Meritage Homes Corp (MTH) 2007 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the Meritage Homes fourth-quarter 2007 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you. Mr. Anderson, you may begin your conference.

Thank you, Tina, and good morning to everyone. Welcome to our conference call today. Our quarter ended on December 31 and we issued a press release with our preliminary results on January 17. After the market closed yesterday, we issued a release with our final results for the quarter and full year. If you don't have those yet, you can find them on our website at www.meritagehomes.com on the investor relations page. That will also have the slides that accompany this webcast.

Please refer now to slide 2 of our presentation. Our statements during this call and the accompanying materials contain projections and forward-looking statements 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 those risk factors, please see our press release and our most recent filings with Securities and Exchange Commission, especially our most recent quarterly report on Form 10-Q and our 2006 annual report on Form 10-K.

With me today are Steve Hilton, Chairman and CEO of Meritage Homes, and Larry Seay, Executive Vice President and CFO. I will now turn it over to Mr. Hilton to review our results for the quarter. Steve?

Thank you, Brent. I would like to welcome everyone to our call this morning. 2007 was certainly the most difficult year for homebuilders in more than 25 years. We experienced slowing sales, weak prices, high cancellation rates, inflated inventories of homes for sale, and a credit crunch caused by fallout from subprime market, all in one year.

In addition, we saw large inventory impairments, a sharp drop in home starts, and builders reporting losses after years of strong earnings growth. Balance sheet management and cash flow are now the focal points of the industry.

Despite this difficult environment, Meritage generated significant positive cash flow during the fourth quarter and used it to reduce our debt by more than $150 million. We made good progress reducing our unsold homes inventory, lot options, joint venture and real estate assets, and strengthened our balance sheet in the process. We also streamlined operations and reduced overhead commensurate with the declines in sales that we experienced.

We are hopeful that the Fed's actions and changes proposed by the government will help homebuyers by reducing mortgage interest rates, raising loan limits, and allowing more buyers access to loans from FHA, VA, or Fannie Mae and Freddie Mac programs, which will allow lower downpayments and have more flexible underwriting standards.

Those may in turn help the homebuilding in industry, but the effects of those actions are uncertain and their timing is unpredictable. So we must manage through this downturn using our own experience and perseverance. We are focused on protecting our balance sheet and maintaining liquidity to both weather this downturn and better position Meritage for the future.

I will briefly summarize our results for the quarter and the year and address the progress we made on our operating initiatives before I turn it over to Larry Seay, our Chief Financial Officer. He will walk through our financials as we normally do, and then we will take your questions.

Slide 5. One highlight of the fourth quarter was that we reduced the outstanding balance on our bank line by over $150 million, a major accomplishment after we turned the corner in the third quarter and started to generate positive cash flow.

We generated cash primarily from seasonally strong closings of presold homes and a 10% reduction in unsold homes inventory, and curtailed spending through reducing lot purchases under pre-existing option contracts by $55 million, along with other various operating efficiencies.

We used this cash to reduce our bank line by $153 million and ended the year with a remaining balance of $82 million on our credit facility. Our goal is to bring the credit facility balance down to zero by the third quarter of this year. We have collected about $24 million in tax refunds already this year and expect to collect an additional $52 million in the first quarter of 2008, which will help towards achieving this goal.

Slide 6. We reported a net loss of $129 million or $4.91 per share for the fourth quarter. This compares to net earnings of $9 million or $0.34 per diluted share for the fourth quarter of 2006. Fourth-quarter 2007 home-closing revenue decreased 25% year-over-year to an 18% decline in homes closed and a 9% decline in average closing price.

Our GAAP loss in the fourth-quarter 2007 is explained by three major items that had little or no impact on cash on a pre-tax basis. Number one, the largest impact was a result of the $130 million of charges for valuation adjustments that related to real estate and joint venture inventory. Market conditions in the fourth quarter weakened further, prompting us to write down inventories or cancel projects that were no longer viable.

Second, number two. Second in the order of significance, we wrote off the remainder of our goodwill, taking a charge of $58 million to leave us with no goodwill assets on our balance sheet at year end.

Number three and third, we incurred $11 million charge in connection with a tender offer for significantly out of money stock options which would provide little, if any, future benefit to our employees. This action accelerated the related non-cash compensation expense that would have been incurred over the next four to five years.

We recorded one of our small impairments of $3 million on our only two golf courses that we own on our active adult communities in Arizona. These were fixed assets on our books and are now assets being held for sale.

By comparison we incurred $63 million of pre-tax charges in the fourth quarter of 2006 for real estate valuation adjustments, but no goodwill or other write-offs. Excluding the fourth-quarter 2007 charges, which had the combined after-tax effect to reduce our net earnings by $133 million, we operated at a small profit for the quarter.

