Meritage Homes Corp (MTH) 2008 Q1 法說會逐字稿

My name is Brandi and I will be your conference operator today. At this time I would like to welcome everyone to the Meritage Homes first quarter 2008 earnings 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. I would now like to turn the call over to Brent Anderson, Vice President Investor Relations. Please go ahead, sir.

Thank you, Brandi. Good morning, everyone. I'd like to welcome you to the Meritage Homes first quarter earnings call and webcast. Our quarter ended on March 31st and we issued a press release with our preliminary results on April 3rd. After the market closed yesterday, we issued a release with our final results for the quarter. If you need copies of either of those you can find them on our website at www.meritagehomes.com on the Investor Relations page, along with the slides that accompany our webcast today.

Please refer to slide two 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 risk factors, please see our press release and our most recent filings with the Securities and Exchange Commission, especially our 2007 annual report on Form 10-K.

Today's presentation also includes certain non-GAAP financial measures as defined under the SEC rules. To comply with these rules, we have provided a reconciliation of the non-GAAP measures in our earnings press release.

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

Thank you, Brent. Good morning and welcome to our call this morning. For those of you following on the webcast, we're starting on slide four. The preliminary results we reported on April 3rd showed weaker year-over-year operating results. While Meritage faced the same weaker conditions that other builders have, we are very pleased to report that we have made significant progress on our initiatives again this quarter, strengthening our balance sheet and improving our liquidity as a result. We reduced our inventory of unsold homes, kept our total lot purchases under option contracts below our new home starts, generated significant positive cash flow, paid off nearly all of our bank debt, and further reduced our total lot supply, and maintained compliance with all of our debt covenants. We believe we've demonstrated disciplined financial management with the tremendous strides we've made over the last nine months.

In addition, we completed a stock offering just last week which raised $83 million cash and further strengthened our capital position. The additional liquidity we obtained through this equity offering further strengthens our balance sheet and provides us additional flexibility to take advantage of lower-cost lots if and when we determine there are opportunities to generate attractive returns.

I'll go into a little more detail regarding the progress on initiatives and provide some color on what we're seeing in our primary markets. Larry will then discuss our net results and changes in our balance sheet.

Slide five -- normal seasonality in the homebuilding industry has historically meant that we borrow against our bank line in the first two quarters of the year to fund construction of homes started during the spring selling season. As we complete and close those homes later in the year, we collect cash and pay down the bank debt again. This year, by contrast, we generated approximately $81 million of positive cash flow from operations during this first quarter, driven mainly by net reductions in inventory and tax refunds collected in the quarter. We used this cash to pay down the balance of our outstanding debt under our credit facility to just $2 million at quarter end. This was a reduction of $80 million from December 31, 2007.

The first quarter of 2008 culminated a nine-month period in which we repaid more than a quarter- billion dollars of debt. It was also a dramatic improvement from the first quarter of 2007, when our cash flow from operations was a negative $83 million.

Slide six -- we sold a net of 339 homes from our inventory of unsold homes the beginning of the quarter, which was a 31% reduction. We ended the first quarter with 768 unsold homes in inventory, half of which were completed homes. Considering that we have 215 active selling communities at the end of this quarter, we're now within our desired range of three to four spec homes, unsold homes, per community, with less than two of these completed and unsold. I commend our sales teams for achieving this during very difficult market conditions.

Slide seven -- We purchased just under [sic] 889 lots under option contracts during the quarter, while starting 1,135 new homes. That's about a 60% reduction in lot take-downs year-over-year for the Company as a whole. Sixty-five percent of those lots were in Texas, which has been less impacted by the housing downturn. That's pretty well in line with our first quarter sales, closing the backlogs in Texas. Our objective is to limit our investment and our supply of owned lots by selling and starting more homes than we're purchasing under option contracts.

We've brought our total lot supply down to 24,591 at March 31, 2008. Approximately 40% of these are owned and 60% are optioned. A year ago our total lot supply was 41,936, so we've reduced the total by 41% in just the last year.

Slide eight -- our total lots under control at March 31st represented about 3.4 years of supply, based on 12-months' deliveries, with two years of that supply under option contracts. This is within our target range of three-to-four years' supply of lots. Approximately 55% of our total lots are in Texas, consistent with our recent sales, closes, and backlog percentages there. Arizona has a higher lot supply, due partly to our active-adult communities there, which require a larger number of lots to support the greater amenities in these communities.

Slide nine -- We recorded about a $60 million pre-tax non-cash charge to real estate impairments and lot option terminations during the quarter. Our impairment charges were the result of both lower home prices in some markets and greater incentives we offered on unsold homes in order to recapture our investment in that inventory. While those price concessions were very effective in reducing our inventory, and generating cash, they also resulted in further impairments caused by reduced valuations on remaining inventory in those communities. California and Arizona together accounted for about two-thirds of the total write-offs in the quarter. The $16 million JV impairments included a $14 million charge related to a joint venture, the Chrysler Proving Grounds in northwest Phoenix.

