Meritage Homes Corp (MTH) 2009 Q2 法說會逐字稿

Good morning, my name is Andrea. I will be your conference operator today. At this time I would like to welcome everyone to the Meritage Homes second quarter analyst 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).

I would like to turn the call over to Mr. Brent Anderson, Vice President of Investor Relations. You may begin your conference, sir.

Thank you, Andrea. Good morning. I would like to welcome you to the Meritage Homes second quarter 2009 earnings call and webcast. Our quarter ended on June 30 and we issued a press release with the results for the quarter and the first half of 2009 after the market closed yesterday. If you need a copy of either the release or the slides that will accompany our webcast today, you can find them on our website at www.investors.meritagehomes.com or by selecting the Investor's link at the hop of the home page.

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 these risk factors, please see our press release and our most recent filings with the Securities and Exchange Commission, specifically our 2008 annual report on form 10-K and our most recent quarterly report on form 10-Q. Today's presentation includes certain non-GAAP financial measures as defined by the SEC. To comply with SEC rules, we have provided a reconciliation of these non-GAAP measures in our earnings press release. With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; and Larry Seay, our Executive Vice President and CFO. We expect our call to run about an hour this morning, and a replay of the call should be available on our website within an hour or so after we conclude the call.

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

Thank you, Brent. I would like to welcome everyone to our call today. Our second quarter was generally better than our first quarter in most respects. Except for the write-offs of one large project in Phoenix, I'm pleased to report that we further strengthened our balance sheet during the quarter. Even though our year-over-year comparisons are still negative, we expect them to improve over the next few quarters. A few recent indicators in the housing market have been positive. Starts, mortgage applications and confidence indices are improving, even though most housing statistics are at or near the all-time lows with a notable exception of affordability, which is near its 40-year high. However, it's reasonably clear that we'll see continued pressure in our new home sales from foreclosures and rising unemployment into 2010, and we can't wait for a recovery or bailout to rescue home owners. Managing through the downcycle, we reshaped the Company and repositioned Meritage to meet the challenges we face and are now focusing on our return to profitability.

I'm pleased with the improvements we have achieved in several key measures this quarter. We strengthened our balance sheet by generating $40 million of cash from operations, fortified our cash position in the quarter with a Company record of $385 million of cash, and reduced our net debt-to-capital ratio to 33% from 41% a year ago. We believe that we're making progress towards our goal of returning to profitability by generating positive EBITDA before impairments for the second quarter and the first half of the year. We maintained our free impairment gross margin at 12% while keeping our overhead expenses down. And we increased our sales over the first quarter sales this year at the lowest cancellation rate we've experiencing since the third quarter of 2005.

On slide 5, we have also seen positive initial results from our product redesign and reposition over the last year or so. Armed today with a stronger balance sheet and increased liquidity, we have been replacing older communities with a sellout and new lower-priced lots. These communities are designed to compete with the increased number of foreclosures in the market, offering more affordable homes for the entry level and first-time move-up buyers who comprised the largest segment of today's housing buying market. We are selling new homes to first-time buyers by marketing a payment that they can compare directly to their rent payment. Our no-tricks, all-inclusive payment includes principle, interest, taxes, insurance and HOA fees so buyers can more easily determine whether they can afford the home. As an example, we're showing on our price sheets on the slide show from a community Rancho Eldorado on slide 5 with monthly payments shown on the right to hit the buyers in when they come in the door to see the price sheet before they even see the sales price.

We have currently 178 communities open for sales. A net increase of 8 during the quarter. About 15 of these have been opened since the fourth quarter of 2008, with new lower costs lots. We have another 12 to 15 communities in the cue and expect to open over the next four quarters as older communities are closed out. Although the communities represent 7% of our second quarter home closing revenue, home buyers are responding to the exceptional values we're offering in these communities, and we're seeing promising indications from them in terms of higher absorptions and better margins. We expect a meaningful impact on our total results over time. It's our goal to return to profitability some time in 2010, and we believe that is achievable based on current market conditions without the necessity for home price appreciation. We are working towards achieving that goal by reconstructing our balance sheet with lower-priced lots, building homes that appeal to entry-level buyers, and maximizing our efficiency in order to reduce our cycle times. Those are our absolute priorities.