Slide 7. Arizona has the largest decline in home closings, off 48%, due to fewer actively selling communities and a more competitive selling environment and difficult comparisons to the fourth quarter of 2006. Home closings in Arizona were still quite strong, only 13% lower than their peak in the fourth quarter of 2005. Conversely, home closings were off 9% in California, and 20% in Florida, and up 6% in Nevada, benefiting from easier comparisons to the prior year's closings. These markets were some of the first to slow and reported much larger declines a year ago.

Slide 8. We also reported a net loss for the full-year 2007 of $289 million or $11.01 per share compared to net earnings of $225 million or $8.32 per diluted share for the full-year 2006. Full-year home-closing revenue for 2007 was $2.3 billion, nearly one-third lower than 2006, our all-time record year for home closings and revenue.

The decline in home-closing revenue was due to an 8% decline in average sales prices compounded by a 27% drop in homes sold. We experienced the greatest declines in closings for the year in Nevada, off 58%, and Arizona, off 49%, due to weak housing markets there. Our home closings in Texas declined only 2% year-over-year. Colorado closings increased 43%, where we are building from a startup operation in 2006.

The full-year 2007 loss is explained by the same types of non-cash charges in the fourth quarter -- inventory valuation adjustments, goodwill write-offs, and the stock option tender offer. Together, these reduced net earnings by $344 million after-tax. Excluding these charges, which were primarily non-cash in nature, we operated at a profit of about $55 million for the full-year 2007 compared to a profit of about $274 million in 2006, excluding the effects of a $78 million in pre-tax inventory valuation adjustments.

The net effect of our 2007 loss was a 28% decrease in our book value per share from year-end 2006 to $27.81 at the end of 2007.

Slide 9. We started the fourth quarter with 1,233 unsold homes in inventory and ended the year with 1,107, a net reduction of 10% or 126 homes despite a 47% cancellation rate that negatively impacted our net sales and inventory reductions.

We believe the high cancellations were due to buyers' inability to sell their existing homes or obtain financing in some cases; and many backed out of contracts thinking the home would decline further in price. Many of the cancellations were also at later stages, meaning that we had more completed or nearly completed homes added to our unsold inventory.

Looking at it another way, we had one home added back to unsold inventory for every two homes that we sold. Once the cancellation rate begins to come down, we expect to see a much larger reduction in unsold homes and a similar increase in net sales. In spite of the high cancellation rate, I am pleased with our progress. We expect to continue to lower our unsold inventory in the first half of this year.

Slide 10. In addition to generating cash as we delivered homes, we reduced our lot purchases under options by approximately $55 million, acquiring about 650 fewer lots in the fourth quarter than we did in the third. The great majority of our total lot purchase in the fourth quarter were in communities where we had limited inventory of owned lots and home sales were generating acceptable margins.

We plan to continue aggressively targeting reductions in our inventory of unsold homes and limiting lot purchases whenever possible, with a goal of reducing our credit facility debt to zero by the third quarter this year, and then starting to accumulate cash reserves.

Slide 11. We have successfully reduced our total lot supply as sales volumes and expectations have declined. We have canceled many projects that were not economically viable and renegotiated others relative to our adjusted expectations. We canceled options for almost 4,500 more lots this quarter, reducing our total lot supply to about 26,000 at year end. That represents a 52% reduction from our peak in the third quarter of 2005.

Our owned lot inventory principally represents active communities which have come down slightly from their peak at June 30, 2007. We expect our active community count to come down about 20% by the end of 2008 as we sell out of communities with fewer new ones in the development pipeline that will begin active sales in the future.

We owned or controlled a total of 26,115 lots at year end, representing a 3.5- to 4-year supply of lots. Since that is fewer years of supply than most builders, our balance sheet is land light, which we believe is a lower risk by comparison.

Of that total, we own about 40% compared to a low of less than 10% just two years ago. Our owned lot percentage has increased mainly as we have aggressively reduced our lots controlled through options during the housing market slowdown. Accordingly, we have also reduced our cash position, cash option deposits, to $87 million, half of what they were at the end of 2006.

Slide 13. A large portion of our total lot supply is in Texas, where we believe there is a low risk of significant impairments. Texas accounts for nearly two-thirds of our option lots at year end and almost 40% of our option deposits, and more than a third of our owned lots.

Homebuilding markets in Texas have been and remain today stronger than other parts of the country, partially because homes there did not generally experience the significant price appreciation seen in other markets, and because supply and demand remained more in balance over the last decade. We also have a high percentage of developer or seller carry options in Texas, which provides more flexible terms than land bank options.

Considering that we have less than a two-year supply of owned lots which we already impaired to reflect today's home prices, and the fact that a large percentage of our lot supply is in Texas, we believe our risk of significant future impairments is limited and the worst is behind us know.

There has been a great deal of concern about homebuilders' joint ventures in the last several months, so I will address our JVs now. As you will see, they are not significant relative to our total operations or financial positions.

We use JVs for two purposes. One is to provide our customers with mortgage or title service. The other is to acquire and develop land.

