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Meritage Homes Corporation (NYSE:MTH)

Q3 2008 Earnings Call

October 28, 2008 11:00 am ET

Executives

Brent Anderson - Vice President, Investor Relations

Steven J. Hilton - Chairman and Chief Executive Officer

Larry W. Seay - Chief Financial Officer and Executive Vice President

Analysts

David Goldberg - UBS

Daniel Oppenheim - Credit Suisse

Stephen Kim - Alpine

Nishu Sood - Deutsche Bank

Joel Locker - FBN Securities

Carl Reichardt - Wachovia Capital Markets, LLC

James Wilson - JMP Securities

Nicole Pecoulas - Babson Capital Management, LLC

Joshua Pollard - Goldman Sachs

Operator

Good morning, ladies and gentlemen. My name is [Laura] and I will be your conference operator today. At this time I would like to welcome everyone to the Meritage third quarter conference call. (Operator Instructions)

Mr. Anderson, you may begin your conference now.

Brent Anderson

Thank you, Laura.

Operator

You're welcome.

Brent Anderson

Good morning, everyone. I'd like to welcome you to the Meritage Homes' third quarter 2008 earnings call and webcast. Our quarter ended on September 30 and we issued a press release yesterday with our results for the quarter and first nine months of the year. If you need a copy of the release you can find it on our website at www.MeritageHomes.com on the Investor Relations page along with the slides that accompany our webcast today.

Please refer to Slide 2 of your presentation. Our statements during this call and the accompanying materials contain projections and forward-looking statements which are the current opinions of management and subject to change. We undertake no obligation to update these projections or opinions. Additionally, our actual results may be materially different than our expectations due to various risk factors. For information regarding those risk factors, please see our press release and the most recent filings with the Securities and Exchange Commission, specifically our 2007 annual report on Form 10-K and our latest report on Form 10-Q.

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

With me today to discuss the quarter are Steve Hilton, Chairman and CEO of Meritage Homes, and Larry Seay, our Executive Vice President and CFO. I'll now turn it over to Mr. Hilton to review our third quarter results.

Steve?

Steven J. Hilton

Thank you, Brent. I'd like to welcome everyone to our call today. Let's start on Slide 4.

Our year-over-year results for third quarter and year-to-date reflect the significant declines we've seen in homebuilding over the last year, as well as the crisis in the financial markets that began in early September. Our sales were down 29% in the quarter, and we've seen a substantial decrease in traffic and sales across the company in the last six to eight weeks, similar to what other homebuilders have reported recently. These factors resulted in additional impairments this quarter and a valuation allowance against our deferred tax asset.

Continuing with our defensive strategy, we increased our cash balance again this quarter, have no bank debt and no debt maturities until 2014, and maintain one of the lowest supplies of owned lots in the industry. We're also adjusting our plans based on conservative assumptions for 2009.

Our third quarter 2008 home closing revenue declined 35% from the prior year as a result of 25% lower closings and a 14% decline in average sales prices. The increase in foreclosures is impacting both sales volume and prices, as banks are heavily discounting their prices on foreclosed homes they bring onto the market.

While Hurricane Ike hurt our Houston operations in early September, the financial crisis and slowing economy have damaged buyers' confidence and resulted in further declines in home sales and asset values, which prompted us to record further real estate impairments in our third quarter. Based upon greater uncertainty as to the timing of the eventual recovery in homebuilding, we also concluded this quarter that a valuation allowance against our deferred tax asset was warranted.

Slide 6. We reported a third quarter net loss of $144 million in 2008 compared to a 2007 net loss of $119 million. Our pre-tax loss for the third quarter of 2008 was $62 million, which included $55 million of pre-tax charges against our real estate and joint venture assets. By comparison, our 2007 pre-tax loss in the third quarter was $192 million, which included $172 million of real estate related and joint venture charges and a $45 million charge to impaired goodwill.

Excluding those primarily non-cash charges in each year, our third quarter pre-tax loss was approximately $7 million in 2008 compared to a pre-tax income of $24 million in 2007. The additional operating loss in 2008 reflects fewer closings, increased incentives, and lower revenue margins on homes closed.

