Meritage Homes Corp (MTH) 2011 Q1 法說會逐字稿

Greetings and welcome to the Meritage Homes first quarter 2011 earnings results conference call webcast. (Operator Instructions). It is now my pleasure to introduce your host, Brent Anderson, Vice President of Investor Relations. Thank you, Mr. Anderson. You may begin.

Thank you, Steve. Good morning. I would like to welcome you to the Meritage Homes first quarter 2011 earnings call and webcast.

Our quarter ended on March 31, and we issued the press release with our results for the quarter before the market opened today. If you need a copy of the release or the slides that accompany 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.

Let's 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 our risk factors, please see our press release and most recent filings with the Securities and Exchange Commission, specifically, our 2010 annual report on Form 10-K. 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 Vice President and CFO. We expect our call to run about an hour this morning, and a replay of the call should be available on our website within an hour or so after we conclude the call. It will remain active for about 30 days.

I'll now turn the call over to Mr. Hilton to review our first quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone to our call today. I'll begin with an overview of our first quarter 2011 operating highlights shown on slide four.

The market was obviously softened since the Federal home buyer tax credit expired in April of last year, as reflected in total US home sales as well as our own sales and closings. When we reported last quarter that it would be challenging to post a profit in the first quarter due to our significantly reduced backlog position at year-end 2010, that was borne out in our lower closings and revenue in the first quarter of 2011.

On the other hand, we were optimistic that we could sell and close an even greater number of specs than usual during the quarter as the spring selling season got underway, which we achieved with limited success. But we did not anticipate February's abnormally brutal winter weather in some of our largest markets in Texas, which affected sales, construction, and closings.

In response to a softer market, we offered larger incentives in some of our communities, which resulted in lower margins that offset the improvements we are achieving in our newer, higher-margin communities. We reported a loss of $6.7 million, or $0.21 per diluted share, for the first quarter of 2011; compared to the first quarter of 2010 net earnings of $2.7 million, or $0.08 per diluted share, which was largely the result of a $2.4 million gain from a legal settlement in 2010.

Slide five. Our first quarter 2011 closings were down 16% year-over-year, which is better than our beginning backlog would have indicated, as it was 29% lower than the prior year. The decline in closings was less than the decline in backlog because our conversion rate was higher.

We closed 87% of our backlog in the first quarter of 2011, compared to 74% in the first quarter of last year. We were initially optimistic that it could have been even higher based on the 93% conversion rate we achieved in the fourth quarter. Our ability to sell and close homes within the same quarter not only increases our asset turnover, but is a good indication that we are managing our spec starts for having popular homes available for quick move-in.

The 16% decline was in closings in the first quarter was partially offset by a 5% increase in average closing prices, resulting in a 12% decline in closing revenue. The increase in ASPs reflects a greater percentage of home closings in closer-in and higher-priced communities, acquired based on the recommendations from our strategic market research team. Our market research identifies some markets that have a greater number of positive indicators for strong sales and margins.

Many of our community purchased in the last several quarters have been in higher-priced areas that fit those criteria. This is most recently evident in Arizona, Colorado, and Florida, which experienced the greatest year-over-year increases in average prices of homes closed. Average closing prices were up 25% in Arizona, 11% in Colorado, and 6% in Florida for the first quarter 2011 over 2010.

Slide six. Our first quarter 2011 home closings gross margin was 17.1%. Excluding impairments it was 17.5%, which was 170 basis points lower year-over-year, but just 60 basis points below our fourth quarter 2010 gross margin.

As I stated earlier, our gross margin contracted primarily as a result of larger incentives offered in response to a weaker market conditions, especially in the 23 communities we closed out this quarter, and in order to move some older spec inventory in certain communities. We also experienced some negative leverage in our construction overhead due to fewer closings in the first quarter of 2011.

