Meritage Homes Corp (MTH) 2007 Q1 法說會逐字稿

Good day ladies and gentleman and welcome to the Meritage Homes First Quarter 2007 Earnings Conference Call. My name is Jen and I will be your coordinator for today. [OPERATOR INSTRUCTIONS] As a reminder, this conference call is being recorded for replay purposes.

I will now turn the presentation over to Mr. Brent Anderson, Director of Investor Relations. Please proceed, sir.

Thank you, Jen, and good morning everyone. I'd like to welcome you to the Meritage Homes First Quarter 2007 Earnings Call and Webcast.

We completed our first quarter on March 31 and we announced our final results in an earnings' release yesterday. If you don't have the release yet, it's available on our website at www.meritagehomes.com, along with the slides that accompany our Webcast today. Please refer to Slide Two of the presentation at this time.

Our statements during this call and the accompanying materials contain projects and forward-looking statement which are the current opinions of management and subject to change. We undertake no obligation to update these projections or opinions. Additionally, our actual results may be materially different than our expectations due to various risk factors. For a discussion of these risk factors, please see our press release and our most recent filings with the Securities and Exchange Commission, especially our more recent annual report on Form 10-K.

In our comments and slides, as well as in our press release, we refer to certain non-GAAP financial measures such as EBITDA and earnings, excluding certain charges. We've provided descriptions and reconciliations of these items in the earnings' release.

Participating on the call today are Steve Hilton, Chairman and Chief Executive Officer of Meritage Homes, and Larry Seay, our Chief Financial Officer. They will discuss our first quarter 2007 and provide full guidance for the full year. At the end of their prepared remarks we'll take questions from the listening audience. We'll keep the call to one hour, so we would ask that you please limit your time during Q&A to one question and one follow up. As a reminder, this call is being recorded and the replay will be available on our website within a couple of hours after we conclude the call.

I'll now turn the call over to Steve Hilton and refer you to Slide Five of our presentation. Steve?

Thank you, Brent. I'd like to welcome all of you to our call this morning and thank you for your interest in Meritage Homes. Our first quarter results for 2007 were closer to 2005 than 2006 in many ways due to the steep increases in 2005 sales, followed by the subsequent decreases in 2006 demand for homes. After nearly a decade of growth through 2005, the housing market slowed last year and surprised nearly everyone with the speed and breadth of that slowdown. Based on several indicators, we believe the worst is behind us, but it may take a while for housing demand to return to normal historic levels. No one knows exactly how soon this will occur or the most degree that it will occur.

Meritage led most of the home building industry in terms of revenue and earnings growth during the five-year period through 2005, and we built a strong balance sheet during that time. As demand slowed, we adjusted quickly and decisively by intensifying our marketing and sales efforts, renegotiating our term day and land option contract, right-sizing our operations to match demand, re-bidding contracts to reduce our direct construction costs, and focusing on process improvements to increase our operational efficiency. These tactical adjustments executed in concert with our long-term strategy protected our balance sheet and helped us out perform many of our peers.

Changes create opportunity and we see this period of change as one of opportunity for Meritage. We've a sound strategy for growth and profitability and a strong organization led by a seasoned leadership team with a proven record of success and a solid franchise in some of the best housing markets in the country. We are using the slowdown in demand as an opportunity to improve in each of these. We are confident in our strategy, but are constantly seeking to improve upon the execution of that strategy.

We have already made some key appointments to our leadership team and may upgrade the organization in other areas as well. We've all but stopped our land acquisitions in markets outside of Texas, and even there acquisitions have slowed. We plan to take advantage of the future opportunities to expand or enter new areas as we find land with attractive terms in highly desirable markets. We expect Meritage will not only remain profitable for the full year, but will emerge from this cycle as a stronger competitor and well positioned to deliver superior growth and earnings for our shareholders in future years.

We'll now review the first quarter's results beginning on Slide Five. Our first quarter 2007 results reflected the broad slowdown in the U.S. housing market and a difficult comparison to 2006. We set all time first-quarter records in closings and revenue during our first quarter of 2006, when we reported year-over-over increases of 41% in home closings and 54% in closing revenues. These records resulted from the strong backlog we carried into the start of the year driven by unprecedented housing demand in 2005. However, demand slowed in 2006 for most U.S. housing markets, which is impacting our 2007 revenue and earnings. As Meritage entered the first quarter 2007, our beginning backlog value had declined 45% from the previous year with lower margins in much of that backlog.

First quarter 2007 home closings were down 29% from 2006, and total home closing revenue was down 32%. Total home closing revenue of $576 million for the first quarter 2007 came from 1,796 homes closed and an average sales price of approximately $321,000. One year earlier our first quarter home closing revenue was $846 million on 2,528 homes closed at an average price of approximately $335,000. These results put us back to about even with our first quarter 2005 levels, which we still consider to be a good performance given the current market conditions.