Slide 7. Asset values fell further during September, causing our real estate impairments to increase after several quarters of declining charges related to real estate. Our asset valuations for determination of impairments took into account the recent impacts of the financial crisis, incorporating assumptions for slower absorptions and lower prices. Impairments on existing communities accounted for $35 million of our total third quarter real estate related charges, with additional impairments of $13 million related to land held for sale, plus $6 million in option terminations and $1 million of joint venture impairments.

More than half our third quarter 2008 real estate impairments were primarily related to four underperforming projects in Phoenix. These four are the only attached home communities that we have in that market. We impaired the inventory and no lots remain on two of these projects, terminated the option for the remaining lots on another, and wrote down the value of the fourth project that's being held for sale.

California, the second-most significant level impairments, made up approximately 20% of the total this quarter as housing markets there were further impacted by falling prices and an oversupply of new and existing inventory, including many foreclosed homes. California has some of the highest foreclosure rates in the nation after experiencing some of the greatest declines in housing values.

Slide 8. The slowing economic environment also contributed to our conclusion to record a valuation allowance against our deferred tax asset this quarter, reflecting our greater uncertainty as to the timing of the eventual recovery in homebuilding. We impaired our deferred tax asset by $106 million in the third quarter, representing our estimate of the amount we believe will not be realized by the end of 2008 and therefore not allowed to carry back to 2006, our last profitable year.

We anticipate that we'll realize approximately $31 million of our September 30 deferred tax asset during the fourth quarter of 2008. When combined with the deferred tax assets we've already realized through the third quarter, we expect to collect a tax refund of roughly $80 million in the first half of 2009. While the $106 million is no longer carried on our GAAP balance sheet, the asset can be carried forward for tax purposes and used to offset further taxable income.

Slide 9. In the wake of September's unprecedented financial system failures and consistent with what other builders have reported, we experienced a substantial decrease in traffic and sales during September which has continued into October. Our September net sales were about 30% lower than our July-August pace, and our cancellation rate jumped to 45% that month alone.

Our third quarter net orders declined 29% from 2007 to 2008 after a 40% cancellation rate for the quarter. This is considerably higher than the 27% and 29% rates in the first two quarters of 2008 and in line with the 41% rate reported in the third quarter of 2007.

Fear has discouraged some buyers as they worry that more bad news may be coming. It's our job to show buyers who are able to buy now that this is an historically opportune time to buy a house, with the latest designs and amenities at some of the lowest prices we've seen in many years.

Analyzing third quarter orders a bit further, our Arizona sales increased over the third quarter 2007 by 17%. We were able to increase absorptions there through programs targeting spec sales, aggressive pricing of our attached home communities, and retooling our product offering, replacing higher end models with more affordable homes that appeal to more buyers.

The largest percentage declines [inaudible] were experienced in Florida, down 74%, and California, down 53%. In California, our lower sales numbers reflect our reduced number of communities in addition to continued weakness in the housing market. We have not been opening new communities nor reinvesting in lots in some areas, so we're simply selling out from fewer stores.

In Texas, we were fortunate that Hurricane Ike caused less than $0.5 million of direct physical damage to our homes in Houston; however, it delayed construction, closing and sales in our largest market. When combined with the overall impact of the financial crisis, those events caused our third quarter year-over-year sales to decline 28% in Texas, resulting in a 16% decline year-to-date in 2008.

Our comparatively large operations in Texas still benefit us relative to many other builders as we reported lesser sales declines in the last several quarters than they have. Recent results from several homebuilders reported 40% to 65% decreases in sales from the same periods last year versus a 29% overall decline for Meritage.

Slide 10. Excluding the real estate related charges from cost of sales in both years, our adjusted third quarter gross margin was 12.7% in 2008 compared to 14.8% in 2007. The smaller margins reflect lower net sales prices on fewer deliveries, partially offset by construction cost reductions and a lower asset base on homes closed due to prior impairments.

As discussed last quarter, we've been working to reduce our costs of construction, and several divisions have already hit their targets of 25% to 30% reductions in average home construction costs per square foot from their peak. The reduced construction costs allow us to offer more affordable homes and compete more effectively for homebuyers today.