Considering that we've now greatly reduced our spec homes in most active communities to our targeted levels, we expect less aggressive pricing on both specs and new orders -- new homes built to order. This should help to reduce our future impairments.

I'll now turn the call over to Larry Seay, our Chief Financial Officer, and I'll end our prepared remarks with a few closing thoughts before Q & A. Larry?

Thank you, Steve. On slide ten -- our first quarter 2008 home closing revenue declined 35% year over year on 26% fewer homes closed, and a 13% reduction in average closing price. The decline in closings reflect weak demand in the second half of 2007, which were almost 30% lower year over year. Our Central Region experienced the greatest declines in the first quarter of this year, primarily driven by Arizona closings and revenue, which were lower than the prior year's first quarter by 58% and 66%, respectively. As expected, due to seasonal patterns, first quarter closings and revenue were also significantly lower than the fourth quarter of 2007.

However, our sales [in] backlog were sequentially higher this quarter compared to last quarter, also reflecting the seasonality of our business. Our ending units in backlog at March 31, 2008 increased 13% from the end of 2007, from 2,288 to 2,594 homes under contract, even though high cancellations and slower sales pace throughout most of 2007 reduced our first-quarter backlog 35% year over year.

Slide 11 -- Homebuilding gross margins contracted in the first quarter, primarily to real-estate-related charges of $44 million in 2008, compared to $17 million in 2007. Excluding these non-cash charges, normalized homebuilding gross margins for the first quarter contracted to 12.2% in 2008 from 18.6% in 2007, reflecting weak demand and lower average sales prices.

We have successfully reduced cost structure to keep our G&A expenses in line with revenues. Of course while revenues are seasonal, most G&A costs are not, so the percentage will vary quarter to quarter. Our first quarter 2008 G&A was about $5 million lower than last year, and about 1% higher as a percent of revenues.

Slide 12 -- we reported a net loss for the first quarter of 2008 of $45 million, or $1.72 per share, compared to net earnings of $15 million, or $0.57 per diluted share in the first quarter of 2007. Excluding our $60 million of pre-tax impairment charges, our pre-tax loss from operations was $11 million. By comparison, our first quarter 2007 pre-tax earnings were $40 million, before $17 million of pre-tax impairments.

Slide 13 -- net orders were off 21% from the prior year's first quarter after a cancellation rate of 27% in both periods. This was dramatically lower than the 47% rate in the fourth quarter of 2007. Although we would expect the first quarter cancellation rate to be lower due to seasonality, we also believe our overall rate for 2008 will be lower than 2007.

Slide 14 -- based on the first quarter results we've seen reported so far, we believe that our strong Texas franchise is becoming a clear differentiating factor for Meritage, when compared to other homebuilders. For the same or similar period, Meritage's net orders were stronger and year-over-year order declines less severe than several large builders.

Texas has continued to outperform other areas of the country for reasons we've explained previously and we expect that it will continue to help differentiate Meritage in 2008.

Slide 15 -- We brought down our total real estate inventory by another $104 million during the first quarter to $1.116 billion at the quarter end. This is almost a $400 million reduction year over year and was primarily due to a reduction in unsold homes, as well as lots and land under development, both in terms of absolute numbers and the post-impairment balances of these assets.

Slide 16 -- We collected $76 million in tax refunds in the first quarter, realized by carrying back 2007 losses to offset 2005 taxable income under the two-year NOL carryback rule. Our deferred tax asset at March 31, 2008 was $148 million, a slight increase from year-end 2007 due to this quarter's loss. We expect to collect another $40 million to $60 million of cash refunds in the first quarter of 2009 by carrying back 2008 losses to 2006. If the NOL carryback rules are modified to allow for a four-year carryback, we may realize additional tax refunds earlier than we would under the existing 20-year carryforward rule.

Slide 17 -- we completed an offering of 4.3 million shares of common stock at $20.50 per share on April 25, 2008. Approximately 300,000 of these shares were granted for over-allotments, in total which yielded net proceeds of approximately $83 million in cash after all underwriters' commissions and fees. These proceeds will increase both cash and stockholders' equity in the second quarter.

On a pro forma basis, after taking these proceeds into our account, our March 31, 2008 net debt-to-capital ratio would have been 41% compared to our actual net debt-to-capital ratio of 47%. At December 31, 2007 our net debt-to-capital ratio was 49%.

Slide 18 -- we were in compliance with all of our debt covenants as of March 31, 2008. Since impairment charges are primarily non cash, they are excluded in the calculation of our interest coverage debt covenant.

We had available borrowing capacity of $377 million under our $800 million revolving credit facility after considering the facility's borrowing base availability and most restrictive covenants. Our interest coverage ratio is 1.6 times interest incurred, based on trailing four quarters' adjusted EBITDA. We're now in the temporary reduction period as defined by the September 2007 amendment to our credit facility. The reduction period provides relief under our interest coverage covenant and we appreciate our bank group's willingness to work with us on that amendment.