Moving on to Slide Six -- We reported net earnings and diluted earnings per share of $15 million and $0.57 per diluted share, respectively, for the first quarter of 2007. This slide breaks out a couple of items that help make the years more comparable. We had a one-time charge in the first quarter of 2005 related to the refinancing debt and land-related charges in the first quarter of 2007, which reduced net earnings by approximately $11 million dollars, or $0.40. Excluding this charge, the first quarter diluted EPS would have been $0.97 per share. Adjusting to exclude both the write-offs and the one-time charges, our first quarter net earnings decreased 68% in 2007 after increasing 82% in the prior year.

Slide Seven -- Although home closing revenue returned to levels achieved two years ago, our margins were much lower due to competitive pricing pressure and the additional land-related write-offs I previously noted. Gross margin on first quarter home closing was 15.6% in 2007, compared with a unsustainable 25.3% in 2006. Adjusting for the land-related charges in 2007, gross margin would have been 18.6%, which is below our long-term target of 20%, but holding up better than some of peers due in part to our large franchise in Texas.

Let's go to Slide Eight -- Net sales orders for 2,073 homes totaled $641 million in the first quarter, a substantial improvement from the fourth quarter 2006, although lower than our near-record first quarter 2006. Net sales were boosted by a decline in order cancellations during the first quarter 2007. Our cancellation rate improved to 27% of first quarter gross orders, down from 48% reported in the fourth quarter of last year and in line with the 28% reported in last year's first quarter.

With the increase in sales, the total value of our backlog is now $1.3 billion at March 31, 2007, which is slightly higher than our backlog at the beginning of the year and we hope to continue to build upon it in the second quarter. Considering the difficult comparison to the first quarter of last year, we are pleased with our sales' results this quarter and encouraged by the overall decline in cancellations.

On to Slide Ten -- We ended the quarter with 217 active communities, up from 185 a year ago. Our absorption rate as measured by sales per average community was 10 in the first quarter compared to 14 in the first quarter of last year. Annualized in the first quarter of this year, it appears that our absorption rate is about the same as last year's.

Considering the developments in the last few months regarding sub-prime mortgage financing, we assessed our exposure to credit tightening. Based on analysis provide by our largest mortgage provider, we estimate the direct exposure to our backlog was well under 10% for buyers who may not qualify under tightened lending standards. So far, few sales have dropped out of backlog due to mortgage availability, indicating that our customers are still able to find loan products and sources to meet their needs. Since about 75% of our customer base are move-up buyers, our typical buyers have higher average credit scores and lower loan devalue ratios than the average homebuyer.

We haven't seen any significant impact on our sales that we contribute to the sub-prime market tightening. Unlike many other builders, we have no captive mortgage company, so we are also insulated from exposure there.

I will now turn it over to Larry to discuss our regional results and balance sheet. I'll be back to discuss our outlook and wrap up our comments.

Thanks, Steve. I'll cover some additional first quarter results and focus more on the strength of our balance sheet.

Slide Twelve -- First, I'll review a little bit about our results by state, beginning with Slide Twelve. We have a strong franchise in top home building states and our operating success and experience in Texas has benefited our results in recent quarters as other markets have slowed more dramatically.

Moving to Slide Thirteen -- Closing and orders slowed in our Central segment comprised of Arizona, Texas and Colorado. Total closing revenue was down 7% on 15% lower volume, partially offset by a 10% increase in average sales price. This increase in ASP was primarily due to changes in mix rather than changes in pricing power. Our total order value in this segment was down 24% year-over-year reflecting slower sales in Arizona and Texas, while Colorado improved slightly compared to the first quarter of 2006. We reported a 63% decline in total closing revenue in our West segment comprised of California and Nevada, while the total value of net orders was much better, relatively speaking, off just 9% year-over-year.

These results reflected slowing in Nevada and continued pricing constraints after we had a very successful project opened in late 2005, which was Yellowstone. However, our California markets actually improved slightly. These markets were some of our first to realize a slowdown. Our California home sales improved 23% in units and 2% in total value year-over-year for the first quarter.

Our Florida markets continue to be our weakest segment in terms of order volume and average sales' price. Total closing was 46% lower, while total order value was 62% lower in the first quarter in 2007 compared to the first quarter 2006. Orlando has held up much better than the Southwest Florida area, but has slowed -- lowered average prices and, therefore, reduced the region's average sales' price.

