Meritage Homes Corp (MTH) 2008 Q4 法說會逐字稿

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Meritage Homes Fourth Quarter and Full Year 2008 Conference Call. (Operator Instructions) Mr. Anderson, you may begin your conference.

Thank you, Sarah. Good morning, everyone. I'd like to welcome you to the Meritage Homes Fourth Quarter and Full Year 2008 Earnings Call and Webcast. Our quarter ended on December 31, and we issued our press release yesterday with our results for the quarter and fiscal year. If you need a copy of the release, you can find it on our website at www.meritagehomes.com, on the Investor Relations page, along with the slides that will accompany our webcast today.

Please refer 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 information regarding those risk factors, please see our press release and our most recent filings with the Securities and Exchange Commission, specifically, our 2007 annual report on Form 10-K, and our last report on Form 10-Q.

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

With me today on the call to discuss our quarter are Steve Hilton, Chairman and CEO of Meritage Homes, and Larry Seay, our Executive Vice President and CFO. We'll keep our call to about 50 minutes this morning so that we end before noon Eastern Time.

I'll now turn it over to Mr. Hilton, to review our fourth quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone to our call today. I'll begin with slide 4, if you're following along on the webcast.

The most significant highlights of our fourth quarter include our cash generation, year-end cash balance, and expected tax refund in the first quarter of 2009. In addition, we operated at a small profit before impairments due in part to reductions in our direct cost in overhead, which we believe will continue to benefit us in the future. Let me walk you through some more of the details on those items.

As anticipated, we generated a significant amount of additional cash, increasing our cash position by $87 million, more than 70% increase in the last three months of 2008. We ended the year with $206 million in cash and no borrowings outstanding under our credit facility. That compares to $28 in cash and $82 million borrowed under our credit facility at the end of 2007. In addition, we expect to collect approximately $112 million of tax refunds in the first part of '09.

In addition to generating cash, the other significant accomplishments this past quarter was our small positive pre-tax income before impairments compared to the prior year's pre-tax loss before impairments. The recent quarter results were due to an increase in our gross margin before impairments which was due to construction cost savings and the benefit of previous quarters' impairments that reduced the cost basis of the homes that we closed.

Our improved results also reflected our decrease in general and administrative expenses of 47% from last year's fourth quarter. We also reduced our community count by 14% during the quarter. I'll address each of these in more detail.

Slide 5. We generated positive cash flow from operations through the middle of 2007. We used that cash to first pay down more than $0.25 billion in bank debt by the end of 2007, and have since added to that cash position every quarter.

We also completed an equity offering in the second quarter of 2008 that raised $83 million and increased our year-end cash balance to $206 million.

Our cash flow from operations for the fourth quarter was $94 million, which brought our total cash flow from operations for 2008 to approximately $200 million.

Slide 6. Our fourth quarter 2008 home closing revenue declined 37% from the prior year due to 30% lower closings coupled with a 10% year-over-year decline in average sales price. We closed 1,488 homes at an average price of about $260,000 in the fourth quarter 2008, compared with 2,139 homes closed at an average price of $288,000 in the fourth quarter of 2007.

As we discussed last quarter, the increase in foreclosures has put pressure on both sales and margins due to their heavily discounted prices.

Slide 7. Fourth quarter net orders declined -- or, I'm sorry, declined 52% from 2007 to 2008, after a 56% cancellation rate in the quarter, sequentially higher than the 40% rate in the third quarter of 2008, and above the 47% cancellation rate we experienced in the fourth quarter of 2007. The total value of sales for the quarter was off 59% year-over-year, reflecting a further decline of 14% in average selling price.

The reverberations from the financial crisis that began in September 2008, impacted all of our markets, and we experienced substantial decrease in traffic and sales during the fourth quarter, which is also historically a slow selling time due to seasonality.

One positive sign was that the gross sales hit their quarterly low point in November and have inched up since then and into January. Shoppers seem to be taking advantage of current prices and lower mortgage rates. In fact, based on the first three weeks of January, sales appear to be on pace that is more in line with our third quarter than our fourth quarter of 2008.

We experienced a 61% decline in our Texas region net orders compared with the same period in 2007. This was due to a large number of late-stage cancellations in December, which we believe was a result of buyer anxiety over the financial crisis. Texas remains our strongest region due to its relatively strong position, strong population and employment growth, as well as housing affordability.

