategy would be or what price we are buying there or what we're not -- or not buying at. So, I would just leave it at that.

Okay, that sounds great. Thanks a lot.

Alex Baron.

Sorry about that. I was going to ask you about your increase in your SG&A from last year. What was that primarily due to and where would we expect the number to go to going forward?

Well, your one thing that -- it's our first quarter where our revenues are traditionally lower. So, you'll probably see a little bit more leverage. Although, I think you'll see less leverage because of the year overall for revenue is going to be a bit flatter than what you have seen as the current sales are reflected in closings in the latter half of the year. As we said in the press release and on -- and in the script here, this call, 2.7 million is from us implementing 123R, which is the stock option compensation expense. If you pull that out, the increase year over year is about 0.7%, and that basically is us continuing to plan for growth.

We've added a few people in HR over the last few months. We've added several attorneys to bring some of our legal work in-house and to beef up the legal department. We are also adding more regional staff in Florida to plan for future growth in Florida. So, some of those costs are running just a bit ahead of our revenue growth. But we're projecting to be at 3.8 to 3.9, so adding some increase in SG&A to plan for that growth is appropriate.

That sounds good. In terms of the discounting, just conceptually, I'm what kind of wondering what your approach is to that whole topic, especially as the bigger builders seem to be more aggressively pushing volume and just kind of wondering how you guys are approaching that in responding to the competition.

Boy, you know, we've always been profit driven, and we think that we've never chased revenue. We've always been one that says we want our next incremental dollar of revenue to make the same incremental profit, and that hasn't changed at all.

We're taking more of a rifle shot approach to incentives than a shotgun approach. We are trying to hold incentives to the subdivisions and particular specs where we need to discount. We're not taking a -- we've got to keep the top-line growth drawing -- damn the torpedoes and full speed ahead kind of concept. We are going to balance incentives with profitability.

Greg Gieber, A.G. Edwards.

Most of my questions have been answered. But I wonder if you could talk about the cancellation rate and how it might be different by sort of product type. I know you are in Arizona, where you have retirement communities and I think you have the Monterey Luxury Homes. Is there any variation there?

I don't think it differs too much by product type, other than what John said earlier, that some of the higher-priced product or the products that were appreciated the most, which is more on the higher end of the move-up housing, we've had a higher cancellation rate. Close to the more entry-level or lower-priced move-up homes, the cancellation rate has been a little bit less. But, I would not say we've had any one sector or segment, whether it's retirement or luxury or entry-level had a higher cancellation rate than any others. I think it's more confined to the higher -- more rapidly appreciating move-up homes.

Okay, can you comment on what happened to your sales in your retirement communities and your plans to expand, stay the same, or contract there in terms of communities?

We are -- the sales are slower in the active adult than we expected. I think those people are being a little more cautious. They are waiting to see what pricing levels off at. So, they are off from last year. We do have plans to open additional active adult communities, nothing that we can announce yet. But, we're working on several opportunities right now.

Stephen East, SIG.

Just a couple questions on the incentives. If we look -- if you look at that as a percentage of sales in the orders that you had this quarter, how does that compare to say, year ago's orders?

I don't have a particular percentage for you. It's kind of all over the board. As I said, we are discounting and offering incentives as we need to in particular subdivisions and on particular models. So, I really can't give you an across-the-board number. Some -- the number is hard to measure too because sometimes an incentive is expressed in terms of -- we will offer you a free upgrade on an appliance package. The cost of that is obviously not the retail value. It's the cost of the product. Where other times, we may actually offer $1,000 off a house, which is a dollar-for-dollar effect. So, it's very hard to measure the incentives as a percent of revenue because of that kind of factor too.

Let me comment a little bit too. I think that when we talk about incentives and discounting, some of our market that we operate in, incentives has always been a normal way of doing business. So, it's not about whether we are offering incentives or not. It's whether or not we're selling the homes net for less margin now than we were before when you take it all into account. So, the way we market it and package it and what we're saying is that in some of the markets and some of those communities that we are in, we've had to lower our gross margin that we're making on those homes, whether that be through discounting or whether that be through incentives. That's what we are experiencing. Some of our margins in these markets are historically extremely high. So, we have a lot of room to move our prices down and still have margins above our Company average.

