Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Brent Anderson - VP, IR

Steve Hilton - Chairman and CEO

Larry Seay - EVP and CFO

Analysts

Joshua Pollard - Goldman Sachs

Steven East - Ticonderoga Securities

Nishu Sood - Deutsche Bank

Carl Reichardt - Wells Fargo

Dan Oppenheim - Credit Suisse

Alan Ratner - Zelman & Associates

Josh Levin - Citigroup

David Goldberg - UBS

Jade Rahmani - Keefe, Bruyette & Woods

Jim Wilson - JMP Securities

Ken Leon - Standard & Poor's

Meritage Homes Corporation (MTH) Q1 2010 Earnings Call Transcript April 29, 2010 10:30 AM ET

Operator

Greetings and welcome to the Meritage Homes first quarter 2010 earnings call. (Operator Instructions)

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

Brent Anderson

Good morning. I'd like to welcome everyone to the Meritage Homes first quarter 2010 earnings call and webcast. Our quarter ended March 31 and we issued our press release with the results for the quarter after the market closed 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 investors.meritagehomes.com or by selecting the Investors 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 the most recent filings with the Securities and Exchange Commission, specifically our 2009 Annual Report on Form 10-K.

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

With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; and Larry Seay, our Executive Vice President and CFO. We expect our call to run 45 to 50 minutes this morning, and a replay of this call should be available on our website within an hour or so after we conclude the call. It will remain active for 30 days.

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

Steve Hilton

Thank you, Brent. I'd like to welcome everyone to our call today. I'll begin with an overview of our first quarter 2010 operating highlights shown on slide four.

Our number one goal, as we've stated for the last couple of quarters, was to return to profitability in 2010. So we are pleased to report that we were profitable in the first quarter without a large tax benefit and without having to add back impairments to get there. After three long years of fighting to return to profitability, it feels good to say we're operating in the black for the first time since the housing downturn began.

As our first quarter results demonstrate, we've reduced our cost structure to a breakeven point of approximately 3,200 home closings, less than one-third of what we did in 2006. Accordingly, to the extent that we achieved closing volumes above that point or continuing to improve margins, greater profitability should follow.

Our profitability this quarter was largely driven by our improved margins on home closings. First quarter home closing gross margin improved to 18.9% in 2010 from 7.5% in 2009 or 19.2% versus 12% if we exclude impairments of $0.5 million this year and $10 million last year. We generated $38 million in gross profit on our home closing in the first quarter 2010, more than double of the $17 million of gross profit we reported last year.

We increased sales 8% year-over-year to 1,064 homes, which was 71% higher than the fourth quarter of 2009. Despite having a fewer open communities, we achieved 24% greater sales per community than in the first quarter of 2009. As a result, our ending backlog increased sequentially by 23% from the end of 2009.

These operating results highlight our successes in reducing cost. We design our homes and position the right product in the right communities. We opened 16 new communities in the first quarter of 2010, and we expect to open more than 20 within the next six months. We also contracted for approximately 1,600 lots in 21 communities, which we believe will lead to continued improvements in our sales pace and margins.

We reported net earnings of $3 million or $0.08 per diluted share for the first quarter of 2010 compared to a net loss of $18 million or a negative $0.60 per diluted share in the first quarter of 2009.

We had $10 million of pre-tax charges due to real estate impairments in the first quarter of 2009 and only about $0.5 million of impairments in 2010. Our first quarter 2010 results include a $2.4 million gain from a legal settlement, and our 2009 results include a $2.8 million gain on early extinguishment of debt.

Slide five. First quarter home closing gross margin improved significantly this quarter to 18.9% or 19.2% excluding a minor amount of impairments, as shown in the slide. On a comparable basis, we increased it from 12% in the first quarter of 2009 and 14.9% in the fourth quarter, surpassing even the first quarter of 2007 margin of 18.7%.

As we've discussed over the past year, we've been replacing older and lower-margin communities with newer and high-margin communities to drive this increased profitability. Our margins in homes closed in these new communities were more than 600 basis points higher this quarter than those we earned in our older communities with older home designs.