I will now review some of the highlights of the quarter and turn it over to Larry for additional color. Slide 6. Our net sales in the second quarter were down 22% year-over-year, partially attributable to a 16% decrease in active communities since the second quarter of 2008. However, our sales pace for community was nearly flat compared to last year and increased over the first quarter of this year. We sold 6.6 homes per community in the second quarter of 2009, compared to 6.9 per community in the second quarter of 2008 and 5.7 in the first quarter of 2009. Our second quarter total order value was down 32% year-over-year as our average sales price also declined 13%. Due to general price reductions and an increased percentage of sales through entry level and first-time move-up buyers. The groups represent 68% of our second quarter 2009 sales compared to 61% a year ago. Additionally, the second quarter of 2008 was difficult comparison as Texas was quite a bit stronger the first half of 2008. Although the accounts were lower, our sales and backlog increased over the last two quarters as we achieved monthly increases in sales from February through May while June and July were a bit slower as we would expect during the summer months.

Slide 7. Our second quarter home closing revenue declined 41% year-over-year due to 36% fewer closings and an 8% decline in average closing price. Closings revenue declined in all states but Colorado and Texas. Texas was down the least to 28% lower than a year ago as with sales, our year-over-year decline in closing revenue was partially attributable to fewer active communities and a shift toward more entry-level homes.

Slide 8. Despite our revenue decline, we maintained our gross margins before impairments by introducing more efficient home designs, realizing construction efficiencies, and negotiating better terms with our subcontractors. Our second quarter 2009 gross margin was 12.3% before impairments, slightly better than last quarter's 12% but approximately 150 basis points lower than a year ago on a preimpairment basis. Margins in Texas were quite a bit stronger than through the middle of 2008 before the credit crisis. We expect to see Texas margins improve over the next several quarters as some of our markets have already begin to do so. Another benefit of our more efficient designs and construction efficiencies is that we're improving our cycle times. We have taken 32 days out of the average cycle time from start to completion, which is a 26% improvement over the last year.

Slide 9. We reported a net loss of $74 million in the second quarter of 2009, compared to a net loss of $23 million in the second quarter of 2008. Our losses quarter included a $55 million impairment charge related to termination of the largest purchase agreement for about 1200 lots in North Phoenix. We know last quarter we were reviewing the project and there was a single largest option contract we had remaining. After much analysis and discussion, we determined that our expected returns didn't support its continued development at this time. Aside from that one project, our total impairments were $12 million in the second quarter, and most of which was related to Las Vegas, one of our most challenged markets in the country and our weakest market.

We now have only $16 million of option deposits and $14 million of investments and joint ventures remain in our balance sheet. These balances represent lots and land predominantly located in Texas where we remain profitable and record significantly fewer impairments. Because the total value of our remaining options and jvs is $30 million, we believe that our risk of any significant future impairments is limited, even if the market were to deteriorate further. We would expect any impairment of our own assets to be small and in line with any market decline. Excluding impairment charges, our second quarter pretax loss from operations was $5 million in 2009 compared with a pretax profit of $5 million in 2008.

I will now turn it over to Larry, our CFO, and I'll end our prepared remarks with a few closing thoughts before Q&A.

Thanks, Steve. First, a few more details regarding our operating results for the quarter. If you turn to slide 10. Our total general administrative expenses were $14 million for the second quarter of 2009. If we exclude the benefit of a $10 million one-time legal settlement in the second quarter of 2008, we reduced G&A by $7 million, or 33%, quarter-over-quarter, and our total G&A was 6.2% of 2009 revenue this year, about 70 basis points higher than last year, excluding the legal settlement.

Slide 11. Looking at our year-to-date results, we reported a net loss for the first half of 2009 of $92 million or $2.97 per share compared to a net loss of $69 million or $2.46 per share in the first half of 2008. Our net loss for the first half of 2009 excluded no tax benefit of the loss in 2008 was partially offset by a $36 million tax benefit. We have fully reserved deferred tax assets since the third quarter of 2008. After the impact of our loss this quarter, our deferred tax balance is now $162 million, though fully reserved, and therefore, not on our balance sheet. However, it's available to offset income taxes on an estimated $415 million of future taxable income. That off balance sheet asset equates to more than $5 per share. Included in our year-to-date losses were $77 million of impairments in the first half of 2009, compared to $99 million in the first half of 2008. Excluding those impairments, we generated positive EBITDA of $13 million in the quarter and $23 million for the first half of 2009. That included a $9 million gain on early extinguishment of debt for the first half of 2009 which, has is included in other income. Roughly equivalent to the benefit of 2008 from the legal settlement.

