Meritage Homes Corp (MTH) 2009 Q4 法說會逐字稿

Greetings, and welcome to the Meritage Homes fourth quarter 2009 conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Mr. Brent Anderson, VP of Investor Relations. Thank you, Mr. Anderson, you may begin.

Thank you, Nikki. Good morning, I'd like to welcome you to the Meritage Homes fourth quarter 2009 earnings call and webcast. Our quarter ended on December 31, and we issued a press release with our results for the quarter and full year 2009 yesterday.

If you need a copy of the release or the slides that accompany our webcast today, you can find them on our website at www.investors.meritagehomes.com, or by selecting the Investors link at the top of our home page.

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 information regarding these risk factors, please see our press release and 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 also 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 VP 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 after we conclude the call.

It will remain active for about 30 days. I'll now turn it over to Mr. Hilton to review our financial -- our fourth quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone to our call today. I'll begin with an overview of our fourth quarter and full year highlights shown on slide four. We reported net profit of $43 million for the fourth quarter or $1.35 earnings per diluted share.

We were profitable in the quarter on a pre-tax basis adjusting for impairments and about $12 million in accruals for certain items that increased our cost of sales and G&A expenses which I will discuss later in more detail. We sold several nonstrategic properties near the end of the year that accounted for $14 million of our impairments but also allowed us to harvest the tax benefits on those properties and increase our tax refund.

Our average margin on the 1,202 homes we closed this quarter continued its upward trend reflecting the cost reductions we have achieved to date, reduced incentives and higher margins on newer communities built on lower cost lots. Despite a general slowing in new home sales near year end, we sold 24% more homes than in our prior year with 14% fewer communities, offset by a 50% increase in sales per community. We are gearing up for the 2010 spring selling season.

We generated positive cash flow if from operations of $27 million in the fourth quarter, after spending approximately $82 million of cash to purchase roughly 2,600 lots during the quarter. For the full year, we generated $184 million cash flow from operations and ended the year with more than $390 million in cash and securities plus another $93 million coming soon in tax refunds.

Taken together our cash and tax receivable equate to approximately $15 per share, roughly equal to our book value and nearly three quarters of our market cap. Our net debt to capital dropped to 31%, the lowest it's been in many years. And we contracted for approximately 1,000 new lots with total purchase prices of $45 million in the fourth quarter, including what I believe were some exceptional buys. That brought our total to more than 4,000 lots put under contract in 2009 for a total purchase price of $150 million, which is roughly equivalent to the number of homes we closed during the year.

Slide five. We were generally pleased with how we ended the year considering that it was a very difficult year for homebuilders and the economy as a whole. In addition to our financial results, we undertook a number of strategic initiatives last year to improve virtually every area of the Company and further enhance our competitiveness. Based on what we've already accomplished and our ongoing plans I believe we've not only positioned the Company for a return to profitability in 2010, but have also permanently improved our competitiveness.

We have significantly reduced our construction costs and overhead and expect to realize further gains through a managed process of continuous improvement in our operations. We have built a robust market research function that we believe gives us a strategic advantage in underwriting lot acquisitions and pricing our homes for a better understanding of the competitive landscape for both resale and new homes as well as home buyer trends in our markets.

We have introduced our Simply Smart series of new home designs to target the first-time and first move-up market, compete successfully with both new and existing homes, and offer Meritage quality at very affordable prices. We expanded our green building initiative to become the first public builder to meet Energy Star qualifications in every home we start beginning January 1, 2010.

And we most recently have rolled out our 99-day guaranteed delivery program in selected communities offering, Your Home, Your Way in 99 days guaranteed. This innovative program allows our home buyers to enjoy all the benefits of purchasing a new built to order home over a used home without the long construction period previously associated with building a new home.

Slide six. We reported a net profit for the fourth quarter of 2009 of $43 million, or $1.35 per diluted share, including $39 million of pre-tax real estate-related impairments and a net tax benefit of $90 million. The net tax benefit was a result of Congress passing legislation that allowed net operating losses to be carried back up to five years to offset prior years taxable income.

As a result of our NOL carryback, we expect to collect a $93 million tax refund in early 2010. By comparison, our fourth quarter 2008 net loss was $79 million, or $2.58 per diluted share, which included $110 million of pre-tax charges due to real estate-related and other impairments and a $30 million net tax benefit. Our loss before income taxes for the fourth quarter of 2009 was $47 million compared to $109 million pre-tax loss in 2008.

I will explain several items that reduced our 2009 net operating profit. Slide seven. Our real estate impairments for the fourth quarter of 2009 totaled $39 million, consisting of $25 million related to homes and lots owned or optioned and $14 million related to land sales which was far less than the $109 million of total impairments in the fourth quarter of 2008.