Slide 14. We're involved in a total of nine JVs with mortgage brokers and title companies. The JVs do not originate or hold any mortgages but serve as loan brokers. Our partners in the JVs do the underwriting and the administration of the loans; and Meritage simply refers customers to them.

These relationships help us avoid delays in closings and deliver a home to a customer while generating additional income. We have invested only about $1 million in capital in these JVs, and the liabilities of these JVs are generally nonrecourse to Meritage so our exposure is minimal.

Slide 15. On the land side, we are actively involved in 14 JVs, 12 accounted for on the equity method and two on the cash method. We have reduced our investment in the 12 equity method JVs to about $22 million after the impairments we recorded in 2007; and we believe that we have little exposure in these joint ventures. Little additional exposure in these joint ventures.

The debt of our equity joint ventures that is not on our balance sheet is generally nonrecourse to Meritage except where we provide limited pro rata guarantees. Our pro rata share of those is about $5 million for repayment guarantees and $88 million in, quote, bad-boy guarantees. We believe the risk associated with these bad-boy and repayment guarantees are not significant.

Should we decide to terminate our involvement in one of these projects and walk away, we would fully impair our equity investments and have little other exposure to the project as the bad-boy guarantees spring into effect only if we try to block the lender from taking control of the assets in the joint venture. We have in fact fully impaired our investment in four of these JVs which together account for about one-quarter of the total assets and the liabilities of the 12. The lenders have provided notices of default on the debt of these JVs, and the JV partners are currently in discussions with the lenders regarding these issues.

Slide 16. The other two land JVs are accounted for on a cash method of accounting. These are very large JVs with many partners; and Meritage is less than a 4% investor in them. Because the lenders have provided notices of default on the debt of these two JVs, the partners in control are discussing options with the lenders to find a resolution. We have totally impaired our investment in one and partially impaired it in the other, leaving our investment at just $2 million.

These JVs also have to bad-boy guarantees, and our limited pro rata portion of the guarantees totals $29 million. We believe the risk of these guarantees being triggered is minimal. We have no obligation under these JVs. The bottom line is we believe our off-balance sheet risk is limited.

Slide 17. We have worked hard at managing our cost structure. We have consolidated and streamlined operations wherever possible, reducing our staff to match our sales and construction activity, and reduced overhead commensurate with our revenue. Despite the difficult homebuilding environment, I am pleased with the progress we are able to achieve on our operational plans and other nonfinancial objectives.

We reduced our unsold inventory and lots under control, continued to shrink overhead costs, and generated significant positive cash flow in the second half of 2007. We also improved our sales training, marketing, and customer relations, including a significant increase in our customer satisfaction ratings during 2007. We completed the implementation of a new management software across all divisions, recognized substantial savings in purchasing, and made many improvements in our human resources and benefits systems. Each of these improved our organizational efficiency or abilities to better serve our customers.

Larry?

Thank you, Steve. Slide 18. Net orders for the full-year 2007 fell 19% due to turmoil in the mortgage and credit markets, rising inventories, and intense competition in new and existing home prices. While year-over-year comparisons were negative, the rates of decline in home sales were less pronounced than last year's across most of our divisions.

Our backlog value was down 44% from 2006 at December 31, 2007, reflecting a 10% decline in average sales price on 38% fewer homes in backlog. The decrease in homes in backlog is explained by lower sales, higher cancellations, and a strong conversion of beginning backlog to 2007 closings. Lower quantities of homes in backlog in Arizona, Texas, and Florida accounted for most of the total decline in backlog value.

Slide 19. High cancellations reduced both our net orders and backlog. We have experienced higher than normal cancellation rates for the last two years, and our cancellation rate was 47% in the fourth quarter, when can-rates are also seasonally higher.

Slide 20. As Steve noted, we recorded a non-cash charge of $130 million of pre-tax real estate related and joint venture valuation adjustments in the fourth quarter. Terminations, inventory write-downs, and joint ventures each comprised about the third of this charge, with the balance related to lots held for sale.

Our total impairments for 2007 are shown on slide 20. About half of the total represented write-downs of inventory in impaired projects. Another third was for the cancellations of about 12,600 lots under option. The remainder was related to impairments of our joint venture investments and land held for sale.

The write-offs were concentrated mainly in California and Arizona, where we had a large presence and where prices have fallen dramatically. These two states account for about two-thirds of our total real estate related charges in 2007 while Texas accounted for less than 2% of the total.

Slide 21. During the quarter, we wrote off all $58 million of goodwill that remained on our balance sheet at September 30, which was associated with Nevada, Arizona, and Texas. We had already written off goodwill in Florida and California by the end of the third-quarter 2007.

The write-off was driven by the fact that our market capitalization didn't support the value assigned to goodwill and is not a reflection of our outlook for those markets.