Approximately 42% of our closings and 45% of our closing revenue in the first quarter of 2011 came from newer higher margin communities we acquired since the beginning of 2009, more than twice as much when compared to 19% of closing and revenue in the first quarter of 2010. As we turn over more communities, we expect our margins to improve. Although market conditions are negatively impacting our results, the newer communities help minimize our margin exposure when slow demand and price pressure would otherwise reduce our margins to an even greater degree.

Slide seven. Let's turn to sales orders now. When we reported our fourth quarter 2010 results, we indicated that January sales had been slightly better than we expected, and we did achieve sequential improvements in our first quarter orders over the third and fourth quarter of last year.

However, the spring selling season for the first few months is off to a tepid start. We have not produced sales at the pace we would have hoped this far into the 2011 selling season. We believe the housing market in general is still bouncing along the bottom, with pockets of strength in certain of our markets.

Our first quarter 2011 net orders of 840, or 5.8 per community, increased sequentially over the previous two quarters, representing the highest quarterly sales and sales pace since the expiration of the home buyer tax credit last year.

Year-over-year comparisons against the fourth quarter of 2010 are difficult, as we believe that our 2010 sales of 1,064 homes, or 7.0 per community, were elevated by the tax credit. The total value of our first quarter orders declined 18% from the prior year, with a 21% decline in the number of homes sold, partially offset by a 4% increase in average sales prices.

Average sales prices increased in all of our markets with the exception of California, which was 3% lower than the prior year. The increase in ASPs primarily reflects a greater share of sales in closer-in communities, as well as sales of larger homes within certain market niches. Our company-wide order cancellation rate remained below its historical average range of 20% to 25% at 17% of gross sales in the first quarter of 2011, compared to 18% in the first quarter of 2010.

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

Thank you, Steve. I'll pick it up on slide eight. We had fewer average active communities in the first quarter of 2011 than one year earlier, which contributed to lower sales in 2011.

We opened 13 new communities for sales in the first quarter of 2011, but closed out 23 older communities, ending the quarter with 141 total active communities. We have added the most communities in California over the last year, while most of the reductions were in Texas.

Although our community count declined this quarter, we believe it will bounce back by the end of the second quarter based on the number of communities we have in our pipeline. We expect to have at least 150 actively selling communities by the end of June.

Earlier this month, we also announced our expansion into the Raleigh-Durham market, which is our first entry into a new market since 2005. The Raleigh-Durham and Chapel Hill markets were ranked number one and number three, respectively by Hanley Wood Market Intelligence, as the healthiest home building markets for 2011, and our own market research backs that up. We have put an experienced management team in place there, and they have already contracted for several communities in the area. We expect to begin selling homes there in the latter part of 2011, and should report our first closings from this new division early next year.

Moving to slide nine. We contracted for about 1,000 new lots during the first quarter of 2011, which included 17 new communities. The number of lots slightly outpaced our closings and brought our lot supply to approximately 15,400 total lots, our 4.3-year supply based on trailing 12-months closings. We own 84% of our total lots, and control the other 16 under option or purchase contracts, of which about two-thirds of our option contracts are in Texas.

Moving to slide 10. We ended the quarter with $388 million in cash and cash equivalents, restricted cash, and securities. That's about $25 million less than our December 31, 2010, balance, primarily due to lower closings and increased inventory. We spent $40 million to purchase approximately 900 lots during the first quarter of 2011.

To the extent that we can selectively find and acquire more communities that we believe will achieve good margins and help leverage our overhead, we may put some more of our excess cash reserves to work in future quarters. Our net debt to capital ratio increased moderately to 31% at March 31, 2011, compared to 26% at March 31, 2010, and 28% at December 31, 2010, but still below our historic average and well within our comfort range.

We ended the quarter with approximately 520 total specs, or 3.7 per community, compared to 4 per community last year. Approximately 48% of our closings were from previously started or spec homes during the first quarter. Selling and closing homes within the same quarter resulted in our higher conversion rate and inventory turnover. As a result of sales outpacing closings for the first quarter, our ending backlog increased to a total value of $245 million from year-end 2010.