Now that we have paid off the outstanding balance under the facility and have additional cash on our balance sheet from the equity offering, our liquidity will offer us greater flexibility going forward.

I'll now turn it back to Steve for final comments.

Thank you, Larry. While total inventories of resale homes nationally remain high relative to the recent base of sales, we believe we're beginning to see less significant declines in new home prices. Most large homebuilders have aggressively reduced their spec inventories closer to desired levels. Stabilizing prices should help improve buyer confidence over the next several quarters and lead to improving demand in 2009 and beyond.

With regard to mortgage availability, a larger percentage of our buyers are utilizing more traditional agency-backed mortgage financing. Recently-increased loan limits have made SHA available to more buyers, with the advantage of easier qualification than conventional loans. We believe that homebuyers should recognize there are great values available on homes today, and should be able to obtain acceptable financing for their purchases from these more traditional sources.

Our primary objectives in managing through this downturn have been to strengthen our balance sheet by reducing inventory and debt and to build liquidity to take advantage of future opportunities. I'm pleased with the significant progress we've made over the last three quarters. We plan to continue our efforts on all of our initiatives. We are hopeful that government-led actions to assist both current homeowners and prospective homebuyers will help bring about a recovery in homebuilding sooner than would otherwise be realized. Until then we will continue to focus on responsible balance sheet management while prudently seeking attractive opportunities to generate superior returns in coming years.

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

(OPERATOR INSTRUCTIONS.) We ask that you limit your questions to one and one follow-up. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Robert Manowitz with RBS.

Yes, hi. Good morning. On the fourth-quarter conference call you gave some color on the first-quarter takedowns. And I was wondering at this point if you'd provide a little bit of color, at least maybe in terms of lots -- number of lots and dollar values for the remainder of the year?

We --

We took down -- go ahead, Steve.

No. Go ahead, Larry.

We took down about a little over 1,100 -- excuse me -- we took down a little under 900 lots for the quarter and started a little over 1,100. We think we'll generally be running in the -- on average around 1,000 lots for the quarter. We do -- had a couple of takedowns on final lot options, where we take a lot down because we have deposits built up, which may run the first quarter -- or the second quarter -- up a little bit. But it's really a non-cash purchase because we're offsetting that against option deposits. But generally speaking, for the amount we're paying cash for, we're running about 900 to 1,000 a quarter.

Yes, precisely, we took down 889 and we started 1,135 new homes. So we started more than we purchased and 65% of the lots we purchased were in Texas. We talked a little bit about that on slide seven.

Right. Excellent. And my next question is more on the seasonality and kind of thinking through April, May, June. You seem to be taking a little bit of a different pricing strategy in the second quarter, now that you've gotten your specs down. What should we expect in terms of the seasonality? Is April going to look kind of flattish to March?

Yes, I don't -- I think it will probably be flat with March. I don't expect any improvement in April. Most builders -- most larger public builders are now starting to try to hold on to prices and we're doing the same. And it will take some time for buyers to recognize that and get some confidence back. So I don't expect to see a lot of improvement in Q2 over Q1.

Right. And if I could sneak in one last question -- I think it's a quick one. You had provided a balance sheet target, I guess, in that you thought you would be out of your revolver by year end, but said it could happen more quickly under certain circumstances, which it did. Would you have an updated target, either in terms of cash flow or where you expect to end 2008?

No. I think we said in the previous call that we'd expect to be out of it by Q3 and maybe if we -- we were hopeful by Q2. And we did it in Q1. But we're not -- I can't give any guidance on cash flow going forward, particularly since we're going to be more aggressive about holding prices. But we do expect to generate positive cash flow for the remainder of the year, but I'm not going to give a number.

Yes, Rob, you know our intent would be to continue to run off lots that we own and start more houses than we're buying lots, which would generate cash. So it's just a matter of how quickly we can do that. And then at some point in time we're going to start to see some opportunities out there that we'll start to redeploy the cash we're generating from getting rid of those old lots into new lower-priced lots. So we don't know when that may start to happen either.

Right. Well, keep up the good work and thank you.

Your next question comes from the line of David Goldberg with UBS.

Thanks. Good morning. If I could kind of start, could you give me an idea of where land prices are maybe in the market now relative to where they'd have to be for you guys to be able pencil deals? And what do you think is -- what gives you the confidence, having just raised some capital, that that land price decline is going to occur over, let's say, the next 9 to 12 months?

Well, we're seeing lots, for example, in the Central Valley in our East Bay division in Northern California that we previously paid $125,000 for a finished lot that we're able to buy now for $45,000 to $50,000. And although we're not seeing a lot of them yet, we're starting to see some deals that are looking interesting. Pricing has come down on many communities that we're in on lots by 50%. And we expect in the second half of this year to see a lot more deal flow as a lot of the private builders now are losing their land positions back to the banks and the banks are beginning to dispose of those assets. So we're very optimistic that we're going to be able to buy lots at lower prices going forward.