The new community that was opened on lower cost lots and was more value-oriented home designs since the beginning of 2009 accounted for 23% of our active selling communities and approximately 90% of our first quarter 2010 home closings and related revenue, nearly double the level of two quarters ago. We expect that approximately 35% to 40% of our closings will come from our newer communities by the end of this year. even though we expect our total community count to remain relatively flat as we replace older communities with newer ones.

Even in our older communities, we achieved average margins to clean impairments that were 400 basis points higher this quarter than they were a year ago. We've reduced incentives, redesigned homes and made operational improvements that have lowered our construction cost. We expect to make further gains as we implement continuous improvement practices via suppliers and contractors to increase our efficiencies and reduce both their costs and ours.

Slide six. We have contracted for more than 5,500 new lots since the beginning of 2009 and now control approximately 13,000 total lots, equivalent to a 3.4-year supply based on trailing 12 months closings. We own 78% of our total loss and control the other 22% under option contracts, most of which are in Texas.

A year ago at March 31, 2009, we controlled approximately 15,000 lots and owned 55% of those. We now own a larger percentage of our lots than we ever had before, because there are fewer opportunities for optioned lots today and the economics are much better to purchase lots from banks or distressed owners than to auction them through a third-party.

We have successfully transitioned from more than 90% optioned lots at our peak to nearly 80% owned currently and have already deployed the capital required to support this transition. Approximately 40% of those lots that we own as of March 31 this year, we put under contract within the last 15 months. Most of the prices are substantially lower than lots we've previously controlled, which is another indication of our potential to increase our future earnings.

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

Lary Seay

I'll pick it up on slide seven. Our first quarter home closings and closing revenue declined 13% year-over-year, primarily due to the fact that we had 12% fewer active communities at the end of the first quarter of this year than we had last March 31st.

However, we increased our community count during the quarter in all states, but Texas and Nevada. As we stated previously, we are actively working to re-grow our markets outside of Texas, but experienced significant reductions over the last couple of years.

Our average closing price was approximately $248,000 in the first quarters of both 2010 and 2009. More than 60% of our sales in Q1 were classified as entry level or first time move-up buyers, consistent with our mix for the past several quarters. But many of these communities are located in more desirable areas, which have kept our average sales price up in the recent quarters.

Our ending backlog at March 31, 2010, totaled 1,351 homes valued at $355 million, which was 24% greater than at the start of the first quarter. We converted 74% of our homes in beginning backlog in the closings during the first quarter of 2010. Assuming a similar conversion rate going forward, which we expect due to our shortened cycle times, we believe we can continue to grow revenue and show positive year-over-year increases in the next couple of quarters.

Slide eight. First quarter 2010 net orders increased by 8% year-over-year to 1,064 sales compared to 987 in 2009, led by gains of 113% in California, 39% in Arizona and increases of 58% in Colorado and 18% in Florida. Our first quarter cancellation rate fell to 18% in 2010 from 26% in 2009, as prices have stabilized and consumer confidence has risen.

Sales in Texas were 12% lower year-over-year, primarily due to 16% fewer actively selling communities. We are actively looking at opportunities to add new lot positions in our key markets, including Texas, to replace our older communities and grow our market share.

Approximately 40% of our closings were from specs during the first quarter, and we ended the quarter with approximately 600 total specs or four per community, which is a little higher than last year's 3.2, but within a desired range of three to five, as we stated last quarter.

We need to have a few specs either finished or in process in order to meet demand from those entry level or first time buyers who want a home ready for immediate moving. However, our faster build times are allowing us to operate with a relatively low level of specs compared to some other builders.

Our average sales price in first quarter orders was approximately $252,000 in 2010 compared to $235,000 in 2009. The increase was due to a mix of sales in Texas, Arizona and Florida where more sales came from communities with higher average prices, and a larger percentage of our sales were in California and Colorado which have higher average sales prices than the company average.