Slide 22. Fourth-quarter homebuilding gross margins were reduced by lower selling prices and real estate related charges of $84 million in 2007, and $63 million in 2006. Excluding these charges, adjusted homebuilding gross margins contracted to 12.1% in 2007 from 19.8% in 2006, reflecting more aggressive pricing strategy.

Average sales prices in the fourth quarter of 2007 as compared to the fourth quarter of 2006 declined 20% in Florida, 18% in California, 17% in Nevada, and 13% in Arizona, with a 5% increase in Texas and a 14% increase in Colorado.

We still have many communities that are selling homes at acceptable margins, though they may be lower than we originally projected. In many cases, however, we're looking for cash returns where we have inventories of homes or lots that represent sunk cost to us. We are more aggressively marketing these to reduce our inventories and generate cash.

Slide 23. General and administrative expenses of $30 million in the fourth-quarter 2007 included an $11 million non-cash charge related to a stock option tender offer, with no similar expense in 2006. Excluding this item, we reduced general and administrative expenses by $17 million or 48% from the fourth-quarter 2006, to 3.1% of fourth-quarter 2007 total revenue, from 4.4% of forth-quarter 2006 revenue.

Slide 24. Including work-force reductions made in January of this year, we have reduced our employee base by almost 40% in total, more than 54% outside of Texas, from our peak in mid 2006. We have sized our operations to reflect current market conditions.

We have also been able to realize savings in every department through tighter budget controls, or efficiencies gained by consolidating or reorganizing work. Commissions and other selling costs were 14% lower than the prior year, although slightly higher as a percent of total revenue due to the more competitive selling environment.

Slide 25. We have already received $24 million in tax refunds in 2008 and expect to receive an additional $52 million cash from tax refunds in the first quarter of this year as we carry back tax losses incurred in 2007 to recover taxes paid in 2005. The anticipated tax refund is already reflected in our receivables balance.

We expect to trigger the realization for tax purposes of approximately $40 million to $60 million of the deferred tax assets in 2009 and the balance of 2010 and beyond. We currently believe the tax asset is recoverable.

Considering these expectations and others that Steve noted regarding our inventory reduction plans, we look forward to reporting further progress in generating cash and reducing our debt in the coming quarters.

Slide 26. We are in compliance with all of our debt covenants at year end and had available borrowing capacity of $381 million under our revolving $800 million credit facility at December 31, 2007, after considering the facilities' borrowing base availability and most restrictive covenants.

Our interest coverage was about 2.3 times interest incurred compared to our 2.0 times covenant requirement based on trailing four quarters adjusted EBITDA.

As previously announced, we amended our credit facility in September 2007 to relax this covenant for a time, while our earnings are being negatively impacted by market forces. This modification allows us to drop our interest coverage ratio below 2 times coverage for a period of nine quarters, and as low as 0.5 times for three quarters.

Our net debt to capital ratio was 49% as of December 31, 2007, compared to 40% at December 31, 2006. Despite a slight reduction in our total debt, the percentage increased due to reduction of equity from the 2007 net loss.

Our credit facility extends to 2011, and the earliest maturities on our long-term debt are in 2014 and beyond.

Our current tangible net worth covenant is at $609 million and as of December 31 we have a cushion of approximately $102 million. Our current leverage is 1.1 times compared to a maximum allowable leverage of 2.25 times, subject to reduction to as low as 1.4 times if our interest coverage has dropped below 2-times level.

I will turn it back over to Steve now to summarize.

Thank you, Larry. This has been the most difficult year we've experienced in homebuilding in more than 25 years and we expect -- currently expect 2008 will also be challenging. Although we may incur additional impairments if market conditions deteriorate further, we believe the great majority of these are behind us, based on the relative strength of our Texas markets and the significant impairments and option terminations we have taken in other markets.

We believe that buyer confidence must return in order for home sales and homebuilding markets to improve. We look for stabilization in home prices, sales activity, and lower cancellation rates to signal recovery. We're optimistic that the Fed and government programs will help the homebuilding industry by adding liquidity to the mortgage market and allowing consumers to buy with confidence again.

In the meantime, we plan to continue to operate conservatively, protecting our balance sheet and maintaining liquidity to weather the downturn. I appreciate the efforts of our employees who have worked so diligently to address the daily challenges and opportunities we face with an optimistic attitude toward better times ahead.

Additionally, I would like to recognize two executives who have done an exceptional job in defending Meritage's balance sheet over the last year. Larry Seay, our Chief Financial Officer, has been our CFO for almost 12 years, has worked extra hard this past year to position our Company for future success.

Tim White, our General Counsel, who has been associated with Meritage since 1991, has been a tremendous resource in helping us navigate through the legal complexities that manifest themselves in these challenging markets. Meritage is extremely grateful for both these gentlemen's leadership during these stressful times.

Our primary focus in 2008 is to strengthen our balance sheet and maintain liquidity. We are committed to protecting shareholder value as we manage the Company through this downturn, delivering high-quality homes and meeting the expectations of our buyers to strengthen Meritage for the future.