Slide 12. Turning to the balance sheet, we have generated positive cash flow for each of the last seven quarters and ended the quarter with $385 million cash and no bank debt. That brought our net debt-to-capital ratio down to 33%, compared to 35% last quarter and 41% in the end of second quarter 2008.

Slide 13. We retired $18 million of our senior subordinated notes due in 2017 during the second quarter by issuing approximately 533,000 shares of common stock in exchange for those notes. This resulted in a $7 million gain on the early extinguishment of debt, which is included as a component of other income. That brought our total debt retired in exchange for stock to about $24 million for the first six months of 2009, for which we issued 783,000 shares of Meritage common stock, representing an applied discount of 41% to the face value of the notes retired. The retirement of those notes will save us approximately $2 million of future interest costs per year. We may retire additional notes in the future based upon market conditions.

We're also planning to terminate our existing credit facilities during the third quarter, which will save approximately $2 million in fees over the remaining term of the agreement. We don't anticipate needing the facility before it expires in May of 2011. We expect to enter into one or more new credit commitments with a total capacity of approximately $40 million to $50 million to replace approximately $22 million in the letters of credit supported by the existing facilities. Terminating our current credit facility will result in a third quarter expense of approximately $1 million to write off capitalized origination fees. While we're currently in compliance with all of the covenants, we will no longer be subject to the covenants and restrictions imposed by the current credit facility after we terminate it. Based on our preliminary discussions, we don't anticipate this will cause any negative action regarded at corporate bond ratings.

Slide 14. Our total real estate assets were $710 million at June 30, 2009, down $150 million since the beginning of the year. Most of that reduction is reflected in speck and finished lots or lots under development. Our speck inventory was down 32% year over year, with 491 unsold homes in inventor at the end of the second quarter of 2009, an average of 2.8 specks per community, compared to 725 unsold homes and inventory or 3.4 per community at the end of the second quarter of 2008. We have been starting more homes at specks in order to ensure a sufficient supply of ready for immediate move-in buyers who are coming out of apartments or have sold their home and want to move in quickly. Almost half of our sales this quarter came from specks, causing our total speck inventory to remain low.

Slide 15. At June 30, 2009,, we controlled a total of 12,986 lots, representing about a 2.7-year supply, based on (inaudible) 12 month closings. More than half of these lots are in Texas. By comparison, we controlled 21,902 lots a year ago, or approximately 3.1-year supply. Since the end of the first quarter this year, our total lots supply education decreased by 2100 lots, including the abandonment of 1200 lots associated with the North Phoenix project and lots utilized for new home starts. We now control just over a year supply of lots in California and Colorado and are looking for a new lot there as well as Arizona and Orlando. It's very important that we secure well-located, lower-priced, finished lots to realize our goal of returning to profitability next year and we expect to acquire additional lots for new communities throughout the balance of this year. We have soon an increase in land acquisition activity in our markets in the last few months. During the first half of 2009, we entered into purchase and auction contracts for approximately 515 new lots priced at deeply-discounted values, and we continue to actively monitor the pipeline of available lots and evaluate the lot acquisition opportunities as they arise. We expect to reinvest in other new low-cost lots where we believe we can achieve a normal, more normal profit margin.

I will notice turn it back over to Steve for concluding comments.

Thank you, Larry. We're on slide 16 for those following along in the slide show. We believe that home builders like Meritage with low levels and high-priced legacy lots, combined with adequate cash to purchase new lower-priced lots, will have a strategic advantage as housing demand recovers and home sales increase. That strategic advantage should translate to a quicker return for profitability and in turn, benefiting our shareholders. Our goal is to return to profitability some time during 2010, and we have a plan to achieve that goal under current conditions without relying on price appreciations. We are absolutely focussed on achieving that goal.

