Meritage Homes Corp (MTH) 2012 Q1 法說會逐字稿

Good morning and welcome to the Meritage Homes first quarter 2012 conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation this will be an opportunity to ask questions. Please limit yourself to one question and a single follow-up. Please know you may rejoin the queue for other questions. Please know this event is being recorded.

I would now like to turn the conference over to Brent Anderson, please go ahead.

Thank you Andrew. Good morning everyone, and welcome to our analyst conference call today. Our first quarter of 2012 ended on March 31, and we issued a press release with our results before the market opened today. If you need a copy of the release or the slides that accompany our webcast, you can find them on our website at investors.meritagehomes.com,or by selecting the Investors link at the top of our Meritage Homes homepage.

Please refer to slide 2 of our presentation. Our statements during this call and the accompanying material 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 Securities and Exchange Commission, specifically our 2011 Annual Report on Form 10-K.

Today's presentation also includes certain nonGAAP financial measures as defined by the SEC, and to comply with the SEC rules, we have provided a reconciliation of these nonGAAP 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, Executive Vice President and CFO. We expect our call to be concluded in about an hour, and a replay of the call will be available on our website after we conclude the call. It will remain active for 30 days. I would now like to turn the call over to Mr. Hilton to review our first quarter results. Go ahead Steve.

Thank you Brent. I would like to welcome everyone to our call today. Since our sales trends provide an outlook of our future earnings potential, I plan to spend most of my time discussing our sales and associated metrics before turning it over to Larry, to discuss our financial results for the quarter.

So let's begin on slide 4. The spring selling season got off to a strong start this year for us, and many of our homebuilding peers. As the US economy and employment picture have improved, consumer confidence has been climbing since August of 2011. More buyers are searching for homes to take advantage of high affordability and inventory of existing homes have declined substantially in many of our markets, with some areas now reporting just a few months supply of homes for sale. As buyers realize the market is tightening, we are seeing a greater sense of urgency than we have for quite some time.

In addition to improve market conditions, our sales have also improved due to the unique value proposition Meritage offers with our energy efficient homes, new plans and features, and great locations for our communities. Our first quarter sales of 1,144 homes represented our highest quarterly sales orders since the second quarter of 2009, and a 36% increase over the first quarter of 2011. Our sales strength in each month through the quarter and in fact have been increasing since November of last year. Both the absolute number of orders and the year-over-year increase grew throughout the first quarter, with a 69% increase over last year in March. April looks like it will also be significantly better over last year.

First quarter 2012 was also our best quarter since the second quarter of 2008 in terms of total order value at $308 million for the quarter, a 40% increase over the prior year. The increase was mainly volume combined with a 3% increase in our average selling price. The higher ASP primarily reflects a shift in mix towards higher priced communities, and a larger percentage of sales in states with higher ASPs. Something we have been experiencing for the last several quarters.

We did begin to raise prices in the first quarter as we became more confident with year-over-year gains that we were achieving. We raised prices in about two-thirds of our communities during the quarter, while certain of our best communities have taken several price increases amounting to 3% to 5% in many cases. Most price increases have been more modest.

Turn to slide five, the increase in demand is probably most evidenced by the fact that we achieved our highest average sales per community since the first quarter of 2008, a 29% increase over last year. Location is still very important with our better communities selling in excess of four homes per month during the first quarter, well above our companywide average of approximately 2.5 homes per month for the quarter. We increased sales orders in every state except Nevada compared to a year ago. California, Arizona, and Colorado led in both sales gains and average sales pace per community. California sales increased by 140% to 187 orders in the first quarter of 2012, compared to 78 last year. That is a 9.1 sales per active community for the quarter across 21 active communities compared to 5.6sales per community in 14 communities one year ago.

Arizona sales orders increased by 67% with a 53% increase in sales per community to an average of 7.2 during the quarter, compared to 4.7 sales per community last year. Colorado increased by 28% with 10.1 sales per community, up from an average of 7.9 last year, and a relatively flat community count. Florida's sales increased 47% over the prior year, despite a decline in average sales per community due to a difficult comparison to 2011, when they led the Company in sales pace. We have some new communities in Orlando that are experiencing excellent traffic, and we expect them to generate strong sales in the second quarter.

We were also pleased to see a 19% in sales pace in Texas, which resulted in a first quarter sales growth of 4% over 2011 despite a 14% reduction in average active communities from a year ago. We have generally completed our efforts to close out communities in lower performing submarkets in Texas, and are beginning to regrow there with about a dozen new communities scheduled to open in the next quarter or two. Additionally, our new market in North Carolina, Raleigh contributed 33 sales during the first quarter of 2012 from its first four communities, all of which opened within the last six months. That is an average of 9.4 sales per community, well above our companywide average. We are very pleased with our successful start in this market.

