Meritage Homes Corporation Q4 2009 Earnings Call Transcript

Transcripts

Meritage Homes Corporation (NYSE:MTH) Q4 2009 Earnings Call Transcript January 27, 2010 9:00 AM ET

Executives

Brent Anderson – VP, IR
Steve Hilton – Chairman and CEO
Larry Seay – EVP and CFO

Analysts

Joshua Pollard – Goldman Sachs
Ivy Zelman – Zelman & Associates
Nishu Sood – Deutsche Bank
David Goldberg – UBS
Josh Levin – Citigroup
Joel Locker – FBN Securities
Timothy Jones – Wasserman & Associates
Carl Reichardt – Wells Fargo Securities
Jay McCanless – FTN Equity Capital
Susan Berliner – J.P. Morgan
Dan Oppenheim – Credit Suisse

Operator

Greetings and welcome to the Meritage Homes fourth quarter 2009 conference call. (Operator instructions) It is now my pleasure to introduce your host, Mr. Brent Anderson, VP of Investor Relations. Thank you, Mr. Anderson, you may begin.

Brent Anderson

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

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

Please refer to slide two of our presentation. Our statements during this call and the accompanying materials contain projections and forward-looking statements, which are the current opinions of management and subject to change. We undertake no obligation to update these projections or opinions. Additionally, our actual results may be materially different than our expectations due to various risk factors.

For information regarding these risk factors, please see our press release and most recent filings with the Securities and Exchange Commission, specifically our 2008 Annual Report on Form 10-K and our most recent quarterly report on Form 10-Q.

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

With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; and Larry Seay, our Executive VP and CFO. We expect our call to run about an hour this morning, and a replay of the call should be available on our website within an hour after we conclude the call. It will remain active for about 30 days.

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

Steve Hilton

Thank you, Brent. I would like to welcome everyone to our call today. I will begin with an overview of our fourth quarter and full year highlights shown on slide four.

We reported net profit of $43 million for the fourth quarter of $1.35 earnings per diluted share. We were profitable in the quarter on a pre-tax basis, adjusting for impairments and about $12 million in accruals for certain items that increased our cost of sales and G&A expenses, which I will discuss later in more detail.

We sold several non-strategic properties near the end of the year that accounted for $14 million of our impairments, but also allowed us to harvest the tax benefits on those properties and increase our tax refund. Our average margin on the 1202 homes we closed this quarter continued its upward trend, reflecting the cost reductions we have achieved to date, reduced incentives and higher margins on newer communities both on lower cost lots.

Despite a general slowing in new home sales near year end, we sold 24% more homes than our prior year with 14% fewer communities offset by a 50% increase in sales per community. And we're gearing up for the 2010 spring selling season. We generated positive cash flow from operations of $27 million in the fourth quarter, after spending approximately $82 million of cash to purchase roughly 2,600 lots during the quarter.

For the full year, we generated $184 million cash flow from operations, and ended the year with more than $390 million in cash and securities, plus another $93 million coming soon in tax refunds. Taken together our cash and tax receivable equate to approximately $15 per share, roughly equal to our book value and nearly three quarters of our market cap.

Our net debt-to-capital dropped to 31%, the lowest it has been in many years. And we contracted for approximately thousand new lots with total purchase prices of $45 million in the fourth quarter, including what I believe were some exceptional buys. That brought our total to more than 4,000 lots put under contract in 2009 for a total purchase price of $150 million, which is roughly equivalent to the number of homes we closed during the year.

Slide five. We were generally pleased with how we ended the year considering that was a very difficult year for home-builders and the economy as a whole. In addition to our financial results, we undertook a number of strategic initiatives last year to improve virtually every area of the company and further enhance our competitiveness.

Based on what we have already accomplished in our ongoing plans, I believe we have not only positioned the company for return to profitability in 2010, but it is also permanently improved our competitiveness. We have significantly reduced our construction cost and overhead, and expect to realize further gains through a managed process of continuous improvement in our operations. We have built a robust market research function that we believe gives us a strategic advantage, underwriting lot acquisitions and pricing our homes for a better understanding of the competitive landscape for both resale and new homes, as well as homebuyer trends in our markets.