We sold several nonstrategic properties near the end of the year that were not needed to execute our current business plan, resulting in charges that represented more than a third of our total impairments in the fourth quarter. However, the land sales allowed us to harvest the tax benefits from previous impairments on those properties. We generated a total of $16 million in proceeds in tax benefits related to the $14 million of land sales impairments.

The majority of the remaining impairments in the quarter related to older lots we owned primarily in Las Vegas and in Arizona. Assuming the stable to improving homebuilding environment in 2010, we believe that our risk of any further significant impairments is minimal.

Slide eight. Our gross margins continue to improve due to our success in reducing construction costs, combined with lower incentives and greater closing volume in our newer communities where we are building more cost efficient homes on lower cost lots.

Our home closing gross profit was reduced by $25 million of our total $39 million impairments and by an additional $3 million charge to increase our accrual for estimated warranty expenses related to the Chinese drywall in Ft. Myers, Florida. We increased our reserve for remediation costs to a total of $6 million, which we believe should fully reserve our liability related to these homes. Including the impairments in the Chinese drywall charge our gross margins on home closings climbed to 16.0% in the fourth quarter of 2009 compared to 14.3% in the prior year.

Slide nine. We have been diligent in controlling our overhead costs as our sales and revenue have declined with a goal of setting our general and administrative expenses back down to a more normalized 5% of revenue. Our fourth quarter 2009 general and administrative expenses of $21 million included $9 million of charges that make comparisons to prior quarters difficult.

$5 million relates to legal accruals for ongoing litigation, $3 million was for discretionary performance award approved by the Board at year end, and $1 million was for lease abandonments. Excluding those items, those three items, our general administrative expenses were 23% lower this past quarter than they were a year ago and represented 4.2% of fourth quarter 2009 total revenue compared to 3.9% in 2008. We were profitable on a pre-tax basis before impairments. These three items included in G&A expenses, and the additional accrual for Chinese drywall claims.

Slide 10. Our fourth quarter 2009 net orders increased by 24% year-over-year to 621 sales compared to 500 in 2008. The increase was driven primarily by 50% more sales in Texas and 19% more in California over the prior year.

Additionally, our fourth quarter cancellation rate fell to 30% in 2009, from 56% in 2008. During 2009, continued low mortgage rates and historically high affordability drew buyers into the market and the federal tax credit provided an additional incentive through the third quarter of 2009. The tax credit didn't benefit sales in the fourth quarter due to the fact that homes that closed by November 30 -- had to close by November 30, to qualify for the credit.

The program was expanded and extended at the 11th hour to include existing homes and apply to contracts signed by April 30, and close by June 30, 2010. We believe the extension reduced the sense of urgency for buyers to purchase a home in the later portion of the quarter. We are optimistic that the extended tax credit incentive will benefit our 2010 spring selling season and we plan to build more specs in some communities in order to capture sales before the April 30, deadline.

Our average sales price on the fourth quarter orders increased to $261,000 in 2009 from $224,000 in 2008. This was mainly due to changes in our mix of sales. We sold more homes in communities that command higher prices because they are in prime locations. Many of these are still considered entry level and first move-up homes despite their higher price points.

A perfect example is a new community we have in Gilbert, Arizona named Quail Springs. Homes in that community sold at an average price of $273,000 compared to sales with the same plans from our Simply Smart series in a community 20 minutes further south which sold at an average price of $166,000 during the quarter.

Additionally, a greater percentage of our total sales in the quarter were in Texas where we have maintained prices in many existing communities and have not opened as many new communities with our lower priced series of homes. In the near term, due to variances in the mix of sales across our markets we expect that ASPs will range between $225,000 and $250,000, even as we continue to focus on the first-time and first move-up buyers.

Slide 11. Our average sales per community increased by approximately 50% in the fourth quarter of 2009 to 3.9 from 2.6 in the same period last year. We were operating with 14% fewer communities, fewer active communities, at December 31, 2009, so this is a very significant metric that we are focused on improving in order to keep our total sales up.

We expect our sales pace to increase as we replace older communities with new communities that were opened on lots we purchased in the last year to 18 months, and as our markets continue to stabilize and begin to improve. We just announced our 99-day guaranteed delivery program which is available in select communities across the country. We believe it is an innovative change for a build-to-order home builder and we expect to be leading the industry in this direction.

The guarantee is offered to all buyers in these selected communities and it gives them the advantage of owning a new home without the long construction times historically associated with a build-to-order home that is tailored specifically to their preferences.

I will 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. I will pick up on slide 12. Our fourth quarter home closing revenue declined 28% year-over-year due to 19% fewer homes closed and fewer communities opened in 2009, coupled with a 10% lower average closing price of approximately $233,000 in the fourth quarter of 2009 compared to approximately $260,000 in the fourth quarter of 2008.