Okay, that's helpful. And then, just the other question, you had a negative gross margin on land. I was assuming maybe you had some option write-off in there. But, it sounds like you didn't. What's going on with it and what should we expect looking forward?

Yes, that's a very, very immaterial number, and I'm looking into what that is. I don't know precisely myself. But, it's not something that somebody should anticipate we're going to start booking losses on land sales in any kind of material way. There may be some ancillary lots here or there we had or some (multiple speakers) --

There was a small piece of land in Phoenix we had some extra costs associated -- allocated to it in a community that we are doing other lots.

If you did write off an option on a piece of property, where would that hit?

It would probably just go into housing cost of sales. It would not go into land cost of sales. If it were a material number, we would wind up disclosing it. If it was immaterial, it would wind up just getting lumped into housing cost of sales.

Timothy Jones, Wasserman & Associates.

A couple questions. You gave us your average price in Orlando at 350. What is it in Fort Myers and Naples?

I think we gave that was the average of Florida.

For Florida?

Yes (multiple speakers).

But, in Naples, are you -- do you just have that one project? But you have more -- the one near Fiddlers Creek or do you have some more now in Naples?

That's the only project we have right now in Naples.

And what status is that at right now?

That status is we're just completing the undergrounds, and we're starting to do the paving and begin the models very shortly. We are taking -- we are pre-selling. But once again, the models have not started yet.

But you are pre-selling?

Yes.

Okay, and secondly, you say that your -- I think it was 89% of your land is either options or purchase contracts. How much is purchase contracts?

The 89% is the combination of all forms of land control through an option or purchase contract or a seller carry financing. So it's everything, any way we control land that's through some kind of an extended contract purchase.

So, he wants to know how much of that is purchase contracts.

Okay, of the 89, of that percentage, the purchase contracts are approximately 30%, 35%. I don't have the specific number.

Do you have any performance clauses or something added, which would make it that you would have to take it or are they still on option?

We have no specific performance contracts in any of our options or purchase agreements.

Okay, so they are still blocked.

Just a deposit.

Just a deposit, thank you.

Stephen Kim, Citigroup.

I actually had another follow-up question regarding the SG&A ratio that Alex had touched on earlier. In answering his question, I got the sense that what you're saying was that you were basically building for growth, and that attributes -- that accounts for about 70 basis points of excess G&A this quarter. But, you were saying that you were ramping that appropriate to a $3.8 billion revenue figure, which you hope to recognize by the end of this year obviously. So, does that mean that by the time we get to the end of the year, we should be looking at G&A ratios that are more comparable to what you had last year? Or does that mean that we might be running for the rest of the year at levels of 70 basis points higher than we were in the year-ago periods?

You know, Stephen, I don't think we will be quite at where we were last year. But, I don't think we will be at 70 either. I think it will be somewhere in between. To be frank, I can't hit it that -- I can't hit it anymore accurately than that than just saying it's going to be somewhere less than 70 but more -- but more than flat on a percentage basis.

At this time, I would like to ask management if they would like to wrap it up. We do have one more question in queue.

Go ahead; take the question.

Rahul Bhattacharjee, Merrill Lynch.

My simple question was, can you give us a sense of the appreciation and land prices in some of your major markets over the past say perhaps 1.5 years or 2 years?

Did you say appreciation or depreciation?

Appreciation.

I was going to say because we've seen no depreciation.

It's a hard one to answer. It varies market to market, location to location, even within the market. But generally speaking, I think land prices have increased anywhere from 10 to 40% in the last couple years.

With that, we would like to thank everyone for your interest in Meritage Homes. We look forward to giving you results for the second quarter later this year in July. Thank you.

Thank you for your attendance in today's conference. This concludes the presentation. You may now disconnect. Good day.