Based on our experience in other markets during this downturn, we were swift in taking aggressive actions in Texas as our net sales there fell during the quarter. We closed certain communities, sold some assets, terminated lot options, and consolidated operations in the region. We continue to be cautious until we're more comfortable with the activity in our Texas region.

Our sales declines were greatest in our Western region, where sales decreased 65% in the fourth quarter 2008 versus 2007. This reflects fewer active communities as well as weaker sales year-over-year. Our average sales -- our average active communities were 35% lower in the fourth quarter 2008 than the same quarter 2007.

Slide 8. We reported a fourth quarter net loss of $79 million in 2008, compared to a 2007 net loss of $129 million. Our pre-tax loss of $109 million for the fourth quarter of 2008 included $109 million of pre-tax charges against our real estate and joint venture assets, plus $1 million impairment related to intangible assets.

By comparison, our pre-tax loss of $197 million in 2007's fourth quarter included $130 million of real estate related joint venture charges, $3 million of fixed asset impairments, and a $58 million charge to impair goodwill and intangibles. Excluding those primarily non-cash charges in each year, our fourth quarter pre-tax income was approximately $1 million in 2008, compared to our 2007 pre-tax loss of $7 million.

The year-over-year improvement reflects our higher adjusted gross margin and reductions in overhead and other costs. Our GAAP gross margin for the fourth quarter was negative due to impairments, but our gross margins excluding impairments improved to 13.9% in the fourth quarter of 2008, from 12.7% in the previous quarter, and 11.6% in the fourth quarter of 2007.

That year-over-year margin improvement of approximately 230 basis points is partially due to construction cost savings and partially from previous impairments, lowered our cost basis on homes we close this quarter.

Slide 9. Economic conditions in the fourth quarter of 2008 were the worst we've experienced to date. We reduced our number of active communities by 14% during the quarter, which we expect to result in future overhead savings and ended the quarter with 178 actively selling communities, down from 207 at the beginning of the period. 109 of those communities are in Texas. Approximately 43% of our active communities have fewer than 25 lots remaining for sale. So, our active community counts should continue to come down over the next several quarters.

Impairments on land sold or held for sale accounted for $23 million of the total fourth quarter 2008 real estate charges. Four properties sold generated $12 million of those impairments, but together with prior impairments accounted for $47 million in tax losses realized during the quarter. Additional impairments in the quarter included $49 million of option terminations, $32 million related to continuing projects, and $5 million related to joint venture impairments.

Geographically, $44 million of the total was attributable to California mainly from two large option terminations and one bulk land sale. In addition, option terminations of lot sales in Texas made up most of the $36 million of that region's total real estate related charges in the fourth quarter of 2008.

We have only about $52 million in option deposits remaining, $20 million of that is in Texas, and the remaining balance is primarily related in one large parcel in North Scottsdale.

Due to further weakening in our markets, we made strategic decisions to cancel options and sell lots in certain marginal projects. Those actions accounted for approximately $67 million of the total impairments in the fourth quarter, which allowed us to realize approximately $106 million of corresponding tax losses. As a result, our total expected tax refunds increased to $112 million.

Considering the difficult economic conditions, we believe that taking swift action today regarding lot sales and cancellations of options will limit our future losses while strengthening our balance sheet.

Slide 10. Meritage has traditionally been primarily a move-up builder, and most of our communities and homes designs were geared to that market segment. However, in today's market, the largest demographic of home buyers are entry level and first-time move-up buyers. Consequently, we have adjusted our product strategy to appeal to that larger demographic segment. We have redesigned our product offering to target home buyers seeking lower price points. More than half of our active communities outside of Texas were redesigned the later months of 2008, and we anticipate redesigning many of our remaining communities in 2009.

We introduced 53 new plans based on extensive market research of what those buyers want in a home. All of these plans are priced to fit within the FHA mortgage caps, where we believe most mortgage financing will come from in the next few years.

The average selling price of these homes is approximately $200,000, so they will compete well with existing homes to make up the largest percentage of the current sales. As our sales mix changes to more of these lower price homes, our company-wide ASP, average selling price, will trend toward that $200,000 price mark.