We've also reduced our overhead expenses as revenues and sales have declined. Commissions and sales costs have decreased 30% year-to-date to about 9% of total revenue, which is relatively in line with our 35% decline in revenue. Year-to-date general and administrative expenses are down 31% lower in 2008 than in 2007, which includes the benefit of a $10 million legal settlement we collected during the second quarter this year. Excluding that item, our year-to-date G&A expenses were approximately $14 million lower than 2007 and were 5.6% of total revenue in this year-to-date compared to 4.4% last year.

We ended the third quarter with about 1,100 total employees, approximately 30% lower than the level of about 1,550 a year ago and about half of what it was at our peak in mid-2006. Unfortunately, we're faced with making further reductions in force to bring our operations more in line with declining sales. These decisions are very difficult, but we believe they're necessary for the continued health of the company as a whole.

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

Larry?

Larry W. Seay

Thanks, Steve.

If you'd turn to Slide 11, our third quarter cash flow has traditionally not been as strong as the fourth quarter due to seasonality as more closing occur in the fourth quarter. In addition, due to Hurricane Ike, some closings in Texas that were scheduled for September were pushed into October, and we lost orders due to higher cancellations. As a result of order closings and higher inventories, our cash flow was modestly positive in the third quarter. Yet, we have generated more than $106 million of positive cash flow from operations for the first third quarters of 2008 and ended the quarter with $119 million in cash and no bank debt.

Slide 12. Despite being a build to order homebuilder, increased cancellations this quarter resulted in our inventory of unsold homes increasing to 809 at September 30, 2008, up from 725 the previous quarter. Three hundred twenty-four of the 809 unsold homes were completed and 485 were under construction. Although the total was 34% lower than a year ago and averages a little less than four specs per community, it's higher than we like. We're working to bring the spec count back down in the next couple of quarters, reduce the capital tied up in inventory, and generate additional cash.

Slide 13. We also continue to reduce our total lot supply controlled, taking it down another 5% in the third quarter, a decrease of almost 1,200 lots. We've reduced our total supply by 62% from the peak in September of 2005 and cut our total owned lots to about 9,100 or 1.0 year's supply, one of the lowest in the industry.

Slide 14. Approximately 57% of all the lots we control were in Texas, which also accounts for about 72% of our remaining option lots. We're even more cautious now about entering into any new lot positions, considering the weak environment. Our community decreased to 207 at quarter end and we've continued to bring it down since the middle of last year. Approximately 40% of our communities have fewer than 25 lots remaining for sale as these older community lower-margin lots are sold, our active community should come down even more over the next several quarters.

Slide 15. Our net debt-to-capital ratio was 46% at September 30, 2008 compared to 41% at the end of the previous quarter and 50% at September 30, 2007. The sequential increase this quarter resulted from a reduction in shareholders equity driven primarily by the deferred tax valuation allowance and real estate impairments. Our interest coverage ratio is 1 times interest incurred based on trailing 4 quarters adjusted EBITDA. We anticipated the potential for deferred tax valuation allowance when we amended our credit facility in July, so its impact was factored into our modified covenants.

At September 30, 2008, we had no borrowings outstanding under our amended credit facility and our borrowing capacity was $338 million after considering the most restrictive covenants in place at quarter end. And our tangible net worth cushion was $195 million at quarter end.

I'll now turn it back over to Steve.

Steven J. Hilton

Thank you, Larry.

Slide 16. We believe the true demand for homes is being depressed by volatility in the financial markets and the constant barrage of negative news. It appears that this may have caused many buyers to defer home purchases until prices and economic conditions stabilize. A few markets, such as Sacramento, have shown sales increases recently as buyers have taken advantage of large selection and low prices on homes and brought down inventories despite the tide of foreclosures.

However, those isolated bright spots may not be indicative of the market in general, so we're emphasizing a more defensive strategy going forward. Let me review some market statistics with you:

Net monthly new home sales from a benchmark group of NAHB builders have fallen 72% from January 2006 to September 2008.

Home sales prices have dropped up to 50% in some markets, with land prices down even more in just one years' time and existing inventory is nearing an all-time high of resale homes.