The lower average closing price reflects a higher percentage of closings for homes in the lower priced communities such as Meritage's new Simply Smart series of more affordable homes as well as general price declines from the previous year. Our backlog of orders was 15% lower in number and value at the end of the fourth quarter of 2009 compared to 2008 due to accelerated closings to capture the tax credit for first-time home buyers as well as success in reducing cycle times which is allowing us to convert backlog from sales to close more quickly.

Slide 13. We reported a net loss for the full year of 2009 of $66 million, or $2.12 per share compared to a net loss of $292 million, or $9.95 per share in 2008.

The 2009 net loss included the following items shown on slide 13 in addition to the fourth quarter charges we discussed earlier; $129 million in pre-tax real estate-related impairment charges, down from $260 million in 2008; a $3 million write-off of capitalized fees relating to the reduction and subsequent termination of our credit facility during the year, which we no longer need to maintain due to our large cash balances and it will save us approximately $2 million in the future doing this; a $9 million gain on extinguishment of $24 million of debt in exchange for equity; and a net tax benefit of $88 million.

In addition to impairments, our 2008 net loss included -- this is 2008 -- a $10 million benefit from a successful legal settlement in the second quarter and a $16 million net tax expense after taking that $106 million valuation allowance to fully reserve our deferred tax assets in the third quarter of 2008. In addition to the $93 million tax refund we expect to receive early in 2010 our cumulative deferred tax assets also totaled $93 million, or $2.91 per share as of December 31, 2009.

$65 million of that is federal and $28 million state deferred taxes. Those assets are fully reserved and, therefore, not reflected on the balance sheet but are available to offset future income taxes.

Slide 14. We generated $184 million positive cash flow from operations for the full year 2009, even after spending a total of $182 million for lot purchases during the year. We ended the year with a total of $391 million in cash and cash equivalents, including $16 million of restricted cash and $126 million in investments, all of which are in very conservative treasuries or treasury-backed securities or deposits in money center banks. In total, this was an increase of $185 million over total cash balances at the end of 2008. This increased cash and reduction of debt from our equity swaps reduced our net debt to capital ratio to its lowest in many years, 31% at December 31, 2009, compared to 45% at December 31, 2008.

Slide 15. We continue to acquire new communities where we believe we can earn near normal margins and generate attractive returns with the least risk from foreclosures, excess inventories or falling prices. We contracted for more than 1,000 additional lots in the fourth quarter bringing our total to more than 4,000 new lots put under contract in 2009 for a total purchase price of approximately $150 million.

Based on our market research, we believe we acquired lots at very attractive prices that should help us return to profitability in 2010. The majority of these projects were underwritten to net contribution margins in the mid-teens. Figuring approximately 5% to 6% G&A overhead, net contributions in the mid-teens should produce pre-tax margins of 8% to 10%, which we believe we can get back to over the next couple of years.

The new communities that we opened in 2009 on lower cost lots made up 20 of our 153 active communities at year end and accounted for 14% of our closings and closing revenue in the quarter. Our average margins on these communities were about 500 to 600 basis points higher than our average in our older communities.

We already own or have under contract lots for another 21 new communities we are planning to open in 2010. We are projecting that sales from our new communities will account for 40% to 50% of total sales by the fourth quarter of 2010. We are excited about our new series of Simply Smart homes designed especially for renters, first-time or first time move-up buyers which we announced last week.

Since many of these are still in the start-up phase, we expect our sales per community to improve as we close out older communities and ramp up sales in our new communities built on the lower cost lots we've acquired.

Slide 16. At year end, we controlled 12,906 lots or about 3.2 years of lots supply based on trailing 12-month closings with approximately 77% of these lots owned on our balance sheet. By comparison, we controlled 15,802 lots at December 31, 2008 with 55% of those lots owned.

I will now turn it back over to Steve.

Thank you, Larry. In summary, we've made excellent progress towards achieving our goal of returning to profitability in 2010 and that will be profitable for the full year anticipating our markets stabilize and improve.

We believe that that's achievable without broad appreciation of home prices due to the improved margins and increased sales pace we've already seen in our newer communities. Recapping our strategy that we've laid out for you. We are using extensive market research to support our acquisitions of lower-priced lots as well as product selection and pricing which is enabling us to compete successfully with foreclosures and resale homes.

We've also implemented continuous improvement principles and are working with our suppliers and contractors to streamline our processes and improve quality at every stage of construction thereby reducing both their cost and ours. These first two initiatives are enabling us to reduce our cost structure, compete affectively on price, while improving our margins and are the foundation of what we referred to as Meritage Forward.