I'll now turn it back over to Steve.

Thank you, Larry. We continue to execute on our strategic initiatives this quarter. They have generated positive results and we believe they will drive our future success.

Our strategies focus on all aspects of our business beginning with land acquisition, and extending through construction and sales by selecting the best locations we can find for our new communities through rigorous market research; reducing our direct cost and redesigning our homes to offer greater value as evident in our Simply Smart Series; reducing cycle times to turn our assets faster, allowing us to offer a 99-day guaranteed delivery; and designing our homes to function better and cost less to operate through Meritage Green technologies.

We were honored this year to be awarded the ENERGY STAR 2011 Partner of the Year by the EPA for the leading home-building industry in reducing energy through innovating high-performance homes. We have continued to raise the bar for the industry by making spray-foam installation standard in all of our new communities opening this year. That effectively doubles the energy efficiency of our basic ENERGY STAR qualified homes.

We also just announced our first net-zero home in the community of Verrado in Buckeye, Arizona. This is not just a concept home. The Ploeser family purchased the first of these homes, and is living there today. It is designed to be energy neutral, in other words, produce as much energy as it uses annually, which we accomplished using our National Advanced building program and solar upgrade package.

We plan to make these upgrades available in every community where we offer solar for as little as $10,000, at a total of 21 communities today, with many more in California, Colorado, Arizona, Texas, and Nevada. Our net-zero home is the first of its kind to be offered by a production home builder in the US, creating an entirely new standard for energy efficiency and value.

We celebrated our 25th anniversary in 2010. I believe we have managed the Company well through some very challenging times over the last four years, and despite the challenges and unpredictability of this market, we have a reasonable opportunity to be profitable again in 2011. I'm confident in our strategies and the team we have assembled to lead Meritage for the next 25 years.

I thank you for your attention, and will now open it up for questions. The operator will remind you of the instructions. Operator?

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Your first question comes from Adam Rudiger of Wells Fargo Securities. Sir, go ahead.

Adam, we can't hear you.

Steve, do you just want to do the next one?

Let's go to the next one, operator.

Thank you. Now, Mr. Rudiger, your line is live.

Operator, why don't you pick up the next one, and we'll come back to him.

Certainly. Your next question comes from David Goldberg of UBS. Sir, you may go ahead.

Thanks. Good morning, everybody. First question, I just want to make sure I've got the math right here. It seems to me that in the first quarter of 2010, if I remember correctly, the spread between new versus old communities in newer purchase land versus older purchase land was about 600 basis points, with old communities doing about 18% and new communities doing about 24%, and now the spread is 500 basis points. And it seems like it's come down, both old communities have come down and new communities have come down, and new communities seems to have come down a little bit more if I'm just doing the numbers right. Is that right? Is there some more margin pressure, and maybe the land cost on some of the stuff you've bought subsequently was higher, and that's what's causing the margin pressure?

I think your numbers are correct. I think it's a variety of things. Number one, we probably have gotten rid of some of the poor-quality, older communities. So, what remains is some longer positions and some better-quality older positions. And the pricing pressure that we have seen in the market is applied to all the communities. So, some of the margins have come down on some of the newer communities that we bought over the last couple of years, but I wouldn't look too much into 100 basis-point change. I think that that number can easily reverse itself over the next couple quarters as we bring on many more new communities. This quarter we plan on opening quite a few new communities.

Just to make sure I understand what you're saying, it seems to me like you're underwriting your communities to about a 20% gross margin, and that seems to be what you are achieving. So maybe some of the stuff you had bought, historically, was achieving a little bit more than your expectations, but you're still getting your 20% gross margin expectations on new stuff.

That's correct.