We will now open it up to questions. The operator will remind you of the instructions for the Q&A. Operator?

(OPERATOR INSTRUCTIONS) David Goldberg with UBS.

Thanks. Good morning. I was wondering if you guys could maybe start by talking about how comfortable you are with the liquidity position that your land bankers have and what -- maybe just give us some general ideas of how land banks are -- the debts out of that is financed, and any concerns that you might have about liquidity problems for the bankers.

Steve, do you want me to handle that one?

Yes, go ahead, Larry.

We have liens recorded on the assets that are controlled by the land bankers. So we have memorandums of option recorded. So that gives us lien rights.

To the extent that those lien rights are subordinated to first lenders at the land bankers, we typically get some kind of tri-party agreement and recognition agreement where the lender agrees to honor the option agreement even if the loan is in default because the land bankers defaulted.

Accordingly, we think we are very well protected from issues that land bankers themselves might have regarding liquidity.

I'd just add to that, David, we haven't had any situations where -- that I can recall -- where we wanted to buy a lot and we couldn't because a land banker could not deliver it to us.

That's great. I guess my follow-up question was -- Steve, you mentioned the four JVs that have gotten notices of default. I was wondering if you kind of give us an idea of the potential scenario of how that might play out.

Is there any chance you guys may end up just consolidating it and buying the JVs out? Maybe just how the negotiations are structured and what the possible outcomes are.

Larry, why don't you take that one?

Yes, sure. We think we are well protected on the legal side from somehow that debt ever becoming recourse and us having to pay it off and having to consolidate the venture.

On the other hand, there maybe occasions where we think it's in the best interest of Meritage to potentially buy the lots out of the venture. I don't think that is going to be a scenario that happens often, but it could be a potential scenario.

So it is not clear how those four are going to work out if we just look forward.

I think it is pretty clear. It is pretty clear, and we really tried to make it clear with the slides in the presentation we made today, that the risk of us making a significant investment in any of those ventures is pretty minimal.

Then if I could just maybe sneak one more in, I just wonder about the timing for the takedowns of the options that are outstanding now. Do you have any deals coming up in '08? Option takedowns where you want to stay in the contract, and so you will be kind of be forced to take down options even though you might normally pass on it and try to postpone it a bit?

No, we don't have any those that we believe are very significant, that would have a negative impact on our cash flow.

Great, thanks so much.

Carl Reichardt with Wachovia Securities.

You have mentioned thinking about shrinking the community count down by 20% in '08 versus '07, Steve. You're expecting that to be a market exit type of shrinkage, or more of a broad-scale across the footprint type of shrinkage? Can you give us a little more detail on those plans?

As you know, right now, about half of our communities are in Texas, and we don't expect our community count to change too much in Texas over the next year.

But we do expect our community count through natural attrition to decrease pretty significantly particularly in places like California, where our community count -- unless we buy more land, which we don't intend to at the moment -- reduced by probably almost half by the end of this year. Same for Arizona. Less so for Nevada and Orlando.

We're not planning on exiting any markets this year. We still have work to do in all the markets that we are in. We evaluate them on a quarter basis. But the communities outside of Texas will decline at a much larger rate than the Company average.

Great, then secondly, the finished goods inventory on the unit basis is kind of flat with last year, which was better than the industry, which is up.

But do you have a -- can you talk maybe a little bit about any specific marketing or inventory flush plans you might have for the first quarter as we head into the selling season? What are you doing to get your salespeople jacked up and excite some buying here, when you know you're going to have traffic?

Well, we're just focused more on the blocking and tackling. We're looking at every single community, doing our competitive market analysis, seeing how we stack up against the competition, if there is anything we can do to change up our product or to increase or decrease our features. Fine-tune our incentives, and just focus harder on individual communities.

We do have two multifamily projects, one in Fort Myers and one in Las Vegas, that we expect to be able to liquidate this quarter which will have some impact on our balance of unsold homes. Probably about 50 to 60 homes combined.

Then we have some other communities that we are putting some extra focus on that we expect also to help us reduce our balance of unsold homes in this first quarter and roll into the second quarter.

Great, I appreciate the help. Thanks.

Nitin Dahiya with Lehman Brothers.

Morning. Looking at the cash flow target that you mentioned about paying off the bank debt by third quarter, you know if you take out the [back fee funds] then you are essentially saying you are going to probably generate at least $10 million of free cash over the first three quarters.

Should we expect any meaningful lumpiness in this year? I mean, obviously, there is a seasonality. But then this year being a little different?

I think we're going to do much better than that.

Okay.

But I don't want to commit to a bigger cash flow number. But you're right; after you subtract out the tax payments, that is not a lot of cash flow. So I think we are setting the expectations low and hoping to significantly exceed that.

But certainly the first quarter of the year is a slower selling quarter than the second and third quarter, so it will be harder to make progress earlier in the year. As we get more into the year, we expect to accelerate our efforts.