Our average sales per community increased to seven in the first quarter of 2010, 23% more from the same period last year and almost 80% higher from the fourth quarter of 2009. The increased sales pace was primarily related to new communities and our successful sales incentives, as Steve discussed, as well as somewhat improved selling conditions in many of our markets.

While the overall housing market has improved nominally, we believe our success has been primarily driven by these new communities and the appeal of our Simply Smart series of efficiently designed homes, our fully Energy Star qualified homes and our promise of a 99-day guaranteed completion of our buyers' home.

We believe we are well positioned within our markets relative to both the re-sales and new homes and are excited about the advances we're making that allow us to offer our customers a more energy-efficient home that fits their lifestyle at affordable and competitive prices.

Slide 9. Our balance sheet is strong and we believe we have an adequate supply of capital to replenish our lot supply and re-grow the business as we bring on new communities and as market conditions improve. We generated $44 million of cash flow from operations during the first quarter of 2010, driven by $91 million tax refund we received in March, partially offset by $59 million used to purchase approximately 1,100 lots during the quarter, and ended the quarter with a total of $435 million in cash and short-term investments.

This increased cash position led to a decrease in our net debt to capital to total capital ratio to a company low of 26% at March 31, 2010, compared to 35% at March 31, 2009. We recently announced a series of transactions to refinance our debt with the nearest-term maturities effectively extending these maturities by five to six years.

We assume $200 million of 7.15% senior notes due in 2020 to retire in full the $130 million outstanding principle amount of our notes due in 2014 and a repurchase up to $65 million of our 2015 notes to tender offers that expire on May 3. We expect to recognize an estimated loss of about $3.2 million on early extinguishment of these debt amounts in the second quarter of 2010.

I'll now turn it back over to Steve.

Steve Hilton

It's satisfying to report that we returned to profitability this quarter. After having made great strides in executing on the strategic initiatives we undertook last year and our improved results are evidence of our successes. We've built a strong balance sheet to provide a solid foundation for future growth.

We've reduced our direct costs while maintaining our average prices, extending our margins back to near normal levels. We've increased our sales velocity with redesigned homes and new communities and believe we can add significant volume without adding significantly to our overhead with a potential to grow our bottom-line faster than our top-line.

With our new Simply Smart series of affordable homes, 100% Energy Star qualification on every home that we build and our 99-day completion guarantee that has gained traction with homebuyers and realtors, we can offer all the advantages of a new home built to suit our buyers' lifestyle at prices comparable to used homes and payments competitive with rents.

I believe we're well position to grow profits going forward, and I'm confident in our strategy and determination of our people to make Meritage successful.

Thank you for your attention and we'll now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Joshua Pollard with Goldman Sachs.

Joshua Pollard - Goldman Sachs

If I do the math that 19% of your closings were newer communities and that roughly 600 basis points between new and old land closings, I estimate roughly 24% margins on new communities and 18% on old communities. Is that roughly right? And could you talk about the direction of each of those in the future? I'm guessing that older community margins could continue to march higher as incentives fade and newer communities could come down a bit as there has been a pretty significant hunt for land here in the most recent few quarters.

Larry Seay

Josh, your math is pretty good. I won't say the numbers are exactly in that range, but they're pretty darn close. And I think what we're saying in some cases our newer communities are actually exceeding some of our expectations, because we've got very good buys on land over the last year or so. And I do think over the next two or three quarters, you'll continue to see margins improve as we continue the reloading process and continue to improve even in our older communities.

I don't know if you'll see quite the same leap you saw this last quarter in margins, but we do expect them to continue to climb somewhat.

Joshua Pollard - Goldman Sachs

My second question is on Texas. Your community count there declined 16%. I get the sense that Texas is doing fairly better than that. You all get a lot of credit for hiding in Texas during the downturn. So I'd like to know if you are strategically moving your incremental community out of Texas or if you feel like Texas is a down 15%, 16% market?

Steve Hilton

I'll let my Texas guys know you think we're hiding there. They're going to laugh over that. But we've dramatically increased our market share in Texas and moved up in the ranks. We're now the third largest builder in Dallas and the third largest builder in Houston according to RSI. And we had a handful of communities that were low absorption, doing one or two a month, and we decided to kind of refocus our efforts on more higher-volume communities. And that's why you see that community count drop.