Okay. Perfect. I just wanted to make sure. And then for follow-up, just to understand, where is the business now in terms of breakout between move-up and entry level? And how do you see that, as you look forward, how do you see that moving in terms of what product you're putting out there?

Larry, do you have those percentages?

I don't have the exact percentages. If you want to address it generally, you can. Or I can.

I think we're still about two-thirds move-up, and the other third is divided up between entry level, Active Adult, and a very small component of luxury. I'd say, a couple of years ago, we were hoping to increase the move-up -- decrease the entry-level percentage, but that really hasn't materialized. And the best opportunities that we're seeing today are certainly in the move-up market, where we're able to buy what were formerly very expensive lots. Maybe they were in the luxury side, and now we're able to bring them to the move-up side, and they're very compelling, even in today's market environment for today's home buyers. So I see that trend continuing, and I see that percentage staying about the same.

Got it. And then you listed Active Adult. I know there was some talk this morning from another builder that Active Adult was performing pretty well for them. I know it's a smaller percentage of your business, but any kind of pick up in active adult in the last couple months?

You know, I don't see it, and I don't -- their numbers for -- in the communities we're competing with them, I don't see it either. So, I'm not seeing a big change in the active adult market.

Got it. Thank you very much.

Thank you.

Thank you. Your next question comes from Dan Oppenheim of Credit Suisse. Sir, you may go ahead.

Hi, this is actually Mike Dahl in for Dan. First question, I was just wondering the impact of the move-in to Raleigh. What should we expect from an SG&A perspective if you are adding the people on the ground now, but no closings until early 2012?

Oh, I think it's going to be really small. We have a very small crew there, so it's going to be negligible.

Okay. All right. And then as a follow-up, just wanted to clarify where, in the release you guys had highlighted that recovery of warranty costs had played a role in margins this quarter, can you quantify how much that impacted?

It's not a large percentage. The great majority of it is just overall margin pressure, and there may be like 20 basis points that might be sequentially impacted by warranty, but it's a very small amount.

Okay. Thanks.

Thank you.

Thank you. Your next question comes from Michael (inaudible) of JPMorgan. Sir, you may go ahead.

Thanks, good morning, everyone.

Good morning, Michael.

First question, I don't know if I'm overly reading in to the press release, but you had mentioned that you have a fairly -- you have a reasonable opportunity to be profitable again in 2011. It seems like a little bit of tempering of the language versus last quarter, where you, I believe you said in the release that you expect to be more profitable in 2011 than 2010. So I just want to make sure I'm looking at that language correctly and interpreting that, and if it's just because of, you're starting off with a greater hole in the first quarter, or are you also less confident on gross margin trends for the rest of the year?

I'd say you're pretty correct. Certainly we were more confident a quarter ago. We didn't expect to lose $6 million this quarter. We thought the spring selling season was going to be stronger than it was. We still feel confident that we'll make money this year. But I can't be so bold as to say, after losing $6-plus million in the quarter, that we're going to make more money than we did last year. I think the next quarter, we have the backlog to break even or make a very small profit, and I'm hopeful that we'll be able to do that. And then what happens in the back half of the year is really hard to predict at this moment.

It really just depends on how the rest of the spring selling season turns out.

Okay. Second question, I guess it's kind of related. You said that the sales trends for the first quarter were less than you were hoping for, but I was wondering if you could also comment on pricing and incentives as you've seen them during the first quarter. Obviously, you've said that you had some higher incentives that have driven your gross margins down over the last couple quarters, but what you're booking right now, what are you seeing in terms of pricing and incentive trends? And do you think your gross margins can hold at these levels or improve slightly, or what are the implications?

It's hard to give an answer to that because it's just different on every single community. To pay on the location, to pay on the competition. Some new communities, the pricing is strong; we're even able to raise prices. And other, more outlying locations, the pricing is weak and we're having to fight it out for every sale. I would hope that as we get more new communities online, and we've got more than 20 scheduled to open this quarter, that we'll be able to drive our margins, gross margins, back up to at least where they were last quarter and maybe at some point beyond that. But I'm not forecasting lower gross margins going forward.