I see. So if you like your own internal target is, if you like, to significantly do better then. So probably sometime even by the end of the second quarter or early third quarter you could report that you have paid that off?

Possibly.

Fair enough. How much of the cash flow projection reflects expectation of reduction in the spec inventory? I mean, is there a target you have for spec? How much are you factoring in when you look at your cash flow target?

We certainly have internal targets. We are not going to come out and say we expect to sell X number of specs this quarter.

A lot of it has to do with the cancellation rate. If we can manage the cancellation rate better, we will create less accidental specs, and we will have more success in reducing the total number of specs outstanding, particularly the finished spec portion.

Fair enough. Fair enough. Lastly, I was a little surprised in your comments when you said that you do not expect future impairments. Obviously, with --.

I didn't say we didn't expect future impairments. We said we expect the worst of the impairments are behind us, and the impairments going forward should be a lot less than what we have experienced in the past.

Okay, no, fair enough. But are you kind of factoring in any incremental price declines when you kind of tested for impairment at the end of fourth quarter?

Larry, you want to take that?

Yes, we run pro formas every month on our communities, if not more often. So the impairments that were taken at year end reflect our current pricing. A lot of times as we are going into the impairment process, the divisions are a little more aggressive in putting in -- instituting price reductions or additional incentives just to make sure they get them in that quarter's impairment.

So I think we have already been pretty aggressive in the fourth-quarter price reductions. Although, again, we have said in this market it is hard to tell if there will be further price reductions and further impairments due to additional competition.

Fair enough. Thank you much.

Joel Locker with FBN Securities.

Just wanted -- was curious about your land options. I guess you terminated around $48 million of them. But the actual drop from the third quarter to the fourth quarter was around $20 million. So I was wondering if the other $28 million was partially letters of credit that were off balance sheet that maybe you converted to cash; or what was behind that?

There are other items like letters of credit that could be sitting over in accrued liabilities and have not been drawn yet as a deposit. The other thing is there could be pre-acquisition costs that are also being impaired, too.

Pre-acquisition costs, other. Then pre-acquisition costs, would that be in other assets?

No, that typically is just in inventory.

That is just in inventory. Then, I guess your other assets fell about $81 million sequentially. Was there any reason behind that? I mean, what was the reason?

I'm looking. I think that has just got to be a classification issue. I would have to go look into that. I don't recall right off the top of my head.

That's fine. I will catch up after the call. The other, I guess, the lot count went from -- it held steady, the owned lot count at 10,400 sequentially. But you took down I think 1,040 or so and closed 2,100 homes. So that was about an $1,100 change that could have dropped off.

But was it just a factor of some of the owned lots that decreased in backlog? Because I know like -- I think you guys separate the actual owned lots versus owned lots that are in backlog.

The lots we have houses sitting on are not in our lot count. Those are in WIP and don't get counted in lot count. You know, obviously each quarter we take -- we took about 1,000 lots down. We start houses. That is typically the main item. I have to check in to see what else is going on that would cause your reconciliation not to exactly tie out. But basically it's (multiple speakers).

Right, because it seems like it would make sense if your backlog went from 3,379 to 2,288; so there went 1,000 of the closings right there. Then the other 1,000 were taken from owned lots and then put into the new backlog. And then you purchased 1,000 or so. So roughly those kind of numbers kind of work to keep owned lots at

Yes, I think we started a few more houses, 100 or 200 more houses than we actually purchased. So as we go through this year we're expecting to be able to continue to start more than we purchased, to start to nominally bring down the number of lots in the owned category down.

Right. Do you have an idea of how many lots that you want to actually -- options you want to purchase in the first quarter?

Well, we hope to be consistent with what we have done in the second half of 2007, and maybe in some respects even be able to buy less.

Right, because that --

We're negotiating every deal, and it is very hard for us to kind of give you a real projection, because it is going to depend on what the market conditions are. In some cases we're buying lots on sort of an as-needed, as we make sales basis.

Rights, so just I guess lastly, like if you closed on a typical conversion rate of 1,200 homes or so, would you expect your actual exercise of lot options to be 1,000 or lower, like they were in the fourth quarter?

Yes, I wouldn't expect that we would be buying more than 1,000 lots in any quarter this year.

Right. All right, thanks a lot. I will jump back into queue.

Nishu Sood with Deutsche Bank.

Yes, actually, following up on that previous question. Steve, last year in the first half of the year when you were taking down more lots than were delivering else of your backlog and your spec, you talked about still continuing to adhere to your longer-term strategy, taking down lots where you still saw some profit potential.

But judging from your comments just on that last question, it sounds like your outlook has changed. Much greater focus on cash flow and less focus, let's say, on future potential profit. Is that accurate?

Unless somebody has been living in a cave, things have dramatically changed from spring of 2007 to today. Not only did we have the debacle of the credit crunch of last summer, but housing prices have declined dramatically in many of the markets that we are in, particularly in the West.