Slide Fourteen -- Meritage is not a spec builder by design; however, cancellations caused by our inventory of unsold homes to increase in absolute number as a percentage of total inventory of last year. Unsold inventory ties up capital and represents a risk that we try to minimize with our build-to-order strategy. In response to the increase in inventory from cancelled orders, we have focused intensely on reducing our number of unsold homes. Our successful efforts resulted in shrinking our total spec count to 1,213 unsold homes at March 31, 2007, representing 31% of our total homes completed and under construction. This was 11% less than our total unsold homes at December 31, 2006, reflecting our success in selling or reselling specs. While still higher than our target of approximately 15% to 20% of specs, we will continue to manage this aggressively.

Slide Fifteen -- We have reduced our lots under control as demand has slowed to 41,936 at March 31, 2007; a 23% reduction from our peak reported at September 30, 2005. This total was reduced by approximately 495 lots in the first quarter of 2007 due to the write-offs Steve spoke about. We own approximately 20% of these total lots with 80% owned by others and under option contracts to Meritage. As demand has slowed, we have continued to purchase lots in order to keep option contracts alive in communities that meet our minimum profit requirements or where it makes economic sense to build out the project. Since sales have not kept pace with these purchases, our total lots owned have increased.

Slide Sixteen -- Our lots controlled are distributed relative to our experience in each market and recent sales trends over the last year. We have abandoned options where the project was no longer economically viable, but we plan to continue to use our option strategy predominantly to control an adequate forward supply of lots.

Slide Seventeen -- Meritage is not a land speculator. Our strategy as a merchant homebuilder is to minimize our risk associated with land values. We target control of four to five years' supply of lots to minimize market risk. We generally lock in our lot supply at fixed prices, preferably through option contracts to a larger degree than most other builders who acquire lots and hold them on their balance sheets.

Slide Eighteen -- We continue to believe that our use of options to control land has provided tangible benefits by leveraging capital to allow us to grow faster when markets are stronger and by reducing our capital at risk; thereby, limiting our land write-offs as markets weaken. Our strategy has benefited our shareholders relative to the amount of shareholder equity that has been written off as compared with other builders in the last year, and we expect to continue to utilize an option strategy.

Slide Nineteen -- I also will note at this time that we believe our goodwill is not currently impaired. We do not expect it to be as long as market conditions stabilize or improve and the downturn is not prolonged. Our most recent acquisitions were in Florida, which makes up less than 30% of our total goodwill balance.

Slide Twenty -- Our net debt-to-capital ratio was 43% at March 31, 2007, which is still better than most other 'BB' rated homebuilders and near the low end of our target range of 40% to 50%. It's reasonable to assume that our coverage ratios may weaken during the year, but we do not anticipate reaching our minimum covenant levels and we expect to maintain significant liquidity throughout the year. We were very pleased to receive an upgrade rating to 'BB' flat from Standard & Poor's Rating Service this past quarter, especially in light of rating actions taking by the agency for other homebuilders.

The total funds available under our existing bank credit facility increased 18% from year-end 2006 to $528 million at March 31, 2007, after considering the facility's borrowing base availability and most restrictive covenants. We increased our liquidity during the quarter by issuing $150 million, a 10-year, 7.73% senior subordinated notes in a private placement completed in February and used the proceeds to pay down our borrowings in another credit facility.

I'll now turn it back over to Steve to wrap up.

Thank you, Larry. Although our operating results this quarter were up against difficult comparisons to the records we posted a year ago, we were fairly pleased with our success considering the market conditions. As we stated previously, we expect 2007 will be a difficult year, but we are encouraged by some early signs of stabilization as we've discussed today.

Relative to our fourth quarter last year we've seen our overall cancellation rate decline, sales pace begin to improve, and incentives begin to stabilize in certain markets, resulting in modest impairments during the first quarter this year. We have taken steps to improve sales, reduce our cost structure and strengthen our balance sheet, and our successes are evident in the results we've reported. While conditions are still challenging with softer demand and weaker pricing compared to a year ago, we are confident in our ability to manage through these difficult times.

Slide Twenty-Three -- Based on current conditions and our projections, we are expecting to close between 7,700 and 8,500 homes in 2007 for a total of $2.4 to $2.7 billion in revenue. Assuming relatively stable conditions going forward and an associated modest exposure to inventory impairments and option write-offs during the remainder of the year, we expect to earn between $2.00 and $2.50 per diluted share for the full year 2007.

We will face difficult comparisons in the second quarter as we did in the first, but we believe order comparisons will ease as we go through the rest of the year. We anticipate that margins will continue to be under pressure due to competition throughout 2007, and we expect modest improvement in demand during 2008, but are not relying on a rebound this year to achieve our projections.