Okay. Thank you.

Thank you.

Thank you. Your next question comes from Alan Ratner of Zelman & Associates. Sir, you may go ahead.

I was hoping that -- just to ask you about your comment about the weather playing a role, at least in Texas, which we certainly heard about as well, and if I remember back, that was predominantly a factor in February. Curious if you have seen the market normalize off of that bad weather impact, and if so, if any sequential trends you might be able to give as far as orders through the months would be really helpful.

Well, we had two weekends in February that were pretty much shut down for sales in Texas. Our March sales in Texas were certainly better because we didn't have the weather in March that we had in February. And I would say April sales company-wide are in line with what we saw in March, not really much better, but not really any worse. It's slightly increased every month throughout the year, but it's just such a nominal increase, it's nothing to get real excited about, and that's why we say the sales for the spring selling season have been pretty tepid.

Okay. I appreciate that. And just as far as the community openings that you have planned for Q2, I was curious if you expect that to be back-weighted towards the end of the quarter, or if you think that's going to have an impact on Q2 results?

I don't think it's going to have a big impact on the results, but I think when we get to the third quarter, we're going to see some impact from both communities. But most of them open up towards the end of the quarter.

Okay, great. I appreciate it. Thank you.

Thank you.

Thank you. Our next question comes from Adam Rudiger of Wells Fargo. Sir, you may go ahead.

Can you hear me now?

Yes.

Sorry about that. I wanted to ask you, Steve, about the incentives a little bit, and what you were seeing that buyers were responding to the most, what was working, and do you think that you'll be able to reduce those incentives in the short-term, if you see the demand? And then also, on the new communities where you've had to enact any newer incentives, how that translated into how those communities were performing relative to your original underwriting assumptions?

I can't think of one incentive that is a silver bullet. We use a variety of different types of incentives,whether they're buydowns or options or just lowering the price. So I can't give you one specific one. Again, on the new communities, some of the new communities are outperforming their original underwriting and selling at a very rapid pace, and others are not performing. But overall, we're very pleased with what we've bought, but the pricing pressure applies to almost all communities across the board. Consumer psychology is the same pretty much everywhere, so I don't really have any specific numbers to give you on the newer communities.

Is that pricing pressure that you just mentioned, do you think that's more from new home builders, competitors of yours, or is it more from the resale market?

Absolutely more from the resale. That's our number one competitor. And home builders in general make up such a small percentage of the overall market today that we don't see a lot of people that are coming and comparing us to brand X. It's more a short sale or foreclosure they can buy, or distressed, used-home opportunity that they are considering, and our marketing efforts are primarily geared to try to bring those buyers into the new home market.

Okay. Thank you.

Thank you. Operator, next question?

Thank you. Your next question comes from Joshua Pollard of Goldman Sachs. Sir, you may go ahead.

Hey, good morning. This is (inaudible) in for Josh. Our first question is, can you please give us a little bit more clarity on what you expect with gross margins for the rest of the year? And, within that context, also touch upon the impact that incentives had in the first quarter, and how you see that playing for the back half of the year?

I think I already answered both of those, but I would hope with our new communities coming online over the next couple of quarters, that our gross margins could return at least to where they were last quarter, and hopefully at some point beyond that. We're certainly not forecasting gross margins to go lower. And the incentives, we're hoping that consumer psychology is going to stabilize and demands for housing is going to increase, and as we go in to the later part of the year, we'll be able to ratchet back some of the incentives we had to offer over the last quarter. And, as we open more newer communities throughout the next couple quarters, the incentives should decline.

You spoke about February being weak, and also touched upon that you saw nominal increases every month. Would you be willing to give us the numbers that you saw in each of the months?

No, we're not going to release the individual monthly numbers.

