Meritage Homes Corp (MTH) 2012 Q4 法說會逐字稿

Good morning, and welcome to the Meritage Homes fourth-quarter 2012 conference call. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions).

Please note, this event is being recorded. I would now like to turn the conference over to Brent Anderson, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Rocco. Good morning, everyone. I'd like to welcome you to our conference call today. Our fourth-quarter of 2012 ended on December 31, and we issued a press release this morning with our results before the market opened. If you need a copy of the release or the slides that accompany our webcast today, you can find them on our website at www.investors.meritagehomes.com or by selecting the Investors link at the bottom left of our home page.

Slide 2 of our presentation refers you to our Safe Harbor language. Our statements during this call and the accompanying materials contain projections and forward-looking statements which are the current opinions of management and subject to change. We undertake no obligation to update these projections or opinions. Additionally, our actual results may be materially different than our expectations due to various risk factors. For information regarding those risk factors please see our press release and most recent filings with the Securities and Exchange Commission, specifically, our 2011 Annual Report on Form 10-K and our more recent 10-Qs. Our 2012 10-K will be available by the end of February.

Today's presentation also includes non-GAAP financial measures, as defined by the SEC, and to comply with their rules, we have provided a reconciliation of those non-GAAP measures in our earnings press release. With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; and Larry Seay, our Executive Vice President and CFO. We expect our call to run about an hour, and a replay of the call will 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 fourth-quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone to our call today. We are starting on slide 4.

We finished 2012 with very good results overall. Our orders, home closings, revenue and margins were up, and we leveraged that growth to deliver earnings of $0.63 per fully diluted share, even before our $72 million dollar tax benefit, that increased our net earnings per share for the quarter to $2.49. Our pretax income improved each quarter throughout 2012, and reached its highest level since the first quarter of 2007. We achieved another quarter of strong year-over-year growth in orders, closings, and backlog. Our sales remained brisk through the end of the year, with only a 9% sequential decline in orders, less of a seasonal slowdown than we would normally expect in the fourth quarter.

Prices continue to rise in most of our markets, and our average sales prices increased even more due to our mix shifting more towards move-up homes in higher price communities and states. Our team did a great job of capitalizing on the general resurgence in the home -- in home demand, and increased our 2012 sales by ensuring that we had well-located land for new communities in high demand areas, designed and introduced exciting new plans into most of our markets, and successfully demonstrated the benefits of our industry-leading, energy-efficient homes. I'll highlight a few of our fourth-quarter sales statistics. Home orders increased 46% over 2011, when combined with an 18% increase in average selling price. The total order value increased 72%. This was our seventh consecutive quarter of year-over-year growth in home orders.

Our average sales price nationally climbed to $323,000 for orders in the fourth quarter. Our average orders per community increased 43% over 2011, and our cancellation rate decreased to 13% from 19% a year ago. Even with a 39% increase in closings, our order growth drove our -- any backlog up 61% in units, and 93% in total value, reflecting a 20% increase in the average sales price of homes in backlog.

Turning to slide 5. All of our markets were effective in increasing sales for both the fourth quarter and the full year of 2012 over 2011. California and Arizona showed the greatest growth year-over-year amongst our largest markets. California grew sales 154% for the fourth quarter and 146% for the year over 2011. We had an 11% increase in average price there for the year, so California's total order value was up 172% year over year. Arizona posted a 46% sales growth and a 7% increase in average sales price, for a 57% increase in total order value for the full year. Colorado and Florida followed with full-year 2012 sales growth of 32% and 31%, respectively. Colorado sales surged 78% in the fourth quarter, ending the full year up 32% over 2011. ASPs grew 10% for the year in Florida, and 4% Colorado. So Florida's total order value increased 44%, and Colorado's increased 38%.

Texas grew orders 10% for the year, despite an 11% decrease in average active communities in 2012 compared to 2011. And average prices increased 3% in Texas, where prices have been more stable than other markets over the last six years. Our new Carolinas markets grew throughout the year, and added a significant number sales to our total orders and closings, but their year-over-year comparison is not meaningful yet, since 2012 was the first full year of operation. We have been very pleased with our initial success in Raleigh. Our full-year sales per community increased year-over-year in every major market for 2012.