We have been able to reduce the average cost per square foot of our active plans in several divisions by as much as 33% from our benchmark in 2006. Our new plans have more efficient designs and less square footage, but still offer our customers the ability to choose from a wide variety of options to suit their own style and budget.

The competitive bids we gathered to cost out these new plans have the added advantage of allowing us to benchmark materials and subcontracted labor across divisions, leveraging that knowledge to assure that we're getting the best prices from our contractors.

We have also been able to reduce our average build times by about one month with these new more efficient plans. Shorter build times should lead to higher inventory turnover, lower carrying costs, and the equivalent of a month longer selling season, which will add another month of sales to our year. It also enables us to move more quickly. We've been able to open a community with models and begin selling homes with our new plans within four months from the date of land contract signed.

Let me give you one example of our new product strategy and execution. We redesigned nearly all of our communities in Orland in mid-2008. The homes we're selling there have an average size of approximately 2,100 square feet; whereas, the average size of homes we previously sold was about 2,500 feet. We brought down the average cost per square foot on our active plans in Orlando by about one-third since the second quarter of 2006, which allows us to offer Meritage quality homes at more affordable base prices, and our buyers can still upgrade as they choose, whether it be a granite kitchen countertop or adding a home theater. Our average price on homes in backlog in Florida were down 22% year-over-year in the fourth quarter, and we sold 57 homes there during the fourth quarter, more than we did in either of the previous two quarters despite a much worse economy.

In today's housing market we compete more with existing homes and foreclosed homes than we do with other builders. We created a new department last year to research each market and submarket regarding existing home inventory, pricing, days on the market, and sales prices, as well as buyer demographics. The research assists us in making decisions regarding product design, positioning and pricing as well as underwriting and potential future acquisition of lots.

Slide 11. As sales and closings have declined, we have reduced our overhead cost in order to keep them in line with lower revenue. Our fourth quarter general and administrative expenses were 47% lower than the prior year, or 35% lower total revenue. As a result, these expenses declined to 3.9% of total revenue in the fourth quarter of last year, compared to 4.8% in the fourth quarter of 2007.

The 2008 general and administrative expenses were 36% lower in 2008 than in 2007, which includes the benefit of a $10 million legal settlement we collected during the second quarter this year. Excluding that item, our 2008 G&A expenses were approximately $28 million lower than in 2007, and were 5.1% of total revenue this year-to-date compared to 4.5% last year.

Slide 12. We currently have about 800 total employees, including 131 part-time employees. That's 42% less than our employee base one year ago, and 63% reduction from our peak in mid-2006. Because payroll related costs are the largest portion of our indirect costs, these reductions were unfortunately necessary to keep our G&A in line with revenue.

Our fourth quarter commissions and sales costs decreased 31% year-over-year, and increased just slightly as a percentage of revenue from 8.3% in 2007 to 8.9% in 2008. They have remained between 8% and 9% of total revenue for the last two fiscal years. We've been able to keep these costs down by utilizing market intelligence to help us save on co-broker commissions and by taking advantage of efficiencies in the way we manage our salespeople.

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?

Thanks, Steve. Turning to slide 13, cancellations increased during the year as the economy continued to weaken, resulting in increases in our inventory of unsold accidental spec homes, yet we successfully reduced our spec inventory to 768, or 4.3 homes per community as of December 31, 2008, from 809 spec homes at the end of the previous quarter. That's 31% lower than our December 31, 2007 total specs. 527 of the 768 homes were completed, and 241 were under construction.

We are primarily a build-to-order builder. However, we're adjusting our strategy with regard to our level of spec inventory in order to compete more effectively with the resells and foreclosures today. Many first-time home buyers are renters who want to move into a home quickly and may not be willing to wait for one to be built.

In addition, due to the fact that it has been taking longer for existing homeowners to sell their homes, many move-up builders are also renters who sold their existing home before shopping for a new home. We therefore feel that we need to maintain an inventory of four to five unsold homes per community that are available for quick move-in.

Our current strategy is to have one to two completed specs and two to three specs under construction per community. That is still well below most other homebuilders' spec inventory levels, and it does not mean that we're becoming a spec builder.

Slide 14. We've proactively reduced our total lot supply through lot sales and option terminations, bringing it down another 24% during the fourth quarter, a decrease of almost 5,000 lots. The total of 15,802 lots controlled December 31, 2008 was 71% lower than its peak three years earlier, and down from 20,738 at September 30, 2008.