We expect to open our first communities in Tampa during the second quarter, and we have acquired our first four positions with 100 lots there recently. Our companywide order cancellation rate fell to 15% of gross sales in the first quarter, the lowest it has been in many years, and one indication of a high quality demand. We ended the quarter with 150 active communities, up from 141 at the end of the quarter into the first quarter for 2011, so down somewhat from 157 at the beginning of the quarter. As we closed out some communities sooner than anticipated, due to increased sales pace.

Our land acquisition teams are working hard to secure high qualities communities in A and B locations, to provide us the best opportunities for above average sales and higher margins, and we have a healthy pipeline of lots to replenish our communities even at our currents sales pace. I now turn it over to Larry Seay to review our financial results for the quarter, and then we will open it up to questions. Larry.

Thanks Steve. I will pick it up on slide six. We narrowed our net loss for the first quarter of the year to $4.8 million in 2012 compared to $6.7 million in 2011, as we increased home closings and revenue while reducing our total general administrative costs and interest expense. We have been operating around breakeven for the last two years excluding the impairment relating to winding down our Vegas operations, and just a small number of home closings can make the difference between being profitable for the quarter or not. With the level of sales and backlog we have reported in the first quarter of this year, we are expecting to achieve higher closings over the next couple of quarters, providing significant overhead leverage, and pushing us into profitable territory.

Our first quarter 2012 home closing revenue increased 15% over 2011, reflecting a 12% increase in closing volume and a 3% increase in average sales prices, primarily due to a shift towards states and communities with higher priced homes. As a result of stronger closings, our quarter end backlog grew to the highest point we have reported in both backlog units and total value since the first quarter of 2010. The total value of orders and backlog at March 31, 2012 increased by 44% over March 31, 2011, due to a 38% increase in units, and a 4% increase in average sales prices, again reflecting a mix shift toward states and communities with higher priced homes, in addition to more modest price increases as Steve described.

First quarter home closing gross margin was consistent with last year at17.2% in 2012, compared to 17.1% in 2011. The lack of pricing power until recently has been constraining margin growth over the last couple of years. As we have begun to raise prices we are also experiencing some cost increases, but are working hard to hold down costs to improve our margins. Commissions and other sales costs increased due to increased closings and expenses relating to our new national contact center, and a complete redesign of our website, which we didn't have in the first quarter of last year. These have been good investments and are driving traffic to our communities and resulting in additional sales.

We reduced our general administrative expenses for the first quarter from 2012 to 2011, and increased closing revenue providing further leverage resulting in 130 basis point improvement in G&A, That dropped our total SG&A to 16.5% of total revenue in the first quarter of 2012, down from 17.1% a year earlier. We believe we have right-sized the organization, with capacity for growth without adding much overhead, and expect to gain leverage as we increase revenue and maintain G&A costs in the range of $15 million to $16 million per quarter. We gained an additional 90 basis point improvement in interest expense year-over-year, as we were able to capitalize more interest to real estate under development and work in process inventory.

Interest expense decreased 8% to $7.4 million, or 3.6% for the first quarter of 2012 revenue, compared to $8 million or 4.5% of first quarter 2011 revenue. Our total interest incurred will increase approximately $300,000 per quarter, due to our debt refinancing transactions in the second quarter of this year.

Moving to slide seven, we spent $61 million to purchase approximately 1,300 lots during the first quarter of 2012, and another $14 million on development of unfinished lots. We also contracted for approximately 1,500 new lots in 32 communities during the quarter. We have been finding a sufficient number of lots to stay ahead of our sales order growth, and our goal is to grow our community account without sacrificing margins or underwriting discipline. We ended the first quarter with a total lot supply of approximately 17,200 total lots. Nearly 1,800 more than a year ago, an increase of approximately 500 from our 2011 year end total of approximately 16,700 lots. Based on trailing 12-month closings the March 31, 2012 balance represents a 5.1 year supply of lots.

Consistent with last year, we own 83% of our total lots, and control the over 17% under option contracts. As shown here, we have rebalanced our lot supply over the last several years, as our markets outside of Texas have grown over that period. Texas is now beginning to grow again, and we have repositioned our communities in better locations there.

Moving to slide eight, we ended the quarter with $277 million in cash and cash equivalents, restricted cash, and securities, compared to $333 million at the beginning of the quarter. Our total real estate inventory increased by $53 million accounting for nearly the entire decrease in cash and investments during the quarter. Net debt to capital, net debt to total capital ratio was 40.4% at March 31, 2012, compared to 30.5% at March 31, 2011.