We finished the year with 158 actively selling communities showing sequential growth, though not quite where we thought we would be at year-end, due to some delays in obtaining permits, as well as continued strong sales that led to many communities to close out ahead of plan. However, we have been acquiring and opening larger communities as we have been selling out of smaller ones, so we should see less turnover in 2013. We've adjusted our current plan to project approximately 190 total active communities by year end 2013.

This takes us right into the next slide regarding our lot position. And that's slide 6. Based on a better-than-expected growth in 2012, and our expectations for additional growth in 2013 and beyond, we invested approximately $175 million in land and development during the fourth quarter of 2012, and grew our total lot supply by 3,000 lots. That brought our total cash investment for the year to approximately $480 million in land and development spending, including the purchase of approximately 9,000 lots. Coincidentally, that's about the same number of lots we put in our contract during the year, even though we have not purchased all of those lots yet. We ended the year with approximately 20,800 total lots under control, an increase of 4,100 lots over year-end 2011, for a total of 16,700, and equivalent to about five years of lot supply based upon 2012 closings.

With that, I'll turn it over to Larry to review a few of our other highlights for the quarter and the full-year results. Larry?

Thanks, Steve. Please turn to slide 7. Our strong sales earlier in the year translated to a 39% increase in fourth-quarter closings, and a 48% increase over 2011 in home closing revenue. In addition to the increased closing revenue, our fourth-quarter gross margins increased year over year, resulting in a 74% increase in fourth-quarter home closing gross profit, or a 50% increase, excluding impairments in both years. Our adjusted gross margins excluding impairments were 19% in 2012 and 18.8% in 2011. Additionally, excluding interest, amortized, and cost of sales, gross margin improved by 60 basis points to 20.5% from 19.9% last year.

The sales price increases we are getting for our homes are largely being offset by industry-wide increases in various cost components. Most of our earnings leverage came from holding SG&A expenses down relative to our revenue increases. Commissions and selling expenses decreased by 120 basis points year-over-year, to 7.4% of home closing revenue in the fourth quarter of 2012, compared to 8.6% of home closing revenue in the fourth quarter of 2011. Additionally, our general administrative expenses decreased by 230 basis points year over year, to 4.9% of total revenue in 2012, compared to 7.2% of total revenue in 2011. Although we did have about a $2 million in insurance recoveries in the fourth quarter of '12, so G&A would have be closer to 5.5% before that benefit.

Interest expense decreased both in absolute dollars and as a percentage of revenue in the fourth quarter of 2012 compared to 2011, as we capitalized a greater portion of interest incurred to assets under development. The net effect was that our fourth quarter 2012 adjusted pretax income increased by $22 million, from $2 million in 2011 to $24 million in 2012. Our diluted earnings per share of $2.49 were impacted by the dilutive effect of convertible notes that we issued in 2012. I can walk you through the details of the mechanics off-line, but the net effect of our convertible notes on diluted shares was an additional 2.2 million shares for the fourth quarter, and 600,000 shares for the full year of 2012, which impacted diluted earnings per share for the quarter in the year by $0.14 and $0.04, respectively.

Moving to slide 8. Our strong order growth we achieved throughout the year drove our total 2012 orders for their highest point in five years, and translated into much higher closing revenue and earnings during 2012. Full-year 2012 home closings increased 30% and closing revenue grew by 38%, as compared to 2011. Home closing gross profit increased 48% over 2011, and our home closing gross margin, excluding impairments, improved by 30 basis points to 18.5% from 18.2% in 2011. As with the fourth quarter, our full-year pretax earnings and improvement was mainly due to leveraging overhead. Our total SG&A was 13.7% of 2012 revenue, compared to 16.2% of 2011 revenue, a 250 basis-point improvement. We've got another 150 basis points of earnings leverage from interest expense, which dropped to 2% of revenue from 3.5% from last year.