Slide 17. In summary, I am pleased with the progress we made this quarter. Despite continued difficult conditions, we strengthened our balance sheet over the last few years by reducing our inventories in debt, generating cash, building liquidity and reducing our cost structure as activity slowed. Many home owners and land developers have gone out of business and the industry is consolidating. Lots once owned by these companies are coming back on to the market and at greatly reduced prices and we believe that Meritage is well-positioned to take advantage of these opportunities. Thank you for your attention and your patience following Meritage. We will now open it up for questions and the operator will remind you of the instructions for Q&A.

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

The first question I wanted to ask was on your goal to returning to profitability by 2010, just looking at the levers, your gross margins x impairment at 12.5, your SG&A including corporate at 14.5. What is going to get you back to profitability given that you're expecting, planning for prices not to increase, for not a great pace of recovery in terms of volumes, so is it going to be continued gross margin improvement, the cost reductions efficiencies, or is it squeezing more out of your SG&A?

I think it's those things plus something else, which you missed is new communities come online. We're going replace a lot of old communities with new community. We're buying lots at today's market price, which is much lower than some of the legacy lots we're running through our income statement, so by rotating out of older positions with new positions, that will help our profitability. As we can get these communities on quicker because we're buying finished lots that are ready to go. We have product in place that we can execute on quickly, get models online in a short period of time and have a meaningful impact on 2010 and in addition to the other areas you mentioned.

What do the gross margins look like on some of these new projects you're opening up?

We're generally underwriting the projects in the 18%, 20% or higher range. And our experience on some of the ones we opened, we bought last year is not quite that high, but it's not that far off from there, and we're feeling pretty confident that we have about 15 communities in the queue. We're in the process of closing on or getting ready to open that will deliver us margins close to that range.

Got it. Second question, if I could, you're following up on this -- these lots that you're looking at. You mentioned 550 lots that you have taken control of in the first half of the year. How would you characterize those purchases? Is that -- some people have looked at the land purchases and argued it's not a sign of recovery but a sign of builders and some of their submarkets are simply running out of product that they can deliver profitably in the near-term. On the other hand, the margins you're describing on these new projects are higher so to more, let's say, bullish sign on your views on the recovery, maybe not a recovery in the market overall but in the profitability. How would you characterize it for investors what it means that you're out there increasing the rate at which you're purchasing land?

The first thing I would say is we have taken great steps the last couple of years to increase our intelligence level to understand what resale housing market is doing. To understand what the pricing is and every competitive market segment we have communities in or thinking about entering. So, we have really good data to see what the supply is of foreclosures, what the price trends are for the foreclosures in those areas, and we want to make sure if we make a new investment in lots and in any marketplace, that we can compete with those foreclosures. So, with that said, if we see demand in a particular submarket of the 12 markets that we're in, going the right direction and we see prices stabilizing, we're going to make investments in lots to grow our business back. We do have a very thin pipeline of lots in many markets, and we do need to replace those. We're not going to replace those at the risk of taking further impairments or producing inferior results, so, we think these new communities that we're purchasing really have a strong opportunity to produce much hire margins than we're achieving today.

Your next question comes from the line of Carl Reichardt from Wells Fargo Advisors. Your line is open.

Morning, guys, how are you?

Morning, Carl.

Morning.

Two questions. One, Steve, I think you have mentioned you have taken 32 days out of your cycle time, I think you said 26% down. The square footage has fallen, too, and as the mix shifted, I would assume towards Texas, the cycle times have came down. How much of that is related to product mix geographic or otherwise versus real improvement? You can quantify that for me?

I can't give you an exact number, Carl, but I would say it's a blend of both, certainly building more entry-level housing that doesn't take as long to build and doesn't have as many options. Going to allow us to build quicker, but I do believe that we have made real progress in the field. We're getting much more cooperation from our contractor base, subcontractor base. Our guys are doing a great job of getting these houses built quicker. And delivering on that. At the same, I would say we have more room to go and more progression to make. We're going to reduce our cycle times even farther, and we're getting communities online and had a contest internally on how quick we could build a new model. A couple of divisions turned them in in 28 days and then we had another division that came in in 22 days and then another division came in 19 and then we had one division in Austin that built a house in seven days. It was really remarkable. So, if we put our minds to it, we can build our houses a lot quicker. Thank you, Steven.