We have introduced our Simply Smart Series of new home designs to target the first time and first move up market, compete successfully with both new and existing homes, and offer Meritage quality at very affordable prices. We have expanded our green building initiative to become the first public builder to meet Energy Star qualifications in every home we start beginning January 1, 2010. And we have most recently have rolled out our 99-day guaranteed delivery program in selected communities, offering your home, your way in 99 days guaranteed.

This innovative program allows our homebuyers to enjoy all the benefits of purchasing a new built-to-order home over a used home without the long construction period previously associated with building a new home.

Slide six, we reported a net profit for the fourth quarter of 2009 of $43 million or $1.35 per diluted share, including $39 million of pre-tax real estate related impairments and a net tax benefit of $90 million. The net tax benefit was the result of Congress passing a legislation that allowed net operating losses to be carried back up to 5 years to offset prior year’s taxable income. As a result of our NOL carry back, we expect to collect a $93 million tax refund in early 2010.

By comparison, our fourth quarter 2008 net loss was $79 million or $2.58 per diluted share, which included $110 million of pre-tax charges due to real estate related and other impairments, and a $30 million net tax benefit. Our loss before income taxes for the fourth quarter of 2009 was $47 million compared to $109 million pre-tax loss in 2008. I will explain several items that reduced our 2009 net operating profit.

Slide seven, our real estate impairments for the fourth quarter of 2009 totaled $39 million, consisting of $25 million related to homes and lots owned or optioned and $14 million related to land sales, which was far less than the $109 million of total impairments in the fourth quarter of 2008.

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

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

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

Our home closing gross profit was reduced by $25 million of our total $39 million impairments, and by an additional $3 million charge to increase our accrual for estimated warranty expenses related to the Chinese drywall at Fort Myers, Florida. We increased our reserve for remediation cost to a total of $6 million, which we believe should fully reserve our liability related to these homes.

Excluding the impairments to the Chinese drywall charge, our gross margins on home closings climbed to 16.0% in the fourth quarter of 2009 compared to 14.3% in the prior year.

Slide nine, we have been diligent in controlling our overhead costs as our sales and revenue have declined with the goal of setting our general and administrative expenses back down to a more normalized 5% of revenue.

Our fourth quarter 2009 general and administrative expenses of $21 million, included $9 million of charges to make comparisons to prior quarters difficult. $5 million relates to legal accruals for ongoing litigation, $3 million was for discretionary performance award approved by the board at year end, and a million was for lease abandonment. Excluding those items, those three items, our general and administrative expenses were 23% lower this past quarter than there were a year ago and represented 4.2% of fourth quarter 2009 total revenue compared to 3.9% in 2008.

We were profitable on a pre-tax basis before impairments. These three items included in G&A expenses and additional accrual for Chinese drywall claims.

Slide ten, our fourth quarter 2009 net orders increased by 24% year-over-year to 621 sales compared to 500 in 2008. The increase was driven primarily by 50% more sales in Texas, and 19% more in California over the prior year. Additionally, our fourth quarter cancellation rates fell to 30% in 2009 from 56% in 2008. During 2009, continued low mortgage rates and historically high affordability drew buyers into the market, and the federal tax credit provided an additional incentive through the third quarter of 2009.

The tax credit didn’t benefit sales in the fourth quarter due to the fact that homes had closed by November 30th -- had to close by November 30th to qualify for the credit. The program was expanded and extended at the eleventh hour to include existing homes and apply to contracts signed by April 30th and closed by June 30, 2010. We believe the extension reduced the sense of urgency for buyers to purchase a home in the latter portion of the quarter.

We are optimistic that the extended tax credit incentive will benefit our 2010 spring selling season, and we plan to build more specs in some communities in order to capture sales before the April 30th deadline. Our average sales price on the fourth quarter orders increased to 261,000 in 2009 from 224,000 in 2008. This was mainly due to changes in our mix of sales. We sold more homes in communities to command higher prices, because they are in prime locations. Many of these are still considered entry-level and first move up homes despite their higher price points.