We own 8,750 lots, representing a 1.6 year supply based on trailing 12-month closings. Consistent with our strategy to reduce risks associated with owning long land positions in depreciating markets, our own lot supply remains one of the lowest in the industry.

Slide 15. Our lot supply in many states is quite low. We have less than two years' supply of lots based on trailing 12-month closing in California, Colorado and Florida. And in Arizona, half of our lot supply is in active adult communities, which require more lots to efficiently amortize the common amenities, and one large option contract in a good infill location in North Scottsdale.

Half of our total lots at year-end are in Texas, which also has the largest option position at 62% of that state's total. Because our short position in these areas, we're actively monitoring market for finished lots, but we're also very cautious about entering into any new lot positions until we believe these markets are stable enough and prices are low enough for us to feel confident that we can purchase new lots that will allow us to earn an acceptable profit.

Our strategy is to contract for only small parcels of finished lots in order to sell out of the community within a year or two of opening it. We believe that many of the land investors in vulture funds who are buying lots and land today will become the land bankers of tomorrow. Many builders have gone out of business and others have large debt maturities and reduced credit facilities, so they will need cash to meet obligations for future working capital. We therefore believe that there will be few homebuilders with resources or appetite to purchase large land positions when the market stabilizes.

We feel confident that we will be able to contract for new lots at lower prices in the future without having to spend a lot of cash to purchase them outright, and we have already had discussions with several landowners regarding alternative financing structure that could provide us reasonable terms or rolling options without large deposits.

Slide 16. Lower home closing, prices and revenue marked another year of weaker market conditions for homebuilders. Our full year 2008 home closing declined 36% in the prior year as a result of 27% lower closings, and 12% decline in average sales price. We reported a full year net loss of $292 million in 2008, including primarily noncash real estate related and joint venture charges of $263 million pre-tax, and $16 million of tax expense, which is comprised of $119 million deferred tax valuation, mostly offset by $103 million of tax benefits recorded in 2008.

By comparison, the full year net loss of $289 million in 2007 included $398 million of pre-tax real estate related and joint venture charges, and $130 million of pre-tax charges to impaired goodwill.

Slide 17. We projected last quarter that we would collect at least $80 million in tax refunds in 2009 based on our expectations at that time of the tax losses we would realize in the fourth quarter. Due to the actual losses we realized from additional lot sales and cancelled option contracts, we now expect to collect a tax refund of roughly $112 million in early 2009.

Our total deferred taxes at December 31 are now approximately $127 million, which is fully reserved. It will be carried forward for tax purposes and can be used to offset future taxable income. Current tax laws allow for losses to be carried back two years to offset prior years' income, and we're at the end of that limit, since 2006 was our last profitable year.

If the five-year carry-back is adopted, as has been proposed, we could reverse much of the $127 million deferred tax valuation allowance we had booked at the end of the year. The reversal would increase our book assets at the time the change is adopted by the amount of deferred tax assets we could realize in 2009 and 2010.

We have recently taken steps to preserve the value of a deferred tax asset primarily associated with net operating loss carry-forwards, and built in losses under Section 382 of the Internal Revenue Code. We have proposed an amendment to our articles of incorporation authorizing the NLL protective amendment, and are holding a special meeting of stockholders to vote on this proposal on February 16.

Slide 18. We further strengthened our balance sheet in 2008 to better weather this recession. At December 31, 2008, we had no borrowings outstanding under our amended credit facility, and our borrowing capacity was $270 million including cash and after consideration of the most restrictive covenants in place at year-end. That compares to $375 million available borrowing capacity at the end of 2007. We have no bond maturities until 2014.

Our net debt-to-capital ratio was 45% at December 31, 2008, compared to 49% at the end of 2009 (sic - see press release). The combined effect over increasing cash, reduction of debt, and $83 million equity offering reduced our net debt-to-capital ratio more than offsetting the decrease in our stockholders' equity from net losses during the year.

We're in compliance with all of the covenants under our amended credit facility as of December 31, 2008. Our interest coverage ratio was 1.3 times interest incurred based on trailing four quarters adjusted EBITDA, and our tangible net worth cushion was $140 million at year-end. I'll now turn it back over to Steve.