We have launched series of related financing transactions in the first quarter of 2012, which are scheduled to close in the second quarter, including the private placement of $300 million of 7% senior notes due in 2022. We are using the net proceeds of that new issue along with some available cash to retire all $285 million of our senior notes due in 2015 and $26 million of our senior subordinated notes due in 2017. These transactions will extend our earliest debt maturities to 2017. These transactions will result in approximately $6 million of expense for early retirement of debt in the second quarter of 2012.

I will now turn it back over to Steve.

Thank you Larry. We believe the market has clearly turned in a more positive direction, and we are switching over to offense rather than defense. We are focused on driving more traffic to our communities, and our sales teams have done an excellent job converting traffic to sales. Our monthly sales have grown progressively since November of last year, and March was our best sales month since June of 2008. Based on current market conditions we believe we can continue to post substantial year-over-year increases in sales during the remainder of 2012, with our increased backlog we are confident we will be profitable for the full year.

Our challenges now are to continue to find well-priced lots in high quality locations for new Meritage communities, maximize our margins in each community by taking price increases where supported by demand and holding down our direct costs, control and better leverage of our overhead costs, while continually striving for operational excellence, and growing both within our existing markets and expanding into new promising markets. It is good to have such challenges to face in stronger market, and I believe we will meet those challenges.

Thank you for your attention we will now open it for your questions. The operator will remind you of the instructions, Operator.

We will now begin the question and answer session. (Operator Instructions). At this time we will pause momentarily to assemble our roster. Again please limit yourself to one question and a single follow-up. Please know you may rejoin the queue for other questions. The first question comes from Nishu Sood of Deutsche Bank, please go ahead.

Thanks, I wanted to ask about to your land strategy. Now you folks obviously are through much of the upside goal, and a couple years ago were focused on optioning most of your land, and that allowed you of course to have a pretty of good sales velocity relative to your capital. Now through the downturn you have obviously shifted more to owned land, and given the pretty intense competition for finished lots, and the lack of development out there, it looks like you will probably have to stick with the more owned strategy going forward. My question is this. There has been a good spring selling season, volumes need to grow a lot in the recovery. Being more owned versus on optioned, is that going to restrict your growth going forward in the recovery?

Well, certainly it is going to be hard to grow, at 50% or more as we did in the 2004 to 2006 time period because we don't have those options. Unfortunately or fortunately, most of the lots we are buying today or a big chunk of lots we will are buying are directly from lenders. They are from distressed situations, and they are cash and carry. And they are just not any, or at least not a significant number of land backers available to the market today. So we still think we can put up some pretty nice growth numbers, but they are not going to be off the hook like t hey were in the early part of the last decade, so we don't, we are not concerned that not having land backers is going to slow us down that much.

And we also think that as the market recovers at land bankers and other people who sell land under option will come back into the market, so that financing strategy will reappear. Maybe not to the extent it was during the last cycle, but certainly it will become more prevalent over the next couple of years.

When it does become available we will certainly take advantage of it.

Great thanks. Second question I wanted to ask is you folks have been very of pretty savvy strategically in terms of market shifting in and out of markets through the downturn and the first part of the recovery here, so the retreat to Texas obviously when things got really bad, obviously you have been diversifying as you mentioned your land positions outside of Texas again. In that light, I wanted to ask about Las Vegas, I understand the new communities in Tampa, and in the Carolinas, but it seems like you would be shifting out of Las Vegas, just as we are beginning to get some signs that things are getting better there. Any second thoughts about that or what are your thoughts there?

No, we are just not comfortable with Las Vegas for a variety of long term systemic issues that market has, even though it is close plane flight to our home office here in Arizona, just not excited or comfortable with that market. So we have no second thoughts or misgivings about our announcement to retreat from Las Vegas.

Okay. Thanks.

Thank you.

The next question comes from Adam Rudiger of Wells Fargo Securities please go ahead.

Good morning thank you. Steve as I think about the last of couple years I think Meritage is a company that was ahead of the curve a bit in restoring profitability. It seems that that first mover advantage so to speak has somewhat eroded a bit since then. I look at your revenues this quarter versus say the revenues in the first quarter of 2010. And you had a much narrower loss then, and you actually made money if you include other income. I was wondering if you could from your perspective. what has transpired really since the market downturn, how have you guys gotten to that improved profitability, and then what has happened since then?

I think certainly sales prices have come down quite a bit from where they were two years ago, which has impacted our margins on both our new communities and our older communities. And we just haven't had the pricing power that we expected to have, we have several initiatives in place to continue to rein in costs. We have brought a lot of new product into the system over the last couple of years. And I think that has had an effect on our cost, although I believe that is going to turn around. And I think we have had a little bit more focus on volume driving our volume moreso than our margin, so that we can leverage our overhead. And I really, even though I have been saying this for a while, I really do expect our margins to improve over the next several quarters, because of our initiatives on the cost side, and because we are being more aggressive about raising our prices, particularly in about half of our markets where we are having pretty strong demand right now.