Moving to slide 9. We indicated earlier in the year that we expected to reverse our valuation allowance against our deferred tax assets by early 2013, and we accomplished it in the fourth quarter of '12, ahead of plan. Based on our improved results and our expectations for a continued recovery in the homebuilding market, we determined, based on our projections, that we should be able to use most of the deferred tax assets to offset future income taxes within the statutory time limits. We reversed $79.9 million of our deferred tax valuation allowance and used $8.4 million for our federal and state tax provision in the fourth quarter of 2012.

The net tax result was a tax benefit of $71.5 million for the quarter. Of course, that means beginning in 2013, our net earnings will include a provision for income taxes at our normalized effective tax rate of approximately 37%, with some minor adjustments that could affect it one way or the other. We still have about a balance of $8.7 million of deferred tax valuation allowance, which relates to couple of states. The deferred tax assets net of valuation allowance at December 31, 2012 totaled $78 million.

Turning to slide 10. A few highlights on our balance sheet. We ended the year with $295.5 million in cash and cash equivalents, restricted cash and securities, compared to $333.2 million at December 31, 2011. We raised $87 million of additional capital through an equity offering, and another $122 million from the issuance of convertible senior notes, due 2032, which increased our total outstanding debt to $722.8 million at the end of 2012. We also secured $125 million credit facility during 2012, for additional liquidity that had no amounts drawn on the facility through December 31, 2012. Our net debt-to-capital ratio at December 31, 2012 was 38.1%, compared to 35.8% at December 31, 2011, and our earliest debt maturity is in 2017. With that, I'll turn it back over to Steve before we begin Q&A.

Thank you, Larry. All in all, 2012 was a much-improved year for the housing market in general, and an even better year for Meritage. We were pleased to finish it out with strong fourth-quarter results. While 2012 was the second year of growth in the US new home sales since they bought them in 2010, and the highest number of new homes we started since 2007.

The absolute level of starts is still far below the historical average, indicating abundant opportunity for continued growth. We believe that the recent reported declines in national existing home sales statistics are due to lower inventories rather than decreasing demand. Assuming the conditions remain favorable for the housing market, we believe that we can grow sales by 20% to 25% in 2013, with a combination of growth in active communities and somewhat higher average sales per community. We entered 2013 with significantly higher backlog, lot supply, total assets, and stockholder's equity than we had at the end of 2011, and we believe that we have sufficient liquidity to grow as the housing market continues to recover.

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

We will now begin the question-and-answer section.

(Operator Instructions).

Michael Rehaut, JPMorgan.

Thanks. Good morning everyone, and nice quarter.

Good morning, Mike.

The first question I had was on your last slide, the expectations for '13 in terms of the community count and order growth. The math on the 190 expected by year-end would point to a 20%, so just don't know if that's just being conservative with 15% to 20% in terms of timing of opening the communities. If you could comment on that. And also the order growth, basically only 5% better than the community count growth, which suggests -- I would assume just a fairly conservative view on what you think you can do in terms of improvement of absorption pace. Given what I think everyone expects is for the market to continue to improve in 2013. Nicely, if that's just being conservative in an area of upside?

Yes. That is a good question, Mike. But we're still in January. And naturally, at this point we are going to be somewhat conservative as to what we project for the year. But we do believe we will get growth from both community counts and average sales per community. That said, we will grow our community count over the next couple quarters, but I think a lot of our community count is going to come in the back half of the year. Therefore, we are not going to get a tremendous benefit out of it, but we will definitely get benefit from additional communities. I think that we're just -- overall, we're just being a little bit conservative and we want to see how things develop. I would say, I'm very pleased with January. Without giving you specific numbers, because we're just finishing it off today. It was a good month, and it exceeded our internal expectations.

All right. I appreciate that. And then in terms of the gross margins. You did 0.2% expectation of improvement in -- for 2013. I just wanted to know if that would also include expectations of improvement, let's say from the back half of 2012 as well? Which I think most people would expect, given at this point it appears that improvement in price is still outpacing, more than offsetting, an improvement -- cost inflation?

Yes. We've said for the last couple quarters that we expect to finish 2013 with a 20% gross margin. We still believe that that's the case, and we are going to progress -- our gross margins should progress throughout the year to that number. We are expecting incremental improvement in every quarter for the year. Larry, do you want to add anything to that?