Okay. And the last thing that we had was the incentives. Was it more focused in any particular product category, or was it broad-base across market?

I'd say it's pretty broad-based.

Okay. Thank you.

Thank you.

Thank you. Your next question comes from Nishu Sood of Deutsche Bank. Sir, you may go ahead.

Thanks. I wanted to ask another question about the order trends. I know the way you folks are looking at it, the orders were disappointing relative to the trends you folks have been seeing. When we look at it externally from an investor point of view, you guys had a pretty significant outperformance in the fourth quarter when you actually had the up year-over-year orders, and now you look more in line with the rest of your peers. When you look at it from that perspective, is there any insight you can shed on what that might mean in terms of the markets here, and obviously the Texas exposure, or your product strategies? Is there any light you can shed on it from that perspective?

Well, we've certainly been trying to trim the tree in Texas and get rid of the older, lower-margin communities and replace those with newer communities, and certainly the opportunities have come later to the Texas market. We didn't see a lot of great land deals there a year ago, but we're seeing a lot of nice deals there today. So it's been a transition period for our business in Texas that came later than the rest of the business, and I think that's impacted our results because we have such a big presence in Texas. I would say that we're really happy with our results in Orlando right now. We've bought -- we're almost all in new communities there, and they're performing really well. We're really happy with what we're achieving in Denver, we've got some really positive results there and in some other markets. But Texas has been a transition, and I'm expecting, going forward, to get continual improvement as we rotate into newer communities and better positions in the Texas markets.

Also I might add, as we said earlier, the decreases in community count have come primarily from Texas over the last couple, three quarters, and we expect that to stabilize. We have quite a few new subdivisions coming online in Texas over the next couple of quarters and beyond. So we should see the community count stabilize and start to regrow in Texas a bit.

Got it. Great, thanks. And another question I had was, the weather disruptions that you mentioned over a couple of weekends in Texas. Weather has been a pretty big theme over the past four months, very, very cold and erratic winter from a weather perspective in many different parts of the country. It always ends up seeming to be a dead loss. In other words, you have two bad weekends, like you mentioned, in terms of weather, and you don't regain that the next weekend it seems like, so it ends up being a dead loss. I was just wondering if you could shed some -- just share your thoughts on that. If someone's going to buy a house one weekend, and it's a stormy weather weekend, they don't seem to come back the next weekend. So is that what you see on the ground, or what does that tell us about the consumer behavior right now?

I think that's true, but I don't think everybody who goes out looking for a house expects to buy a house. So, they have to be sold when they come through our community. So if we don't have traffic we don't make sales. I think we're like, in some respects, maybe like a restaurant. If we're closed one weekend, we won't make the business up the next weekend. I think that's a true observation that you've made, and I just think that's just the way it is.

Got it. And just last quick. Have you made any comments about April? Just wondering your thoughts on the continuing trends.

No, I think April is pretty much in line with March, and probably pretty consistent with what you heard from other builders. I don't see a significant increase over March, but on the other hand, it's not getting worse. It's about the same.

Great. Thank you.

Thank you.

Thank you. Your next question comes from Paul Przybylski of Ticonderoga Securities LLC. Sir, you may go ahead.

You mentioned Denver as being a strong market. I was wondering if you might be able to add some color on that, if that is really just driven by the overall conditions in that market, or your community locations? And then if you were planning on to aggressively expand community count there?

It's strong for us for a variety of reasons, some of which you've mentioned. Number one, we've got only one old community there, and everything else is new, just from the last 18 months or so. So we're in good locations and new, lower land prices with lower home prices that are really in tune with the market. I think the market in general is doing better there than some of the other Western markets. I think job growth in Denver is stronger, certainly than Phoenix or Las Vegas or even some markets in California. I think the market's helping us, and I think the Denver market has been down for much longer than many other markets, so I think the pent-up demand might be stronger there. So it's a whole variety of factors.

Okay, but will you continue to grow your community count there, or should we look for things to remain flat?