But I'll point out that we're very bullish on Texas. We think the market is starting to recover there. Job growth is picking up. And 40% of the lots that we bought last quarter were actually in Texas. So we're very bullish about our franchise there, and we think it's an opportunity to expand it.

On the same point, we would certainly like to expand our business elsewhere and rebalance our deliveries where Texas is a little bit smaller percentage of the total. But at the same time, we don't want to retreat from the market share gains that we've gotten there, and we won't let that business shrink.

Operator

Our next question is from Steven East with Ticonderoga Securities.

Steven East - Ticonderoga Securities

Steve and Josh saved us the Texas conversation. If we look at the first quarter and into April, if we're looking at demand with the tax credit, what do you think your business did that was related to the tax credit and how much do you think was more organic recovery in the housing market and the consumer coming back, both in the first quarter and then what you're seeing in April?

Steve Hilton

As most builders have said already that they don't believe the tax credit has provided the impetus that we expected, and we believe the tax creditors serve icing on the cake. We believe there is some pent-up demand due to lack of affordability. And there's a lot buyers that are taking advantage of these great low prices, coupled with low interest rates.

And the tax credit may've just sped up their decision a little bit, but we're just not seeing the surge, and we're not expecting to let down. Our April sales are probably a touch less than March, very nominally less, but certainly more than we achieved in February.

Steven East - Ticonderoga Securities

Is there a way for you all to quantify what percentage you think were tax credit sales?

Steve Hilton

No. We've been talking to our buyers and trying to ascertain what their chief reason to buy has been, and we're just not getting crystal clear information on that. So we don't think it's that much.

Steven East - Ticonderoga Securities

And then one other question on the gross margin, the big jump, both sequentially and year-over-year. I know a lot of that you've already pointed to your new communities. But are you also seeing anything going on quarter-over-quarter from an incentive perspective? Were they coming off or you're seeing a mixed shift towards a little bit more profitable product. What else are you seeing there?

Steve Hilton

Well, it's a combination of a lot of things. We've been able to pull back on some key incentives in certain key locations. We've been able to continue to reduce our construction costs. Our salespeople have gotten better with more training. And creating more absorption per community allows us to leverage our overhead. Of course, the new community, as we've talked about quite a bit, it's a lot of these things that are adding to the increasing margin.

Steven East - Ticonderoga Securities

Okay. And if I can sneak in one thing, homes under construction right now?

Larry Seay

Well, backlog is a little over 1,300 in our houses under construction. It is about the same, about 1,400, 1,500.

Operator

Our next question is from Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

I wanted to ask about the kind of mix shift in terms of your product. Obviously, in the past couple of quarters, you have emphasized the first-time buyer and kind of recast your product type. But looking at just some of the more recent trends, obviously you talked about the rising price environment, absent just obviously the lack of incentives. And as well the new lots you purchased, the $59 million, 1,100 lots, that implies a little over $50,000 per lot, which sounds more like a move-up type product.

So I was just wondering if you could go into that in a little more detail. You touched on better locations. Maybe you're moving closer in. Just wanted to get your thoughts on that on whether we could begin to see some shift back to the move-up type product.

Steve Hilton

I would put a lot of stock in that $50,000 number, because certainly if that was a number in California and Colorado, that would be entry-level. But the truth is that you can spend $60,000, $70,000, $80,000 for a lot in California and be entry-level and lots in Texas are $20,000 to $25,000 in their entry-level. So I think 60% of our sales were first-time and first-time move-up.

It's hard to distinguish between what's first-time and first-time move up. I don't think we're going to be able to get down to become a pure play first-time builder. I think we're going to kind of be in between there, between first-time and the first-time move-up.

And we're not saying we're completely vacating the move-up housing business. We still see opportunities there. But we see more opportunities certainly at the lower price points, because we're trying to convert renters into homeowners. And they don't have the baggage of trying to sell homes right now.