We are hopeful the actions being taken by our federal government and other leaders will restore faith in the credit markets, ease liquidity and stem the tide of foreclosures. We urgently need a housing stimulus package that will revive demand for home sales and stabilize prices. Reviving the housing market is among the quickest methods of generating job growth, as home construction produces 3.1 new jobs for each new home built.

In 1975, Congress enacted a temporary tax credit and reduced 30-year fixed mortgage rates. That measure yielded an immediate upturn in the economy not only in the short term but well beyond the expiration of the legislation, leading the way to economic recovery of the mid-1970s. We are encouraging Congress to implement such a plan again in order to stimulate home sales.

At Meritage we are focusing our efforts on reducing our inventory of unsold homes, reducing construction costs and overhead expenses, generating cash and protecting our balance sheet. We'll be cautious in acquiring any new lot positions. Despite lower sales and current market conditions, we expect to generate positive cash flow for the next several quarters from our continued reduction of inventory and projected collection of roughly $80 of tax refunds in the first half of 2009. We will continue to focus on protecting the balance sheet, and we believe that markets will offer some of the best long-term opportunities for homebuilders.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Goldberg - UBS.

David Goldberg - UBS

I'm wondering if we could maybe start with a conversation about the spec home levels and maybe try to put a little bit of quantification around where you think the spec home levels could go into the future. And I appreciate the detail on the breakout between what was finished and unfinished, but maybe give us an idea of where you'd like to see that going and maybe what kind of cash flow that could generate.

Steven J. Hilton

Well, we don't expect it to go higher, and it's always been our stated goal to have no more than a couple, you know, two to three spec houses per community. So as our community count falls, our spec house level should fall, you know, with that. But with about 200 communities, you know, we'd like to get that number down close to 600 and I believe we're a little over 800 this quarter. So if we could knock 200 specs off over the next couple quarters, that should generate, you know, $40 to $60 million of cash flow for us.

David Goldberg - UBS

Maybe to ask it another way, too, is to say, you know, the last slide you guys had, generate positive cash flow, including the change in spec inventory and the carryback losses and the NOL carrybacks, but if you didn't have those, if you were just looking at your normalized business model now, without the benefit of the tax refunds and without the spec inventory reduction, is it still a free cash flow positive model at this point as you look forward?

Steven J. Hilton

I think so.

Larry W. Seay

Essentially our net income excluding inventory changes and tax assets is pretty much cash flow. You know, there's a little bit of depreciation and amortization, but not a whole lot. So our goal, excluding inventory changes and tax asset refunds is to operate as close to breakeven as possible during this difficult time and get back to profitability. But if you're operating at a breakeven profit, you're operating at pretty close to a breakeven cash flow with a little bit of add back for depreciation and amortization.

David Goldberg - UBS

And then I guess my other question has to do with Texas. And maybe, I know operating profit ex impairments this quarter were negative on the whole, but maybe you could give us a little more color how it might have looked in Texas versus some of the other markets and just some more granularity on maybe if you're still operating profitability in Texas.

Steven J. Hilton

We are still operating profitability there, although the traffic and the sales have slowed down quite a bit, particularly over the last couple of months. But we're not seeing the radical price declines, the large incentives, the large discounts that we've seen in the other markets that we're in on the Coast and in Arizona. So we feel pretty confident the prices are going to hold for the most part in Texas. But sales levels are certainly off.

David Goldberg - UBS

Has that been a trend that's accelerated, the decline in sales in the last, let's say three or four weeks?

Steven J. Hilton

I'd say since the early part of September it's really accelerated. You know, I think it started with the hurricane and it just didn't pop back after the hurricane passed.

Operator

Your next question comes from Daniel Oppenheim - Credit Suisse.

Daniel Oppenheim - Credit Suisse

I was wondering if you could talk a little bit about the pricing strategy in terms of the sales per community in some of the regions. If we look at the orders per community, should we think about were there a lot of cancellations in September that sort of drove that or were the cancellations consistent across the markets? Just a little color in terms of what you're seeing there in terms of that trend in September.

Steven J. Hilton

Well, I don't think that cancellations are what's driving the low absorption. It's just less traffic, less buyers in the market. I mean, people are getting barraged every day with negative news about the economy and the stock market and they're seeing the gyrations up and down in the stock market and they're just afraid.