On that note, on the price increases what is the early read from the price increase you have taken in the quarter? Has it head to buyers thinking they have missed the bottom and to increase urgency, or have you seen some negative elasticity instead?

We haven't seen very much negative elasticity at all. I think actually the price increases have been a good thing, and they have actually created even more urgency. Particularly in markets like Phoenix, northern California, Denver, and Orlando.

Thank you very much.

Thank you.

The next question comes from David Goldberg of UBS, please go ahead.

Thanks nice quarter guys.

Thank you David.

First question has to do with the first mover advantage, but my question is really about the green product some of the work you guys have done from a differentiation standpoint. Are you seeing your competitors come in and try to adopt similar construction techniques, similar points differentiation, assuming you guys all share the same subcontractor base, are you seeing that becoming less of a competitive advantage as the market is getting a little bit better right now?

We still think it is a distinct competitive advantage not only for dealing with, competing with other new homebuilders, but certainly with resale. Certainly the homebuilder community has woken up to energy efficiency and green, and a lot of our competitors are doing more and more in that area. Although I don't think there is anybody out there that is doing the complete package that we are. It starts with spray foam insulation, and moves down to windows, mechanical systems, and so forth. So I feel just as confident and bullish about our strategy today than I did a year ago or even two years ago, when we started on it, and we think it is going to pay long term dividends particularly after this summer, when we are able to demonstrate to our customers actual utility bills from homes that we built, and how they perform throughout the summer periods, which are where the highest energy bills are for most of the homes we built throughout the southern United States. So very excited about the opportunity there over the next year.

Got it. Then my follow-up question is a little bit theoretical. You mentioned earlier in the call that a lot of land deals obviously are still coming from lenders, broken deals, distressed deals, that you guys are able to step into. I wonder if you think about it in in the aggregate. What kind of discount to replacement cost do you think you are buying land at now?The reason I ask is I am trying to get an idea if we had to get back to a stage where you had to buy raw land at some positive value, and then develop it, to get all of the way through the entitlement process to development, what your profitability might look like, considering there is a real chance that there will a shortage of lots as we look forward?

I wouldn't say there is a discount to replacement cost necessarily like we saw a year or two years ago. I mean land prices have come up considerably in most markets. So there is a residual for land today, first of all we are not buying a lot of finished lots. There just are not a lot of finished lot deals out there,from lenders or from developers. So when we are buying a deal from a lender, maybe that is a third to half of the deals we are buying, generally now most of them are raw land. They are certainly less than what they were at the peak of the market, but they are not too far off from what they were in the 1990s and early 2000s. The land market particularly in A and B locations has come back substantially.

Is it safe to assume that the land you are delivering today has a lower basis than the land you are buying today? The prices have come up enough that some of the land you are delivering today is a little bit less expensive stuff you might have bought a year or two years ago?

Yes, I would say that is fair. But I would say prices are rising too.

Okay thank you.

The next question comes from Dan Oppenheim of Credit Suisse, please go ahead.

Thanks very much. I was wondering you talked about the pricing that you have gotten especially that you are getting on the contracts, especially in the later months of the first quarter, and talking about margins. How would you describe margins in backlog versus margins on deliveries, in terms of the confidence of the improvement over the coming quarters?

Slightly improving, I think margins are going to be rising throughout the coming quarters, and that relates to our ability to sell at better locations, and our ability to raise prices. So I don't want to predict on a quarter-by-quarter basis what margins are going to do, but I am pretty confident that they are going to get better.

Great. I guess second question wondering about you talked about on recent quarters there was a focus on some of the volume, and to leverage the overhead, but also a lot of talk in terms of pricing now. Would you describe that as a shift or would you say that is really the pricing now is a function of market improvement, whereas you are still trying to go for that overhead leverage, and focusing on the volume, but now the market is improving and allowing you to get the pricing here?

It is a combination of both. We have some communities, a select number of communities where the demand has been really high. If we are going to sell more than five or six houses a month, then we need to get a significant price lift on that. And in those cases we are pushing prices as hard as we can. Other areas where volumes are low , and we are only selling two or three houses a month, we are going to be less aggressive about pushing prices, and even more focused on maintaining that minimum volume. So it is not one lever you are pulling different levers in different communities every

Great thanks very much.

Thank you.

The next question comes from Ivy Zellman of Zellman and Associates, please go ahead.