Thank you, Larry. 2008 marks the end of our third year in the housing recession, which has eliminated many of our competitors and weakened all of our peers. We have built a substantial cash position that should provide greater flexibility for the future. In addition to the $206 million cash we had at the end of the year, we expect to collect $112 million in tax refunds in the first few months of this year.

Our new product strategy is designed to appeal to larger market segment of entry level and first move-up buyers. We have redesigned our products, eliminating home plans in communities that didn't meet current market requirements, introducing more than 50 new designs to appeal to entry level home buyers. All of these are priced within the FHA mortgage caps. We have reduced our construction cost to allow us to sell these homes at lower prices while still earning an acceptable profit.

By executing our asset-light strategy as it was designed, we have managed a lower spec inventory, lower lot supply, and relatively strong balance sheet. At some point we intend to begin acquiring lots again at what will be greatly reduced prices. However, we are keenly aware of the risk in this environment and therefore plan to redeploy capital only where we believe we could achieve return to justify the risk.

We fully expect 2009 will be anther challenging year and we are not hanging our hopes on rescue packages that are out of our control. Having defended our balance sheet well to date, we are focused on minimizing our losses and engineering our return to profitability. We have consolidated operations, reduced overhead, and limited purchases in order to preserve cash. Despite lower sales in current market conditions, we expect to generate modest positive cash flow before tax refunds for the full year 2009, before any potential limited land acquisitions. We look forward to better market conditions that will enable us to take advantage of such opportunities.

We'll now open it up for questions. Operator, will you -- the operator will remind you of the instructions for Q&A. Thank you.

(Operator Instructions) Your first question comes from the line of Nishu Sood of Deutsche Bank. Your line is now open.

Nishu? Operator, why don't you move onto the next one?

His line should be open now.

Hey, can you guys hear me now?

Yes.

All right, great. Good morning, everyone. So, first question I wanted to ask was, Larry, you made a very interesting point in your commentary that with as large as the cash balance is that some of the builders have built up, they're going to need that either for their debt repayment or the working capital buildup. So, a lot of the builders I think are -- or most of the builders are going to be migrating more towards asset-light strategy similar to you folks. When you take a look at that dynamic as well as your shifting now in quite a big change to more the first time type of product as opposed to the move-up, really, the kind of differences that have marked Meritage in the past and strategically seem to be eroding. So, I just wanted to get your thoughts on that, your strategy in terms of what's going to differentiate you versus the other builders going forward?

This is something we've been doing for a long time and other builders have not, so I think we're going to be more experienced at it. We know how to do rolling options, and I think we just have more flexibility than others. Larry?

Yeah. Well, I think because we have used alternative financing structures and used them in ways that minimized our risk with keeping to our principles of low deposits and no current pay deals, and things which really transfer the risk to the landowner, I think we did a better job in the past doing that and we'll continue to stick to our guns.

And we're just pointing out the fact that even though our cash balance may not be as large as some other big builders, we don't have as many cash needs going forward and we don't believe we'll be operating at a competitive disadvantage because there will be these alternative sources of financings going forward. And, as we said, we are having conversations with several landowners now about innovative new option structures.

I would also say that our product will still make a difference. We will think our product designs are going to be competitive, if not better than a lot of our competitors. Even though we're moving down to more entry level, first-time move-up, we're still going to have that Meritage flair and excitement about our product that we think will distinguish us from our competitors.

Just as kind of a way of framing your capacity to pursue these sorts of opportunities, you look at your cash balance, just over $200 million, you probably have about $325 million or so once you get that tax refund. If things were to turn around right now, how much of that, or I guess even in a broader context, how much liquidity do you think you would have to deploy right now towards new opportunities?

Well, you know, some of the option structure we're talking about, because landowners are sitting on land or having difficulty selling are no down or limited down option structures, where there is actually less risk than under the old structure. So, we could potentially tie up a lot of land with very little investment. And the only investment then required is building a model or two and having a few spec houses.

They're just not going to turn around that fast, also. And if they did turn around that fast, you'd have price appreciation, which means builders would return to profitability relatively quickly, and they would be able to go back into maybe their credit lines. But I don't expect that to happen. I think it's going to be more of a gradual recovery.