Rather than being overly pessimistic about short-term fluctuations, we're focusing on the long term; maintaining a strong balance sheet while investing to improve in our people, processes and systems; and to position Meritage to take advantage of the opportunities to grow again as the market stabilizes and improves. As I said before, we expect Meritage will remain profitable for the full year 2007. We will emerge from this cycle a strong competitor, well positioned to deliver superior growth and earnings in future years to our shareholders.

We thank you for your attention and we will now open it up for questions. Operator?

Thank you, sir. [OPERATOR INSTRUCTIONS] In order to stay on schedule today and allow all participants to ask a question, please initially limit yourself to one question and one follow-up question. Thank you. We'll pause for a moment to compile questions.

Gentlemen, your first question is from Alex Barron with JMP Securities.

Yeah, hi Steve, hi Larry. I wanted to ask you guys about your impairments this quarter. I'm wondering if you can break it up between what was land and communities impaired versus options you walked away from, and how that broke out by markets as well.

They were about equally broken out. We had one project in California in the Central Valley where we were negotiating with a land banker. Those negotiations were unsuccessful, so about half of the write-down was from that. The other write-down was from owned houses and a few lots we own in Fort Meyers. So those were really the two significant write-downs. Everything else was fairly insignificant.

So, how many communities are we talking about then, just a couple?

Just a couple. Really, there is one large community in Fort Meyers comprised of two or three product types and that was a community we got through our initial acquisition of colonial homes. And then there was one option project with one product type in California. Of course, California the dollars are bigger, so the write-offs are a little bit bigger.

In Bakersfield.

Right. Now, to understand, when you guys write off options, are these active selling communities or are they communities that you would have started, I don't know, a few years from now?

They can be in both, because anything we have that's not currently bruising we are preparing a pro forma, looking at what current pricing is if we were selling there today. You know, obviously in that case, the NRV analysis and pro forma is based more on estimates. Whereas, if we're currently selling, it's based more on hard sales and current sales' data.

Okay.

Alex, so it's probably not going to be a few years from now. It's probably stuff that's starting within the next year or already underway.

Okay, got it. So, how should I think about your comment that you guys are kind of taking on a few lots to keep the options alive and, obviously, it seems like your debt levels are growing as well. How do you guys think about at what point do you kind of keep doing that versus at what point do you, I don't know, maybe take a write-down and discount the homes in order to not kind of stuff too many lots into your balance sheet, or just walk away from the option?

Right now, we are pleased that our debt-to-capital ratios have stayed relatively in check. As we said in last quarter's call, we expect that this phenomenon will gradually -- will continue through the year, but some time towards the end of the year it will probably start to peak as we burn through and buy the last lots under those options and then start to sell off lots that build up on our books in L.A. So, we see this as being a few-quarter phenomenon, one that will naturally take care of itself.

And one last one just to understand your confidence in that you'll stay profitable through the rest of the year, is that basically making an assumption that home prices won't go down and that the sales' pace will stay at current levels or even get better, or kind of what are some of your assumptions for the next 12 months?

It's assuming the conditions remain constant with what they are today.

All right, thanks. I'll get back in the queue.

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

Thanks very much. I was wondering if you can talk about your goal for spec homes; what you'd like to get that down to and also where the geographic concentration of the specs may be at this point.

We'd like to get down to 15% to 20% of our backlog. I think our specs are pretty evenly distributed amongst all of our markets would you say, Larry?

Yes. I don't think we have an over-concentration on any particular market.

Okay, and then secondly, I was just wondering in terms of the options at this point. What do you expect your percentage of land control via options versus ownership to end up as we work through '07, as that percent continues to drift towards more owned land?

We -- go ahead, Steve.

It's hard to say, but I think we'll probably -- it'll probably drift to a little bit more owned; I mean maybe as much as 30% wouldn't you say, Larry?

Yes. I think probably 70/30 would be the low point or high point, however you look at it. And of course, long term we're planning to continue to use options, but it may take us a while to kind of build it back up closer to where it has been historically.

Okay. Thanks very much.

Your next question is from Stephen Kim with Citigroup.

Hi, this is JoHanna Niles with Steven Kim. I had a couple of questions. Can you give a breakout of the inventory this quarter; specifically, homes under construction and unsold homes?

We don't have that breakout available yet, but it will be in our 10Q and that will get filed here in the next week and a half or so and will be available at that time.

But can you tell me was there a sequential decrease in unsold homes just to get a directional idea?

Yeah, as far as the dollar amount of unsold homes, I believe that number is coming down, and our pre-sold home numbers may have come down just a smidgeon, but staying relatively flat. As we've said before, our finished lot inventory is going up a bit.

Okay, and your average sales price increased sequentially by 5%. Is that something that we can expect to be sustainable going forward?