Good morning it is actually Alan on for Ivy. Steve my first question is on your slide seven, which shows the lot count change since the end of 2008, and I think what is interesting here is your lot count is actually up it almost 10% from that time, yet your community count is down 16%. I was curious what is driving that, is it a greater share of raw land, or do you just have a lot of communities in the pipeline ready to open up that may be double-digit type growth is reasonable to expect over the next few quarters?

I think it is a couple of things. It is number one, a lot of the communities we bought in 2009 to 2011 time period were pretty small. We are talking about 20, 30, 40 lots at a time, 50 lots. And we burn through a lot of those really quickly. Because we got them at really good prices. And they were in good locations and they propelled a lot of our sales activity over the last couple of years.

Number two, the communities that we bought most recently over the last year have been more development oriented, and they have a longer lead time, and a lot of those aren't going to come online until the end of this year and end of next year, and even beyond. So we have kind of stocked the shelves for the future. We are not seeing the immediate impact of it, because we have to develop these communities. I don't necessarily believe it is going to result in spectacular community growth rates, But I do think we will steadily be able to grow our communities over the next year or two. So I hope that answers your question.

Great that is really helpful. And the second question unrelated to that, is just on your pricing comments. I was hoping you might be able to quantify some of the moves you have taken year-to-day, maybe just give some examples in the different markets you are in, on what apples-to-apples pricing is up, and then to follow on to that, is how that compares to the cost increases you guys are seeing?

Well our strongest markets for price increases have recently been Phoenix and northern California. The Phoenix market right now is just really strong, particularly the last two to three months. Most communities in Phoenix we have raised prices $5,000 to $10,000. In some cases more, in some cases a little bit less, but volumes have been pretty strong. Pretty much the same for our northern California communities. We have been taking pretty good price increases there.

In Florida, Colorado, price increases have been more in the $3,000 to $5,000 range, 1% to 2%. In Texas it has been more spotty. Not every community has taken a price increase. Some of them have been taking small ones,and so forth. There is pressure on cost. I can't quantify across the board for you what costs have done, but it has been again a market-by-market situation certainly our contractors see the sales demand, and they see the pricing demand, and they see what is going on, and they are using that to try to increase their prices, but we are trying to keep that in step with what we are doing on the sales side. So I don't expect construction costs to outstrip price increases, and I expect there to be a pretty close correlation going forward.

Great, thanks a lot.

The next question comes from Michael Rehaut of JPMorgan, please go ahead.

This is actually Jason Marcus in for Mike. My first question just going back to the gross margin for a second. Looks like gross margin X impairments has declined about 140 basis points sequentially, a decent amount lower than it was over the last couple of quarters. So I was done wondering if could you kind of go over the key drivers there?I know you mentioned that you expect it to improve over the next several quarters, I was wondering if you think you can get back to the level where you were in the last quarter or two?

Larry, why don't you take this one.

Sure, we have always seen a kind of seasonal change in our gross margin because of levering fixed costs that are in our gross margin, like land development costs and construction overhead. And we said on the last quarter's call that we expected the margins sequentially to fall, and to get closer to what it was in the beginning of last year which it has done, and that we would expect to see sequential margin improvement throughout the year, but we thought that comparing year-over-year that we would see overall margin improvement from 11 to 12, and that is consistent with what Steve has said in his previous comments.

Okay. And then going back to the sales progression which you mentioned increased on a monthly basis during the quarter. I was just wondering if you could break out the January and February, and then also you mentioned that April looks like it is going to be significantly better. Would you say that it is kind of on pace with March's year-over-year growth, or is it looking more like the quarter?

January our sales were only up single digits. February I don't have that I am trying to find that. Larry,do you remember what February was?

It was.

Up like 30% or something?

It was in that range but I don't recall 20% to 30%.

Yes, it was about 30% plus or minus area, and then of course March was 69%. I think April is going to be probably somewhere in between February and March. I think it is going to be pretty darn good compared to last year, and we have quite a few communities opening this quarter, we also have a lot that are closing out. But I think that is going to help our sales activity as well for May and June.

Great thanks.

The next question comes from Joel Locker of FBN Securities, please go ahead.

Hi guys. Just I wanted to talk to you about the community count a little bit. Just where do you see that at the end of this year?It drops down in the first quarter I guess sequentially based on seasonality, but do you see it recovering and getting back towards 160?

No I think I said in previous calls that we are going to finish the year in 160 to 165 range, and I still believe that is going to be the number. And it is going to jump up and down quarter to quarter, but by the end of the year we should be getting close to around that 165.

Right. And what about I guess just labor split between labor and material costs going forward increasing?I know one go hand in hand but are you starting to see a lot more on the labor side?