And I guess I would add, we don't anticipate utilizing much of the cash we're building up in 2009. We think we'll still have very small amounts of land acquisitions in '09, because we're still waiting to make sure that it's the right time to start to tie up new positions, and most of that is going to be optioned.

Operator, next question?

Your next question comes from the line of David Goldberg from UBS. Your line is now open.

Thanks. Good morning, guys. Question was really, the first question is on the cost. I know you mentioned bringing cost down. I'm just trying to get an idea of where you think cost per square feet, maybe on your new product cost per square foot is relative to where you were before, and maybe how much of that is coming from raw material savings relative to labor savings?

Well, it's both. You know, there are less materials in the house. The types of materials. The labor is less because the houses are more streamlined, they're more efficient to build. But we're building a lot of houses in the West and in Florida, maybe excluding California for less than $40 a square foot, where previously they were either in the high fifties or over $60 a square foot. California is still more expensive than that, maybe more in the forties, where it was in the sixties and seventies. So, we're having a lot of success either from renegotiating, because the subcontractors are more eager for the business and they've become more efficient and brought their cost down, and just through the redesign.

Do you have any idea what the breakout would be between how much you'll be able to take labor down, at least?

I don't have a breakout on that, but a third, I'd say. Maybe more on the material side, because commodities have come down as much as 50% in the last quarter. So, significant on the materials and then significant on the labor as well.

Great. And then my second question was, I was hoping you guys could give some more details on the Texas market, and specifically on a cash-on-cash basis. Are you still profitable on that market, i.e., can you go out and buy, if it's the right piece of dirt, can you go out and buy land, take it through the process and still generate positive free cash flow on a new piece of dirt?

Can we go out and buy dirt and make money?

Uh-huh.

I think you can. I mean, we're not buying any dirt in Texas, so I can't give you any real life examples.

I guess another way to put it, then, would be when you're closing homes in Texas, if you're generating free cash flow on those homes, how much of that is return on capital versus return of capital when you've previously invested in land?

We made money -- I think we made money in three out of our four markets last year in Texas even after our impairments.

On cash-on-cash basis or --

No, I'm talking on a pro forma -- on an income statement basis. We're still making -- maybe two out of the four, I may have misspoken. But we made money in markets in Texas last year at lower prices. Now, the margins are pretty skinny. They've gotten skinnier, but we have not seen the large price declines in land on the whole and on the houses in Texas that we've seen in other markets.

Great. Thank you.

Your next question comes from the line of Jim Wilson from JMP Securities. Your line is now open.

All right thanks. Good morning, guys. Two things. I guess the first one, as you kind of noted that sales got a little better in December and January. Could you give a little color on where or anything, or what you would want to give credit to, maybe just lower interest rates? But could you give a little color on that?

I'd say our best action has been in Texas the last few weeks. We had better gross sales and less cancellations than we had the last couple of months of last year. We had a pretty good couple of weeks in Orlando and we sold some homes in Arizona, but I don't see a big turnaround. I can't tell you that three weeks makes a trend, but certainly we're not seeing the December type activity in January. We're doing better in January than we were in November, December. More in line what we did in the third quarter last year.

Okay. All right. And then with all the improvements in cost, I know I see a decent improvement sequentially in margins in Q4. Could you give us some color on what margins, gross margins look like in backlog?

Larry, do you want to take that?

Sure. We've seen some improvement in gross margins and we'd like to think that we would see that trend of being a little bit better than last year continue. In this market we really aren't going to make any gross margin projections. It just depends on what further happens to the market. If things stabilize and prices stabilize, I think we could start to see some improvement. But it's just very hard to make any predictions there, Jim.

And your next question comes from the line of Eric Landry from Morningstar. Your line is now open.

Morning. Thanks. Hey, Larry, I'm a bit confused on the deferred tax asset evaluation allowance.

Sure.

You talked about 127 million slides, yet nothing was broken out. Was there a $21 million addition in the fourth quarter?

Well, there was -- the deferred tax asset is very confusing, because you have additions from impairments occurring. You have realization occurring as assets are disposed of. And then on top of that you have the reserves being book against the asset you previously booked. So, it's very difficult to understand.

But in the third quarter we, if you go to our summary income statement, we had about a $30 million benefit -- excuse me, in the fourth quarter. In the fourth quarter we had $30 million benefit, which means that we had tax realization of write-offs in that quarter that exceeded the write-offs, or exceeded reserves.