A perfect example is a new community we have in Gilbert, Arizona, named Quail Springs. Homes in that community sold at an average price of 273,000 compared to sales of the same plans from our Simply Smart Series in the community 20 minutes further south, which sold at an average price of 166,000 during the quarter. Additionally, a greater percentage of our total sales in the quarter were in Texas. We have maintained prices in many existing communities, and have not opened as many communities with our lower price series of homes.

In the near term, due to variances in the mix of sales across our markets, we expect the ASPs will range between 225,000 and 250,000 even as we continue to focus on the first time and first move up buyers.

Slide 11, our average sales per community increased by approximately 15% in the fourth quarter of 2009 to 3.9 from 2.6 in the same period last year. We were operating with 14% fewer communities, fewer active communities at December 31, 2009. So, this is a very significant metric that we are focused on improving in order to keep our total sales up.

We expect our sales pace to increase as we replace older communities with new communities that were open on lots we purchased in the last year to 18 months, and as our markets continue to stabilize and begin to improve.

We just announced our 99-day guaranteed delivery program, which is available on select committees across the country. We believe it is this innovative change for a built-to-order homebuilder, and we expect to be leading the industry in this direction. The guarantee is offered to all buyers in these selected communities that gives them an advantage over owning a new home without the long construction times historically associated with a built-to-order home that is tailored specifically to their preferences.

I will now turn the call over to Larry Seay, our Chief Financial Officer, and I will end our prepared remarks with a few closing thoughts before Q&A. Larry.

Larry Seay

Thank you, Steve. I will pick up on slide 12. Our fourth-quarter home closing revenue declined 28% year-over-year due to 19% fewer homes closed and fewer communities opened in 2009, coupled with a 10% lower average closing price of approximately 22,3300 [ph] in the fourth quarter of 2009 compared to approximately 260,000 in the fourth quarter of 2008.

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

Slide 13, we reported a net loss for the full year of 2009 of 66 million or $2.12 per share compared to a net loss of $292 million or $9.95 per share in 2008. The 2009 net loss included the following items shown on slide 13 in addition to the fourth-quarter charges we discussed earlier, $129 million in pre-tax real estate related impairment charges, down from $216 million in 2008, a $3 million write-off of capitalized relating to the reduction and subsequent termination of our credit facility during the year, which we no longer need to maintain due to our large cash balances, and it will save us approximately $2 million in the future doing this.

A $9 million gain on extinguishment of $24 million of debt in exchange for equity, and a net tax benefit of $88 million. In addition to impairments, our 2008 net loss, and this is 2008, a 10 million benefit from a successful legal settlement in the second quarter, and a 16 million net tax expense after taking the 106 million valuation allowance to fully reserve our deferred tax assets in the third quarter of 2008.

In addition to the $93 million tax refund, we expect to receive early in 2010, our cumulative deferred tax assets also to total 93 million or $2.91 per share as of December 31, 2009; $65 million of that is federal and $28 million state federal taxes. Those assets are fully reserved, and therefore not reflected on the balance sheet, but are available to offset future income taxes.

Slide 14. We generated $184 million positive cash flow from operations for the full year 2009, even after spending a total of $182 million for lot purchases during the year. We ended the year with a total of $391 million in cash and cash equivalents, including $16 million of restricted cash and $126 million in investments, all of which are in very conservative treasuries or treasury-backed securities or deposits in money center banks.

In total, this was an increase of $185 million over total cash balances at the end of 2008. This increase cash and reduction of debt from our equity swaps reduced our net debt to capital ratio to its lowest in many years, 31% at December 31, 2009 compared to 45% at December 31, 2008.

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

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

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

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

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

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

And now I will turn it back over to Steve.

Steve Hilton

Thank you Larry. In summary, we have made excellent progress towards achieving our goal of returning to profitability in 2010. And that will be profitable for the full year, anticipating our market stabilizes and improves. We believe that this achievable without broad appreciation of home prices due to improved margins and increased sales pace we have already seen in our newer communities.