So what we were practicing in the first quarter and the first half of the year is completely out the window. We're much more of a defensive position today. Those subdivisions I talked about that were profitable in the first half of 2007 are not as profitable today.

We're just focused on paying down debt and generating cash. I want to have a significant cash balance in this Company at the end of this year, so that we can take advantage of some of these distressed lots out there that we can buy at lower prices when the market turns around.

That may not be this year; that may be next year or may be later. But as business continues, our balance sheet continues to liquidate and we will pay down debt and generate cash.

Yes, looking at some of the numbers, the figures you gave here, the lot purchases that you reduced. But just I think the numbers you had given were $55 million and about 650 fewer lots. If you kind of look at the per-lot value there, you come out to about $85,000 or a pretty high number.

I know that doesn't work exactly that way, but where are you walking away from more of your contracts? I know you had said you're focusing a lot more on Texas. So is it mostly in Arizona and California?

Well, one of the reasons I am very bullish that we won't have a lot of impairments going forward, particularly as it relates to option terminations, is because we walked away from so many already; and we just don't have that many more. Particularly in California, Arizona, and Nevada, we just do not have that many options outstanding today.

Larry, you might able to give more color on what we did this last quarter, but I know we walked away on a couple larger deals in Florida and Orlando; and we terminated some small deals in Texas to date. There has been relatively few impairments or option terminations in Texas. But on the other hand, we don't expect to see a significant number of option terminations or impairments in the Texas market.

So, Larry, do you want to add (multiple speakers)?

Yes, I guess I would point out that if you look at the land bank deposits remaining, we only have about $7 million of land bank deposits remaining in Arizona and only $10 million in California. So we're down to the point where we just don't have that many land bank deals out there anymore.

Most of the deposits as you see in land bank and developer carrier in Texas, where again we just don't see the market getting as soft as it has gotten other places.

I guess I would add that we are -- we will continue to take lots down because we still have a bunch of communities that are profitable, that don't have a lot of lots on the ground or maybe have no lots on the ground. So every time we sell a house and want to start one, we have got take a lot down.

So people ask us, why are you taking any lots down? It's because a great majority of our on a communities we need to continue to take lots down to be able to start houses.

So that 1,000 number was not going to go to zero. It might go to 800, but we still need to take lots down every quarter to be able to start profitable houses.

Got it. A quick housekeeping question, Larry. There was a $5 million of interest you were not able to capitalize this quarter. So I was just wondering if you could give us some color on that.

Yes, we're in a position now where our inventory under development has shrunk either because we have now classified some projects as not under development or just the total balance because of the lowering of the level business has shrunk. So we're not able to capitalize 100% of our interest incurred to the asset balance.

Accordingly, we're starting to expense that every quarter. So until we get our debt paid down some more and business starts to pick up, you will probably see a little bit of interest expense roll through the income statement directly instead of being capitalized and rolling through cost of sales.

Okay, great. Thanks a lot for all the detailed disclosures as well. It's always very helpful.

Jim Wilson with JMP Securities.

Let's see, my two questions, I guess first we have talked a lot about your lot position now and what -- the concentration in Texas with all the write-downs. But Larry, do you have the number -- I'm sure it will be in the K -- of the percentage of assets now in dollars, given all the write-downs in other places? That is Texas versus a percentage of the total.

Well, we do that on slide 13 for owned real estate and option deposits. So we have a total between owned lots -- not counting presold inventory or specs, you know, houses. But just speaking of lots, we have about $180 million of owned lots or land in Texas; and then another about $37 million of option deposits for a total of about $215 million in land or land-related assets. That is about 30% of the total.

Okay, all right. Then the second question, on your four JVs that are in default, can you characterize the partners? Are they other public builders? Are they private guys that might have some of their own financial issues? Or kind of characterize who's in there with you.

I don't want to -- they're a combination of private and public guys, and everybody has their own issues they are dealing with. These are joint ventures that for one reason or another they are not working out right. Because of the discussions with lenders we're having going on, I don't think it is appropriate to really comment much further than that.

Okay, all right. Thanks.

Somebody on the call asked about other assets going down so significantly, and most of that is goodwill decreasing from the $120 million or so we had on the books at the beginning of the year to zero at the end of the year. So that is the answer to that question, by the way.

Keith Wiley with Goldman Sachs.

Quick questions on the joint venture details you provided. The slide indicates that you have an obligation to fund interest payments of $11 million or up to $11 million. Would that be total or is that on an annual basis?

That is the total commitment we have for the venture. At that point we have no other equity contribution requirements. That number already shows up as a contingent liability because it is supported by an $11 million letter of credit, so that number is already in our letter of credit contingent liability disclosure.

Okay, great. Then the other question is just on these bad-boy guarantees. My understanding is that they are not really troublesome unless the mezzanine financing is collateralized by equity. Do you have any of these? If so, can you provide an update on that situation?