Yes, Mike. I might add, on the incremental improvement. We have normal seasonality in the business, so typically our first quarter closings is the lowest quarter, and we do have fixed components in construction overhead. I think the first quarter sequential margin improvement will be rather modest, with more of that happening in the second, third, and fourth quarter.

Okay. So, that getting to 20% by the end of '13, that's a little bit bolder than your competitors in terms of willing to put a number on that. I assume that is just based on what you have in the pipeline and the communities that are being rolled out?

That is correct.

Great. Thank you.

Nishu Sood, Deutsche Bank.

Thanks. I wanted to ask about the land purchases have been making. Obviously, you picked up or control 3000 lots in 4Q. You also said something interesting that you are going to be pursuing larger communities so there will be less sellouts. Or, I'm sorry -- less closeouts. Larger community-wise, is that just a reflection of the higher absorption pace? In other words, obviously, if absorption is double then you need a twice-long a community, or lot supply, to have the same years of supply. And also, on the lots that you are purchasing, how far out in terms of community openings are you planning right now? Are these new purchases for '14 and '15? Or are they sooner than that?

Sure. Good question. For the last couple of years, a lot of what we bought was distressed finished lots that we purchased from lenders and people like that. And we were buying 30, 40, 50 lots, the remnants of a lot of communities that we went in and finished, that we were getting at very distressed prices. Earlier this year, we did not see those opportunities. Those opportunities have been declining. We've been more focused on buying entitled, but undeveloped, lots.

If we are going to go out and develop some lots, we are going to be looking to develop larger communities of 80, 90, 100, 150, maybe 200 lots. It doesn't make sense to go out and develop 30 or 40 lots. It is too much brain damage, too much work to do a small number of lots. As the distressed lots have burned off -- the availability of distressed lots burned off, we have been focused more on larger development opportunities. To the second part of your question, there's not many lots we can buy today that we are going to develop and have them hit our 2014 -- or 2013, I should say, income statement. Most of what we are buying at the moment right now in the first quarter, is going to hit 2014 and beyond. There may be a few exceptions, but generally speaking, we have everything tied up and under development or open that we're going to be needing to meet our 2013 plan.

Got it. Great. That is a great answer. And the second question, I wanted to ask about the cancellation rates. They have been looking great the past few quarters, below probably what you might consider normalized at 13%. My question is, what do you think is going to happen to that going forward? Maybe an odd way of asking it is, would an increase in the cancellation rate be a good thing in a recovery? Because the lower cancellation rate indicates real conservatism on the part of buyers. Would you prefer maybe a little less conservatism and people more fully buying into the housing recovery -- your customers coming through your communities?

I don't put a lot of stock in that number. We ask ourself a lot, well, maybe we're not selling hard enough. We should have a higher rate. I think it's just we are doing a better job of prequalifying our buyers. You burn up a lot of overhead and a lot of wasted time and energy when you sell a home to somebody who's really not qualified and maybe doesn't really have the desire to complete the transaction.

I think we're just doing a better job on the front end, which is driving -- drove the cancellation rate down. It might in reality be higher than that, because maybe we have people that have an interested buyer, and they don't make through the contract process because they do not qualify. But again, we've moved our business more into the move-up business and less into the entry-level and first-time move-up than we were a year or two years ago. That means we have a more qualified buyer with a lower cancellation rate.

Okay. Thank you.

Thanks.

Ivy Zelman, Zelman & Associates.

Congratulations, guys, on a great quarter. Steve, just to make sure I fully understand what you're saying regarding your margins and what you can do for 2013. To clarify, is any of that contingent on home price inflation, or is it really a function of mix and desirable positions, and maybe any changes you've made that are allowing you to provide some cost savings. If you can answer that first, then I'll come back with a second question?

Well, we're certainly expecting some inflation. But, it's not completely contingent on inflation. I think what we are going to -- we have a lot of internal initiatives in place to better manage our costs on the construction side, which we believe are going to come to fruition in 2013. We also have a lot of new communities opening that we are very bullish on that we expect to deliver high margins -- higher margins, because we bought these in 2011 and early 2012 at very good prices. And we think those great land buys are going to translate into higher margin. There is a lot of things that we're doing internally that give us confidence that we are going to achieve that 20% gross margin.