Recapping our strategy that we have laid out for you, we are using extensive market research to support our acquisitions of lower priced lots, as well as product selection and pricing, which is enabling us to compete successfully with foreclosures and resale homes. We've also implemented continuous improvement principles, and are working with our suppliers and contractors to streamline our processes and improve quality at every stage of construction, thereby reducing both their cost and ours.

These first two initiatives are enabling us to reduce our cost structure, compete effectively on price, while improving our margins, and are the foundation of what we refer to as Meritage forward. We have increased our focus on the entry-level market and the first-time homebuyers by offering lower-priced homes starting more spec homes. We are marketing an all-inclusive monthly payment to appeal to renters, who want to own their first homes.

These are both embodied in our new Simply Smart Series of homes, which we announced last week, and have referred to several times in our presentation today. We are decreasing our cycle times in order to deliver more homes without needing to invest additional capital, which is helping us to better compete with foreclosures and resales.

As a result, we have just announced our 99-day delivery guarantee for new Meritage homes on Monday of this week. And we have made a corporate commitment to build green. We are the first large national homebuilder to be 100% Energy Star qualified in every home we build starting January 1, 2010, which we announced on January 12th this year.

You could find those press releases and learn more about each of them at meritagehomes.com. I have never been more confident in our people and our abilities than I am today, and I believe our future is bright. While we face a number of uncertainties, including the sustainability of an economic recovery, high unemployment, and the risk of inflation and potential fiscal and public policy actions by our government, we have also seen many signs of stabilization and even improvement in certain of our markets that makes me optimistic.

I believe the potential for positive outcome significantly outweighs the negatives at this point, and eagerly anticipate the future successes we will achieve in 2010.

Thank you very much for being on the call today, and we will now open it up for questions. And the operator will remind you of the instructions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Mr. Joshua Pollard from Goldman Sachs. Please proceed with the question.

Joshua Pollard - Goldman Sachs

Good morning. I quickly read the math on the margins for your new versus old communities, and I get to number around, slightly around 20% for your new communities, somewhere in the 14% to 15% range for old communities. First quick question is, are those the same numbers that you all get, and do you expect further improvement on your older communities, and the margins you get on your older communities to support you guys as you attempt to be profitable in 2010?

Steve Hilton

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

Larry Seay

Yes.

Steve Hilton

Certainly, our new communities, where we have changed a lot of product out, we are still bringing cost down. We're pulling back some of the incentives. So, we expect the margins in the older communities to increase as well as certainly our newer communities are achieving a significantly higher gross margin.

Joshua Pollard - Goldman Sachs

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

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

Steve Hilton

I just don't think that is a true assumption. I mean I do know which of our competitors are saying that, but you know in California and Arizona, Florida and Colorado it is very hard to find an option that cancels [ph]. Most of the land we are buying today is distressed land from banks or like kind parties and they want cash. And there are no options available from them.

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

Larry Seay

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

Steve Hilton

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

Joshua Pollard - Goldman Sachs

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

Steve Hilton

Well, the first part of your question, we will have to move on to somebody else Josh. The first part of your question, I would say the difference could be as 5% or 6% in margin. You know on a $250,000 home it could be 12,000 to 15,000 odd difference in lot price or more.

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

Joshua Pollard - Goldman Sachs

Thank you very much.

Steve Hilton

Thank you.

Operator

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

Ivy Zelman - Zelman & Associates

Thank you. Good morning guys.

Steve Hilton

Good morning.

Ivy Zelman - Zelman & Associates

I like to ask your thoughts just in general in two areas, one would be your future growth incorporating any strategy that might incorporate acquisitions, and then secondly just talk about the diminishing supply of finished lots in the market. You have alluded to in recent press, Steve that you guys aren’t going to chase land, and maybe some of the prices are getting a little stretched. So, recognizing that you are going to be prudent there, can you help us mitigate the concern that you might not be able to find enough lots for, I guess, growth going forward, and then if I may follow up, but those are the two areas I would love for your thoughts.