We've increased our focus on the entry level market and the first-time home buyers by offering lower priced homes and starting more spec homes. We are marketing on an all-inclusive monthly payment to appeal to renters who want to own their first homes. These are both embodied in our new Simply Smart series of homes which we announced last week and have referred to several times in our presentation today.

We're decreasing our cycle times in order to deliver more homes without needing to invest additional capital which is helping us to better compete with foreclosures and resales. As a result, we've just announced our 99-day delivery guarantee for new Meritage homes on Monday of this week. And we've made a corporate commitment to build green. We're the first large national homebuilder to be 100% Energy Star qualified in every home we build starting January 1, 2010, which we announced on January 12, this year.

You can find those press releases and learn more about each of them at meritagehomes.com. I have never been more confident in our people and our abilities than I am today and I believe our future is bright.

While we face a number of uncertainties including the sustainability of an economic recovery, high unemployment and the risk of inflation and potential fiscal and public policy actions by our government, we've also seen many signs of stabilization and even improvement in certain of our markets that make me optimistic.

I believe the potential for positive outcomes significantly outweighs the negatives at this point and eagerly anticipate the future successes we will achieve in 2010. Thank you very much for being on the call today, and we will now open it up for questions, and the operator will remind you of the instructions.

Thank you, we will be conducting a question-and-answer session. (Operator Instructions) One moment while we poll for questions. Our first question comes from Mr. Joshua Pollard from Goldman Sachs. Please proceed with your question.

Good morning. I quickly ran the math on the margins for your new versus old communities and I get two numbers around slightly under 20% for your new communities, somewhere in the 14% to 15% range for old communities. First quick question is, are those the same numbers that you all get?

And do you expect further improvement on your older communities and the margins you get on the older communities to support you guys as you attempt to be profitable in 2010?

I think the short answer is yes and yes, Larry. I think you agree, right?

Yes.

Certainly our newer communities where we've changed a lot of product out, we are still bringing costs down. We are pulling back some of the incentives, so we expect the margins on the older communities to increase as well as certainly our newer communities are achieving a significantly higher gross margin.

Another quick question on land, you've often mentioned your extensive market research, but I want to understand something quickly, the rationale between owning versus optioning land for Meritage. We continue to hear from your competitors that many sellers are willing to option, get into 20% look backs and enter into take-down schedules that are quite favorable and improve returns on invested capital.

Could you walk through the rationale for leaning towards owning land versus some of the favorable options out there?

I just don't think that's a true assumption, I don't know which one of our competitors are saying that. But in California and Arizona, in Florida and Colorado, it's very hard to find an option that pencils most of the land that we are buying today is distressed land from banks or like kind parties and they want cash and there is no options available from them.

Certainly you can control some lots that were purchased by investors or hedge funds or so forth. But most of those we can't make them pencil and they seem to be options on further house price appreciation and that's not something that we are interested in at this point. We are looking to make money today and not looking to tie up an option for banking on future appreciation. I just don't think that's a correct assumption.

When you look at the differential between a cash purchase price and the option purchase price that differential is wide today. We just don't think that considering our current cash-heavy capital structure that it makes sense to option something on a very extensive carry basis when we are sitting on cash that we are wanting to redeploy. As we move down the road, and we start to regrow our business and we see that our capital needs start to increase, we can start doing more options at that time. But at this point in time, we don't think the cost benefit differential is worth it.

I'd also add on that, our research tells us that those locations that we are buying lots, there is minimal risk of house price declines and that housing prices have stabilized and inventory in those particular areas is back in line with historical averages. So we feel confident making these cash purchases today whereas we may not have been in the past.

How wide is that gap between the type of margins you get on owning the land and buying with cash versus optioning? And my last follow-up is could you talk a little bit about the trajectory of profits that you guys expect throughout the year? Some of your competitors who are looking for profits as well have oft mentioned that 1Q will not be profitable or the first half will not be profitable. Could you talk a little bit about that trajectory? Thank you.

The first part of your question, and then we need to move on to somebody else, Josh. The first part of your question I would say the difference could be 5% or 6% in margin. On a $250,000 dollar home it could be a $12,000 to $15,000 difference in lot price or more. We think that's pretty substantial.

And that certainly, in that case, makes sense for us to own it. And with regards to what quarter we'll be profitable in, we are not going to give a forecast on that, a prediction on that. But I would say the first few weeks of January sales are encouraging and they are much better than what we saw in November and December.

Thank you very much.

Thank you.

Our next question comes from Ivy Zelman of Zelman Associates. You may proceed with your question..