And just to follow on that. The acquisitions that you're making now in lots that you are going to be assumingly delivering in '14 and beyond, are you underwriting those with inflation? And assumingly not inflation -- are you achieving in your underwriting a 20% gross margin or better on those acquired yet to be put into the machine?

Well, we underwrite everything to a minimum of 20% gross margin. And we put a contingency in there through internal interest calculation, so that if our -- if we have some modest cost overruns, we can absorb that. But, regarding inflation, I think it depends on upon what market you're talking about. Certainly, in some of the western markets, we have to include some modest amount of inflation or we would not be able to buy any land. But it's not enough to raise an eyebrow, and I believe the inflation numbers are low single digits. I think it's reasonable to expect that, particularly in the West. We're not underwriting any inflation at all in Texas, as that market is not rising nearly to the degree of some other markets.

Very helpful.

Ivy, if I could add to that. Could I add that?

Yes, please.

Most of the time if we are factoring a little bit of inflation and it is in a long-term contract, say, in Phoenix, where we have a very good current lot supply, so we are looking at more 2015, and we've tied up a property that maybe needs a little entitlement work. So, we have a soft deposit. We're doing entitlement work, and that is more of the case that we'd factor in a little inflation, because we're doing some zoning and entitlement work that adds to the value, while also the closings is out farther. And we have almost a free look, to some extent, for the first six months, nine months, or a year while that's going on.

That is very helpful.

Does that make sense?

Makes a lot of sense. I lastly would ask you, Steve, if you could tell us with your footprint across very ideal markets, which market would you say you're most excited about in terms of the nearer-term and intermediate opportunity? Obviously, Texas being your largest, but is there one that just jumps out at you right now that is the most exciting?

That's hard to say. I am excited about all our markets. We have a tremendous franchise here in Phoenix. We bought a lot of lots in 2011. I'm excited about what those are going to produce for us this year and beyond. We've done really well in northern California. We have grown our business tremendously in Colorado. We're going to be a top three or four builder in that market, if not better. Orlando continues to be strong for us. We are a top three builder in that market.

I'm real excited about the Carolinas. We have not got much yet out of Charlotte. That is going to come through this year. Tampa, we just got a new president there. I have got a lot of confidence in him and what he's going to be able to deliver for us and how we're going to be able to grow our land position there. And in Texas, we've got some great new communities coming on in Houston, and in Austin. I'm excited to what they're going to do for us in '13 and '14. I'd hate to just --.

You're excited about everything. I'm excited (multiple speakers).

I can't pin it on any one market, but there's a lot of good markets right now in homebuilding that are going to have an impact in this year and beyond.

Thanks, Steve.

Sorry if that sounded like a advertisement

Thank you

Dan Oppenheim, Credit Suisse.

Great. Thank you. Was wondering if you can talk a little bit -- you talked about the -- some of the land buys recently that will bring higher margins? Wondering also about your sales strategy to bring higher margins in California. It looks like you're selling at above pace of four per month, and if you could forward, the land supply doesn't look that long. Just wondering how you're thinking about that in terms of taking the sales there versus trying to push pricing a bit more in those communities?

We had a breakout year in California. 150% growth in orders. We're not going to have that in 2013. But we have restocked the shelves in California. Those stores will open later this year and into next year. I think it will allow us to continue our growth there. I'm not sure what you're looking for the first part of your question about the land purchases?

Just was wondering more that if the -- if you got effective less than two years of land in California looking ahead, and you're selling it over four month. Why not slow that down a bit and push the price of it more and get the margin that way?

Yes. I think we're doing that. Our margins in California, particularly in northern California, have been quite strong. We've been very cognizant of that. We know we have a shorter land position. We have a lot of land in our pipeline that has not shown up yet. I'm very confident that we will continue to build and grow our business in California in '13 and beyond.

Dan, I might add, too, that this last year we have talked about the leveraging the SG&A more, and have said that we really plan to get more dropping to the bottom line by growing revenue and less focus on a price. But, as our volumes have picked up, we're pivoting a bit, particularly in places like California, where we are now focused more on pushing price than pushing volume. We are refocusing -- we are still, obviously, focused on both, but the strategy is now switching more to price from volume.