So I guess what I'm trying to do is to reconcile that thought, that the banks are getting more aggressive with the small privates and you expect to see land prices coming down in the second half of the year, with the idea that you feel like your impairments are mostly behind you and that because the big publics are generally holding their prices, which I [don't] absolutely agree with, you're not going to see more home price deterioration from the small private builders and the impact then on the market. Can you maybe help me understand the way you're thinking about that a little better?

Well, a lot of the small private builders can't lower their prices any more because they have secured bank financing. And the values of the homes are less than their financing release prices. So the only way those homes and lots are going to be released are when they go back in the banks. And relative to the publics, the private guys just don't have a lot of inventory in pure numbers. Most of the larger markets that we're in, the publics dominate 60-70% of the market. And I just don't see the private guys having an impact on the public. So I think once the banks get some of these assets back this inventory will able to be cleared. But the public guys have already cleared their inventory for the most part.

So to say it correctly, the banks bringing those assets back on the market is not going to impact the overall market -- the home prices on the overall market? That's what you're trying to say?

Yes. I mean most -- might have a mild impact with a smattering of spec houses they're going to get back that the privates couldn't sell because the release prices were too high. But from the lot perspective it's going to be able to feed us lots at lower prices that we're going to be able to make a profit on and, amongst other builders, that's where we're going to find finished lots. Another public builder is not going to sell us finished lots at a price low enough for us to make a profit on, because they would just build through them themselves. Where we're going to find those lots is from banks and land developers who need to sell them.

And then if I could just get a quick follow-up to that. I guess if you could give me some ideas looking forward about how you think about the option-focused model, the availability of financing on the land development side or on the -- for somebody who's [stuck in between], whether it's land bankers or somebody else -- how do you see the model potentially changing, given what's an increased perceived risk in holding land now? And maybe the cost for you guys to be able to have somebody else take that risk with an option-focused model in holding land?

Well, I'll take part of it and Larry, you take a little part of it. But essentially, the way we're looking at it is there's a lot of money out there today chasing land. A lot of what we call "vulture" funds and we think some of this capital is going to get deployed. And we think builders are going to be adopting more of a land-life strategy, as we have. And a lot of these "vultures" or investors will be selling lots on terms or on options. And we won't be able to maybe go back to some of the land bankers we did business previously, but they'll be new entrants into the market in terms of some of these investor funds that will be buying these lots and then selling them on more terms or option-type deals. And some of our land bankers are quite healthy and made it through the market pretty well and we expect them to be in business going forward. Larry, did you want to add to that anything?

Yes. We have several land bankers that called us up and are looking for new business that were well capitalized and minimize lot losses and they just figure this is one downturn that they have to ride through. And they've been in business for 20 years and plan to be in business for another 20 years. Having said that, the terms may be a little more expensive, or more onerous, and we'll have to weigh that against putting things on our balance sheet. I would say we probably won't get up to the 90/10 ratio we had where 90% of our lots were optioned, but we still plan to use a land-life strategy and use options to the extent available and that they make economic sense.

Perfect. I appreciate it.

Your next question comes from the line of Nishu Sood with Deutsche Bank.

Okay. This is actually Rob Hansen on for Nishu. What was the -- was there any benefit from prior impairments in the gross margin?

I'm sure that that's the case. Part of our impairments related to option deals we [walked,] which obviously doesn't benefit future margins, but some of that did relate to lots and houses owned, although we don't break that number out and I can't tell you what that number is precisely.

Okay. And just kind of read-through on the impairments -- with the unsold home prices coming down and kind of driving the lower spec levels, does this mean you are impairing the construction-in-progress? And how much in general in the past have been in the construction-in-progress?

We are -- I think you'll see more, a higher percentage of our impairments be owned property versus impairments of options, to start with, because we have already terminated and gotten rid of so many options. And most of our options outside of Texas are not around anymore. As Steve said, like about 65% of our purchases of lot options were in Texas.

Now when it comes to the breakout of housing, yes, we are -- because of aggressive pricing in the first quarter we did write down some work-in-process, as well as that lower pricing impacted lots we own. So it's a combination of those. I don't have the specific breakout on whether it's a house or the lot sitting next to the house that's still un-built. But we think -- even though we may have some additional impairments -- we think that with the hold-the-price line that we'll be able to minimize those impairments going forward, so that you'll gradually see them continue to taper off. But I can't give you that specific breakout because we don't have that number right here at my fingertips.

Okay, thanks.

Your next question comes from Susan Berliner with Bear Stearns.

Morning. I was wondering if you could help us on the joint venture. I know it was notable impairment this quarter and I guess I was just trying to figure out going forward what do you think is going to happen with the joint ventures? And if you can give us color on what you're seeing out there on the joint ventures?