And the people that are in the market buying homes today are really focused more on the foreclosure market than they are in the new home market, even though our prices are relatively competitive with foreclosed homes and we've lowered our prices in some markets 40% to 50%, and we're in line with a lot of the foreclosures but, for some reason, a lot of potential buyers believe the foreclosures are a better deal today, and we're losing a lot of that business. Even though you've seen, in markets like Phoenix and California, levels of resale activity are up 50%, 60% from a year ago, that activity is going to the foreclosures, not to the new homes.

Daniel Oppenheim - Credit Suisse

I guess what I was wondering about, so that it helps in terms of thinking about the activity just with lower traffic, I guess with the goals for cash flow in the fourth quarter, is there anything you can quantify with that? And then how is it that you're going to achieve some of the reductions in specs and the cash flow coming through with this lower traffic?

Steven J. Hilton

Well, I don't think we're in a situation where we've just got a ton of specs that we've got to get rid of. Like I said to David earlier, we're only a couple hundred specs above where we normally want to be, so our level of specs is not as out of balance as you might think that it is. So we're not going to have a fire sale to try to bring our spec level down. We want to be cash flow positive, but we don't want to do it at the expense of the balance sheet and create a tremendous amount of additional unnecessary impairments.

Larry W. Seay

We will plan to - most of the cash will come from winding down subdivisions and selling out the last work in process homes, the last model homes, the last spec homes and the last few lots we have. So as we wind down subdivisions, each of those subdivisions will generate positive cash flow as our subdivision count falls. So over the next several quarters a lot of it's going to come from that. Some of it will come from specs but, as Steve said, we don't have a terribly out of balance spec level today, but it's certainly higher than we would like.

Steven J. Hilton

We certainly had more specs in prior quarters. I think we had one point where we were well over 1,000, so, although we're not down at the level we want to be, we're not panicking about it either.

Operator

Your next question comes from Stephen Kim - Alpine.

Stephen Kim - Alpine

My question relates to your inventory breakout. I wanted to know whether or not you could provide the breakout in dollars between your finished home sites and home sites under development, just a rough percentage. How much of that - I think $499 million is finished home sites - if you have that?

Larry W. Seay

Most of that is finished home sites and a small portion of it is under development. But, you know, the numbers probably something like, oh, 20% to 25% under development and 75% to 80% finished lots.

Steven J. Hilton

It may not even be that big, Larry. I bet it's even less than that.

Stephen Kim - Alpine

The second question relates to I guess what you would consider to be incremental land spend. You know, I tried to triangulate in on that and I came up with a figure that, at least on a rough cut, looks like it increased in the third quarter from what you'd been running at in the second and first quarter. And this is basically, you know, the amount of investment you're making into parcels which you needed to get to the finished stage so that you could build on and that kind of thing.

And it seemed like the dollar outflow this quarter was greater than that in the first and second quarter, but I'm doing it with rough numbers and triangulating. Would you say that that's a fair statement or did you actually spend about the same or less than you spent in the first and second quarters?

Larry W. Seay

I don't think it was a lot more. We really haven't been buying any new land. Of course, we're continuing to buy, particularly in Texas, lots under option where we're selling houses and starting houses on them, so we have that normal land spend. But the only thing we did for the quarter, we actually did buy a couple of very small subdivisions in Phoenix at really, really good prices, about 150 lots for about $8 or $9 million, so maybe you picked that up.

Stephen Kim - Alpine

Last question, if I could, gross margin, I just have here that it looked like it increased sequentially while your SG&A was sort of flat sequentially. I was just curious whether or not - well, first of all, did your gross margin actually improve and secondly, you know, as we go forward, should we look at that third quarter gross margin number as sort of a reasonable base from which to go forward or was there something aberrational in that number and do you think SG&A could be cut significantly as you go forward as a ratio?

Larry W. Seay

As we've said before on other calls, the gross margin number, we think that, you know, we were at 12.7% after backing out impairments and, you know, we think we'll be around that number. We don't see it going a lot lower but, on the other hand, we don't see it going up significantly until we see some improvement in the market.