The next question is the idea of reinvesting in land at attractive margins. What are you seeing in terms of your competitors when you are looking at deals. Do you you sense there is a number of bids or you're the only one? Seems to me it's not just builders that don't have legacy land but some who do have legacy land positions who have cash are investing ,and so I'm trying to figure out how sustainable the margins you're seeing in your pro formas might be if you have other peers out there chasing the same dirt.

We're seeing seven or eight of our public builder competitors out there competing with us for these lots. The finished lots. A few more aggressive than others. There is definitely competition today for lots, different than it was a few months back where we competing more with investors. Today we're competing more with other builders for lots. There is no question that public builders are back buying lots again. Not a lot of transactions have closed yet. It's still early in the process, but I do see the land departments of our competitors being very active.

Great, I appreciate that. Thank you, Steve.

Sure.

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

Thanks, good morning, guys.

Morning, David.

Hi. The first question is a followup to Carl's question and Steve, your comments just now about how you're seeing seven to eight bidders on some lots and the most, the public's getting active in the market. What I'm trying to reconcile, and maybe you can help me out, is you talk about the fact that you're getting deeply discounted prices -- really, you know what I think? When you get the good prices on the lots. How come the other builders, if they are bidding somewhat aggressively, how can you overbid them and win these auctions and acquire these lots and still not be bidding the price up to the point where it is less attractive?

We are not winning every bid. Sometimes we have the high bid, sometimes the lower bid. There is a competitive environment for all of these lots. Builders make different assumptions on prices for their houses. Not everyone has the same dataset. Not search going to value a lot at the exact same member. But some will win, some are losing.

It's not seven or eight on every bid either. It might be only two or three. The other think this is with our redesigned product, we have a better cost structure than others and can make more with a better margin.

Okay, that seems reasonable. My second question was about the speck count, and I know that the slide you mentioned, you said before you're targeting four to five specks per community. The number is now well below that, I think in the high 2s. I guess the question is, are you going to start to spend more free cash flow to build up the speck count to get back to that targeted level and maybe building up the working capital a bit?

Probably. We will spend some of our cash, but right now we're selling specks as fast as we can get them built. I think we mentioned somewhere that about 50% of our sales are coming from specks. Even though we're trying to build it back up to four or five, we're having difficulty doing that because we're selling them early on in the construction process. But I would say over time that we will use up a little bit of our cash.

Does that argue that you don't need to spend as much since on specks since you are selling them early on in the construction process? People still have to wait for delivery?

No, because people don't want to wait. If we can continue to reduce our cycle time and reduce will the time from when the person makes the order to buy the home, and we can deliver it. We'll build less specks. That is our goal. A lot of people buying today are renters or they have already sold their house and need to get in a new house quickly. We need to appeal to the market by building specks.

Got it. Can I sneak one more in?

Sure.

It's a quick question, I promise. Steve, in the commentary when you mentioned about being profitable in 2010, I wonder if that is a cash-on-cash kind of assumption or are we talking about GAAP?

GAAP profitability.

Would that also be cash-on-cash profitable?

You mean positive cash flow?

Where you originally bought out the lots, the GAAP impairments, but actually looking at what you spent for the land, cost to develop and title it through.

I don't know if I could answer that, Larry. We would have to pro forma back all of our impairments.

I think that is based upon our current impaired value, adding in new lots buying over time, and as that gradually grows, we'll gradually go back to profitability, and I don't think we can go back and say, what would it be as if we hadn't take impairments on lots we owned two years ago.

Got it. Thank you much, guys.

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

Good morning to you all.

Good morning.

A quick question on your land spend, you secured up 550 lots. Can you talk about the implied price per lot there, and where you securing these lots from? I'm guessing that they're coming from banks. But the question on the option side, are you finding that larger regional banks are willing to option to home builders now where they otherwise were not or is there a lot of these lots being secured from the investors.

I'll let Larry take the first part and I will take the second part. From a cash perspective, the prices we're paying for these on a finished basis per lot basis is $25,000, $30,000 depending on the market. They're very well priced and we are paying cash for most of these lots. There are a few cases where we have investors that are selling us lots. A few in Florida, Orlando, we picked up, but in most cases, the banks are asking for cash down, short sales, 30, 45 days purchase contracts.

I would say there are no options available from banks. We haven't seen any of those.

Okay.

Even from smaller regional banks.