That's something that is just affected by mix more than anything else, and it's just a matter of what subdivisions are selling out and what subdivisions are coming on line.

It may come down a little bit more as Texas becomes a bigger part of our mix, but we can't tell you exactly how much.

Okay, thank you.

Actually, guys, it's Steve Kim. I just got on. Can I ask you a quick question about your overall strategy versus the rest of the industry in the markets you're encountering? Certainly, your results today were better than some of your peers, and some of your commentary about the direction of the market demand also seemed to be a little bit more sanguine than some others. And so, I'm trying to figure out how much of this is a function of Meritage's specific performance and how much of it may be due to either geography or the type of product you're building versus your competitors? Could you maybe shed any kind of light? For instance, are you seeing that some of the price discounting that we're hearing from some of the other builders is occurring at price points may be a little bit below where you are, or in maybe more of a far-flung or outlying areas? Let's say Phoenix versus where you are; things like that that could help us understand maybe if you're fighting the same battles that everybody else is.

Oh, I think there's a few differences, Steve. I think mainly, number one, it's our Texas franchise. We have a larger percentage of our business in Texas than most builders and I think that's -- although it affected our margins in the good times, it's helped us in these slower times, and it's really one of the key distinctions between us and competitors. I think the other thing is just clearly our option strategy. We just don't own a lot of land and we don't have big write-offs associated with land that we own. But beyond that, I mean I think we're in similar price categories and competitors and similar markets. Our exposure to Florida is relatively minimal. Discounts are very large there. I actually think our franchise in Arizona has been helpful, because we have some pretty good land positions here that still have decent margins and we're still making good profits here, so. But I go back to saying that certainly Texas is really the big difference.

Got it. Great. I appreciate it. Thank you very much.

Your next question is from Shanna Saduken [sp] with Lotus Partners.

Hi, guys. Just a great job. My question is, in terms of the guidance for the year, how much are you assuming that the Company will be affected by impairments in Q2 through Q4? Does the guidance assume some impairment going forward, or does it assume zero impairment going forward?

It assumes some, but I don't know that we're giving a specific number on that. But there are some relatively small impairments compared to our past year that are calculated into that number.

Okay. And the second question is, could you go through your major markets, so Arizona, California, Texas, Florida, and talk about which markets the inventory situation, meaning homes on the market, in which markets is inventory decreasing and in which markets is new inventory still coming on the market, or homes that were taken off the market are now being put back on the market?

Are you talking about resell?

Yes, exactly; resell.

I don't have all those numbers in front of me here, but I'd say from what I can recall Arizona's relatively stable. It's at a high level, but I don't think it's increasing. I think Vegas might be increasing. I think some markets in California are increasing. Certainly, Southwest Florida is not improving. I can't tell you about Orlando and I really can't tell you about Texas right now.

Okay, thank you.

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

Morning, gentlemen. I wonder if you could talk a little bit about your -- what happened with commissions' and sales' costs? As percent of homebuilding revenue, it showed a jump from 5.7 last year to 8.2 this year. Are you giving high -- really trying to incentivize independent broker/retail, you know real estate agents to sell your product or what?

Larry?

Yeah, Steve, I have the breakout on that. The two-thirds of that increase is from two numbers; one is commissions and other types of commission-related costs. And yes, we are doing more co-broker commissions. We are increasing commissions in some areas and that's a little over 100 basis points of the increase. And also because we do have a few more stores open and our absorption rate isn't as high on an absorption rate per month level, our model and sales office costs are a little bit higher of percentage sales, and that's about 60 basis points. And then there's other things which I won't get into which make up the balance.

Okay. What should we sort of think about modeling that going forward? Will that decline back toward where you have been, or is it going to stay high the entire year?

I think it's going to continue to stay high at least through '07 and we'll start to moderate in '08, but that just depends on where market conditions are in '08.

Okay. Next, can you give some guidance on your tax rate? It came in lower than I had expected and lower compared to a year ago's average?

Yeah. There are two things going on there. One, the 199 domestic production activity deduction increased from 3% to 6%, so it doubled. That's causing about a 1% tax rate improvement. So, I would assume over the year you'll generally see a tax rate that was last year kind of in the low 38% drop to the low 37% range. Now, in addition, this quarter there were some discreet items that are reversed and are running through the tax rate in this quarter. And with 1048 and the focus on making sure taxes are up to snuff, what people used to do is take some of those discreet items and spread them over the year and use an average tax rate, so you came out with a smooth number. You will see more variation in quarterly tax rates going forward as people book discreet items in particular quarters. So that was the reversal of some interest in other items on tax positions taken last year that we have resolved and have been able to reverse the tax accrual.