And as far as G&A goes, we're working hard to cut G&A as we speak. With the credit crisis, we've made a decision that we need to cut overhead more than what we have in the past, and you should over the next few quarters see the G&A number come down.

Stephen Kim - Alpine

As a ratio, right?

Larry W. Seay

Yes. You know, now whether we can cut it the same percentage as revenues fall it remains to be seen, but our goal is to bring G&A down significant over the next few quarters.

Operator

Your next question comes from Nishu Sood - Deutsche Bank.

Nishu Sood - Deutsche Bank

During the quarter, despite your spec count coming down, your cash flows increased so I just wanted to try to get some of the dynamics behind generating the cash flow this quarter. Did your specs get younger, so to speak, or did deferred development, you know, things like that?

Steven J. Hilton

I think it's a combination of things. I mean, less development, less lots, getting rid of or selling more completed homes and having cancellations of homes that were earlier in the construction phase, which increased the total spec number but didn't necessarily increase the cash expenditures. It's just a variety of things. I don't think we can pin it on any one item.

Nishu Sood - Deutsche Bank

And just looking at some of the regional stuff, the volumes in Arizona were up on a year-over-year basis, but you took a lot of impairments there. Was this larger kind of promotional activity or was this detached and single-family, you know, were the sales completely different in the two different markets?

Steven J. Hilton

I think we were very aggressive with our marketing this last quarter. We changed up our marketing strategy a little bit. We did a lot of DPA, the down payment assistance. We were aggressive about moving some of our attached homes. We took some pretty big impairments to get those off the books and get cash flow. It certainly wasn't anything from the market here. It was more what we did internally.

Nishu Sood - Deutsche Bank

And were sales weaker in Arizona in September as well?

Steven J. Hilton

Yes.

Operator

Your next question comes from Joel Locker - FBN Securities.

Joel Locker - FBN Securities

I just was wondering on the lot deposits. You have $69 million, obviously, on the balance sheet. What additional letters of credit and pre-acquisition costs do you have against the 11,600 auction lots?

Larry W. Seay

On the letters of credit, I don't have the precise number, but it's somewhere in that $10 to $15 million range now. We only have about $30 plus million of letters of credit, and some of those relate to other kinds of matters.

As far as the pre-acquisition costs, I don't have a number. We have several projects where we have incurred pre-acquisition zoning, legal, some development work. I just don't have a number for you today, Joel.

Joel Locker - FBN Securities

Is it larger than the option number or the LOC of $10 or $15 million additional?

Larry W. Seay

It's certainly more than a few million dollars. I would say it's up into several tens of millions of dollars. So it's, you know, $20, $30, $40 million. I don't really have the precise number.

Joel Locker - FBN Securities

And the other thing, on the $111 million settlement from Hancock, I believe, is there any time table or actually what percent do you think you may actually recoup from that?

Steven J. Hilton

It wasn't a settlement, it was a judgment that we received. I'm not claiming that we're going to collect $111 million, and we can't even project what we're going to collect.

Joel Locker - FBN Securities

When would the final ruling be on that? Would it be a few months down the road?

Steven J. Hilton

Well, he filed personal bankruptcy last week, so it's going to go through the bankruptcy court and we're just going to have to go through all his assets and see what's available for us to collect. I'm sure he has other liabilities as well. But we don't want to give anybody the impression that we're going to collect $111 million because that's not going to be the case, but on the other hand, I can't tell you what we're going to collect.

Joel Locker - FBN Securities

And the last question, on the Florida orders, I guess those are down 74% year-over-year with flat communities. Was that more of a factor of the cancellations or just gross orders or both?

Steven J. Hilton

It's kind of all of the above. We're winding out of communities. In Orlando we have a very light lot position there. I think we own about 400 lots now, cancelled all the options. So we have a scattered number of lots left and traffic was off substantially this last quarter. So I think it's a combination of what we have for sale and the fact that there's not a lot of buyers.

Operator

Your next question comes from Carl Reichardt - Wachovia Capital Markets, LLC.