Thank you, good morning, guys. I would like to ask your thoughts just in general, two areas, one would be your future gross incorporating any strategy that might incorporate acquisitions? And then, secondly, just to talk about the diminishing supply of finished lots in the market? You've alluded to in recent press, Steve, that you guys aren't going to chase land and maybe some of the prices are getting a little stretched.

So recognizing that you are going to be prudent there, can you help us mitigate the concerns that you might not be able to find enough lots for growth going forward? And then if I may follow up, but those are the two areas I would love for your thoughts?

Regarding acquisitions, our eyes are always open and we are certainly open to seeing what is out there although I don't expect that there is a lot of opportunities, certainly not what we saw in the 90s and early part of the decade.

We needed to make acquisitions in the early part of our growth story for Meritage because we needed to move into new markets. New markets are not as important to us today. We are really more focused on growing out the markets we are in. Acquisitions would be made in accordance with that strategy.

As far finding lots and chasing deals I think there is still many opportunities, plenty of opportunities. Prices have gone up certainly, in some markets more than others, but I still think there is opportunities to buy finished lots. I think the next stage will be to buy partially finished lots and lots maybe that are mapped and we can get a very solid read on what the improvement costs are going to be, while we're taking little development risk.

Certainly we are not in a position to take any entitlement risk whatsoever. I think the early bird got the worm and some of the best deals certainly are gone. But I think there will be plenty of opportunities to buy lots throughout 2010 and into 2011.

Thanks, Steve. Just a follow-up on the acquisitions. You mentioned historically you were acquisitive as it made sense to expand your footprint.

When you any about the greenfield approach going forward, given management structure and ability to grow if you were looking at a bull case scenario where housing would just snap back, how fast can the Company grow top line in units without having risk that you are growing too quickly without the right, I guess, measures and foundations in place for a prudent growth? So is it a 15%, 20% type number or can you do something much more than that?

I think we could grow at a 15% or 20% clip with not a lot of appreciation in the market just by buying some distressed lots in our existing markets. Certainly if the market tailwinds are going in our favor we can grow faster.

A lot of the growth can just come from an increase in the absorption levels in our communities. Even though absorption level increased 50% in the fourth quarter of 2009 over the fourth quarter of 2008, they are still by historical standards very low.

If we can just get more sales out of each of our communities with a better market ,plus adding on newer, better performing communities to that, not necessarily increase in the community count that dramatically, the growth numbers can be pretty significant.

I think we can grow this business significantly, almost double the size of it, without increasing our capital base. I think we have a lot of excess capacity.

Doubling it over like five years, not a year you are saying?

No, not a year, but over -- I don't think it will take five years but over the next three to four years. It's just going to depend on what kind of market we are running into. If the market environment doesn't change that much, I think a 15% to 20% growth rate is more realistic. But if the market begins to improve in the later part of this year into next year, maybe we can do better than that.

Great. Thanks, guys, appreciate it.

Okay, thank you, Ivy.

Thank you, our next question comes from Nishu Sood from Deutsche Bank. You may proceed with your question.

Thank you. I wanted to follow up on Joshua's question earlier. Steve, this is something we've talked about before. You folks have obviously been very proactive in responding to the downturn and some of your new strategic initiatives here, the Simply Smart and the 99 days are reflective of that.

But it also means that in two of the kind of hallmarks of what Meritage's strategy have been traditionally, your option versus your owned, and your mix of products being skewed more towards the move-up that you continue to move further away from. And so I wanted to kind of revisit that subject.

Obviously, that's's what the times demand now and that's what you decided. In terms of the length of time of this detour from what Meritage's strategy traditionally have been is this just a matter of when, where, in the bottom of the cycle here that this is the appropriate strategy? Or do you see a longer term shift away from those kind of historic operating principals?

I think I see a longer-term shift because I think maybe we are a little out of balance and I think being two-thirds move-up, and the balance between mixed between luxury, active adult and entry level was probably not the best strategy going into this cyclical downturn that we've had.

I think to better prepare our elf for next downturn -- there will be one down the road some day -- we want to be more entry level because I think that part of the market performs better in a downturn. Certainly, the financing that's going to be available for buyers going forward is more skewed towards the entry level buyer and that's part of our strategy why we want to be there.

We are at the highest level of affordability that we've seen in 40 years and a lot of entry level buyers are coming into the market today that couldn't buy a home several years back. So I think it's a permanent shift.

Got it. And what about on the option versus owned?

You mean optioning lots?

Yes.

Well, I think I talked about that before. There is no better time to buy a home than today and there's no better time to buy a lot than there is today. If we are going to buy distressed lots we are going to have to pay cash.

Certainly we would like to do options like we did before, but in most markets outside of Texas they just don't exist. The ones that are out there are few and far between and they don't make sense. Until bank financing comes back for land bankers where they are able to leverage their investment, there probably won't be a lot of land making available and we are going to have to pay cash. That's really the way the world is.