Larry, go ahead.

Well, the one impairment we took was to write off the remaining balance on one large project up in northwest Phoenix, and that either wrote off or reserved any further capital commitment we had to that venture. So at the end of the quarter we're down to only $21 million in investment in all of our joint ventures. So from Meritage's point of view we think the exposure is fairly minimal for the -- as we talked about previously, we have four or five joint ventures that we have fully impaired. The last one that we wrote off was fully impairing a fifth joint venture.

Beyond that, we don't believe we have a lot of additional exposure because the seven remaining equity-method joint ventures are all kind of immaterial individually and are doing pretty well. They're in cities or states that seem to be holding up, for example, Texas. And beyond that, we've minimized our guarantees. We've talked about that where we don't really have much in the way of additional guarantees or support to the ventures, so if one other venture did have a significant problem it would be an immaterial impairment.

Overall, I can't speak for the rest of the homebuilding industry, but I think Meritage has done a pretty good job isolating joint venture problems from the parent company.

Great. Thanks. And just one follow-up -- I was wondering if you could give any color on I guess the LCs outstanding on your bank line and where your tangible net worth cushion is?

Yes. We have about 30 or 40, I don't have the specific number, of LCs still outstanding. And at the end of the quarter -- before our offering, we had about $60 million after-tax cushion. We get in the bank facility a 50% credit for the equity, so that brought it up to around $110 million on a -- I meant to say after-tax number. So you would multiply that or divide that by the tax rate and it would multiply into a number significantly greater than that, somewhere in the $170 million range. So we feel pretty comfortable that we have adequate tangible net worth cushion at this point.

That's great. Thanks very much.

Your next question comes from the line of [Joel Walker] with FBN Securities.

Good morning. Just on Texas, in general -- obviously it's your strongest region right now, but saw the order price sequentially drop 7.5%. Just was wondering if that was more of a mix issue or anything else behind that?

I think primarily it was mix. I think we probably are -- certainly gave them some concessions there. But I would chalk a majority of it up to mix. Would you agree, Larry?

Yes. Yes.

So that's just -- and then it might pop back up or -- ?

Yes.

Depending on the size of the house or -- okay. So then also just on the gross margin front, I guess it was pretty significant that you actually stabilized them sequentially on a Company basis, but just was curious about what your gross margins are, ballpark figure, in Texas right now?

Larry?

Well, we don't typically break out state ones, but our Texas gross margins are significantly better than the Company average. Obviously in some places like California our gross margins are very, very low. Generally speaking, our gross margins in Texas are kind of in the mid-to-high-20's, depending upon which project we're in. So if that gives you --

Mid-to-high teens you mean, Larry.

Yes. Mid-to-high teens, excuse me. I misspoke.

Right. Mid-to-high teens. All right. That's it. Thanks a lot.

Your next question comes from the line of Carl Reichardt with Wachovia Securities.

Steve, I'm curious in your theoretical Central Valley example of $45,000 to $50,000 a lot relative to $125,000 before. If you were looking at a project like, what kind of operating margins would that generate for you? And how would you think about the pro forma on sort of -- are these quick-delivery lots, something you could put up in a hurry?

Yes. I wouldn't say it's theoretical, because I think these are lots we're actually thinking about buying. And we're thinking about building smaller houses. Before we were building houses on these lots that were probably averaging like 2,800 feet, so we're probably thinking about building houses that might average 1,800 feet. So 1,000 feet less, with less features, where we can bring the average price down into the 2's, where originally they were approaching $500,000. So there's a real compelling opportunity really to find a broader audience. And at $280,000 or $275,000 if we pay $45,000 cash for these lots, they're fully improved, we can make a 20% gross margin, which should lead, with some volume, to 10% net.

Okay. Then your commentary earlier about the variety of entities out there looking at land right now, if this opportunity is so sort of obvious and in front of you, isn't it your sense that other builders who have liquidity, of which there are some obviously, and the vulture funds themselves would be looking at similar transactions? And how are we to be confident that that pricing will stay so attractive for a long period of time if there's all this capital looking at deals currently?

Well, I think inherently builders can pay more than "vultures" for finished lots. So I think public builders will probably be the ones that will be buying those lots versus the vultures that will be more focused on the periphery, on more of the outside-the-loop locations. And then I don't think all builders are in a position to buy any lots. I think there's a lot of builders that are going to be on the sidelines for quite some time because they don't have the balance sheet to buy lots of they just have too many lots that they're still working through. So I don't think the competition is going to be as keen as you might suspect. Private guys aren't going to be able to get credit and not all the public guys are going to be able to participate.

Okay, great. Appreciate the color. Thanks, Steve.

Your next question comes from the line of Timothy Jones with Wasserman & Associates.

Yes. Good morning. Couple of questions -- first of all, I'm wondering why your subdivisions, given the fact that business has slowed down so much, are still -- the average subdivisions are basically flat? With Texas I can understand being up, but I'm curious about especially Nevada being almost double last year's average subdivisions. Could you address that, please?