So, in that quarter, because we sold so many -- so much land and we triggered so many losses from terminating options, that actually exceeded the impairments taken. So, that's why you see that trend happening. But at the end of the year, we had $127 million deferred tax assets left of which every dollar was reserved. Does that help?

A little bit, but I still -- so, if the impairments are more than the actual taxes, then you can break it out; otherwise, you don't break it out, is what you're saying?

Well, we would typically not break it out. We toyed with trying to show the full detail to people and it's just very confusing. But essentially -- this is just an example. If you had $20 million of impairments you took in the fourth quarter, and you were able to trigger $30 million of previously recognized book losses for tax purposes, you would wind up with a $10 million net tax benefit in the quarter.

On the converse side, or the other way around, you reserve $30 million for book purposes but you only triggered $10 million, you would wind up having the opposite occur, where you would have to reserve that tax asset, yes, that net tax asset, and you have a tax expense instead of a tax benefit. Okay? And if you'd like to talk to me afterwards, call me. I'll be happy to walk you through more examples.

Your next question comes from the line of Carl Reichardt from Wachovia. Your line is now open.

Thank you. Actually, our questions have already been answered. Thank you.

Your next question comes from the line of Joel Locker from FBN Securities.

On your -- just saw your option deposits dropped about $17 million on your line item, but you wrote off $49 million, and I guess I wanted a little more color on the breakdown of the $49 million, or how many were letters of credit, or where that number actually came from?

Well, that's a good point. I don't have the specific detail, but there were some letters of credit outstanding relating to options that were terminated. And there were also some pre-acquisition costs relating to options that were terminated. So that some of those, the actual investment, letters of credit and pre-acquisition costs added up to the $49 million.

All right. And if you -- do you have a total exposure number in addition, letters of credit per acquisition cost and plus the $52 million in option deposits that are listed on the balance sheet as of the end of the fourth quarter?

Well, in our Q we do break that out. The total letters of credit we have is about $30 million, which by memory about $10 million or $5 million relates to options. So, there's not very much left, in addition to what you see on the balance sheet of the $52 million.

Right. And last question on the 8,700 owned lots. How many of those are completely finished, would you think?

Oh, I'd say almost all of them. Would you say that's correct, Larry?

Well, I would say maybe 75% to 90% range. There is certainly probably 10% that aren't, but the great majority are.

And the 10% that aren't are halfway there or almost finished, kind of?

Yeah. I mean, we don't have any that are close to raw. I mean, I'd say there's not much development expense left on those lots.

Right. All right. Thanks a lot, guys.

Your next question comes from the line of Lee Brading from Wachovia. Your line is now open.

Can you hear me?

Yes.

My first question is in regards to community count. I guess this year is down about 20%. If I think I heard you right, you said 43% of your communities have less than 25 lots left for sale?

Uh-huh.

And I guess, is there any guidance you can give us going forward? I mean, if one way you can look at it by simple math (inaudible). If you look at running through 40% of your communities potentially this year, kind of maybe on the worst side, or it looked like a similar year to last year, I guess.

Well, it all depends on sales pace. I don't know if it will be 43%, but we would think that it would be a number certainly in the double digits. It's hard to give projections because we just don't know what our sales pace is. But I think it wouldn't be anymore than 43%. On the other hand, it could wind up being 20%, although that's just an estimate. It's not a projection.

That's fair.

And that's assuming we're not replacing any of those communities with new communities. Of course, today we're not doing that, but as we get later into the year and into next year, if the market does recover, we'll start to replace them.

Okay. And on the JV side, I don't imagine there was much of a change, but I just wanted to make sure. It seems like you didn't have much of an impairment there, but from a Q3 kind of off balance sheet, was it much of a change versus Q3 and Q4?

I'm not certain I understand, but the balance sheet exposure now for JVs is down to about $17 million, if I recall. So, there is not any one large JV in there. It's a smattering of smaller JVs, and to date the ones we still have going seem to be performing okay.

What I was getting at was on the balance sheet, off balance sheet when you disclose that. I mean, last quarter you had about $560 million of real estate assets and mortgages associated with that are about $400 million. I was just wondering if there are significant changes in that Q4?