I think we're going to grow our community count. I wouldn't say it's going to be dramatic, but I think we're looking for land right now, and we expect to make more acquisitions this year. We absolutely could grow our community count in the next year.

Okay. And then moving back to Raleigh, are you proforming any kind of margin of safety in your gross margin assumptions, or are you going with what you would typically look at for the overall company?

No, we're expecting the same or better gross margins in Raleigh than we have everywhere else.

Thank you.

Thank you.

Thank you. Your next question comes from Jade Rahmani of KBW. You may go ahead.

Hi. Thanks for taking the question. I was wondering if you could give some insight into mortgage availability and cancellation trends, and the overall buyer profile. For example, what percent of cancellations are due to loan rejections or qualification issues? And is this, indeed, the main driver of cancellations?And then, related to that, are any of these prior cancellations showing up in future orders, and do you have any initiatives underway to help get borrowers approved?

I'll take some of it, and Larry, you can take whatever I miss.

Sure.

Number one, our cancellations are very low by historical standards. I believe we reported they were 17% for the quarter, slightly less that last year at this time, and certainly less than they've been over the last couple, few years. And most of our cancellations occur before we start construction of the home for a variety of reasons, whether they're buyer remorse or failure to qualify, et cetera. I think there is plenty of mortgage availability for people with reasonable credit, a job, and a small down payment. I think the challenge is that a lot of buyers are credit challenged, and particularly, as we move down the price band, we're running in to a lot of buyers that just have bad credit and challenge with their credit. Larry, what were some of the stats we saw the other day?

Just in general, most of the people we sell, like almost all of the people we sell homes to today, have a 620 or better credit score. So you've got to be there or better, it's very difficult below that, sometimes you can get somebody qualified. The great majority of people coming to buy our home, sign a sales contract, can get a mortgage. Maybe there's, I don't know, 10%, 15%, 20% at the most of people who want to buy a home can't because we can't get a mortgage for them. Most of the cancellations, as Steve said, that we have are because of buyer remorse early in the process, and not because of mortgage qualification.

Thanks. And then can you give the mix of FHA that you have, and also the average, current FICO score? Thanks a lot.

I think our current FICO score is about, is it about 720, Larry?

It's actually about 730 now.

730 average. I think about 90% of our loans, or 95% of our loans, are government loans, and about half of our loans are FHA. Does that sound right, Larry?

Yeah, about half are FHA-VA, and the other half are conforming loans. So, 99% of our loans are conforming or FHA-VA loans today.

Thanks a lot -- oh, any impact from the FHA fee increase in April?

No.

Okay. Thanks a lot.

Thank you. It appears we have two more questions in the queue. Our next question comes from Michael Smith.

Hey, guys. So just a couple of questions on community count growth. Obviously, it looks like Q2 is the one where you'll reverse the year-over-year downward trend and start to grow on a net basis. Can we expect that same kind of community count growth throughout the rest of 2011, or are you guys looking at it as more front-loading it in the front half, and then falling off of the pace of growth in the second half?

Yeah, I'd say our biggest growth is going to be this next quarter. And then we expect to grow a little bit more in the quarters following that. But certainly, we're going to open 20 to 25 new communities. Of course that's going to be mitigated by ones that we're going to close, but we're going to open a lot of new communities this quarter. And then we're going to close less and open less in the next two quarters. Maybe we'll finish the year around 160 communities, somewhere in there. But we're not going to see as dramatic a bulge in the pipeline in the last two quarters as we will in this quarter right now.

The last quarter increase is somewhat dependant upon tying up additional lots, or still looking for lots that we could get online, and start closings and sales in the fourth quarter, at least sales in the fourth quarter, so that's somewhat dependent upon how successful we are in getting new lots on board.

And the other challenge is, a lot of lots we're finding today need to be developed. The supply of finished lots is declining, so the distance between when you acquire the community and when you open it is increasing, because you've got to develop the lots and bring them online.