Are you talking about community count?

Yes, community counts.

Well, we had several large communities come on line last year in Nevada, which increased our community count, but they had been planned for quite some time. And about 120 of our communities, out of our 215 approximately, are in Texas and that community count really hasn't changed. I think you'll see in the latter part of this year our community count really start to decline. I can't give you a number, but I can tell you we're going to finish the year below 200. And it should start to decline at a pretty good clip over the next couple quarters.

I'd add to Steve's comment about Nevada, that Nevada had an unusually low community count beginning in 2007 because it had sold out a lot of communities very fast and these newer communities hadn't yet come on line. So it was unusually low.

So you are comfortable with -- I mean, Nevada's a very tough market, I don't have to tell you. And you're comfortable with the level of communities you have there?

Yes. We have about 1,000 lots, plus or minus, in Nevada and we're not opening any new communities other than what we've got right now in the large joint ventures up there, one called Inspirada and other one called Providence. And we're just going to work our way through those. We're certainly not buying any lots in Nevada and we're comfortable with where we are.

Okay. The second question is, just a second. Oh. You implied that you were going to try to hold prices. Now, over the last year or so Standard Pacific first tried it, then D.R. Horton, and most recently KMB. All of them after -- showed precipitous declines in sales and had to reverse their attempts. What makes you think that you can do it now?

Well, I don't know that the builders that announced it in this last quarter, KMB specifically and a couple others, have really changed courses. What I see in the ground in the field is builders continuing to be disciplined to hold prices because builders like ourself and KB have the balance sheets to be able to do that. A builder like Standard Pacific doesn't have the ability to do that. And if I were Standard Pacific I would never have came out and said I needed to hold prices. So we're two years into this, or more than two years in some markets. We need to instill confidence in buyers. We've burned off all -- a lot of our unsold home inventory and I don't think we have the motivation to continue to sell houses at very low prices. And we'll do what we need to do to maintain a proper amount of sales to cover the infrastructure and organization, but we're not going to continue allowing a freefall in housing prices.

I think the builders have seen that they've dropped prices far enough and so far that it obviously today in many cases doesn't make sense to start a new-build house on a vacant lot if the cash you're going to generate from building that house and selling the house and getting a recovery of cash out of the lot that you've already made is just a fraction of the value of the lot of the original value. So people are making the economic decision that the residual lot value is at a point with prices where they are now that they don't want to continue to drop prices because the cash flow generation gets to be too minimal to be worth the effort. So people have the economic incentive today to hold prices because of that.

Tim, that's a key point. I mean it's just -- you're in a much different situation when you've got a lot of inventory, lot of specs to sell, than when you only have lots. And I think Larry did a good job of articulating that. The cash return is just not substantive enough that you want to take the risk to go build another house when you're not getting much money. So --

Well, a lot of builders are having to do it, just to -- they have two choices, sell the land at $0.20 on the dollar or build the house and lose maybe, lose on the land, get 80% of the land price.

Yes, but if you have a good balance sheet and you're really not getting much for the land, then why would you -- if you had -- if it cost --if you had a house that was $400,000 and now it's $300,000 and you were getting $100,000 for the lot and now you've got to sell it for $270,000 and you're only going to get $20,000 for the lot, you might think twice about doing it.

Oh, I agree with you. There's a (inaudible).

Yes. Yes. Okay, do you have a follow-up question or was that it?

I guess you talked about overhead. What's your headcount and what was it versus the peak?

Larry, at peak it was like 2,300 and today we're probably under 1,300 -- does that sound right, Larry?

That's about right. We don't have the specific numbers at year end compiled yet, but that's pretty close.

Quarter end, yes.

Okay. Thank you so much.

Did I say year end?

Your next question comes from the line of Shaumo Sadhukan with Lotus Partners.

Hi. Can you talk about the 889 lots that you bought this quarter? What are margins like on those lots?

It varies, because some of them are in Texas where the margins are still good. And others are in Arizona, California, and Nevada, where the margins aren't as good and there might not be much of a margin, but there's a good cash margin. And it's different in every community. Larry, do you want to -- ?

Yes. An example would be, say, in California where the market's pretty tough we may have a zero accounting margin and but yet because of the deposit, because of marketing, model costs --

[Truck] costs.

-- we may recover 10% of the sales price in cash, so we look at that and go, gosh in that case we're making a zero accounting margin but we're making a 10% cash margin. It probably makes sense for us to go ahead and build through that and recover that cash. On the other hand, if our cash margin was just 2%, we wouldn't buy that lot. We would go gee, it's not worthwhile for us to continue through the subdivision, buying lots from a land banker, building out the houses to only make a 2% cash return. But 8%, 10% cash is probably kind of the low end of our range of continuing to buy lots to recover the cash we had to spend.