Steve Hilton

I mean regarding acquisitions, our eyes are always open, and we are certainly open to seeing what is out there, although I don't expect there is a lot of opportunities, certainly not what we saw in the 90s in the early part of the decade. You know, we needed to make acquisitions in the early part of our growth strategy story for Meritage, because we needed to move into new markets.

New markets are not as important to us today. We are really more focused on growing out the markets that we are in. So, you know acquisitions will be made in accordance with that strategy. As far as you know, finding lots and chasing deals, I think there are still many opportunities, plenty of opportunities. Prices have gone up certainly in some markets more than others, but I still think there is opportunities to buy finished lots.

I think the next stage will be to buy partially finished lots, and lots may be that are mapped, and we can get a very solid read on what the improvement costs are going to be, while we are taking very little development risk. Certainly, we are not in a position to take any entitlement risk whatsoever. And you know, I think the early bird got the worm and some of the best deals certainly are gone, but I think there is going to be plenty of opportunities to buy lots, throughout 2010 and into 2011.

Ivy Zelman - Zelman & Associates

Thanks Steve. Just a follow up on the acquisitions, you mentioned historically you were acquisitive as it made sense to expand your footprint, when you think about the Greenfield approach going forward, given management structure and ability to grow, if you were looking at a bull case scenario where housing would just snap back, how fast can the company grow top line in units without having risk that you were growing too quickly without the right, I guess, measures and foundations in place for prudent growth. So, is it a 15%, 20% type number or can you do something much more than that.

Steve Hilton

I think we could grow at 15% or 20% clip with not a lot of appreciation in the market, just by buying some distressed lots in our existing markets, and certainly if the market tailwinds are going in our favor, we can grow faster. But, you know a lot of the growth can just come from increase in the absorption level in our communities. Even though our absorption level increased 50% in the fourth quarter of 2009 over the fourth quarter of 2008, there are still by historical standards very low.

And if we can just get more sales out of reach of our communities with a better market, plus adding on newer better performing communities to that, not necessarily increase in the community count that dramatically, the growth numbers can be pretty significant. You know, I think we can grow this business significantly, almost double the size of it, you know without increasing our capital base. I think we have a lot of excess capacity.

Ivy Zelman - Zelman & Associates

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

Steve Hilton

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

Ivy Zelman - Zelman & Associates

Great. Thanks guys. I appreciate it.

Steve Hilton

Thank you Ivy.

Operator

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

Nishu Sood - Deutsche Bank

Thank you. I wanted to follow up on Joshua’s question earlier, Steve this is something we have talked about before. You folks have obviously been very proactive in responding to the downturn, and some of your new strategic initiatives Simply Smart and the 99 days are reflective of that, but it also means that in two of the kind of you know, hallmarks of what Meritage’s strategy have been traditionally, your option versus your own and your mix of products being skewed more towards a move up that you continue to move further away from that.

And so I wanted to kind of revisit that subject. Obviously that's what the times demand now, and that's what you have decided. In terms of the length of time of this detour from you know, what Meritage’s strategy traditionally have been. Is this just a matter of when we are in the kind of bottom of the cycle here that this is the appropriate strategy or do you see a longer-term shift away from those kind of historic operating principles?

Steve Hilton

I think I see a longer-term shift because I think we are may be a little out of balance, and I think being two thirds move up and the balance being mixed between luxury, active adult and entry-level was probably not the best strategy going into this cyclical downturn that we've had, and I think to better prepare ourselves, you know for the next downturn there will be one you know, down the road someday. We want to be more entry-level, because I think that part of the market performs better in a downturn, and certainly the financing that's going to be available for buyers going forward is more skewed towards the entry-level buyer and you know, that's part of our strategy why we want to be there, with the highest level of affordability we've seen in 40 years, and a lot of entry-level buyers are coming into the market today that you know, couldn't buy a home you know, several years back. So, I think it's a permanent shift.

Nishu Sood - Deutsche Bank

Got it and what about on the optioned versus owned?

Steve Hilton

You know, you mean optioning lots?

Nishu Sood - Deutsche Bank

Yes.