So I think you're going to continue to see us around that $50,000 average lot prices. We'll continue to buy lots certainly in California where it costs more, and in Texas where a lot of them cost less.

Nishu Sood - Deutsche Bank

And second question, Steve, you mentioned you would expect your community count to be flattish as the year progresses. Now, obviously you folks were very early and that was obviously a great decision in terms of land purchases last year. So with your growth stance and your kind of earliness into the market, why wouldn't community counts be growing? Is that just a function of some delay in opening communities? Or do you have a lot of communities that just have a handful of homes left? So why wouldn't that be growing?

Steve Hilton

Well, we still have a lot of communities to roll off that we have to replace with newer high margins. And we've made a conscious decision not to move into any new markets and to redouble our efforts to grow market share at our existing markets. So I'm not saying we're going to flat forever, but just for the next couple of quarter, as we replace older communities with newer communities, we'll probably be relatively flat. And then as we go into next year, we'll start to increase community count again.

And also, we're focused on quality over quantity, and there's just not as many great opportunities that we can produce higher margin on available today. And there is a lot of action with the prices going up, and we're going to be judicious about sticking to our underlying standards and be patient and chase return more than the top-line.

Nishu Sood - Deutsche Bank

So the communities that you are buying new here, the new lots that you're buying, these are still land lots of the sort where you can turn around and open them up pretty quickly, get a sales center growing, let's say, a month or two?

Steve Hilton

Yes, for the most part, it's a few months. If we buy something today, we're going to be selling it on in three or four months, and we got to get our product approved, of course. There might be some minor work to do there, got to get our models built. But within three or four months, we could be opened.

And we are starting to buy some partials. We have to do a little bit of onsite development work, and it may take a little bit longer. But generally, we're trying to put them into the pipeline very quickly.

Operator

And your next question is from Carl Reichardt with Wells Fargo.

Carl Reichardt - Wells Fargo

I'm curious, Steve, during the course of the quarter, if you could give me a sense of what percentage of your communities, your floor plan count, you bumped your base prices on? I realize obviously you're getting some margin enhancement from incentive production. But I'm curious about the base prices in general and if that's starting to help or you think it will help margins?

Steve Hilton

I wouldn't say we had a lot of base price increases. I think it's more about us ratcheting back the incentives. I would say some of the newer communities we opened, sales pace has been better than we expected. And in those situations, and they're relatively limited, because it's only around 20%, we've actually raised base prices. But across the board, older communities, we're not really raising prices on a broad scale. We're just kind of dialing back the incentives a little bit.

Carl Reichardt - Wells Fargo

And then, Larry, just have a question for you. I wanted to clarify your cycle time comment. You did mention that you thought that backlog conversion rate would improve, but I wasn't sure if you meant sequentially. Do you think you're going to be in the mid-70s for the course of the year except fourth quarter, or are we looking at just a slight improvement year-on-year on conversion rate?

Larry Seay

I don't think I said it would improve. I think I said we'll see about the same, and of course it's a little bit seasonal. So typically during the back half of the year, you do close a little bit higher percentage of backlog than in the front half. So it could go up a little bit. But it's a pretty good conversation rate now. So I'm not expecting it to go up much.

Steve Hilton

Yes, I would say, our conversion rate is kind of at a historically high level. But with that said, because we're building homes quicker, we have a 99-day guaranteed program, and we do have probably a few more specs than we normally would have, we expect the conversion rate to stay pretty close to where it's at right now.

Operator

Our next question is from Dan Oppenheim with Credit Suisse. Please proceed with your question.

Dan Oppenheim - Credit Suisse

You talked about the spec levels being a little bit higher than you liked, but within the range. If you can talk about where that is at this time or at the end of April relative to where it was at the end of March?

Just wondering where the spec count is here at the end of April. You don't have the specs now, but potentially next week, specs aren't quite as desirable once the credit is over. Do you know where your spec count is here at the end of April?

Steve Hilton

We don't have our numbers yet. I mean, Larry, do you have anything?