Yeah, there have been a lot of the joint ventures that have been -- we've had discussions with banks where we've either given the property back to the bank at the joint venture level and they were nonrecourse loans, or we've been able to sell the project to another party and pay off the debt. So, I don't have those numbers to talk about now, but we will have significant reductions that we will disclose in our summarized and capitalized balance sheet data in our K.

Thanks.

This is the conference operator. We will only be taking two more questions. Your next question comes from the line of Dan Oppenheim. Your line is now open.

Thanks very much. I was wondering if you can talk about, actually about the gross orders bottoming November with cancellations were -- late stage cancellations came through in December. Can you give us a sense of how cancellations went over the course of the quarter by month?

If I'm correct, Larry, they spiked substantially in December.

That is true. That is true.

We had, particularly in Texas, we had a lot of closing scheduled for December, and we had a lot of people that didn't show up at the closing table for their houses, and those houses turned into accidental specs. So, it was the worst cancellation month we've ever seen in Texas. That being said, we don't have that many cancellations now in January, and we're making pretty good gross sales numbers and it's sticking.

The other thing I don't think we talked about is we sold quite a few specs in the last three weeks. Was it correct to say, Larry, we sold about a third of our finished spec inventory in the last few weeks?

Yeah, I think that's right. Because of the late stage cans, we wound up with more finished specs, so our mix of finished specs was more two-thirds finished and one-third under construction. We'd like for that ratio to be flipped, so we made a concerted effort to sell those completed spec homes early in January.

That should have a positive impact on cash flow this quarter.

For the first quarter, correct.

Okay, great. And then wondering, you talked about redesigning some of the communities in the past few months of '08. How many of those, or when did those come on line and what have you seen in terms of sales performance with those redesigned communities?

We actually started -- we probably misspoke -- we started earlier than last few months. We started actually in the second quarter redesigning a lot of communities. We opened, as we said, several communities with new product in Orlando and Phoenix. Now, every one of our communities in Phoenix now has new product in it. Several of them are already open and some are opening in the next month or two.

Everywhere we've put in this new lower priced product we've had good sales success. We're seeing the difference already in our sales number between the new product and the old product, because the old product just doesn't compete today with the foreclosures and the resales, because it's too expensive. So, we need to get this new product on as quick as possible.

We built several model complexes literally in one month. From the day we broke ground to the day we completed the model and opened for business, we were able to do it in a month. We've seen build times that I haven't seen in 25 years in the business, because subcontractors aren't very busy and they're kind of standing around. They're very accommodating, they're helping us get these houses built very, very quickly.

I'd add that other than Florida, even though we have all these things, these subdivisions open now, it really hasn't had time to fully impact our sales. We've seen it in Florida, we haven't seen it in the sales results. Hopefully we'll see that this quarter.

Your last question comes from the line of Timothy Jones from Wasserman & Associates. Your line is now open.

Impressive that you've cut your cycle time by 31 days. I love that figure. Could you tell me from -- what's the absolute number that it went from and it is now?

Larry, do you have that?

It kind of varies by product type, but I don't have that off the top of my head, I'm sorry.

We could get back to you on that, though, Tim.

Okay. Thank you. And the other one, what's your feeling here on this tax loss NOLs being taken back by five years? You know the last time it was up, it was stripped by the Senate. Do you have any better feeling on that?

So far what we're hearing is it's on track to happen. That doesn't mean it's going to happen for sure, but so far so good. There's still amendments to be offered and negotiations to take place between the Senate and the House, but as of today it looks, from what we know, it looks positive.

And you said something that under the accounting rules you can't actually put the deferred taxes that you wrote down back on the balance sheet, can you? You said you could utilize them, but --

No, I think -- well, Larry, can we? I think we can.

Yes, actually, we will do an estimate of what taxes -- if the five-year carry-back goes in place, we'll estimate what losses we'll trigger for tax purposes for '09 and 2010, and we will reverse the reserve against the tax asset. And I think a large portion of that reserve would be reversed, so would make the deferred tax asset balance go back and our equity would go back up, and we'd have this kind of tax gain in the quarter of implementation. Okay?

Does that answer your question, Tim?

I think he's cut off, but --

Okay. Well, thank you very much. Appreciate your participation and your support of Meritage, and we'll look forward to talking to you again at the end of our next quarter. Have a good day.

This concludes today's conference call. You may now disconnect.