Steve Hilton

Well, I think -- you know, I think I talked about that before. You know, there is no better time to buy a home than today, and there is no better time to buy a lot then there is today, and if we are going to buy distress lots, we are going to pay cash and certainly we'd like to do options like we did before, but in most markets outside Texas, they just don't exist and the ones that are out there are few and far between, and they don't make sense. So, until bank financing comes back for land bankers or they are able to you know, leverage their investment there probably won't be a lot of land making available and we are going to have to pay cash. So, you know, that's really the way the world is.

Nishu Sood - Deutsche Bank

Great, and second question, I wanted to drill down, it's very helpful that you've given us some sense of the difference, margin difference, you know the 500 to 600 basis points between old communities and new communities. Now, imagine part of that is simply a function of accounting and that you don't typically tend to mark down land to the same level of gross margins that you would get if you bought a new piece of dearth [ph] in the market. I wanted to get a sense of how much of it might be accounting versus how much of it might be operational, in other words the ability to buy in better locations and to have a different kind of product type.

Steve Hilton

Well certainly, you can't impair a community to a normal margin, equate to what you would buy lots for new community to. I mean, most communities are being impaired to a breakeven type level. So, you know, some communities weren’t impaired, some communities we were buying lots of rolling options. Certainly in Texas, we are able to go back and, you know, redo the option agreement, get a better price from the land developer, land seller. You know, lower our direct cost for construction, you know, fine tune our pricing, you know, and some of those margins will be better, but some of our worst performing communities, you know, we are operating near breakeven. So, you know, no two communities are the same. The margins are across the board, but you know, on the average new communities are you know, 500 to 600 points basis points different than old communities. Larry, you want to add to that.

Larry Seay

Yes, I guess that the new communities are what we would call near normal margins and, you know, we set our gross margins in the past after construction overhead, which is included in gross margin as, you know, running 19%, 20% or so and you know, the way the impairments work, you know, if we are say at 12% in that contribution and say at 15%, 14% or 15% gross margin. That lines up being a near breakeven community after overhead.

So, you know, we essentially impaired to that level. So that's why the older communities that are kind of the worst performing communities, Steve says they kind of get to that level of breakeven, and of course there's a lot of variability as Steve said really into each of the older communities, because each project is different and the margins are different, and there is quite a bit of spread, but on average that's why they wind up being, you know, that 500 or 600 basis point differential between a new, brand-new normal community.

Nishu Sood - Deutsche Bank

Okay, thanks a lot.

Steve Hilton

Thank you.

Operator

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

David Goldberg - UBS

Thanks. Good morning guys.

Steve Hilton

Good morning.

David Goldberg - UBS

First question is actually about, Steve your comments about building some more specs in more communities ahead of the tax credit. I'm just -- I'm wondering about if you could give us just some more color around that. You know, what kind of numbers that would look like in terms of, you know, potential increase in inventory. How much working capital you need to support that and are you worried at all that the builders are going to kind of overshoot demand here, because everyone seems – a number of builders seem to be taking on this kind of strategy of building more specs before the credit.

Steve Hilton

Well, I don't think we are coming up with an idea that is novel, you know, exclusive to us. Certainly other builders are doing the same thing, but certainly we learned you know, last year that buyers are procrastinators, and a lot of them don't come out to make the decision to buy a home until the last minute. So, we expect, you know, late February, March, April you know, we are going to see a significant pickup in demand and we want to be prepared for it. On the other hand you know, we are going to be prudent and you know, our spec count really is, you know, today I think what do we have about 500 specs, Larry?

Larry Seay

514, it's only 3.35 specs per community. We are just still on the very low end. Yeah.

Steve Hilton

So, maybe that'll increase from you know, 3-1/2 to 5-1/2, but I think we got plenty of cash and capital available to do that. I don't think it's going to have a significant impact on our position, you know, whatsoever we are building these houses very quickly now. I was in Las Vegas yesterday and our average build time there is 40 days. So, we're almost able to build a home without even you know, paying in for it until we close it. So, you know, we are going to be prudent. We are not going to overbuild, and I don't think it's going to be material to our balance sheet.