Yes, I mean labor is, labor is also includes the profit and overhead of the contractor. Certainly a lot of subcontractors have not been making much money if any money at all over the last many years, and as demand picks up, and volume increase they want to get back to profitability so they are going it push their prices, just as we are. So certainly there is a lot of excess capacity on the material side, and as material suppliers want to increase pricing, they are going to try. I think there is a lot of capacity. And I think we still have a reasonable distance between when we are going to see real substantial construction cost increases, not to say we are not going to have them, and we are going to deal with them. But I think we have got an opportunity to get out in front of that.

Alright. Thanks a lot guys.

Thank you.

The next question comes from Steve Kim of Barclays, please go ahead.

Hey guys.

Good morning.

My question relates to your commentary about pricing, something that we have been intrigued by how different the commentary has been from the various builders, and how I guess I figured you would probably be in a very good situation to be able to shed a little bit of light on it. We have observed as you have pointed out that in places like Phoenix and Denver, you have seeing some very good price increases, and we have seen some others as well, but in some other areas outside of those two, it seems like it is a little bit different depending upon whom you speak with. I was wondering like for example I was out in southern California, around like Riverside, San Bernardino, and some of the better parts of Inland Empire, and the builders were saying they had raised prices every month for the last three months in all of the communities in that area. And I know not everybody is seeing that.

I guess my question to you is do you feel that when you look at where you are able to achieve price increases, out of side of Denver and Phoenix, that it is primarily a function of the particular land parcels that you happen to be on this those particular markets?Or do you find that it has maybe more to could with marrying the particular product type?Maybe it is your green homes, it is a product issue, or is it more of a specific land issue in your estimation?

I think you have nailed it there. It is a specific location issue. So like going back to your southern California discussion there, in the Inland Empire there are certain parts of the Inland Empire that we have raised prices, and there are other parts that we have not. And it is due to the supply constraints in those certain submarkets within the market. Certain areas there is a tight supply of new home inventory, and there is a tight supply of resale inventory, and you have got more pricing powers than other parts. Like the Inland Empire, there is a lot of competition and there is a lot of inventory still, and you don't have the ability to raise prices there.

In Texas, price increases have been pretty nominal. We don't have the tightening of inventory there that we have in other markets, which is causing the price increases. So I don't think it has to do with the green, or make a good land buy or not making a good land buy. I think it is really about just that specific location. In Phoenix, I am kind of surprised we haven't gotten more questions on that, the inventory of houses listed for sale, single family detached houses is under 10,000 right now. And it is just an incredibly low number. Those people that are in the housing market have shifted now from buying resales to buying new. And for a lot of them, because they can't buy a house. A lot of people are underwater on their mortgages, so they can't put their houses on the market, and then a lot of people don't want to sell until prices rise. So that has really had a big impact on the supply side, and really given the builders in this market a good tailwind.

Thanks. I had two other follow-up questions if I could. One is I was curious if you could comment on whether you are seeing that builders generally speaking are all adopting a somewhat similar approach to attempting price increases where they can get them, or are you finding that there are a couple of players who are less reluctant to even test the waters as aggressively as you have, even if they have a product that is selling pretty well, but that they would rather just take the volume versus the price?

That is a hard question to answer. From what I am hearing in these markets like Phoenix that are a little more robust than others, everybody is taking price increases. But it has been a pretty short time period, just the last couple of months, so I haven't been able to do a real detailed survey to see what people are doing versus others. But everybody is having good sales success, even in outlying markets which is surprising me that some of the poorer geographies, they are selling houses.

Right. That leads to my last question, which you touched on with respect to the absence of inventory in the market place. I was curious if you could respond to this,one of the things that people sometimes ask me is well that can all change once people who have been sitting on the sidelines decide to put their house up on the market for sale, and won't that basically dismantle that favorable situation that we have now with the shortage of inventory, because now all of a sudden you will have a lot more existing inventory. My view on that would be that you are creating another buyer there as well, I was wondering if you could comment on how you think that kind of, as we evolve into that kind of market where more people feel comfortable putting their house on the market, how that will change the dynamics in the market?

I think it is exactly what you said it will create more buyers, but it will also bring it more back to normal. It is just not normal right now. It is just unreasonably tight. It can't continue to be this tight. And it will have to rebalance itself. I am not worried that prices go up 20%, and we are going to have an oversupply of houses, because everyone is going to want to sell. I don't see that coming, but significant price increases in markets like Phoenix, is going to bode well for us. Of course land is going up at the same or higher rate, and we are going to have to deal with that. And that is why we have been aggressive in the land market over the last several quarters, because it is only going to cost more in the quarters to come. But it is a little out of balance right now, and it is going to have to get rebalanced.

Okay. Thanks very much.

If I could jump in here for just a second. There was a question on sales percentage increases by month, and the February answer is mid-30s, is that February is up mid-30s percentage over the prior February.