Carl Reichardt - Wachovia Capital Markets, LLC

Steve, I'm curious. Many builders have been talking about foreclosures and competition with new, but do you have any evidence, data support for who's actually purchasing these foreclosures? Because I think there's a difference between your customers buying them versus an investor pool out there buying them and not solving our vacancy issues. So can you give me some more color on that or sense? I don't understand why a comparable product of yours wouldn't be more attractive to a core customer if it's similarly located at a similar price, with a twoyear warranty or whatever.

Steven J. Hilton

You know, I wish I could answer that for you, but I just have this: the feedback I'm getting from the field is people think when they're talking to prospects that prospects, for some reason in their mind, think because it says foreclosure on it it's a better deal. I still think we're competitively priced with a lot of the foreclosures.

There are some investors buying them. As to what degree, I don't know. But I'm hearing about private investors going out and buying multiple foreclosed homes and renting them.

But that's a good question. I'm sorry. I just don't have an answer.

Carl Reichardt - Wachovia Capital Markets, LLC

And then, second, I'm curious. Proposition 201's on the ballot in Arizona. That's a big state for you. If passed, our read of it is some really significant negatives for the homebuilding industry if it passes. Maybe you can outline what one or two of those might be and what your sense is as to whether or not it's got a shot or not. It's the last thing the industry needs, obviously.

Steven J. Hilton

Well, number one, I don't think it's going to pass but, again, you never know. But the work that we've done tells us that people are not in support of it and it shouldn't pass. But there's a lot of things in there regarding a buyer's right to rescind. They have up to 100 days. You have to give them their money back. A lot of issues with regard to litigation; you can't mediate, you have to litigate. You can't collect attorney's fees if a builder litigates with a customer and the builder wins, the builder can't collect attorney's fees. There's just a lot of things in there that are real negative for our industry.

This was created as a blackmail tactic from unions because we wouldn't help them unionize some of our subcontractors. So hopefully it won't pass and we'll put it behind us.

Operator

Your next question comes from James Wilson - JMP Securities.

James Wilson - JMP Securities

I was wondering, as you mentioned maybe a market in a little better condition in Sacramento, are you actually - I mean, I remember seeing that in the resale market. Are you seeing that at all in your sales pace relative to the obviously weak performance in other parts of California?

Steven J. Hilton

We just have very few communities left in Sacramento. We have a very, very small presence, so I don't think that we could be a bellwether for the market. But with that said, the few communities we have, we're not seeing a lot of positive traction. We are kind of winding up a few stores there. But from what we're hearing, the resale market has become much more back into balance with a three or four months' supply of resale homes on the market.

James Wilson - JMP Securities

And then I know - and it makes sense - you're not being very aggressive with land buys and holding onto cash, trying to generate cash, but I know you've been looking for deals out there. Could you kind of describe the environment? Does the pricing look attractive enough or is that a little hard to tell yet? Can you get your hands on any land deals from the banks?

Steven J. Hilton

We bought a few small deals of lots, similar deals, lots for less than $30,000 apiece. We're looking for smaller communities of 50 to 100 lots so we can get in and out quickly and make money even at today's low housing prices.

We are seeing an acceleration of opportunities. We're seeing some pretty interesting deals come to the market here, particularly recently, the last couple of months, and expect, as we get closer to the end of the year, those opportunities are going to accelerate and on into 2009.

So we have a very light land position and we are going to generate cash from the liquidation of the lots on our balance sheet and from specs, but we're going to be cautious about reinvesting in those. But as we see opportunities going into next year, we will pursue some of those selectively. It'll help us get back to profitability.

Operator

(Operator Instructions) Your next question comes from Nicole Pecoulas - Babson Capital Management, LLC.

Nicole Pecoulas - Babson Capital Management, LLC

With respect to Texas, in the past you've focused on that market because it's held up pretty well. Now that there's been some weakness there, any change in sort of your regional strategy of developing more in California or things like that?

Steven J. Hilton

You know, our strategy always has been to be in about a dozen markets in six Sunbelt states and we expect to continue with that strategy. Texas became a bigger part of our business only because those other markets were more effective and sales declined much more rapidly there than they did in Texas. I think over time things will balance out with approximately a quarter or a third of our business in California, a third of it in the Arizona-Nevada area, and then a third of it or so in Texas.

So I think that's just going to rebalance over time, but at this point we're not changing our strategy.