Larry Seay

I don't think it's come down that much from where it was at quarter-end at 602. So it's probably come down a bit, but I don't think we have the number. But we're not worried by having 600. 600 is about four per community, and that's a good number for us to have going forward. So it's certainly not an inflated number that we grow up in order to get closings for the tax credit. It's a number we're comfortable with going forward.

Steve Hilton

And then particularly concerned we're going after more of the entry-level buyer. And as we now have started to more renters, we need to have a few more specs than we traditionally had. We've traditionally been in that two to three range. Now we're at four. And as Larry said, we're very comfortable with that.

Dan Oppenheim - Credit Suisse

Second question, I'm wondering about the land buying. How aggressive do you wanted to be with that in terms of what's the goal in terms of your supply of land that you have at this time? Historically, your aim was to not have such a long supply of land. What's the thought on that right now and is there any thought in terms of just what you'd like your overall exposure to be on a regional basis?

Steve Hilton

We don't manage our business based upon year supply. We will look at trying to achieve 15%, 20% growth rate. We'd look at community count. We'd look at strategic positions that we can support in A and B markets. It's more opportunity-driven than it's year supply driven. So that's just not one of the factors that we're focused on.

Operator

Our next question is from Alan Ratner with Zelman & Associates.

Alan Ratner - Zelman & Associates

Steve, I was hoping that maybe you can expand a little bit on some of your comments you made about the land market. And I know you indicated that you're starting to purchase some lots that maybe require a little bit of development work. I was wondering if that's more a function of prices on finished lots, maybe getting bid up beyond the point that you guys are comfortable paying, or is that just more a function of the supply of finished lots in your market dwindling to low levels?

Steve Hilton

Well, I think you're on point. I mean the prices are getting are high. Opportunities are becoming fewer. And there is more upside if we're willing to do some development work. And the better bargains certainly are the lots that may have a little bit more hair on them.

So not to say there still are not finished lots to buy. We've identified many of them over the quarter. We've identified even more here in April, going into May. And we continue to build/buy finished lots, but at the same time, we realize that the supply finished lots is going to dwindle and we need to start looking at lots that we need to improve.

Larry Seay

It's not to imply there aren't finished lots now. A great rate majority nearly in all the lots we have purchased the last quarter were finished, but we can look forward several quarters and see that that trend or a period of a year or so is going to have to start to switch to more development deals.

Alan Ratner - Zelman & Associates

Got it. So when I kind of look at the pace that you've been acquiring lots, you've been kind of in the 1,000 to 2,000 range over the past three quarters, is that something that you kind of shoot for going forward or is it really just a function of what comes to market?

Steve Hilton

It's what we shoot for, but it's also a function of what's out there. I still think there is quite a bit of supply. I think the banks are becoming more (inaudible) than they were certainly a year ago as prices have come up. And certainly some of the margins of some of the deals we've bought are into the high 20s, and those are not sustainable. We underrated things to a normal marginal course. So I'm not worried that we're not going to be able to find lots. There's going to be opportunities there.

Alan Ratner - Zelman & Associates

And one just unrelated question, if I could, on the margin. Obviously, you get some positive momentum as the mix to new communities increases. Are you concerned at all about rising commodity costs and do you foresee that being any material headwind in the coming quarters?

Steve Hilton

I'm not that concerned. I mean certainly there's been some spikes in certain materials, but I think they're going to retreat here as we go into the later part of the summer. I mean with building volumes still at historically low levels and excess capacity in all the major components to go in the building homes, I'm not worried about significantly rising commodity costs.

Operator

Our next question is from Josh Levin with Citigroup.

Josh Levin - Citigroup

You said April sales were a touch less than March, but only nominally so. What percentage of April sales will close by the June 30 tax credit deadline?

Steve Hilton

Probably only the ones with specs.

Josh Levin - Citigroup

So basically everyone who bought homes in April for the most part, unless they were buying a spec, they knew that they are not going to get the tax credit?

Steve Hilton

Right, unless they buy spec. I'd say a few buck by the end of March and we're building newer house, we probably could get you by end of June. Our spec sales have been between one-third and one-half of monthly quarterly sales. So I'd say between one-third and one-half of the homes that we sold in April we will deliver by June 30.