It would also depend on how many lots we had on our balance sheet already in that community. If we have a lot of lots, we probably wouldn't be buying them as aggressively if we didn't have any, or a very small number.

So I guess what I'm trying to understand is -- so right now you have 9,900 owned lots and 14,700 option lots. How many of those option lots will you probably end up taking down at low accounting margin but high cash margin because you think it just makes sense for you to take them down? Where are we in terms of kind of thinking about that issue at this point?

Well, we're getting close to the end of the option terminations. I'm looking for the (inaudible) --

Well, first of all two-thirds of those option lots are in Texas, which are still making relatively good margins. So you're only talking about a third of the option lots being outside of Texas, and those are spread out in communities where today most of them meet that minimum cash return criterion or else we would have terminated them already.

So maybe 4,000 low margin lots.

Okay. So that's within the 19 -- so sorry -- within the 9,900 that you own there's some low-margin lots and maybe 4,000 low-margin lots in the options, in the option piece? Is that a good way to think about it?

Well, on the option side I think you've got it right. I'd have to think about what you said on the owned lots.

Well the owned lots we're looking at cash return. In addition to margin we're also looking at the cash return for the lot. So we really look at those as a return of some capital.

Okay. But I guess my point is, so then, just to sort of think about how this will develop over time, once you work out those lots, right, so that, if I did the math right, maybe it's 8,000 total lots between the owned and optioned part, sort of your legacy lots that you have to work through where you're not really making much accounting margin -- once you work through those lots at the current pace maybe it takes you, say, a year to work through those lots. Maybe it's a year and a half, who knows? But once you work through those lots, then you can start recapturing margin back as a company? Is that the correct way to think about it?

Well, sure. If we bought some lots today -- I'm not saying that we're doing this, but if we were to buy some today -- they would hit our income statement on the second half of next year. So as the opportunities start to become available, and as we feel comfortable that the sales are there at the prices to match the lot prices, we'll start to gravitate into some new inventory to kind of average our cost down. But it won't hit our income statement until later next year.

Because it takes a while to get the subdivision up and running. But that's exactly the point we attempt to make, is that because we have a short lot position, we can work through these legacy lots, as you call them, that have lower margins and start to reload with newer, lower priced lots more quickly than maybe other builders. But that really won't start to happen until, at least in earnest, until the latter half of '09.

This is absent any housing appreciation. If we have housing appreciation it will be beneficial to all the lots, but, assuming we don't have any, we could still make a profit in the back half of next year on newer lots.

Right. And so these lots that you're talking about in California, where the prices have fallen by more than half, let's imagine you were to buy them and there was a little bit of price depreciation still to come in those markets and you're at current pace. Can you still make this 20% gross margin, 10% net margin, operating net margin before tax? Can you still make those at current pace even if prices decline a little bit, or are we talking (inaudible) ?

No. If we buy those lots and we calculate wrong and we underrate them at 20% gross margin and the price declined from there, then we're going to make less. So to the extent that they decline, but we can't be out there buying lots if we don't think prices have stabilized.

Okay. I guess my question is can you do it at current pace? That's really the key question. Can you make those types of margins if you were to buy those lots today if price held, but could you do it at current pace, meaning do you need pace to pick up to get those types of margins back or can you recapture margin even at current pace?

Well, there are builders, including ourself and others, that have some subdivisions that are selling pretty high volumes. When you -- there are buyers out there for homes at the right price. So if we can ascertain what the correct velocity is, matching up to the correct price -- if it's four a month or five a month or three a month and we can hit that pace, then we can make money. But we can't go into a community and achieve the pace that we're achieving on average in all of our communities today and be profitable. So we need to get a more realistic what level of volume to achieve a reasonable return.

And again, it's not zero or 10%. It's a continuum and if you're selling at a slower pace with a well priced, low priced lot you can make money. You just won't make quite as much money as if you were selling at a higher volume to cover your fixed overhead for that project. But I guess I'd come back to California and our example. We only own about somewhere between 900 to 1,000 lots in California. That's it. So in these very difficult markets, we don't own very many lots. We've terminated most of our options. So our total exposure in California is not that large and we can start this process in California as we start to see the opportunities arise pretty quickly.

All right. Thanks. That's really helpful.

Your next question comes from the line of Joshua Pollard with Goldman Sachs.

Hi. It's Chris Hussey, Goldman. Good morning, guys. Question on Texas -- if we were to hearken back a couple of years, builders never talked about Texas as being the most terrific market to be in. When you think about your long-term strategy -- I can understand sort of hiding out in Texas, but when you think about the long-term strategy for you guys, is Texas really just a great housing market or is it just a great place to hide out until the great housing market comes back?