That's helpful. Let's switch to the mortgage market. In talking to your mortgage bankers, what sort of feedback are you getting on Alt A? A lot of people are noticing a significant worsening in the performance of the securitized Alt A bonds, and that now seems to be a growing issue. Do you have any idea what your exposure is to Alt A? It has to be high certainly in California?

Larry?

We have talked to our mortgage people, particularly the MTH Mortgage, which handles most of our business. And although I can't specifically address the Alt A issue, we have had many conversations with them about the quality of buyers we're seeing, the types of mortgages that they can be approved for in our slides covering that. We really feel that our backlog exposure is pretty small and that the people we're seeing that are coming in today are better qualified. They already have their home up, or they've already sold their home, so they're better able to qualify. Now, maybe people in the past were opting to go with a no down or a low doc or no doc loan. But today, some of those products aren't as available, but we're still getting people qualified under other products. So, it's not having a significant impact on our sales today.

Okay, thank you.

Your next question is from John Kohler with Oppenheimer.

Good morning. It's actually Oppenheimer. What was cash flow from Operations for the quarter?

We don't have that number compiled yet. It will be in our Q, and again, because of the lot purchases that we're doing through '07 from the lag effect between option takedowns in sales and starts, that number will be negative. I can't tell you how negative, but as we grow that position on our balance sheet that is a use of cash. On the other hand, we are planning for that. That's why we planned our balance sheet the way it is to be able to handle that and we don't see that being a major issue going forward. Of course, we are going back and renegotiating as many lot takedowns as we can to push those off, but we aren't going to be completely successful. And I also emphasize that these takedowns are options, so we're choosing to go forward and put lots on our books because they still make economic sense and we're not being forced to. These are not puts. It's part of our strategy.

Right. If I could just get some clarification. If you're not forced take them on and they make economic sense but you're trying to renegotiate them down, I guess the sort of juxtaposition there is I don't quite understand. I thought the value of the option would be able to walk away.

Let me try to explain it to you. You're halfway through a project and now your option deposit is building. Let's say it started at 10%. Now, you're halfway through the project, you're up to 20%, and although the margin has decreased significantly because prices have gone down you still want to get your 20% back. So, you're not going [inaudible] said deposit, so you're not going to walk that option. And also, on the back half of the project, you're not going to have a lot of leverage with the land banker to get a significant reduction in price or terms. So, in those kind of situations while we're still profitable, although profits may be a lot less than originally pro forma'd, we're going to continue with those options and we're going to put those lots on our books and we're going to have a positive cash flow coming through those lots. So, that's why we continue to buy lots in projects that are seasoned. A brand new project that we just started, or maybe haven't even started yet, we're going to have a lot more negotiating leverage with the land banker and we would not proceed at the same degree.

Okay. And then, just one last question. The deposits that you're taking on orders, could you say if those are going down?

They're about the same as they've been in the last year. I mean some places they're a little bit less and some places they're the same or more. But we're somewhat a victim of what our competitors are doing and some of our competitors are taking pretty minimal deposits in a lot of places. So we have to compete, but we're doing the best we can to get as much money as possible so that we can have a better position when buyers come in near the closing and try to renegotiate a contract or find a better deal down the street.

Right. Okay, thanks.

Your next question is from [Bob Wettenhall] with Royal Bank of Canada.

Hi. Good morning. Congratulations on the upgrade. Had a few questions. I know your option-heavy and your land position is very light relative to other homebuilders. In that context of your guidance, do you have an estimate for what your -- or a guesstimate of what your '07 free cash flow's going to look like?

As I said before, we aren't providing that number either for the quarter or the year. It just depends on how good of a job we can do in managing pushing off takedowns. As Steve said, in some cases we have less leverage than others, but we'll do our best. Overall, I think we will wind up with more lots on our balance sheet at the end of the year than we started and that's certainly use of cash, so there's a lot of other factors that go into it. What happens to our spec inventory; how good we are at dropping that; how profitable we are. So, I'm not going to venture a guess on that number today.

Sure. Do you have a debt-to-capital target, or a net leverage target for the year?

Yeah well, as we said, the broad target is 40% to 50%. Although, we think we'll be able to continue to operate the business in the lower end of that range.

Okay and one final question. Texas, your ASPs were up on new orders by 6%. Is that mostly due to mix?

Yes.

Got it. Good job, guys. Thank you.

Okay, thanks.

Thank you.

Your next question is from Brian Duncan with The Boston Company.

Hi. Great quarter, guys.

Thanks.

Thank you.

I had a question on Slide Thirteen and just kind of the home closing ASPs versus the order ASPs. I'm looking at Arizona from 19% to 10%. Can you kind of talk about the different geographies there and what's going on in those?

Larry?

Closings versus orders?