Our margins in northern California particularly are very high. They're significantly higher than the company average.

Okay. Thanks.

David Goldberg, UBS.

Good morning, everybody.

Good morning, David.

My first question -- Steve, I thought it was very interesting the comments about not seeing the seasonality as much as you might have expected in December. And I'm wondering, if just from your conversations that you're having, do you think there's any reason to think that there's less seasonality in the business at this point? Or do you think just the trajectory has changed and we'll see normal seasonality as we go into the selling season?

I think it's more the trajectory. I think there's going to be seasonality going forward. But, there is a real increased desire to buy a home today due to the rising prices and low interest rates. And I think the short inventory is creating some urgency. I think that is why we are not seen the typical seasonality. But at sometime it is going to come back. Maybe not so much in '13, but in the years to come I'm expecting to see seasonality again.

Great. Just as a follow-up question here, on the new land that you're buying, are you finding that the larger parcels going away from the distressed property where you had to buy it straight out and now going to the bigger properties, it might take more development work? Are you finding it easier to buy those with options versus having to buy them outright? Is there any change the sellers' willingness to do options versus straight sales?

No. There's very few options available. There is literally none in the West. We are finding a few in Texas and in the Southeast, but generally speaking, most everything we are buying today is cash and carry. We're not taking entitlement risk. But we have to pay cash.

Okay. Thank you.

Joel Locker, FBN Securities.

Hello guys. I wanted to check on the G&A, which was -- it was nice -- I guess, lower than expectations, and what do you see going forward? Obviously, only up $100,000 year over year based on the revenue growth.

Larry?

Yes. As we said before, that number was -- appears lower than the normal run rate because we had a pick-up in an insurance recovery, which affected the number of $2 million. I think going forward, we got to not look at $17.7 million as being the number, but something $2 million higher than that. Obviously, there is some -- certain things get accrued throughout the year at different points. It is typically a little bit lower in the first part of the year. Maybe part of that increase would not be as prevalent in the first quarter and you might see a little bit more increase towards the back end. But, as I said, the number was more like 5.4 % or 5.5%, if you adjust for the insurance reserve.

Right. And then the community count. How many communities do you plan to open in 2013? If you have anything initially for 2014?

Larry, what's the -- do we have those numbers? I think --.

Yes. Go, ahead Steve.

No, you go ahead.

Well, we are going to open well over 100 communities during the year. They are pretty well spread out throughout the year, but as Steve said, there is a few more oriented towards the back half. I don't have the specific numbers right in front of me today. But it is well over 100.

Right. And just one last question on investors in your western markets. Have you seen that change in the last two or three months? Based on competitors or what you're seeing there?

We are selling very few homes to investors.

Right.

Were --.

I'm saying, just in general, from peers, or on the existing side, or just the prevalence of investors in those markets versus, say, three, six months ago?

The only thing I'm -- well, we have not seen investors buying our homes at all over the last two or three years. But I am hearing that at some entry-level communities in the West, there are some investors buying homes. But I do not think it is that significant. I think they are more focused on the resale market than they are the new home market.

Right. Thanks a lot guys.

Okay. Thank you.

Stephen Kim - Barclays

Great, guys. Thanks. Good quarter. Most of my questions were answered. Two larger picture questions for you, Steve. You guys are one of the few public builders that has the opportunity to over the next several years really grow into new geographies. A lot of the other builders are already fairly national. I was curious as to whether or not as you look back over the last couple of decades, if there is any particular lessons learned that you think will encourage you to do things a little differently, in terms specifically of expanding, maybe financing that expansion? Or staffing it?

Well, we made at about nine acquisitions from 2000 -- or, sorry, 1997 to 2005. We learned a lot from those acquisitions. Some of them worked out extremely well and some of them worked out quite averagely. There is a lot that we learned from that. As you know, the last three markets we entered -- Raleigh, Charlotte, and Tampa -- we did it organically.