Great. And second question, I wanted to drill down, it's very helpful that you've given us some sense of the difference, margin difference, the 500 to 600 basis points, between old communities and new communities. Now I imagine part of that is simply a function of accounting in that you don't typically tend to mark down land to the same level of gross margins that you would get if you bought a new piece of dirt in the market.

I wanted to get a sense of how much of it might be accounting versus how much of it might be operational? In other words, the ability to buy in better locations and to have a different kind of product type?

Certainly you can't impair a community to a normal margin, equate to what you would buy lots for a new community to. Most communities are being impaired to a break even type level.

So some communities weren't impaired, some communities we were buying lots on rolling options. Certainly in Texas we were able to go back and redo the option agreement, get a better price from the land developer, land seller, lower our direct cost for construction, fine tune our pricing, and some of those margins will be better.

In some of our worst performing communities we are operating near break even. No two communities are the same. The margins are across the board. On the average, new communities are 500 to 600 points, basis points, different than old communities. Larry, you want to add to that?

Yes, I guess the new communities are at what we would call near normal margins, and we've said our gross margins in the past after construction overhead which is included in gross margin is running at 19% to 20% or so. The way the impairments work, if we are 12% net contribution and say a 15%, 14% or 15% gross margin, that winds up being a near break even community after overhead.

We essentially impair to that level, so that's why the older communities that are kind of the worst performing communities, as Steve says, they get to that level of break even. And then, of course, there is a lot of variability, as Steve said, to each of the older communities because each project is different and the margins are different and there is quite a bit of spread. But on average, that's why they wind up at being that 500 to 600-basis-point differential between a brand new normal community.

Okay. Thanks lot.

Thank you.

Our next question comes from David Goldberg from UBS. You may proceed with your question.

Thanks. Good morning, guys.

Good morning.

First question is actually about, Steve, your comments about building some more specs in more communities ahead of the tax credit.

I'm wondering about, if you could give us just some more color around that? What kind of numbers do you (inaudible) that would look like in terms of potential increase in inventory, how much working capital do you think you need to support that? And are you worried at all that the builders are going to overshoot demand here because everyone seems, or a number of builders seem to be taking on this kind strategy of building more spec before the credit?

I don't think we are coming up with an idea that's novel, that is exclusive to us. Certainly other builders are doing the same thing. Certainly we learned last year that buyers are procrastinators and a lot of them don't come out to make the decision to buy the home until the last minute.

We expect late February, March, April, we will see a significant pickup in demand and we want to be prepared for it. On the other hand, we will be prudent and our spec count really is, today I think what do we have about 500 specs, Larry?

514, it's only a 3.35 specs per community, which is still on the very low end, yes.

So maybe that will increase from 3.5 to 5.5. But I think we got plenty of cash and capital available to do that. I don't think it's going to have a significant impact on our position whatsoever. We are building these houses very quickly now.

I was in Las Vegas yesterday and our average build time there is 40 days. We are almost able to build a home without even paying for it until we close it. We are going to be prudent, we're not going to overbuild and I don't think it's going be material to our balance sheet.

Great. Then just my follow-up question, is about the 99-day from sale to close program, and I'm wondering if you could give us, you mentioned Vegas, your build cycle is 40 days, what's the breakout between the timing between sale and beginning of construction versus the actual cycle time on average?

And kind of with that, I'm wondering how much of this is really process improvements and cycle time improvements on your part versus maybe shifting product down to do more entry level and less move-up so your cycle times are just coming down naturally because you are building smaller homes? And I guess the final part of the question, not to throw (inaudible), where do you think your 99-day sale to close is relative to peers and how much of an advantage is it in the marketplace?

Well, we think it's a big advantage, and we think it's an important marketing edge or we wouldn't be doing it. I think certainly we are able to build houses quicker as we move down to more entry level homes, but I think most of it comes from just general process improvement. Even the bigger homes that we are building we are building a lot quicker than we ever have before.

I think a key to it also is the start time. We are really targeting from the point the person comes in and signs the contract to when we actually put the home into the ground to be about 21 days, which would be about half of what it's been before. And then to build the home in about 60 calendar days, so that would add up to about 81 days, and then the balance, 18 days or so, for bad weather or delays by the city or what other kind of issues we could experience to give our self a little bit of cushion there.

But I think it's a paradigm shift for us. I think we are doing it for the obvious reasons, number one. To be able to capture more market share from people that are considering resale homes, just don't want to wait six months for a home, they want to get in quicker.