Josh Levin - Citigroup

Does that mean that's 50% to two-thirds will not be closed by June 30?

Steve Hilton

Correct.

Steve Hilton

But let me go back to our backlog what we had at March 31 and look at what our conversion rate was, and you can try and extrapolate what our deliveries are going to be.

Operator

Thank you. Our next question is from David Goldberg with UBS.

David Goldberg - UBS

First question is kind of follow-up on the spec question. As opposed to thinking about it from the perspective of whether you're trying to bring your specs down, I wonder if you could talk about some of your competitors maybe who've built more specs and if you think you saw price discounting as you moved through April. How worried you are about there being excess spec in the market now and what kind of possibility there is that there's going to be some price discounting that's going to kind of become a contagion for the rest of the builders?

Steve Hilton

Well, number one, we're not trying to bring our spec count down. Number two, we didn't see a lot of discounting. We saw the opposite of that. We see incentives tightening. So that's what's helping our market to go up to some extent. And number three, we don't see a lot of builders doing a lot of specs, except for maybe one and you know who that is.

And so that's the only builder that's out there kind of going aggressively building the specs. And we are able to compete with that builder, even though he has got more specs.

David Goldberg - UBS

Maybe I need to clarify the question. The question wasn't so much a March-based question. It was an April-based question and beyond. Are you worried that that particular builder or any other builders for that matter are going to be out there trying to discount to try to gain market share?

Steve Hilton

No.

Larry Seay

David, another thing, 90% of the homes being sold are resales and foreclosures, and we don't really see ourselves competing against the other homebuilders. We're competing against the resale market and we've priced our homes to compete head-to-head with foreclosures and resale. So as long as we are competing with that segment of the market, a few specs out there that the builders may have built aren't going to, in our minds, upset the other market that much.

Steve Hilton

That builder, as big as he is, he can't sway the entire market. Our locations and our products and our salesmanship and our offering, we are able to compete with that builder.

David Goldberg - UBS

Got it. Actually that brings up an interesting kind of follow-up question. We've been hearing a lot that with HAF in place now, you're starting to see more short sales as opposed to foreclosures. Especially in some of the markets that have been really hard hit by foreclosures, you're starting to see banks start to shift towards doing short sales. And I'm wondering if you guys could comment on how you think that impacts the housing market. Do you think that's a big benefit for price stability? And kind of maybe how that's affecting your business in terms of competition?

Steve Hilton

Well, the foreclosure short sale situation is a challenge for us, and we're not building a lot of appreciation into our models going forward. And that's why we got to be very disciplined about what land we buy and where we buy and what we pay for it. And that's why we believe our research helps us localize the business and to find those pockets where housing prices has stabilized, and there are many; and avoid those pockets where prices may have risk of falling even more is key and is paramount to our strategy.

So we got to continue to improve our game, and we got to be able to compete against resales and used homes and drive our costs down and improve our product by building homes quicker and offering energy-saving features that differentiate us from resale and used homes. And we are going to compete.

David Goldberg - UBS

So it's safe to say there's no difference in terms of whether it's a foreclosure or a short sale, though, in terms of the way it impacts the market?

Steve Hilton

I don't think so.

Operator

Our next question is from Bose George with Keefe, Bruyette & Woods.

Jade Rahmani - Keefe, Bruyette & Woods

This is Jade Rahmani for Bose George from KBW. I wanted to ask about your capital deployment strategy and how you weigh the trade-off between debt pay-down or debt instruments in land acquisition. Do you expect to use a balance of capital deployment strategy or would you consider increasing leverage as you make some of these land purchases?

Steve Hilton

Well, we don't expect to pay down anymore debt than what we've previously announced. We've termed our debt; it's pretty long-term. We think we can do better by deploying our excess capital into buying land that we can get high margins and high return on assets and with the same token with over $400 million of cash in old lots, so we can still generate cash from. We don't expect only to be taking on a new debt for the foreseeable future. I think our balance sheet is pretty much what you see what you get.