Nicole Pecoulas - Babson Capital Management, LLC

And then one quick question on Slide 15. The bank line availability of $338, the note says it includes cash so does that mean you actual availability on the revolver is the $338 less the $119 in cash or $219 actually?

Larry W. Seay

Yes, well the $119 is - the cash is part of the borrowing base. So if [break in audio] spent the cash on the non-borrowing base item, yes, your borrowing base would go down by the amount of cash you spent. If you bought borrowing base assets, the borrowing base would go up by the percentage of advance rate on the asset you bought.

We footnote that because it's not correct to say that it's completely excluded or completely included. But yes, the number does include cash, but if you spent the cash and bought borrowing base assets, the borrowing base would go up and your availability would not go down dollar for dollar. It might go down by $0.30 on the dollar or $0.20 on the dollar, if you see what I'm saying.

Operator

Would you like to take one more question?

Steven J. Hilton

Sure.

Brent Anderson

I think, yes, we have one more, Operator?

Operator

Certainly.

Brent Anderson

We'll take one last one and then we'll wrap it up.

Operator

Certainly. Your final question comes from the line of Joshua Pollard - Goldman Sachs.

Joshua Pollard - Goldman Sachs

The question is around your tax refund. You're saying you expect $80 million in the first half of '09. You had previously said you were expecting $40 to $60 million. What's changed over that time?

Larry W. Seay

Well, we've been more successful in triggering tax losses on previously impaired property, so at the end of the quarter we have $60 million in tax asset receivable and another $30 million we hope, or so, that will be triggered. We said $80 million to be a bit conservative because we may not completely be able to trigger that last $30. So we're in kind of that $80 to $90 range and we've kind of said the lower end of the range.

Joshua Pollard - Goldman Sachs

Okay, so there's $30 million to be triggered in the fourth quarter potentially, leaving you from $60 to somewhere in the $80 - $90 range for the first half of '09. Is that correct?

Larry W. Seay

Exactly. And we've just been real aggressive in trying to sell projects that have large impairments or in some cases terminating partnership investments or selling a piece of property here or there. So it's been a full court press to trigger as much as possible.

Joshua Pollard - Goldman Sachs

My second question is on your absorption levels. You guys changed your estimates there. What are they now and what were they and are they higher in Texas than they are for the rest of your operations?

Larry W. Seay

Are you saying sales per community? Is that what you're getting at?

Joshua Pollard - Goldman Sachs

Yes, your sales per community estimates that you guys changed for your write downs.

Larry W. Seay

Well, unfortunately we're selling in the third quarter less than 2 sales per community per month. And at that kind of sales level we can still make a profit, but it gets to be fairly thin because of overhead at the divisional level. So it's that kind of absorption slowing from where we were in July and August to what we've seen in September and October that triggers further impairments. Although in Texas we're still making relatively good money in most of our subdivisions and still have not to date had any real impairments in Texas. All the impairments have been in the other states.

Joshua Pollard - Goldman Sachs

So when you think about Texas, do you have higher absorption rates in Texas or are you just able to make more money at similar absorption rates to the rest of the company?

Steven J. Hilton

No, we don't have higher absorption rates in Texas, but it's a lower overhead model because the communities in Texas generally only have one model home per community and the business is a little bit more fragmented there, so it's less overhead intensive. But the absorptions aren't higher in that market.

Larry W. Seay

But pricing, also, has held up better in Texas, and that's the other thing that continues to make us profitable in Texas.

Steven J. Hilton

Yes, that's really the key difference, it's the pricing.

Joshua Pollard - Goldman Sachs

Last question, close to $120 million in cash, what do you guys have that invested in now? Where is it?

Larry W. Seay

It's sitting in Treasury or Treasury agency backed securities. It's got the full faith and credit of the government behind it in mutual funds or it's sitting, in some cases, in some very large banks that are in our credit facility. But most of it's in Treasury money market type funds.

Steven J. Hilton

Thank you very much. That's going to wrap up our call for this quarter and we'll look forward to talking to you again after the first of the year. Thank you very much.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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Source: Meritage Homes Corporation Q3 2008 (Qtr End 9/30/08) Earnings Call Transcript
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