Got it. And then the second question on the your sale strategy. Feels like the world is becoming a better place out there, and in that environment, you probably see rates move up and potentially mortgage rates move up. How would your sales strategy change if you saw rates go from the 5s back to the 6s? Would you guys do something different, as opposed to putting the price on the garage door?

I don't think generally it will change our strategy. Certainly we will tweak it. Certain markets, but I think we're going to be marketing to the first-time home buyers for a long time into the future. I think that is a permanent, semi permanent shift in our strategy to appeal to where we think the market is going to be for quite awhile.

The last quick one, can you explain the rationale for the debt for equity swap, given the extended maturity. I know you guys are saving some money. Seems with you guys out there looking for lots, having the liquidity might be more important at this stage in the cycle. What are your thoughts there?

We aren't paying, go ahead, Steve.

No, go ahead, Larry.

We're not paying cash, they're swap so in doing the swap, we're not utilizing any cash. What we're doing is seeing that in our subnotes, they particularly deeply discounted and we're just harvesting some of that discount. We don't plan on doing a large amount of this. Although we still plan on doing some. We have $385 million sold and have very adequate liquidity to go out and buy new lots, one as current projects that haven't liquefied yet and so some more money will still keep coming in from that and taking some of the cash we have and spending some of that for new lots. And we don't really look at this being a liquidity issue in reloading today.

If you look at the discount we're able to harvest on the bonds we purchased, it would be like issuing stock in the high 20s or as much as 30 per share, and so we thought that was a pretty fair trade, take advantage of the discount that we were able to purchase from the bonds.

Yes. On average, it was a 41% discount off of face.

So. Next question, operator?

Your next question comes from the line of [Alex Bar] from the [ACC Trading Group]. Your line is open.

Hi, guys, how are you doing?

Morning, Alex.

Great, thanks.

I wanted to ask you, in terms of the lots you're buying, what kind of discounts are you seeing? Are they selling under development costs?

Some cases, yes. Some cases they're right at what it costs to develop them and some cases a little bit more. Generally two-thirds to 75% off what they originally sold for or cost.

Okay. And in terms of geographies, is there any one place where you're finding more of the opportunities than others?

Well, we spread it out quite a bit, all the markets outside of Texas. We bought a few deals in Florida, several in Phoenix, and a couple in California.

Colorado.

One or two in Colorado. We're not doing anything in Vegas, because we see that market continuing to get worse or at least see a lot of pricing pressure. We haven't done much in Texas. We haven't seen the opportunities to be as interesting there yet and I think that will continue.

Okay. Any comment you can offer on orders so far in the third quarter?

I think we said that June, July were less than what we saw in May. But they were consistent with what we saw in February, March, and April, and they are really falling in line with what we generally see for this time of the year. A little bit weaker summer months but in line with our expectations.

Okay. And you talked about Vegas. I guess I was there recently. I understand what you're talking about. I was kind of wondering since you are involved with some of these really big projects, focused projects, what is going to happen there in terms of any impairments or debt you're on the hook for. Has that already been impaired through your numbers, or is there any remaining risks there?

We have impaired our entire investment of the joint venture and any locks we purchased down to what we think can be realized and obviously, there are debates going with the bank and the builders and focus, and we don't think it would be appropriate to talk about that.

Okay, thank you.

It's a very small number, though, what is left in those projects and one project is nothing and the other one is very small.

Okay.

Fortunately for us, we were only 3%, 3.5% ownership in the deals. We have a very, very small exposure.

So like after you're done in the phase, for example, in [Insperado] the lots you guys have there, you're not -- you don't have to buy any more, or is that to be settled at some later date?

Correct. Yes, at this point in time, we don't anticipate buying anymore lots.

Got it.

Part of our impairment this last quarter was some of the lots we owned.

Okay, great. Thanks.

And just another thing for -- we disclosed bad boy guarantees and there is one bad boy guarantee for $7 million, $8 million, the total debt on our share of it. That gives you an idea of the total exposure if someone could make the case that was recourse, obviously, the builders don't think this it is.

Got it thank you.

Thanks.

The next question comes from the line of James McCanless of FTN Equity.

Good morning, everybody. I wanted to ask on, I believe, flat 14, you talked about four to five specs per as a community as a goal. I wanted to see the timeframe for that goal and how the upcoming expiration of the first-time tax credit would effect that goal.