Certainly advantageous for them to buy new versus used and to make our capital go farther. And land banking isn't going to be prevalent. As I mentioned before, we were able to extend our balance sheet over the last decade by using land banking.

That's not going to be available so we got to find other ways to make your money going farther and this is certainly one of them.

Thank you very much.

Thank you.

Thank you. (Operator Instructions) Our next question comes from Josh Levin from Citigroup. Please proceed with your question.

Thank you, good morning. You talked about January sales being off to an encouraging start. Do you have a sense of what percentage of buyers are compulsory buyers, meaning job relocations, divorces and so on versus discretionary buyers? Is the buyer profile changing?

I couldn't tell you. I just don't have that information.

Okay.

I mean my quick answer would be probably not.

Okay. Going back to margins on a consolidated basis you reported a 16% gross margin excluding drywall charges. Assuming home prices are stable going forward, should we assume that you can do a 16% gross margin on a consolidated basis over the next few quarters?

I think so. Yes.

Okay.

We are actually targeting that as we add more new communities and those new communities become a bigger percentage of our closings you should continue to see them trend up.

I will be disappointed if we don't do better than that.

Fair enough, thank you very much.

Okay, thank you.

Thank you, our next question comes from Joel Locker from FBN Securities. Please proceed with your question.

Hi, guys. Just a quick question on the owned lot count, how many of the 10,000 owned lots are completely finished?

Larry?

Yes, again, most of them are finished, about 75% or so. We did buy Provence down in Maricopa, south of Phoenix, and that had 450 finished lots and 800 or so unfinished lots. So that increased our unfinished count a little bit. But generally speaking we're in that 75% to 80% range. We don't have a huge amount of cost to complete on lots.

Right. And any idea what your land spend is going to be for 2010? Do you have any kind of rough estimate or ballpark on what you are targeting?

Just, in the current year, or 2009, excuse me, last year we spent in cash about $180 million buying lots and that was, we would think it would wind up being the same or more as we go forward and reload. You have to remember now we are at the point where we own 75% to 80% of our lots, we are kind of stabilized there. We only have 10% of lots under lot options and 10% lots under developer options, so there's not a whole lot of options to continue to wind down and we will continue to do options in Texas.

Our own lot count could creep up to 80%, 85%, maybe as close to 90% and that would require some capital and require us to maybe increase that $180 million number a bit. But $200,000, $200 million,.

$200 million, $250 million, I'd say, Larry, we are trying to grow a little bit and it will depend on what opportunities are available to us. I would rather spend a little more than a little bit less if the opportunities present themselves. So I think $200 million to $250 million would be the range.

All right. Thanks a lot, guys.

Thank you. Our next question comes from Timothy Jones from Maloney Associates Incorporated. Please proceed with your question.

Good morning. Congratulations on being one of the first builders to earn money before impairments and write-offs.

Thank you.

First of all, I need a clarification, was your cancellation rate this year 30% or 38%. I think you said 30%, and I got 38% somewhere else.

It's 30%.

30%.

30%. Okay. Thank you. My two questions have to do with the deferred taxes and land write downs. What was the size, what was the dollar value of the land that you sold where you got the $14 million lots and what was the pre-write down value and how many lots?

I don't have those numbers precisely. We did generate a loss, but we did get significant cash back so we thought the trade-off. I think the point is that those were lots that we didn't need to use in our current business plan. They were excess lots that we weren't going to build houses on this year or next year.

So they were written down significantly, that's why they generated a cash loss. But I don't have the specific number of lots or acres or the original purchase price.

I'll talk to Brent on that. The second question is related to this, you basically were expecting to get $60 million back from the government three months and you got $93 million. You -- part of it obviously was selling the excess land. But you only took a $14 million write-off. That has to imply that that land had already been significantly impaired before.

That's correct. Yes. It was impaired before we probably underestimated the $60 million, we were probably a little too conserve and we closed more homes in the quarter that had impairments on them, at least on lots, and that's why the number is higher.

About a third of the increase came from the land sales and the rest of it came from us just refining the numbers and making sure we were taking tax deductions where appropriate and as we went through the quarter we were able to refine the numbers more and we wound up with a significantly bigger number than we originally thought.

Thank you very much.

Thanks, Tim.

Thank you. Our next question from Carl Reichardt from Wells Fargo Securities. Please proceed with your question.

Good morning, guys, how are you?

Hi.

Good morning.

I had a question on your average order price which was quite a bit higher than what we had. As you look out at new community mix changeover next year, how sustainable is that, does that order price or is it going to bounce around some, Larry, or Steve? And also in the last quarter, can you give me a sense of the percentage of communities in which you've actually raised prices on your base models?

Larry, you can jump in here too, but I think it's going to bounce around a little bit. It's going to depend on mix. We had some really high priced communities in California that were closing out last quarter that I think had some influence on that the ASP going up.

And I think until we get more new communities on line it's going to move around a little bit. What was the second part of your question, I'm sorry?

Just curious about pricing power you've seen on your base models in the fourth quarter in particular, but if you got a sense on any of your new communities whether or not you are pricing above pro forma, I'd be curious about that as well?

I think we have been able to pull incentives back in a lot of communities that may have given us two or three points. In our better located communities.

I can't say we are raising prices across the board. That's certainly not the case. But in select communities we are able to start to gradually bring the prices in a little bit.

Thanks, Steve.

Thanks.

If I could add to the average sales price comment. What we are seeing when we are going out and buying new deals is that our market research shows that in some cases buying in a more infill community, where the lot might be a little bit higher price but because it is infill, there is less foreclosures, there's more stable demand that we are putting our new product, our new Simply Smart product, on a lot that is a little bit more expensive because it's infill.

But we are able to charge significantly more for that same product in that infill location than we would in a far out location. So we've made some buys like that which is causing, even though we are doing a first-time or first-time move-up product our average sales price is a little higher than maybe we would have anticipated a couple of quarters ago.

Okay. Great, I appreciate, that thanks much, guys.

Thank you.

(Operator Instructions) Our next question comes from Jay McCanless from FTN Equity Capital. Please proceed with your question.

Good morning. Two questions. The first one, can you talk about why the cancellation rate increased from Q3 to Q4?

I think that's just a seasonal thing with the end of the year. I can't give you any specific reason why that happened other than that.

Okay. Second question, could you just talk about which market you acquired the most land in during Q4 and what you're going to close on in Q1?

Larry, do you have that handy?

We -- in the fourth quarter, we actually purchased $81 million of land for about 2,500, 2,600 lots and those purchases were kind of across the board. They were in California, in Phoenix, in Colorado, in Florida, and Texas. The only place we are not buying land today is in Las Vegas.

We have people looking at deals, it's hard to project how many deals are going to come through the door, but the last couple of quarters we have been running in that kind of $50 million to $80 million a quarter clip. So I would anticipate we will continue to have a pipeline of new purchases running in that dollar amount.

I apologize but I've got to get on an airplane here shortly. I'm going to take two more calls and we are going to have to wrap. Operator, the next call?

Thank you. Our next question comes from Susan Berliner from JPMorgan. Please proceed with your question.

Hi. Good morning, thanks.

Good morning.

Quick, first question is on the community count, I was just wondering how we should think about the number increasing next year, or this year I should say, for 2010?

I don't think it's going to increase that much. I think we are really focused on replacing these older communities with newer communities. Hopefully, we can find enough to increase it somewhat. But I don't want to give a specific number or projection, but don't expect a dramatic increase.

Okay. Great. And the second question is can you give us an update on some of your markets, any interesting color that you are seeing?

Certain parts of certain markets are improving. There is no one shining star that sticks out amongst all of them. Certainly, Houston continues to be probably one of our best markets.

Southern California is performing better. Land is tighter there, of course. But even within the market, certainly a market like Phoenix, certain sub-markets are doing great and some are not doing well at all. So it's very local right now.

Great, thank you.

Okay.

Thank you. Our next question comes from Dan Oppenheim from Credit Suisse. You may proceed with your question.

Thanks very much. I was wondering if you could talk a bit more in terms of the spec strategy, you talked about how you did that in some communities. Not so much from a balance sheet perspective, but wondering in terms of an inventory and pricing perspective?

When you see the demand in the early part of the spring, if it's a strong demand would that make you more willing to start specs (inaudible) better or to be a bit more cautious thinking that's sort of pulling forward in the demand and you don't want to have inventory as you get to May after the tax credit expires?

Yes, we don't want to build, have a bunch of houses sitting on our books after the tax credit expires. So we need to be very careful to try to anticipate what the demand is going to be on a per-store basis for March, April and May from the tax credit. We are only building more specs in those entry level communities where we think we can pull some renters and turn them into homeowners. We are going to be very careful about it.

Okay, thanks. And then, secondly, in terms of land, you want the land purchases thing, you want land to make money now, how is the Company in terms of just the head count right now? What volume do you think you could support with the current head count there before you'd need to add?

I think we can significantly increase our business without significantly increasing our head count. I think we are under capacity right now. And, of course, our preference is to increase our business by increasing the absorption in the communities that we have, not necessarily adding a lot more new communities. So as we bring better communities on that perform better, we won't have to add any additional overhead.

Okay, perfect. Thank you very much.

Okay. Thank you very much. I appreciate everybody's support and following of Meritage and we'll look forward to talking to you again next quarter. Have a good day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.