I've never heard anybody describing it as hiding out before. But I can tell you, Texas is one of the greatest housing markets in the country, because it's got some of the best job growth in the country. And you've got larger cities like Houston and Dallas that are near the tops in job growth year in and year out. Now the margins are lower there because there's a lot more supply. And there's a lot less restrictions to growth. But it's very stable and demand doesn't go up and down in Texas like it does in other markets, so if you're willing to accept lower margins it's a place you can sell a lot of houses. And if you're very disciplined about your business and you run a tight ship, and you have great sales teams, and you have great construction people that know how to buy materials and know how to subcontract, and you're good at buying land and you don't design away your profits, you can make good money in Texas year in and year out. And I would not describe it as we're hiding out there. We're just -- it just happens to be one of the few places in the country that hasn't been as affected by the downturn as the coastal markets have.

Going forward, do you guys envision yourselves with maybe 50% or greater of your business coming out of Texas?

No. No, certainly as the other markets recover it'll probably drop down more to about one-third, which is where it was a few years back. And we're very comfortable having one-third of our business in Texas and two-thirds in the other five states. Today, because the other five states have been more dramatically affected by the downturn, we're a little more than half in Texas, but we expect that to turn over time.

That's fair. On the joint venture, the old Chrysler property, is it your intention to walk away from that property, or are you guys going to stay in that joint venture, you've just written it down to zero?

No. We're not -- Toll is managing it. We have 18 months to go on the loan and we'll just see where we are in 18 months. We're completing the entitlements right now and haven't made any definitive plans what's going to happen there.

But if there's a capital call within that 18 months you guys would -- ?

Well, there won't be.

Okay. There won't be. And then finally, could you maybe talk a little bit about the owned lots? What's the investment that you require in those owned lots to get them so you could build a house on them?

Larry?

Yes. That varies and I don't have the number of what it would take to complete every single lot we own to a finished state. Most of our lots we own are already finished. There's a portion of them that aren't, roughly about 2,800 that we own that aren't completed. But I don't have the number that -- obviously we're holding back on development costs and only spending the dollars when we need to start building on the lots, so it's not something that we'd have to have this big CapEx number we'd have to spend today in order to get houses built.

Okay. So the bulk of your investment then, going forward, is going to be buying out these option lots rather than investing in your lots.

Right. There obviously is some of that, but it's not a huge number.

Great. Hey, thanks guys.

Your next question comes from the line of [Nicole Terraco] with Babson Capital.

Hi. Good morning. Just a couple of follow-ups on your JVs -- can you give us an updated number on what your guarantees are at this point on the JV debt?

Well, we have very little in the way of direct guarantees. That number I believe is about $5 million. The other significant group of guarantees we have are what we call bad-boy guarantees, which only spring into place if the venture partners were to file a voluntary bankruptcy in most cases.

Wait. Do you have that number?

Well, I don't have the precise number right now, but last quarter it was $88 million and I don't expect it to change a whole lot from last quarter.

Okay. In terms of your debt covenants, do you have a leverage covenant right now or is it just the coverage and the tangible net worth?

Yes, we do have a leverage covenant and, generally speaking, that number's around 2 times, or 2.25 times, depending upon which indenture we're talking about. But the bank indenture, or the bank document does tighten down as our interest coverage floor lowers, so at the worst point in our modified bank facility we have a debt-to-equity -- tangible equity -- ratio of 1.4 times. And currently with our current equity position and our current debt position, we don't perceive that to be an issue for us.

Okay. Great. And one last question -- on your adjusted EBITDA calculation for the first quarter of 2008, you're including this other income expense item. Do you know what's in that line item?

Yes. Generally speaking -- well, other -- first of all there's a loss in other income today, which is really the $16 million of impairments we took on our JVs. So if you back that out, there's also interest expense on that number of about $5.6 million, $5.7 million. So those are expensed items running through there, but if you look at the other income side of it, excluding those negative loss numbers you would have mortgage and [title] JV income of about $2.5 million. And you'd have a miscellaneous number of about another $2.4 million, which consists mainly of forfeiture income from people walking away from purchase contracts and us retaining their deposit.

Okay. Thank you.

Management, would you like to take one last question?

Yes, one last question, please.

Your final question comes from the line of Jim Wilson with JMP Securities.

Good morning, Jim.

I think you've answered pretty much everything, but I was just wondering kind of, as you're discussing prices and where you think you're beginning to hold them, if you could kind of put it in perspective in your various markets -- how much they've dropped and which of those markets you feel you're closest to being -- the market conditions suggest you're closest to being in a position to start holding prices?

Well, I think in California net prices have dropped probably 30 to 40%, in Arizona 25 to 30%, Las Vegas 25 to 35%, Orlando 25%, 30%. Now I think in all those markets we're pushing hard this quarter to hold prices. We have very few completed spec homes and we're going to try to hold prices on new dirt sales.

So really all of them you think, with this kind of drop, are in a position to start holding prices?

That's right.

All right. That makes sense. All right. Thanks a lot.

Okay. Thank you. Thank you very much everybody. We'll look forward to talking to you again in Q2. Good day. Thank you.

This concludes today's Meritage Homes first quarter 2008 earnings conference call. You may now disconnect.