The next question comes from Jade Rahmani of KBW please go ahead.

Thanks for taking the question, a quick one on backlog conversion. It has been in the 83% to 85% range the last few quarters. I just want to see if you think that is a reasonable expectation going forward, or if the strong recent orders should drive that ratio lower perhaps into the high-70s?

I think that is a distinct possibility, that it could drop into the high-70s. I would hope that would be the bottom. We are pushing hard but with the spike in sales activity, it might be a little harder for us to keep up with it in the short term, but I think over the longer term, we should be able to stay around 80%, if not better. We have sold more dirt sales also over the last couple of months than we have specs. And I don't know if we have a percentage on that Larry, but we were like 50/50, I think we might be down 40% specs. And that will also decrease the backlog conversion a little bit.

We are running in the 35% to 40% range now.

Right.

Okay thanks. And then I wanted to ask about the mortgage environment. One of your peers similarly does not have a captive mortgage company, and did experience some operating issues over the past year, there have been numerous changes in the market including several players exiting correspondent. I just want ed to see if any of these changes have caused you to reconsider how Meritage's position, and if you could just remind us how your sales offices are set up to help customers gets through the mortgage financing process, and if you have seen any changes in availability or tightness of mortgage credit?Thanks a lot.

Okay. We are absolutely committed to our mortgage model that we have, nothing has changed there. We haven't experienced any changes whatsoever over the last several quarters, a year. We have a few mortgage joint ventures, one large one with a company called Imortgage, based in Arizona, they do all of our mortgages in the joint venture, and California, Arizona, Colorado, and Florida, and they are also doing some now in Texas, and we have a couple smaller joint ventures in Texas as well. And those have worked very well for us, and we don't see any changes to that model. And as far as mortgage tightening it has really been about the same over the last several quarters. We haven't really heard of any real differences.

In fact on our Imortgage JV, our capture rate has improved. We are approaching a 90% capture rate it is between 85% and 90%. So we are very happy with the performance of that JV.

Thanks a lot.

Okay. Thank you, next question operator.

The next question comes from Alex Barron of Housing Research Center. Please go ahead. Mr. Barron your line is open, please go ahead with your question?

I am sorry, good morning guys how are you?

Good morning Alex.

I wanted to ask in terms of where you have been most successful in seeing the higher sales rates and in raising prices, is there anything that you have seen those communities have in common, are they kind of towards the lower end of the price range, or are they in the quote unquote A locations, or is that where the, I know for example like in Phoenix, there is overall tight supply but is that where there are submarkets where it is even tighter, is there anything that jumps out at you that what those communities might have in common?

Not in Phoenix. It has been across the board. We have a couple entry level communities, and some remote locations that are left over from years past, and we have been able to raise prices there, and get strong sales demand, and then the better locations the same. I mean, I guess the one thing I would say is the active adult business, we haven't seen the same increases and we haven't had really any pricing power in that market. But as far as the rest of the business, it has been pretty much across the board.

Okay. And I was in Phoenix recently and I saw some of your competitors were selling houses to investors. I guess people who couldn't find stuff in the resale market. What is your, I guess, thoughts on that and is that something you guys are doing as well?

By the way, I read your piece on Phoenix and it was very well done and I have been sharing it with a lot of my friends. But I have been hearing the same thing, and I have been very sensitive to that. And we have been checking in with our salespeople and our sales offices, and examining our backlog very carefully, and we may have a few investors out there, but we are trying to be really careful about that. There have certainly been lessons learned from the past dealing with investors, and we don't expect to repeat those mistakes, and we are making sure we don't have a lot of investors in our backlog.

Got it. And my last question, maybe this is one for Larry. Larry in terms of it seems pretty obvious this is your bottom in terms of probably your last quarter you guys will lose money, and you should start to see some pretty good leverage going forward. Any sense on the timing of when you guys expect to get back to DTA?

We still think it is sometime in 2013, depending upon how the next few quarters go. It might be earlier. It could be later. We don't have complete clarity from our auditors on that at this time, and it does depend on several factors and there is a lot of judgment involved.

Got it. Okay. Thanks guys.

Thank you.

The next question comes from Susan Berliner of JPMorgan, please go ahead.

Hi this is actually Rich for Sue. Quick question, it seems like just given the increase in demand, you guys are a little getting more aggressive in the land market. Can you guys comment on what we should roughly expect for land spend this year?

Larry what do you think?

Sure, this last quarter we were running in the, including development costs including about the $75 million range, and previous quarters have been a little lower, more down in the $55 million or $60 million range, so I would think that you will see that little incremental $5 million, $10 million, $15 million per quarter higher run rate over the next few quarters.

Yes, I think it will be at least $75 million a quarter going forward. I mean I hope it is not going to be less than that.