Yes, we have discussed -- we have a couple of mezzanine facilities and we have discussed those situations and the protections we have in the mezz lender documents with our attorneys, and think that we are well protected. Again, I don't think it's appropriate for me to go into any more detail than that.

Okay, great. Thanks.

[Ben MacIvac] with [Rivana] Capital.

Can you break out the other assets?

Not off the top of my head. But, the Q will have further detail on that.

Okay. Then do you have a cash flow from operations number you can share with us?

We do not have that schedule finalized yet; and again that will be in the Q. But obviously the debt reduction goes a long way to explaining what our cash flow from operations is. Obviously, there is a few differences. But the number should be close to the debt reduction number.

Okay, great. Thanks.

Dan Oppenheim with Banc of America Securities.

I just wanted to follow up on some of the comments you have made on Texas. If you could talk a little more about your sales and pricing strategy there going forward. Understanding that things have held relatively better in those markets, we have still seen backlog come down quite a bit.

If it continues to come down, is that somewhere where you look to get a bit more aggressive?

Well, I think we're being a little more aggressive on our price so we can maintain our volume there. But we are still very profitable in almost all the markets. I would say not as much in San Antonio, but certainly the other three markets we're real profitable and we're real comfortable with our position there. And we don't expect 2008 to be that much different than 2007.

Okay, thanks. Then just on the deferred tax assets, I was wondering if you could walk through some of the assumptions there on not taking a reserve against the remaining balance. Just looking at the sizable loss in '07 there, it seems like it would be tough to avoid a cumulative three loss period.

Can you just talk about what your -- kind of that the basis is there? We have seen accountants be a bit more aggressive on pushing for charges with some other builders.

I think managements of the different companies have different perspectives. I also think the accounting firms have different perspectives. We believe that the homebuilding industry is certainly a cyclical industry that has large peaks and valleys and that a three-year measurement period is too short for the homebuilding industry.

I think there are other builders who agree with that and who have discussed that with their accountants and have been able to use a longer period, maybe a four-year period.

I know that in some cases, people are looking out and projecting what a future period might look like. Some people say, no, it should not be based on projections; it should be based on actual experience. So whether you look towards what you expect to have happen in '08 or just what has happened in '07 has an impact on whether you would take a reserve.

But I guess beyond that what I would point out is that of the $141 million tax asset we have, we are going to collect we believe around -- our trigger -- around $40 million to $60 million in '08, which can be carried back to '06, where we have plenty of profits. And would be collected in '09.

And the balance of $80 million to $100 million would be the balance that would have to be carried forward to points in time where we would expect to be profitable again. I think at this point in time, it would be premature to assume that we will never make money over the next 20 years; that probably in the next year or two or three, some point -- we don't know exactly when -- we will become profitable again and get back to normal. And we will be able to carry that loss generated in '07 and '08 forward to those years.

So at this point in time, we think it is appropriate to not be reserving that asset.

Okay. The $40 million to $60 million, is that through kind of your projected closings and where the impairments actually lay, and realizing -- kind of unlocking those assets or held for sale land?

Yes, it is all of the above. In some cases it is option terminations that we weren't able to formally terminate in '07 that will be formally terminated in '08. The rest of it would be land sales and house sales, those kinds of things.

Okay, great, thanks.

So it is an estimate. That is why we use a broad range of $40 million to $60 million.

Okay, thank you.

Presenters, would you like to take one or two more questions?

Sure.

Joel Locker with FBN Securities.

Just on the capitalized interest front, what was the balance at the end of '07 and the end of '06 if you have it?

The balance at the end of -- let me see here if I got it. The beginning balance at the end of '07 was $33 million at the end of the year, it is $41 million, but I would point out that the beginning of the quarter it was $47 million. So we peaked in the end of the third quarter and are now starting to bring that number down.

Right. Through the interest expense now that you are reporting.

Right, and as inventory shrinks you would think that the interest contained in the inventory would also run off, too, which it is.

Right, all right. Thanks a lot.

Ramin Kamali with Credit Suisse.

Thanks a lot for taking my call. Most of my questions have been answered, but just a couple questions on the JVs. Do you any provide any completion guarantees at all for any of the equity or cash joint ventures?

Yes, we do have some completion guarantees, not in all cases. A lot of times the land may be raw land without a development plan. But in some cases we do have completion guarantees.

In most cases, if there are completion guarantees, it requires a lender to continue to fund in order for us to be held to doing the work. Not in all cases, but in most cases.

Have you attempted to potentially quantify what this can be?

No, right now, we don't think there is anything that should be accrued for accounting purposes, because either the joint ventures are performing or we have good defenses in the ones that are not.

Okay, thank you very much.

We have now reached the allotted time for the question-and-answer session. I will now turn call back over to the presenters for closing remarks.

Thank you for joining us this quarter and we look forward to updating you on our results at the end of the first quarter. We look forward to talking to you then. Thank you.

Thank you. This concludes today's call. You may now disconnect.