You know, that's -- again, a lot of people focus on these average sales prices and try to read into them; maybe that's a market-driven sales' price. And certainly in a lot of cases where we're seeing decreases, it is market-driven, but a lot of the decrease is also driven by mix issues. I think there is a focus on making sure our product is attuned to the market, so we may even be adjusting some of the standard features in the house to try to bring the sales' price down, but that may not affect our margin. As far as the particular instance in Arizona goes, why the closing is larger or is positive, up 19%, that is just we had a lot of very good backlog in Arizona and we're still closing some of the that from a few quarters ago. A part of it's mix. And then, certainly, the negative for the orders is being affected by market, but you can't read that that's a 29% swing all caused by market. Part of it's mix and part of it's market.

And one follow up. I mean as far as that 10% decrease in orders, I mean is that -- how much of that is going to affect your margin versus your ability to kind of change what you're offering people and have the same margins on that product?

It's difficult to talk specifically about a particular project, our division, but as you saw from our results our gross margins were at 18%, significantly down from a year ago; below our target. But really, 18.6% is not too, too bad. We've also said though that during the rest of the year we think there's going to continue to be margin pressure, so I think there is a little bit of a continued downside push, excluding NRVs. This is just on a straight-up basis, where that 18.6% could be a bit lower over the next quarter or two and that's built into the guidance we have provided.

Great. Thanks a lot.

Your next question is from John Emrich with Emrich's Capital.

Thanks. I was just wondering if you would be willing to expand a little bit on the back half of your comment that the worst is behind us, but you're not predicting a return to normal yet. I'm looking for your definition of normal and how does existing homes' inventory play into that amongst all the other variables you could consider?

Well, I'd say a couple of things. Number one, April started off kind of slow, so we're not getting real excited that it's completely behind us. Number two, a normal market for us is one house per community per week; selling one house, four houses a month, 50 houses a year. We're not there yet. We're about 75% of that, so we're not quite what we deem is completely normal absorption levels. Although, it is better than it was a quarter or so ago, so it's going the right direction but it's certainly not normal.

So, that's a sales activity term, if you will, you're referring to?

Right, sales order term.

Okay. And then, you just started to address this in the last question, which is that the margin's trending down from here. What were your margins on average say the five years before 2005? I mean 20% still feels like a well above -- and maybe you guys wills be -- but above average; maybe not for you but maybe it is. I don't know.

No, I think 18% to 20% gross margin is kind of an historical place we've been.

Right.

With SG&A of 9% to 10%, we try to finish up approximately 10% net profit.

Ten percent operating costs?

Pre-tax.

If I might add, in our recent annual report that just came out, we have a 10-year summary. And if you'll look at the gross margins, excluding '05, they essentially ran from 19% to 21% throughout a 9-year period. The year being public was a bit lower, so that 19% to 20% is a good, solid historic range. And '05 was the only year that it was above that at 23.6%. So really, '05 was out of character, and then '06 started to head back down. But that 19% to 20% range we feel fairly confident that that's a good long-term solid number.

And a 10% to 11% say operating profit margin?

Yeah, more in the 10 range; historically, it's kind of been in that 10 range.

That sounds reasonable. Then, I guess the only variable for everyone to fill in is how many homes we build a year and whether they're kind of smaller over the next 10 years than they were the last 10 years.

And how long will it take us to get back to that historical range.

Exactly. Yeah, which gets back to the issue of the existing home inventory. Thank you very much.

I could add about the comps getting better, if you look at our sales' trends, particularly the sales' trends comparisons to the fourth quarter of last year; our sales were off significantly last year, kind of in the 40% to 50% range. So that's why we say that when we get to the fourth quarter of this year, the comps do get significantly easier on the sales' side.

Your next question is from Robert Tracy with Kynikos Associates.

Judging by the change in the net debt quarter-over-quarter, it appears like the cash burn was a lot higher than you historically have had, especially in the March quarter. I understand it seems like it's from the bringing down of the options. Can you talk a little bit about like how much more -- because it sounds like some of these options may be are not as discretionary as maybe we originally thought -- how much more capital are you going to invest over the coming year on bringing down more of these options and investing in the land? What is your community count going to be at the end of the year?

Well, we're not giving guidance on cash flow, so I can't give you that number. But, lots on the balance sheet is probably going to increase. As we said earlier, we're going to probably end up closer to a 70/30 mix. What was the second part of your question? I'm sorry.

It's curious because I mean other builders do provide some assurance that they are going to be cash flow positive. Will you be cash flow positive by the end of the year, or you cannot make that assurance?

We can't guarantee that.

You could actually burn through cash by the end of this year?

Well, could I comment? Other builders have a bunch of lots on their books, okay? We never invested that money in the lots. We've had them invested in option deposits with just a fraction of the total lot cost. So when they make the statement we're going to be cash flow positive, what they're doing is liquidating a whole bunch of lots that were already on their books. We don't have those lots on our books to liquidate. We're to some extent a little bit the opposite position where we have a few building up and we're investing in lots that we haven't had to invest in before. We don't consider that to be a major problem. Sure, it's an issue we are dealing with and addressing and we are doing all we can do to continue to run on our option model. What we're saying is during this period of time there's a slight deviation, not a major deviation. Depending upon if we are successful in pushing off a lot of those lots and we can keep the number down, that will change how we view the cash flow over the full year. But if we're less successful, we may build up some more lots and I don't consider that to be -- it's not like we're losing money. We're just investing in land that will be liquidated in '08 instead of being -- not having to vest it in '07.

Well, I guess, maybe should we .

It's short-term land. It's not long-term land.

In terms of your investment in real estate, do we expect that number to start coming down or should we expect it continue to build?

Well, again, it's the -- go ahead, Steve?

It will probably go a little bit before it goes down. We think another quarter or two it might increase and then, hopefully, it'll go down from there.

Okay, and so your community count will be higher then in December?

No. I think our community count will be pretty flat, and as we go into 2008.

So the inventory will go up, but the community count's going to remain somewhat flat then?

Correct.

Yeah, but that is because -- let's say in the past we had 10 owned lots per community. Now, we might have 20, just to give you an example. But it's not like we're expanding our communities, and it's just those other builders may have had a whole bunch more lots per community. We are just going to be going up a little bit before it comes back down, but it's something that we're managing and controlling and aren't overly concerned about it. But yeah, we're very focused on return on assets, so we're doing everything we can to bring spec levels down and to bring our lot levels down. But lot levels -- spec inventory as I said are already peaking and coming down and lots are going to lag a couple of quarters, and how much it lags and how much it goes up is not quite predictable, so that's why we're not giving a number.

Okay, thanks a lot.

Thanks.

Thank you.

We'll take one more question, which comes from the line Alex Barron with JMP Securities.

You let this guy ask two questions?

Thanks, guys.

It's okay, Alex.

I just wanted to ask you about the sales' trends in the quarter. How did they kind of look January, February and March, and can you comment on April? I'm particularly interested in California, how it's been affected by the sub-prime sort of meltdown.

Well, I'd say sales got stronger through the quarter. As we got more into February and March sales got better, but I'd say we've seen a pretty significant drop off from our March levels going into April. The first few weeks of April for whatever reason have not been at the level that we saw in March. Maybe it's just because everybody tried so hard to finish off the quarter strong that we ran out of bullets, but this quarter, this month has been weaker than we expected. Whether that portends to a trend for the quarter, I don't know yet. It's too early to tell.

Okay. Was there anymore significant weakness that you saw in California due to the sub-prime issues?

No, it's really just been everywhere. It's been consistently weaker everywhere.

Now, as it pertains to taking a write-down or increasing your level of incentives, you said that you try to target a sales' pace of one home per week per community, so how low does it have to go before you kind of say, okay, it's too low?

For a write-down?

Or to increase our prices.

Yeah, or to increase your level of incentives.

Well, we're tweaking our incentives all the time. We're trying to get the axis to cross between absorption and profitability and price. So, I'm not going to give away the secret sauce on how we do that, but I would say a write-down is really more dealing with whether it's profitable or not. If a community can be profitable at one sale per month, then we're going to keep doing it at one sale per month. But if it takes three or four sales for it to be profitable and cover the fixed overhead, then that's going to factor into our NRV calculation. Isn't that right, Larry? Do you want to add on to that?

Typically, one sale a month would not do it for us, because it wouldn't be covering the overhead of operating the model and the construction process and all that. So, I would say we try to rock back and forth between three or four, and certainly better than that's better. But you know, once you get down into the one to two range it starts to become more problematic.

Yeah, but some communities, like say in Texas, can be very profitable on low absorption rates because they have very low fixed costs. They only have one model, instead of three or four you might see in California. So, they can be profitable at lower absorption levels. Some high-priced communities, like we have one here in Scottsdale, we only have one model. The margin's really strong. We can make money at one and a half to two sales per month. Other communities where we're more to the medium price, or maybe even below the medium price, we need to have that absorption level to cover the fixed costs.

Okay, got it. Thanks. That's helpful. Take care, guys.

Thank you for joining us for Meredith's First Quarter 2007 Earnings Call and we look forward to speaking with you next quarter.

Ladies and gentlemen, we do thank you for your participation in today's conference call and this does conclude the presentation. You may now disconnect. Have a great day!