Great, thanks guys.

The next question comes from Joshua Pollard of Goldman Sachs, please go ahead.

Thanks a lot for taking my questions guys. First one is on normalized gross margins, Steve or Larry, what in your view are your normalized gross margins, and can you talk about the path to getting there as you guys made some comments to some earlier questions about increased labor and increased construction costs. I am just wondering how you all and the group reset higher, closer towards whatever you believe normalized margins are?I generally assume 20% to 22% but I love you all's view?

Alright 20% is normalized gross margin for us. We are at 17 and change right now, and the way we are going to get there is through more pricing power. Number one, and number two, continue to manage our costs, our direct construction costs, and then lastly leveraging the little bit of construction overhead that is in there, and I think we can get there over the next couple of years, and certainly if the market continues in the direction it is going right now, giving us more pricing power that is going to happen. But I can't tell you precisely how long it is going to take of course.

I would add too that the other side of the equation is growing revenue, so you leverage your overhead, and there is a balance there and certainly at this point we are focused on growing volume too. So we don't want to increase price too fast, and slow volume growth down, so it is possible that you could grow gross margin faster at the expense of revenue growth, and I think we are balancing that to really leverage our overhead.

Given what is going on in Phoenix, are your gross margins there above normalized already?

Not yet. Above normal?

Yes.

I would say they are approaching more normal. I mean, again it has only been a couple months we have really been able to raise prices, so very little of that if any has flown through the income statement. It is going to start flowing through over the next several months as we start to close some of these houses. I do think margins are going to improve certainly in this market, and northern California the margins have done a complete 180 over the last few months. We had some difficult real difficult margins up there, and they have, with the pricing power we have had there, they have improved dramatically. So we are just going to have to wait and see.

I know this may be a little bit of a stretch, but I wonder what your outlook is in your markets on foreclosures?There have been a number of things. There were a number of moratoriums last year. Is there niacin on your part about a wave of foreclosures hitting your market, such that some of the nascent pricing power that you currently have gets squelched a bit?

Joshua it is going just the opposite, everything I am hearing is supply is dwindling, foreclosures are declining, and investor appetite is enormous, and there are literally fights breaking out on the courthouse steps between investors trying to get these foreclosures, and bidding wars, because the average buyer just cannot get access to these units and the supply has declined dramatically. If anything I think as prices are rising, lenders I expect would be even more careful about wholesaling out these units, these foreclosures, and trying to recover more from them on sales. So I think it will only get tighter. I am not worried about the supply increasing.

The price point of the foreclosures is much, much lower than new homes, and they are in much inferior locations, and they are a much inferior home because of deferred maintenance. So they are become less and less direct competition to new homes anyway.

Thanks guys, I really appreciate it.

Thanks Josh.

Excuse me, this is the operator, is there time for one more question?

This will be our last question operator.

That will come from Jay Mccanless of Guggenheim, please go ahead.

Good morning everyone. I apologize if I missed it what was the spec count in the quarter?

Spec count is 535 total specs right now.

Okay. And then I wanted to ask the competition question a different way with all of the supposedly large funds that have been out there buying foreclosures and going to turn them into single family rentals, are you seeing that competition hit yet, do you expect it to be more pronounced in certain areas, and what effect do you think it is going to have on pricing power?

Number one I am not seeing a lot of funds getting foreclosures, maybe aspirations of buying pools of foreclosures, but I am still hearing that most of the foreclosures are being bought by mom and pop investors, and private groups, and groups of investors, non-institutional investors, and as I said previously, this just doesn't have an impact on us. They are, that is the supply of foreclosures is tightening, and we don't compete with them to begin with, because on a large part they are generally much more toward the entry level part of the market, and there are more of them are in C locations where we don't build. And we are seeing less and less impact from them every day.

Okay. And then my other question with the increase that you had in the orders this quarter, how do you expect closings to progress through the year? Do you think you will probably see the peak during the second quarter or third quarter this year, rather than the fourth, or do you expect this to be a normal year in terms of seasonality for your closings?

I think it will be relatively normal due to seasonality, although the numbers I expect to be higher. We are going to close a lot more homes in Q2 than we did in Q1, and I expect that to allow us to be profitable on an operating basis, we have to deal with the loss from the bond transaction, but I do expect that we are going to be able to significantly leverage our overhead this next quarter with the higher volumes, and make us profitable certainly on an operating basis.

Okay.

Where that peak occurs depends on how strong second quarter sales are. If it continues to be real strong you might not see it fall off at the end of the year at all, it might just keep going. It is just too early to call.

Okay. Great. Thank you.

Okay well thank you very much everybody. I appreciate your participation in our call today, and we look forward to talking to you again after our second quarter. Have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.