And then as far as the communities, you've been talking a lot about closing out of older communities, and that that should help your margins. Do you guys have a plan of what you want to aggressively close out of no matter what the sales pace looks like? Or is that more dependent on what the sales pace looks like, you might be more aggressive if it remains slow, if it picks up some you might be a little less aggressive in trying to close out? Or is that something you guys have kind of decided, and that's just how it's going to go no matter what?

Well, we're selling for margin, not for return of capital, because we've got cash in the bank, and there's no point in liquidating older communities for no profit just for the sake of getting rid of them. And we can amortize some of our overhead over at those older communities, so we'd like to sell at least one house a month in some of these older communities, and we try to do that as a minimum. Hopefully we can do better. But we're very much focused on profitability and not on cash flow.

Okay. And then just one last quick follow-up, as far as regional breakdown, am I right to assume that the pattern we've seen is going to continue a little bit more aggressive about closing out in Texas, a little bit more aggressive about opening stuff in California?

I wouldn't say aggressive about opening stuff in California, because I think Southern California is certainly doing better for us than Northern California. And the opportunities are somewhat limited in California, at least for us, because it takes a lot of dollars to participate in California. And I'd say we've turned over a lot of our older communities in the markets outside of Texas, so we don't have a lot of older communities in those markets left to get rid of. But we can still get newer communities in all of those markets, certainly in Orlando and in Denver, and in Phoenix we're going to add some new communities this quarter. And we expect Raleigh to have a positive impact, but certainly with about half of our business being in Texas, opening up a lot of new communities there moves the needle.

All right, thanks, guys.

Okay. Well, I think that's all our questions. I appreciate your participation in the call this quarter, and you're support, and we'll look forward to talking to you next quarter. Thank you.

Excuse me, it appears we have another question.

We do? We've got one more?

Yes, sir.

Okay.

Okay. Your next question comes from Stephen East of Ticonderoga Securities.

Oh, we couldn't forget Stephen.

Sir, you may go ahead.

When you look at your gross margins over the last five quarters, they sort of tick down nearly every quarter. If you rank order, what's going on there between -- the biggest driver of it, whether it's incentives, whether it's geographic mix shift in to less profitable areas, whether it might be the distressed land opportunities aren't as great, or more development costs that you just touched on? How would you rank order of all that?

I think it's really one thing. The market's gotten weaker. Five quarters ago -- I don't know if that's entirely true, but assuming that it is, five quarters ago, we weren't selling that many homes out of new communities. It was a relatively small percentage, so the new land deals couldn't have that much of an impact on it. The market's gotten significantly weaker than it was a year ago, and that's drove prices and profitability down for everybody.

Stephen, the other thing I would say, the last couple of quarters we were pushing the sale out of older communities, and selling a few of the older, dated specs, so that probably had a little bit of impact the last two quarters. The other thing I would point out is, the first quarter of 2010 was kind of an abnormally high margin quarter, and if you pull that one quarter out, the trend line looks a lot smoother. So I'm not exactly certain what was going on there, but that was a little bit of an abnormality.

I know exactly what was going on. It was the tax credit. And that was the quarter where we got the big (inaudible) from the tax credit and pricing was stronger. I think you got the tail of two halves here. You got pre-tax credit and then post-tax credit, and certainly since the tax credit ended last year, prices have declined.

Are you seeing -- one last question, are you seeing any difference in incentives that you have to offer first-time buyers versus move-out buyers?

No, I think first-time buyers are more credit-challenged than move-up buyers. I think it's harder to get those people financing, not because financing is tight, just because their credit is not as good. It's bad. And on the move-up side, people have stronger credit. So I think that's a healthier part of the market for us.

Okay. Thanks a lot, guys.

Thank you. I think that was our last question. So again, we appreciate your participation, and we look forward to talking to you next quarter. Thank you.

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