Well, I mentioned it to previous caller, who asked a similar question. We're endeavoring to get to four to five specks. Half of the sales today are speck homes, the houses are getting sold as quickly as we can get them started, so, we may not be successful getting in there, but and it's per community goal. We have a different speck level, each community, depending on the goals and the types of buyers we're seeing. Selling to a lot of renters today and a lot of people already sold their home and want to get in a new home quickly. As far as the $8,000 on the tax credit set to expire November 30th, we're hoping that that gets extended and continues, although we're not banking on it, and certainly that will have an impact on the number of speck homes because I think that is driving some of the demand for entry-level buyers.

Okay. Great. Thank you.

Thanks.

Your next question comes from the line of Daniel Oppenheim from Credit Suisse. Your line is open.

Thank you very much. I wanted to follow up with the question of the buyers and such. On the slide presentation, you showed the community in Arizona with the Justice Department of Agriculture loans for the zero down payment.

Right.

You can give me color in terms of what mortgages the buyers are giving, what percentage of USDA loans are now versus FHA versus traditional?

I don't think I have the exact percentage for particular community, but I would say overall, it's predominantly FHA. Larry, do we have a percentage?

Yes, about -- today, about a little over half are conforming conventional and a little under half are FHA or VA and very few are -- .

USDA.

Yes.

Okay. Thank you very much. In terms of the land opportunities and looking at that, you say a lot of cash deals. What is your appetite for going out for the cash deals right now in the market with it being a little uncertain and historically, you have done more optioning land. How do you think about that now? How much would you think about spending on the land in this environment?

Well, there is generally not a market to be able to get that option outside of Texas. There are some exceptions, so, if you want to buy lots and replace inventory, you are going to have to pay cash. We're buying smaller communities, 50 to 100 lots, versus before we may have bought bigger communities, up to 200 lots. And we see a bottom in several of our markets where we see good opportunities and we can buy lots on and make normal -- more normal profits on today's housing prices, so in those cases, we'll buy lots.

Thank you very much.

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

Thanks, good morning, guys.

Morning, Jim.

Hi.

I was just wondering on the, on the Phoenix and Desert Springs, that s I assume, written to zero, correct?

Correct.

I made that assumption. And are many of the lots finished or kind of -- I'm looking at, you're not going to do much but you think you can sell off the finished lots?

In that project?

Yes.

None of them are finished and we don't own any lots there.

Oh.

It was strictly down payment on a contract/option and predevelopment costs.

Okay. All right. That's it. Okay. All right. Great and I guess then, as you look at residual risk, obviously you have outlined it here pretty well, but there is nothing left, also you mentioned options and JVs, was in nothing left on balance sheet of any material side size. That is the only other thing was going to check on.

Correct, everything that is optioned or JV is much, much smaller pieces and 84% of our options are in Texas. So, and there are a lot of individually small communities. And nearly all of our JVs are in Texas, there are three or four JVs in Texas. Individually, $2 million to $4 million a piece. So, there is nothing big out there like the current impairment that we did this quarter.

All right, and my final question, just, active adult, any different you're seeing in how it's selling or moving or profitability that you could comment on compared to the conventional part of your business?

I would say it's been a bit slower but we're -- we see signs of hope in certain communities that it's going to pick up again in the fall. But, overall, certainly the last spring season was a bit slower than the -- from the market in general.

Okay. Great. Thanks.

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

Morning, guys. With your balance sheet getting stronger, are you thinking about maybe going into some other markets where you see distress also, nice demographics and things like that, maybe the Carolinas, Chicago or something along those lines or are you going to stick with your similar market you are in .

We have no plans to go into any new markets right now. We have a lot of opportunities to gain market share in the 12 markets, we're in and we're going to really focus on that to to get bigger.

Got you.

Get bigger in the markets and use our capital in the new markets.

And just a quick question on the $22 million of LOCs left, how many are tied to option contracts?

I think it's about maybe $6 million or $7 million relate to options and the rest relate to other matters. It might be a bit higher, but it's not a large number. The rest of the options support other kinds of contracts, but not option deposit type contracts.

So just total option exposure is around $23 million? $16 million?

I think it's $20 million, $22 million.

$22 million, $23 million.

Yes, total option exposure is on $23 million, if you add the LOCs to the cash deposit.

Right. All right, thanks a lot, guys.

Your next question comes from the line of [Robert Roll] from [River Source Investment]. Your line is open.

Hi, good morning. A couple of questions on the newer communities versus older communities. I think you mentioned 7% of your sales, deliveries came from the newer communities, I was wondering another 15 in queue, taking it up to 15% or so in the future. I was wondering if you could highlight or give more color around the progression and maybe if you would care to venture a guess at what percentage of sales or orders the newer communities might be at, say, year-end 2009, heading into 2010.

Boy, let's see. Larry?

We-- that is dependent upon the additional communities we find and how quickly these ones we already have tied up come on and it's -- I don't want adventure at this point, I guess. Obviously, we think it will continue to increase how fast and what percentage we at the end of the year or this time next year is difficult for us to estimate at this time.

Okay. What, about community count? It grew sequentially. Should one expect it to continue to grow sequentially?

I don't think we expected our community is going to change too much from where we are today. It should stay in the 175 to 185 range, but what is important for us is to replace or rotate out of older communities with newer communities. Not necessarily to expand. The total and newer communities will give us better margins and better absorption.

Okay and finally, what is the current, if you can break yet out, what is the current ASP differential on the homes being offered in the newer communities versus the older communities? I think the average is $230,000. How does that break out between the legacy communities and newer communities?

I don't know if we have the number for that, but I can tell you it's probably lower. The newer communities are more entry level and we're targeting more communities under $200,000 so it will probably continue to bring our ASP down.

Okay, thank you very much.

Thank you.

Your next question comes from the line of Bose George from KBW. Your line is open.

Good morning. A couple of things. One, you noted 68% of your buyers were entry level or first-time move up. Can I get the number for the first time? The first-time buyers you guys have?

It's running around 35% or so for first time.

Okay. Great. The question on the FHA tax credit monetization program, has that gotten any traction?

No. No, not that we're aware of.

Okay. And then finally, I wanted to just -- the math of the write down, the $55 million on 1200 option lots, you can break that out between the option costs and what other costs are in there?

It's roughly about 50/50. The down payment and preacquisition. Money we spend in doing some off site improvements that were required by the contract are planning and zoning and product design. That would be preacquisition versus payments we made to the seller.

Okay. Great. Thanks a lot.

Your final question comes from the line of [Alex Bar] from ACC Trading Group. Your line is open.

Thanks, guys. I guess looking forward to when you do become profitable, how does the accounting work, Larry, in terms of getting credit back for the deferred tax asset?

Well, I think it will be interesting to see how the various accounting firms and builders allow that to be rebooked, but my understanding and, again, it probably needs to have more discussion with the auditors, you would have to establish a track record of profitability. Whether that is two or three or four or five quarters of profitability, but you would have to establish that and be able to indicate that you, it looked like you were going to remain profitable to rebook, if not all,, at least a portion of the tax assets.

Okay. So, you don't know at this time whether you get to book it all one shot or it's just gradual?

I think there might be some concerns, depending upon what your future profitability is, where you would over 20 years you would get there. I think you would wind up rebooking the whole thing, as long as you could show you're going to get back to more normal operations of several years ago, and I can't say that for certain. I don't know. That is why I'm not committing to rebooking all at one time.

Okay. And in terms of these debt-to-equity swaps, who is on the other side of this deal?

There are people who bought the privately-placed debt and are happy to do a stock trade with us. It provides them with liquidity in the form of having a registered share that they can then sell.

Okay. It's basically people who couldn't sell these things otherwise?

They're privately placed and unregistered. They're not as liquid as -- what our stock is.

The only part of the debt structure that is available to do this that one bond due 2017?

That is what we have done so far. Possible we may do it with the other two issues tradeable and we're not committed to doing that. It's possible we could .

Okay, last question on gross margins. What was the benefit from the previous impairments to your gross margins this quarter?

We don't track that and I can't give you that number. It's not something that we have tracked over time.

Okay. Thanks a lot.

Thanks, Alex.

Take care.

There are no further questions at this time. Gentlemen, do you have any closing remarks?

Thank you very much, we appreciate your interest in Meritage, and we look forward to talking to you next quarter.

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