David Goldberg - UBS

Great, and then just my follow-up question is about the 99 day, you know, from sale to close program, and I'm wondering if you could just give us you know, you just mentioned Vegas your build cycle now is 40 days and what's the breakout between the timing for you know, between sale and the beginning of the construction versus the actual cycle time on average, and kind of with that, I'm wondering how much of this is really you know, process improvements and cycle time improvements on your part versus maybe shifting product down to more entry-level, and less move up and so your cycle times are just you know, coming down now because you're building smart homes, and I guess, the final part of the question, not to throw three in one, but where do you think your 99 day, you know, sale to close is relative to peers, and how much of an advantage is it in the marketplace?

Steve Hilton

Well, we think it's a big advantage, and we think it is an important marketing edge or you know, we wouldn't be doing it. And I think, certainly we're able to build houses quickly as we move down to more entry-level homes, but I think most of it comes from just generally process improvement. Even the bigger homes that we are building, we're building a lot quicker than we ever have before, and I think a key to it also is the start time. You know, we're really targeting from the point the person comes in and signs a contract to when we actually put their home into the ground to be about 21 days, which would be about half of what it has been before and then to build a home in about 60 calendar days.

So, that would add up to about 81 days and the balance, you know, 18 days or so for you know, bad weather or delays by the city, you know, or other kind of issues we could experience to give ourselves a little bit of cushion there, but I think it's a paradigm shift for us. I think we're going to -- we're doing it for obvious reasons, number one, you know, to be able to capture more market share from people that are considering resale homes, just don't want to wait, you know, six months for a home, they want to get in quicker.

Certainly advantageous for them to buy new versus used and you know, to make our capital go further, and, you know, land banking isn't going to be prevalent as I mentioned before. We were able to extend our balance sheet, you know, over the last decade by using land banking. It's not going to be available. So, we've got to find other ways to make our money go further, and this is certainly one of them.

David Goldberg - UBS

Thank you very much.

Steve Hilton

Sure, thank you.

Operator

Thank you. As a reminder due to time restraints, please keep your questions to one follow-up. Our next question comes from Josh Levin from Citigroup. Please proceed with your questions.

Josh Levin - Citigroup

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

Steve Hilton

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

Josh Levin - Citigroup

Okay.

Steve Hilton

I mean, my quick answer would be probably not.

Josh Levin - Citigroup

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

Steve Hilton

I think so, yes.

Josh Levin - Citigroup

Okay.

Larry Seay

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

Josh Levin - Citigroup

So, 16…

Steve Hilton

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

Josh Levin - Citigroup

Fair enough. Thank you very much.

Steve Hilton

Okay, thank you.

Operator

Thank you. Our next question comes from Joel Locker from FBN Securities. Please proceed with your questions.

Joel Locker - FBN Securities

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

Steve Hilton

Larry?

Larry Seay

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

Joel Locker - FBN Securities

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

Larry Seay

Yes, you know, in the current year or 2009, excuse me, last year, we spent in cash about $180 million buying lots and that was you know, we would think it would wind up being the same or a bit more as we go forward and reload. You have to remember, now we are at the point where we own 75% to 80% of our lots. We're kind of stabilized there. We only had 10% of lots under lot options, and 10% of lots under developer options.

So, there is not a whole lot of options to continue to wind down, and we will continue to do options in Texas. So, you know, our own lot count could creep up to 80% to 85%, maybe as close to 90% and that would require some capital and require us to pay -- maybe to increase that 180 number a bit but you know, 200,000 -- $200 million --

Steve Hilton

$250 I'd say Larry, I mean just you know, we're trying to grow a little bit, and it's going to depend on where opportunities are available to us and, you know, I'd rather spend a little more than a little bit less if the opportunities present themselves. So, I think you know, $250 million, $200 million to $250 million is probably the range.

Joel Locker - FBN Securities

All right. Thanks a lot guys.

Operator

Thank you. Our next question comes from Timothy Jones from Wasserman & Associates. Please proceed with your question.