Larry Seay

We will eventually foresee spending some of the cash on expanding the business, buying new lots, growing WIP as the market recovers. And we would expect the net debt to capital ratio to go back up to the kind of 14% range over time as that happens. But we don't plan to leverage up the company. We don't want to raise a lot of debt and take a really leveraged position going forward.

Jade Rahmani - Keefe Bruyette & Woods

And then secondly, just going back to the Texas question, we wanted to find out if there is any sharper seasonality in Texas versus other states or anything else driving the declining community count that you could speak to.

Steve Hilton

No, I think declining community count, as I said earlier, that's getting more efficient and rotating out of some of the low absorption, lower margin communities that we had on option, and focusing on a less-is-more strategy with communities that we can get higher absorption rates. So I don't think there's anything else to it than that.

Jade Rahmani - Keefe Bruyette & Woods

And no further seasonality in Texas?

Steve Hilton

No.

Operator

Our next question is from Jim Wilson with JMP Securities.

Jim Wilson - JMP Securities

My questions are just really related to margins, particularly regionally. Larry, was there any meaningful difference in what you found in gross margins for the quarter and kind of how pricing and margins are proceeding?

Larry Seay

Well, most of it is being driven by where we've added the new communities, but there are still a couple of difficult markets, particularly Nevada, where margins have been a little more depressed and remain depressed and where we haven't bought new communities. So I would point that Nevada is being still the toughest market we're in from a margin standpoint.

Jim Wilson - JMP Securities

And then on a go-forward basis, as you look at these deals, is there any meaningful difference in the margins you're looking for in any given market, higher in California, for instance, or versus lower in Texas, given the nature of the market? Or how would characterize what you're seeing, what you're getting?

Steve Hilton

We look at markets within markets. So some of our A-plus markets we may be willing to accept are a little bit lower margin, because there is less risk, and then B-minus market. So we don't ascribe a different margin return to California versus Texas, because we see them all recovering. We're looking more at the individual submarkets within the market and ascertain the risk to those and have not derived what our margin is going to be.

Larry Seay

Or for example, finished lot deal would have less risk than a development deal, because of development risk. So we might have a slightly higher return requirements for a development deal than a finished lot deal.

Operator

Our next question is from Ken Leon with Standard & Poor's.

Ken Leon - Standard & Poor's

A couple of questions on land acquisitions and new communities; first a clarification. The 20 communities to be built out, are they owned or still part of new acquisitions?

Larry Seay

We already own those or control those, and they're just working through our system to bring in the market, either we'll build in the models right now or waiting to get permits, but we already do own or control those.

Ken Leon - Standard & Poor's

And then as you shift your acquisition to unfinished lots from finished and look at your targets, whether it be margins or returns, are you still looking to build out unfinished lots in 2010 or do these become part of what you have in inventory for 2011 where the pricing environment might be very different?

Steve Hilton

Well, it's getting pretty late in the year for us to buy a raw land and finish it and deliver it in 2010. So those will be driven more towards 2011 and beyond. That said, there are still opportunities for us to buy finished lots this year right now and deliver homes on them this year, because our cycle times have shrunk so much. We can bring these communities to market very quickly. And we can get WIP delivered very quickly.

So we still think we can improve the back half of the year or the last quarter of the year by taking advantage of certain opportunities that we're pursuing right now. But that said, as I point here, in the near future our acquisitions are going to be benefiting 2011 more than 2010.

Ken Leon - Standard & Poor's

Okay. You're in most markets, but are there some markets other than the two that you mentioned where you feel it's worth taking a bigger stake and trying to get a bigger share of the market?

Steve Hilton

We're very bullish about Austin and San Antonio, and we're trying to improve our market share there, of course, and are aggressively out looking for land opportunities in those markets as well.

Okay. Thank you.

Steve Hilton

I think that wraps up all our questions for today. And I appreciate everybody's attention and support to Meritage, and we'll look forward to talking to you next quarter. Thank you.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Meritage Homes Corporation Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts