Meritage Homes Corp (MTH) 2010 Q3 法說會逐字稿

Greetings and welcome to the Meritage Homes third quarter 2010 conference call. (Operator Instructions).

It is now my pleasure to introduce your host Mr. Brent Anderson, Vice President of Investor Relations for Meritage Homes. Thank you, Mr. Anderson. You may begin.

Thank you, Manny. Good morning everyone. I'd like to welcome you to the Meritage Homes third quarter 2010 earnings call and webcast. Our quarter ended on September 30th, and we issued a press release with our results for the quarter after the market closed yesterday. If you need a copy of the release or the slides that company our webcast today, you can find them on our website at investors.meritagehomes.com or by selecting the investors link at the top of our home page.

I'll refer you 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 2009 annual report on Form 10-K and subsequent quarterly reports on Form 10-Q.

Today's presentation also includes certain non-GAAP financial measures as defined by the SEC. To comply with the 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 replay of the call should be available on our website within an hour or so after we conclude the call, and it will remain active for 30 days.

I will now turn it over to Mr. Hilton to review our third quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone to our call today. I'll being with an overview of our third quarter operating results and recap our progress on our strategic initiatives that we have been pursuing for the last couple of years before turning it over to Larry for a more detailed review of our financial results.

Let's begin on slide four. I'm pleased to report that we were profitable again this quarter, making it four quarters in a row of positive net income and three quarters of positive income before tax benefits. We generated a net income of $1.2 million or earnings of $0.04 per share on $234 million of closing revenue, which was a big improvement over last year when we reported a third-quarter loss of $17.8 million or $0.56 per share on revenue of $232 million. One big difference is that we had less than $1 million in impairments this year compared to $13 million of impairments last year.

Please turn to slide five. Our home closing revenue increased slightly despite a 16% decline in home closings due to a 21% increase in our average closing price, which I'll explain. Our average closing price rose to $275,700 per home in the third quarter of 2010 from $228,400 a year ago.

The year-over-year increase reflects a couple of shifts in our mix of homes closed rather than actual home price appreciation in our communities. More of our closings came from states and communities with higher average prices. For example, California, Colorado, and Florida currently have the highest average prices of the states we operate in. Together they made up 28% of the total homes we closed in the third quarter this year compared to 16% of our closings in the third quarter of last year.

Our total closings in those three states were up more than 15% year-over-year. On the other hand, Texas made up 50% of our third quarter closings this year compared to 60% last year as a result of the intentional rebalancing of our markets.

On average closing prices in Texas approximately $253,000 in 2010 was much lower than our average prices in California, Colorado, and Florida, which were approximately $391,000, $323,000, and $283,000 respectively.

In addition to the mix shifts between states, we're also experiencing a shift in our mix of buyers. We had a larger percentage of move-up buyers this year compared to more first-time home buyers at lower price points last year.

Over the last few years many homeowners have moved their product offerings down the price spectrum believing there is less opportunity in the move-up market at this time. While we also pursued this strategy, recently we've had good success acquiring close and move-up lots in A locations, which other builders may have passed on.

Due to our lower acquisition price and construction cost, we are currently able to sell homes in these communities at dramatically lower prices than we were able to just a few years ago, offering tremendous value and opportunity for home buyers.

Slide six. The increase in our third quarter net income was primarily driven by margin improvement. Our third quarter reported gross margins on home closings were 18.2% in 2010 versus 10% in 2009 after impairments or 18.5% versus 14.5% excluding impairments in both years respectively.

The year-over-year improvement was a result of system wide cost reductions that were achieved through our Meritage Forward strategic initiative as well as higher margins we're achieving in our newer communities built on lower-priced lots. Those gains have helped offset margin compression from additional concessions we made in some communities.

We made continued progress in replacing our older communities with newer ones opened on lots we've acquired since the beginning of last year. Homes closed in our newer communities generated approximately 600 basis points higher margins in the third quarter then we averaged in our older communities.

The improved margins that were achieved in our new communities were the result of success in each of our major initiatives. Our lot costs are lower due to excellent acquisitions based on strategic market research, our construction costs are lower due to simplified designs, improvements in purchasing, and greater construction efficiencies which have reduced both material and labor costs, and our new plans allow us to build and deliver homes faster without sacrificing quality.

Approximately 44% of our sales and 31% of our closings in the third quarter of 2010 came from communities we acquired since the beginning of last year. By comparison, new communities accounted for 13% of our sales and 6% of our closings in the third quarter of 2009.

We've opened 16 new communities on recently acquired lots during the third quarter. We already own or have under contract an additional 29 new communities that we plan to open over the next several quarters.

Slide seven. Our new communities include several state-of-the-art extreme energy efficient green communities in Arizona. I spoke about our Lions Gate community in Gilbert, Arizona last quarter. It was the first of its kind in the nation and generated a great deal of interest by the media, contractors, public officials, and even many of our competitors.

Customers find these high energy-efficient green homes very compelling, and we've opened several similar communities in Phoenix and Tucson already. Collectively they have been some of our best-selling communities since they've opened and have been selling at a significantly higher average sales pace than our other communities as well as our competitors' communities.

We call them extreme energy-efficient green homes because they offer up to 80% energy savings over the average existing home in the US. We designed them from ground up to offer a fully-integrated system of standard features using the latest energy-efficient technologies which is much more effective than bolt-on features sold as options in other homes.

We achieve cost efficiencies by standardizing these features in every home within these communities at no additional charge to our buyers. You'll hear me talk about his often, as I'm very excited about what we're doing to be the leader in energy-efficient home building. I believe it is one of the most important strategic initiatives and that it has the potential to be a real game changer within the home building industry.

Slide eight. Our sales in the third quarter were 36% lower than the prior year, and our cancellation rate was 24% compared to 20% in 2009. The decline in sales was partially due to a 12% decline in our average active communities. We had an average of 149 active selling communities in the third quarter of 2010 compared to 170 in the same quarter last year.

That is the main reason for the 42% decline in our Texas sales. We had 24% fewer communities on average in the third quarter this year than last year in Texas. We have closed out many older marginal communities in Texas over the last year and are beginning to reload on newer communities there.

The majority of our new communities in the last seven quarters have been added in other states like California where the average active communities increased 19% over the third quarter of 2009 and Arizona which had 10% more active communities on the average than a year ago.

In addition to fewer communities in total, our sales per community fell to 4.7 in the third quarter this year from 6.1 the second quarter and 6.5 in the third quarter of 2009. All of those are well short of where we'd like to be. An increase in our sales pace represents our greatest opportunity to increase earnings by leveraging our current infrastructure.

While we've reduced our overhead this quarter and could reduce it further if business remains slow, we would prefer to grow our revenue and earnings by increasing our sales pace and growing our community count over time. We could nearly double our sales and revenue with very little additional overhead by getting our sales per community back to the nine to ten per quarter range where it was before the housing boom.

We had a 12% increase in our average sales price year-over-year for the reasons I described earlier which partially offset the 36% decline in homes sold. The increases by state ranged from 3% in Las Vegas to 32% in Arizona, even though our average sales price in Arizona is slightly lower than our company-wide average.

In light of the lower sales levels we've experienced the last couple of quarters and our lack of forward visibility, we would anticipate lower closing revenue in the fourth quarter which could make it more challenging to maintain profitability in the next quarter. We have taken additional steps to control our costs, both direct and indirect, while retaining our organizational talent and advancing our strategic initiatives.

It's difficult to predict when buyer confidence will return and the market will strengthen, but we are optimistic that we'll see some improvement next year.

I'll now turn it over to Larry Seay, our CFO, to review some additional details of the results for the quarter. Larry?

Thanks, Steve. I'll pick it up on slide nine. Commissions and other sales costs increased as a percent of revenue due to additional marketing expenses, some of which related to opening 16 new communities as well as some initial costs associated with the new deconstructed models and related educational materials for our extreme energy-efficient communities. These deconstructed models are a key selling point for these communities as they provide a behind-the-walls view of all the energy-saving features.

Our G&A expenses were sequentially lower in the third quarter than they were in the second quarter by a little more than $1 million primarily due to some staff reductions we made during the third quarter. Compared to last year, our total G&A expenses were up $1.4 million due to bonus accruals booked in the third quarter this year that were recorded in the fourth quarter last year.

As Steve pointed out, we have a significant opportunity to leverage our existing overhead by increasing our sales per community and revenues which has the power to reduce our SG&A percentage and increase our earnings.

Slide ten. For the first nine months of 2010 our home closing revenue climbed 6% on a 1% increase in home closings combined with a 5% increase in our average sales price for the reasons Steve explained previously.

We've achieved gains in the number of homes closed in California, Florida, and Colorado, which were up 48%, 49%, and 5% respectively. With the addition of higher average prices, closing revenue in California and Florida increased 51% and 79% respectively. We closed 6% fewer homes in Texas year-to-date partially due to 15% fewer actively-selling communities on average in the first three quarters of 2010 compared to 2009.

We reported net income of $8 million or $0.25 per diluted share for the first nine months of 2010 compared to a net loss of approximately $110 million or $3.52 per share in the first nine months of 2009. Much of the improvement was due to lower impairment charges, which were less than $2 million in 2010 compared to more than $90 million in 2009.

Partially offsetting the year-over-year improvement was a $3.5 million loss on the early extinguishment of debt in 2010 compared to a $9.4 million gain on early extinguishment of debt in 2009, a $13 million swing in total.

Excluding those items are adjusted pre-tax income improved to $13 million for the first nine months of 2010 compared to a pre-tax loss of $27 million for the first nine months of 2009.

Our deferred tax assets, which are fully reserved, totaled $88.4 million at September 30, 2010, and are available to offset the federal and state income taxes on an estimated total of approximately $230 million of future taxable income. That estimate may change going forward due to the various state and federal limitations on the use of NOL carryforwards.

Slide eleven. We continue to replenish our pipeline of lots as we replace older communities with new ones. We purchased approximately 1,600 lots for a total of $65 million during the quarter. We added new communities in every state we operate in except for Nevada.

Eight of those communities and a majority of the new lots were in Texas where we're looking to replace those older communities we've already closed or expect to close out in the coming quarters. We now control approximately 14,500 total lots as of September 30, 2010, equivalent to a 3.6-year supply based on trailing twelve-month closings, still one of the lowest in the industry.

We own approximately 79% of those compared to owning approximately 63% of our total 13,200 lots at the same time a year ago. We have acquired approximately half of those 14,500 lots since the beginning of 2009, and about a third of our actively-selling communities are comprised of those recently-acquired lots.

Slide twelve. Our balance sheet is strong with a high cash balance and one of the lowest net debt to capital ratios in the Company's history. We ended the quarter with $420 million in total cash, cash equivalents, restricted cash, and short-term investments. That's about $22 million lower than the end of last quarter, and it's the first quarter in the last year that our cash generated from operations did not outpace the total amount we invested in new lots and homes during the quarter.

Considering that we expect to generate less cash from closings over the next couple of quarters based on slower sales recently, we could show a modest use of cash during that time as we continue to purchase new lots to replace those being sold.

Our net debt to capital ratio improved to 27% at September 30, 2010 from 35% at September 30, 2009. We ended the quarter with 591 total specs, less than four per community, of which 371 were completed. We generated approximately 40% of our sales in the quarter from specs versus new homes started under contract, which also drove our conversion rate of 81% of beginning backlog. We would expect our conversion rate to continue to be higher than in the past since we're focused on providing more spec homes that we can deliver quickly to compete effectively with the resales.

One final note. We received a number of inquiries about our potential exposure to mortgage repurchases based on recent concerns about the banks having to repurchase loans. We have very little exposure if any due to the fact that we have no captive mortgage operations and never have had any. The only exposure we have is a very small investment in three mortgage JV's, approximately $1 million in total. Meritage has never had to repurchase a mortgage, nor have any of these JV's.

Now I'll turn it back over to Steve.

Thank you, Larry. With the low prices and interest rates available to home buyers today, affordability is very high, which makes this one of the few times in history when you actually should be able to own a home for less than the cost of renting. Mortgage rates have already begun to move up slightly, and inventories of homes in some of the best areas are shrinking. So the best window of opportunity may soon pass us.

We are confident in our strategy and pleased with our accomplishments through this most challenging time for home builders. We were one of the first builders to return to profitability. We have a strong balance sheet with a relatively light supply of land, no near-term debt maturities, and significant liquidity, which is enabling us to replace communities with lower-priced lots as we close out our older communities.

We have reduced our direct costs in offering and are offering new series of value-priced homes that we can build much faster to compete more successfully with existing home market. At the same time we are achieving high margins of sales velocity in our new communities.

And I confidently can say that we are leading the industry with the most energy-efficient green homes available from any production home builder today. Meritage is well positioned to be a strong competitor in the home building industry, and we believe the successful execution of our strategic initiatives is driving sustainable competitive advantages for Meritage.

Thank you for your attention today. We will now open it up for questions. Operator?

Thank you. (Operator Instructions). Our first question is from the line of Joshua Pollard with Goldman Sachs. Please go ahead.

Good morning to you all.

Good morning.

First question is around your community town. The first thing I noticed is that you guys opened 16 new communities. That's relative to eight last quarter. We're seeing this across a number of the builders in the space, an increase in the number of new communities opened into a slightly more bearish environment.

I'm trying to understand the rationale behind opening further communities in this environment. If you could shed any light on that, I'd really appreciate it.

Well, Josh, as you know, we were a land-light builder. At the peak of the market, 90% of the lots we controlled were on option. And as you know, we terminated a lot of those options and wrote off the option deposits, which resulted in significant impairments. So we dramatically dropped our lot count from around 50,000 to under 10,000.

So we literally just ran out of inventory. I mean our shelves were just literally bare if you were to compare us to a store. And the only way we can sustain our business model is to replace these old communities that we got rid of with new communities.

We're a little different than other builders who have long legacy land positions and really don't need to buy any lots to continue to have lots to build on. So for us it's more of a necessity, and it's also part of our strategy to return to profitability because the profits on new lots you can generate from building homes are much greater than they are on old lots because we're buying the new lots for a lot cheaper.

You cannot impair your old lots, or I should say most builders have not impaired their legacy lots to today's market prices for lots. So I think it's been pretty effective. We would have lost a lot of money if we hadn't started buying lots early last year because the profits on those are pretty high.

Josh, I'd add in the last quarter too our community count really was pretty much stable and so was our lot count, so we aren't necessarily bulking up on a lot of new lots and growing our community count rapidly. We're really focused on maintaining and gradually where it's prudent growing, but at a slow pace particularly considering the current environment.

Up to now it's been more of a replacement strategy to replace the old with the new that we can get higher margins, they are in better locations, and we can generate higher absorption rates.

Excellent. My second question is just around what you guys are seeing in October relative to September, and I'd love if you guys could talk about within your markets what you're seeing for new homes versus existing homes.

We're starting to hear a little bit in the channel that some of the myth around the mortgage putback and foreclosure moratoriums shifted some sentiment back towards new homes. Was wondering if you'd seen that?

And then the second part of that question is 40% of your sales coming from spec, you often talk about the difference between new versus old communities, but I'd love to understand at this stage of the downturn what's the difference in profitability between your specs and your dirt sales. Thanks a lot guys.

Well, let me take the last part of your question first. If you manage your spec strategy correctly there shouldn't be a big difference between spec sales and dirt sales. And we're building more specs today than we have before because a lot of the buyers today want a house immediately. Either they're renters that don't have a house to sell and they're looking to move or they're people that have already sold their house and they need to move into a new house quickly or they're relos.

So having more specs today in this environment is an advantage. And we're trying to take advantage of that market dynamic.

Relative to our sales, as everybody reported I think our summer was dismal, pretty anemic. We didn't see a significant change in sales month-to-month from May until September. September actually I think dipped a little bit down. We were pretty disappointed in what we saw in September. We thought September was going to be better.

October is looking a little bit better certainly than September. There's been a little bit of improvement, but not enough for us to get excited and see that the winds are really changing.

We don't -- we have not seen anything specific to -- from the foreclosure headlines that we've seen lately that we can point to where there is a shift in the market. It's been pretty much the -- pretty flat for the last several months with a little slight uptick in October.

Operator, next caller?

Thank you. Our next question is from the line of Dan Oppenheim with Credit Suisse. Please go ahead.

Thanks very much. Was wondering just about the thoughts in terms of shifting to do more in terms of move-up. You guys have been very good in terms of shifting from some Southwestern markets into Texas from move-up to first time, picking up new land. Just how much of a shift should we think about this now in terms of sort of the higher price points and how much land are you looking for in terms of accomplishing that?

We're just trying to be more opportunistic. So if we can find an infield parcel, suburban infield parcel that we think is a double-A location and there's going to be a lot of demand for because -- and there's no competition, even though it might be a little higher priced, we're going to take advantage of it.

But I can't give you guidance on emerging trends as to where it's going to go. We're still trying to drive our average price down although it's jumped up significantly because of those acquisitions we've made recently. But, Larry, what can we say there?

I guess I would add that we have said that we want to drive about two-thirds of our business to be entry-level and first-time move-up, and I guess I would emphasize more the first-time move-up than entry-level. Of the 65% to 70% of our deliveries this quarter that were in those two categories, two-thirds of that 65% to 70% were first-time move-up.

So I think we have to be careful that people aren't hearing entry-level too much and they recognize that still most of our business is first-time move-up although certainly the second-time and third-time move-up has dropped dramatically and is today only around 25% to 30% of our business.

Got it. And just a quick follow-up. I was wondering in terms of the -- you talked about the absorption of the newer communities being better and also those having higher margins. If you think about the older communities with the slower absorption there and sort of the drag, what do you think about in terms of pricing given with -- in terms of sales per community, those right now being below the average. Are you going to be more aggressive to try to work through those older communities?

Well I don't think we're motivated to trigger impairments and discount those houses. It's not like we need to generate more cash because we have some debt -- we have some use of the cash. We still have a hefty cash position on our balance sheet.

So there's not a lot of motivation as long as we're breaking even to plow through those communities at a faster pace. There's just not a lot of strategic advantage to doing that at this time. And I think as long as we can maintain at least a breakeven sales pace on those older communities, we'll muddle our way through till the market improves.

Okay. Thanks very much.

Thank you. Our next question is from the line of Ivy Zelman with Zelman Associates. Please go ahead.

Good morning guys. Good quarter in a tough environment. The questions I have really kind of just feed back in a little bit on Dan.

Your sales pace right now in terms of this quarter would be obviously less than the sales you generated in the prior quarter and you were able to basically make a million bucks in this quarter. So as we think about your break even, it looks like we're looking at about 1.6 houses a month, a little bit maybe making money on that. But what can you do to reduce the break even and continue, if anything, to take out costs?

And I guess the good news, Steve, is that you are not really looking to discount and further reduce pricing. It sounds like the industry is being more rational. But if sales don't improve is it possible that you can wind up losing money again if we don't see an improvement given the weakness in demand right now, or are there more costs to come out?

I think most of the costs have been taken out and there's not a lot of costs left to get out unless we're forced to reduce costs even further. I think our strategy is to continue to try to bring on new communities with higher gross margins, which in essence lowers our break even point as we increase our gross margins.

Certainly -- back to the earlier part of my response, we can always reduce costs, but I think it's our strategy just to try to keep our team together, keep our important people on the field, and expand our revenues as the opportunities present themselves.

Larry, you want to jump on that?

Yes. I would say our break even -- our break even point for the quarter is around 800 to 810 homes, and because we did have some cost cuts during the quarter which didn't all fully impact the quarter, I believe that break even point now is now down below 800, probably in the high 700s.

So we can cut costs. It's possible. We are taking the position in the fourth quarter of waiting to kind of see how the spring selling season turns out. And if that turns out not being a little bit of a bump up we could be forced, as Steve said, to start taking cuts, but we're not planning in the next couple of quarters to start cutting. We're going to focus on increasing sales and not cutting costs.

We did actually have a layoff in September. I think we reduced our headcount 7% or 8%.

Right. Well, you know it's a tough environment and certainly you guys are outperforming your peers.

Just to ask a more specific question on spec, can you give us the numbers relative to 2Q and what they are per community, and recognizing that hopefully we are moving through a lot of that, but where are you guys in those numbers please?

Are you asking what the total spec count was last quarter compared to this quarter?

Right.

Yes. Our total specs at the end of last quarter at June 30 were 579 specs versus 591 at the end of the third quarter. And of those, 303 were finished last quarter and 371 were finished this quarter.

So Larry, just as Steve was finishing on that thought about pricing pressure, it sounds like the industry is being more disciplined. Would you say that that's the case and even with specs still out there that we're not seeing discounting as much as you might have expected in the weak environment we're in? What are your general thoughts on pricing?

I think that's a fair statement. I think generally most builders are being pretty disciplined and home aligned on pricing. I think we are seeing some discounting and some locations would tend to be more of the farther out or remote locations, but generally we're not seeing the heavy price cuts that some people may have predicted right now.

We have also been very, very careful in starting the right specs in the right place. We are starting specs that tend to be a lower price. We're not putting a lot of option in them. We're making sure that the model types we're starting to make in each community are the model types that are in demand. So we're being very, very careful about which specs we start. That's the spec strategy that Steve talked about earlier.

Great. Well thanks guys. Congratulations on the quarter.

Thank you, Ivy.

Thank you. Our next question is from the line of Nishu Sood with Deutsche Bank. Please go ahead.

Hi. It's actually Robert Hansen on for Nishu. Just in terms of your geographic mix. Texas has come down a lot, and you mentioned you've got the higher price points elsewhere in the country. When do you expect Texas to ramp back up in terms of a share of closings?

Well, I don't think it's our strategy to increase Texas's share of closings. I think, as the market tailed down Texas became a higher percentage of our sales and closings because the market in Texas wasn't affected as much as it was in other markets.

So we're really trying to rebalance our deliveries across all of our regions with a heavier emphasis on rebuilding our business certainly in California and Arizona and in Florida. So we are going to replace a lot of low-absorption communities in Texas with newer higher-absorption communities, but I don't think it's our goal to dramatically increase community count there.

Okay. And now that you're going to be profitable pretty much for the whole year, have you begun to have any discussions with your auditor about putting the GPA back on the balance sheet?

Larry?

Yes. We have had discussions, and I think all of the builders are having discussions, but there's still no clear strong profitability trend out there that has had people start to draw lines in the sand when they could book them. I still think it's going to be at least a couple or three quarters, some time next year I think, that people will start to rebook these. But amongst my conversation with our CFOs within the industry I haven't heard anybody saying, "Oh gee, we think we're going to book them right around the corner."

So I think it's still a little ways off. I think we need to book clearer profit trends and the industry as a whole needs to show a little bit more improvement before that happens.

All right. Thanks guys.

Thank you. Our next question is from the line of Stephen East with Ticonderoga Securities. Please go ahead.

Thank you. Good morning guys. If we talked about the communities a little bit, I know you're not looking for a lot of growth. In 2011 and 2012, will we see any type of growth at all? Would we see a mid-single-digit-type growth out of it?

And then what type of crossover should we expect on communities from old to new, and then also how many energy-efficient communities do you have out there and is there any change in profitability from those versus your other ones, different selling prices, et cetera?

Well, let me try to take a few of those. If I miss one, come back to me, but --. I don't want to give guidance on what our community growth -- new community growth rate's going to be, but we do plan to grow communities next year, more probably in the back half of next year and into 2012. So community count should start to increase.

Of course that depends on what the market conditions are and if the market cooperates with us. But if the market begins to gradually improve next year, our community count will grow with it.

Regarding the energy-efficient homes. We've -- we have four versions of energy-efficient homes. Version one is what we're building in all of our communities right now, which makes them Energy Star qualified and has eight different components. And we're doing that in every community across the country.

Version two is when we take it up a notch and we include spray-foam insulation, which dramatically reduces the HRS rating and makes the home significantly more energy efficient than version one. We're doing that in every new community that we're starting January 1st in every market across the country.

In Arizona we've piloted what we call version four, which is the super high energy-efficient home. We have solar included as a standard feature amongst several other features, which drops the energy costs by almost 80% against resale homes.

We're beginning to pilot those in every one of our markets throughout the nation, and we should have one or two communities opened in every market by the end of the first quarter of next year. And we'll start to gradually roll that out throughout the entire system as we rotate in new communities in 2011 and 2012.

Are those communities more profitable, the number four that you were talking about?

Well I wouldn't say they are more profitable on a per-unit basis. But I would say the absorptions are higher. We're selling two to three times faster than our other non-extreme high energy-efficient communities and than our competitors, so we end up making more money because we're able to leverage our overhead and reduce our interest cost because we're moving through the communities at a much faster pace.

Now again, we don't have a lot of history because we've only been doing this since June, but in the communities we've done here in the Phoenix area, and we have four of them open here now, the absorption rates are much faster.

Okay. And then you had mentioned that you had about 44% of your sales from new communities. As we look out over the next year, the changeover from old to new, what should we assume there as you replace the old communities?

We've thrown that -- we've thrown a number out before, last quarter. For the end of the year we were thinking we'd be at 40% to 45%. We've exceeded that goal by getting to 44% in the third. So we are hopeful we get to the 45% to 50% by the end of the year this year, and then next year we've thrown out 65% to 70% goal. So we would hope to have almost three-quarters or two-thirds of our communities switched over to new lots, newly-acquired lots with new designs by the end of next year.

Okay. And then, Steve, just one last question. Could you give us an update on the land market and what you're seeing and the track that you're taking in some of these areas that you want to grow?

Well we're still buying lots and land. We're trying to be cautious. The market has softened slightly in most markets, at least it's stopped going up. Prices have stabilized a bit. There seems to be in a lot of situations sort of a standoff between buyers and sellers as to what the values are.

But we're still finding a very significant number of opportunities that we find compelling, and to the extent that we have the capital and we like the asset, we're pursuing it.

Are they primarily finished?

Yes, but I'd say we're buying more partially-finished and undeveloped lots now than we were certainly a few quarters ago. We're seeing the better buys are in the undeveloped or partially-developed lots than they are in the finished lots.

Okay. Thanks.

Thank you. Our next question is from the line of Jade Rahmani with KBW. Please go ahead.

Yes. Hi. Thanks for taking the question. I wanted to -- I know you touched on the rep and warranty issues the mortgage industry is dealing with and your limited exposure, but I wanted to see if you could provide a sense for what historical delinquencies or foreclosures have been like at Meritage communities and how you think these compare with existing homes in areas where you're located?

You know we don't keep those stats. I have no way of telling you what the foreclosures would be in our communities. We unscientifically drive around and look at some of the for sale signs, but I couldn't give you any numbers that would be reliable. I'm sure they are probably in line with what you may be seeing from most other public home builders, but again, we're only a mortgage broker. And these are in our JV's, and our JV partner has all the liability for any mortgage putbacks, and we've never taken a loan back, and we don't expect that we ever will.

Okay. And just do you have a general sense that Meritage communities specifically or new homes in general perform better than the mortgages on existing home properties, or is that not the case?

I think it would be hard to make that as a blanket statement. I think certainly since a higher volume of our business has been in Texas and there's less foreclosures in Texas than there are in other places, we probably have less foreclosures in our communities than maybe other builders because 50% of our business had been in Texas for quite a while.

But certainly there have been foreclosures in a lot of our communities in Arizona and California and Las Vegas like everybody else. But I wouldn't say generally there's something better about our communities that makes them foreclosure resistant.

If I might add, because about half of our communities are new now and they were purchased since the beginning of 2009, certainly those new sales, there really aren't foreclosures in those communities because they weren't bough at the peak. All the foreclosures are coming from the older communities. And because we have changed over our communities faster than other builders, I think we have less competition within our existing older -- existing communities than some other builders that are still selling out of a community that's been in place for many years.

Okay. Thanks a lot for that. And then secondly, just on land acquisitions. Do you guys consider distressed sales or acquisitions of loans, and are you working with banks to acquire any of their portfolios, or is that not something you look at?

We haven't been working on any specific portfolios. We looked at some portfolios, but we're really more focused on individual assets, individual communities, and we're talking to banks, a lot of different banks on a daily basis in all of our markets.

Okay. Thanks a lot. I appreciate it.

Okay.

Thank you. Our next question is from the line of Josh Levin with Citigroup. Please go ahead.

Hey everyone.

Good morning, Josh.

Good morning, Josh.

So I guess maybe there are two opposing forces that are going to impact your gross margin over the next few quarters. On the one hand you have these new higher-margin communities. On the other hand you might have to increase incentives a little bit if the market stays weak.

What should we think about in the terms of the trajectory of your gross margin going forward? Is it stable? Is it going up? Is it compressing a little bit?

I'm thinking more stable. I don't really see it going up or down in the next couple few quarters.

Yes. Certainly with the sales being weak over the last few months that has kept the trajectory that would normally occur upward from the new communities from happening, and that's why the last couple of quarters we've been a little flat. Last quarter I said I thought it would be flat, and I think for the next couple of quarters we think it'd be flatter. But the long-term trend once the market stabilizes and maybe improves a bit should resume back to that improvement caused by our newer communities coming online.

Okay. So a separate question. I know it's very difficult to make predictions right now but I was curious to hear your thought. If the job situation is unchanged, meaning it's no better or worse from here for the next several quarters, how much better do you think your sales can get in the spring relative to where they are now? Is a changing consuming confidence by itself without a change in the job situation enough to get a real bump up in sales in the spring?

I think that consumer confidence is everything. It's not 10% or 15% of the people don't have jobs, it's the 20% or 30% or 40% of the people who think they might be losing their jobs that are affecting our ability to sell homes.

So if we can get that segment of the economy feeling better about where things are going, then I think we can have a meaningful impact on our sales. So I do think it can turn relatively quick.

Okay. Thank you very much.

Thank you. Our next question is from the line of Carl Reichardt with Wells Fargo. Please go ahead.

Hey guys. How are you?

Hey, Carl.

Good morning, Carl.

Just in terms of this AST this quarter and obviously I know you have move-up mix shift, but also you've got a better quality land mix shift here it looks like this quarter too. I'm just trying to figure out which was the more important driver. Was it the total square footage of the box on the lot or was it the higher quality lot that drove that AST up? I'm still confused as to which was more important.

Well it's both. It's number one we're buying these in some cases lots in custom home communities and we're building production houses in formerly $700,000, $800,000, $900,000 custom-home communities. We're going in there and building a $300,000 to $400,000 house. But we're also giving people 4,000 square feet. They're getting a big home for low dollars per square foot.

And that's part of our strategy is to create a very compelling value proposition where you can get a home in a gated community on a large lot for like $60 a square foot. And those are opportunities that people can't pass up even in the lousy selling environment that we're in today.

Okay. And then just on the 99-day delivery strategy. I know it's not in all your communities. Could you give me a sense of how many it is in and whether or not this impacts your margins, how it may impact your absorption rates? Are you doing spec on the 99 days that helps make sure you can guarantee a delivery? And what happens if you don't get done in 99 days?

Well it's in about half of our communities. And if we don't get it done in 99 days we make a payment to the buyer, a penalty fee they get. It's not designed for specs. It's designed for new builds. So if you come in our sales office today and you sign a contract, we'll have the house ready for you to close on in 99 days. And it's certainly helping our cycle times. It's reducing our cycle times.

And it's playing well with realtors because they get paid quicker, and it's helping us convert potential spec home buyers into buyers we can build a home for or renters that want a home relatively quick. So it's been a positive strategy for us. Certainly it's more effective on more entry-level and first-time move-up buyers than it is on the larger homes that we're building.

Sure. And then just real quick, what's the can rate for the quarter? I didn't see that anywhere.

It's 24%.

Okay, 24%. I'm sorry I missed that. Thanks.

Thank you.

Thank you. Our next question is from the line of David Goldberg with UBS. Please go ahead.

Thanks. Good morning everybody.

Hi, David.

Good morning.

My first question, if I've done my math right, it seems to me like the 600 point discrepancy, the basis point discrepancy between the new and the older communities implies that new communities are doing about 23% gross margins, if the math is right. And I just want to get an idea of how that compares to how you guys are pro forma deals? Is it kind of in line with what you thought you were going to get, maybe a little bit better?

And if it is a little better, which maybe it is, how do you reconcile that with kind of the overall environment maybe being a little bit worse than you had thought before?

Why don't you take it, Larry?

Okay. Yes, that's a pretty fair estimate on the new projects, and that is a couple of points above where our target margin is. So what's happened is some of those deliveries are coming from lots we bought at the depths of the bottoms of the market where -- back last spring where the market was just frozen up, so we got some extraordinary buys on those. So that has shot some of those margins past our targets because of that.

On the other hand, the newer stuff that we bought over the last few quarters is more hitting our targets or slightly exceeding our gross margins. So on average as maybe some of those really great buys go away and that will hurt the margin on our new communities, what's going to offset that is more new communities will come online that will be at our target.

So you'll see that blend continue to happen, and that's why we don't feel we'll have a decrease in our margin on our newer communities because we'll continue to just add more communities which will offset those extraordinary buys as they gradually sell out. Does that answer your question?

Yes. Absolutely. It just means the margins on the new stuff come down a little bit, but it's a greater percentage, so in net margins there's not a lot of margin pressure unless things get worse. I think that's --.

Exactly.

Right.

The second question I had, and it's great to hear you guys talking about the success of the green product and the sales pace that that achieves, but I'm trying to get an idea of how sustainable that advantage is for you. Are you starting to find your competitors realizing? I mean, we've heard from a lot of public builders that they're trying to become greener and offer a greener product because that's selling well with consumers.

And I'm wondering when you look out is it that Meritage gets the reputation of being a green builder and so that gives you a longer-term and a sustainable brand, or is it that this is something that eventually everyone kind of copies and it becomes the norm and the advantages that you're having from a selling perspective start to ease a little bit?

Well I think it's both, but I think it's a win-win either way. We're not doing anything that we can patent or proprietary. I think over time most builders are going to gravitate towards the strategy and we'll be doing something similar if not the same.

But I think we do have a first-mover advantage. Some of the things we're doing I think other guys have not thought about till now. But I think over the long term it's a win-win for our entire industry because I think if we're all doing this it makes new homes a more compelling proposition against resales, and that's because if you can buy a new home and it's going to cost you a lot less to operate that home versus a used home, you might be willing to pay more for a new home. Or if things are more equal you'd be more focused on buying a new home than you would on a resale.

So the way we're going to get -- certainly we've got to get supply back into balance with the foreclosure situation, but over time as the foreclosures start to wane and we want to make new homes more compelling, we can do this by lowering the operating cost, the utility cost of a new home versus a used home.

Great. Thank you.

Mr. Hilton, we have two more questions in queue. Would you like to take them?

Sure.

Okay. Our next question is from the line of Jim Wilson with JMP Securities. Please go ahead.

Oh, thanks. Good morning guys.

Hi, Jim.

Most of my questions have been answered. You got a lot in this morning. Was wondering though, I'm looking at with your new community category being 44% on orders for the quarter, I was wondering what percentage actually of communities opened are new? I'm assuming besides higher margins they also have a higher sales base because they're better located and better priced, but I'm just trying to put that into context.

What's the number on that? About a third, Larry?

Yes. About a third of our communities are -- of our 150 communities are the new communities.

Okay. And 44% of sales. All right.

Well actually 53 to be exact.

Okay. All right. And so then when you talk about next year, I just want to be clear. When you said 60% to 70% should be new, is that just 60% to 70% of communities opened?

Of sales.

Oh, of sales. Okay. So maybe somewhere around 50% of actual communities opened should be in the new category?

Yes, 40% to 50%.

Got it. Okay. That's what I was wondering. That's what I thought. Okay. And, all right. That's really all I had left. Thanks a lot.

Okay. Thanks.

Thank you.

Operator, last question?

Yes. Our final question is from the line of Alex Barron with Housing Research Center. Please go ahead.

Yes. Thanks. Good morning guys.

Good morning, Alex.

Hi, Alex.

I wanted to ask you -- I think you guys have done a good job as far as reducing SG&A and reaching profitability at the operating level more than -- much more than other builders. But at the same time there 's still this interest expense below the operating line, so I'm kind of wondering about your thoughts as far as maybe not holding so much cash and reducing some of the debt to lower that interest expense versus holding on to it for I guess other opportunities? What are your thoughts on that?

And then I have a follow-up on your green homes.

Well, Alex, you know a lot of builders say they don't have bank lines, and so we don't have a source of short-term liquidity other than the cash that we're carrying. So we need to keep that liquidity around so when the market turns we're able to take advantage of it.

But certainly it is something we think about every day. If the market was to be pretty negative and no improvement for a long period of time, paying down debt might be something we should be thinking more about. But at this time we still think it's a prudent strategy to keep our liquidity to be able to take advantage as the opportunities present themselves here over the next year or two to grow our business back.

Okay. And then on the new green homes, I actually went to visit the one you mentioned in Gilbert. I saw that you guys were advertising like $50,000 worth of value. I was just kind of wondering how much of that -- how much is it really costing you? And do you guys get any sort of rebates from the government for building those kinds of homes?

We get rebates from three or four different sources. We get rebates from the utility companies. We get rebates from state and federal governments. In some cases there's rebates from city governments. So we take advantage of all that to mitigate the cost.

We don't really want to share what our costs are with our competitors, so we're not releasing those costs. Actually I'd like to tell our competitors that we're not making any money on those homes and we're just doing it because we want to be green, but you know that's not the truth.

And we're actually doing quite well in the profitability on those houses, and considering the absorption rates are much faster, it's actually a net benefit -- a net increase over a traditional non-green community.

Got it. Okay. Well thanks a lot.

Thank you, Alex. Okay, well thank you very much for sharing your time with us today on our call, and we look forward to talking to you again next quarter. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.