We are much more focused on our culture today than we were 10 years to 15 years ago. That's not to say that we will not be making acquisitions going forward. It is certainly a strategy that we are very much interested in. But it has got to be the right fit and the right market at the right price. We do have our eye on a handful of markets we would like to be in, either through organic growth or by acquisition. We will just have to see which opportunity presents itself that's better suited for the company.

Okay. Second question relates to innovation. One of the things we've seen over the last few years is a significant price premium that new homes are getting over existing. I think that some of that relates to some of the -- pretty marked improvement in house construction technology. You guys have been at the vanguard of that, I would say, with marketing the energy efficiency of your homes. And I'm curious as to whether or not you feel that that has significantly more room to run in terms of distancing you versus your peers? Or whether you think that the first mover advantage you've had on that is largely peaking? And then secondarily, if you think there's other kinds of innovations? For example, Lennar with their nex-gen type product. And there -- I assume are some other things. I was curious if you could comment on your outlook on other innovations like that?

I think there's still a lot of innovation left in housing. I think we have a lot of tricks left in our bag that we think are going to be well received and exciting. But we do not want to unveil those all at once. Number one, we have to make sure the cost benefit makes sense and that we can do them in a cost-effective way. But, I think there is a lot more to come that will increase the gap between new homes and resale homes.

We think there is still a lot left in the energy efficiency area. We are prototyping and piloting several innovative ideas in that area. We expect to roll out some this year. I think that is one way we can differentiate ourself as a company, as a industry -- amongst the -- from the resale market. You've got to remember, the new home market is still a very small piece of the entire housing market. In order to grow that percentage, we have to show value, and we can do that through innovation.

Great. Thanks a lot.

Thank you.

Hey, Steve. If I could jump in here for just a second. A more specific question on community openings. We expect that somewhere around 110 to 115, and then closeouts of around 80 or 85, netting to that 30- or 35-unit increase over year over year.

Community increase.

Yes. Community increase, right.

Next question, operator?

Jade Rahmani, KBW.

Thanks for taking the question. Can you comment on where you expect the average price to come in for 2013? Both your average order price and price in backlog were above $300,000 in the quarter and I wanted to see if you thought you could average above that for 2013?

Give us a second. I think we're --

Yes. We have not provided a specific number. But I definitely think we're going to be north of $300,000.

Okay. Thanks for that. Just a follow-up question. The shred between your average order price or average price in backlog and the average sales on closings has been increasing the last few quarters, and I wondered if you could discuss the drivers. For example, is it a function of different cycle times by market, or lower spec sales, or moderating backlog conversion rates?

Correct me if I'm wrong here, Larry, but I think a majority of the increase in ASP is mix. Getting more sales out of our higher-priced markets, particularly in California. And then, less than a majority is coming from just pure price increase.

Correct. We had about a 7% price increase this quarter, and less than half of that was true price increase. Maybe 3% is true price increase and 4% is more mix-oriented.

Okay. Lastly, is there any adjustment that's made to the price between the time an order is counted as a sale and when the actual home is delivered?

Yes. Sure, to the extent the buyer buys upgrades and options. After we signed the initial contract, the price will rise.

Thanks a lot.

Adam Rudiger, Wells Fargo

Steve, I wanted to go back to your comments about buying some bigger land parcels because it's a little easier from an underwriting perspective and causes less of a headache. If you were to -- when we asked some of the more land-heavy companies in the middle of the downturn what some of the lessons learned, it might have been that they were getting -- they were buying too big of a land parcels because it was easier to do. I was just wondering -- recognizing you're on a different scale when you're talking about 150 to 200 lots, potentially, to what they were doing. But if we look at your lot count mix right now, versus the peak, it's exact mirror in terms of real heavy on owned and very few optioned. I was wondering what your thoughts were on the risks associated to that in the cycle? And also if you think this is a permanent shift in your company, or will you be an optioner again?

Well, believe me, all was not lost on what happened in the last cycle. We would have rode through the downturn in a much smoother fashion if we would have just stuck to the -- our principles, but what happened was we got involved in some very large land deals. And I'm talking -- when I talk about very large, I'm talking about over 1,000 lots that we shouldn't have. We increased our risk there.

When I talk about larger land deals today, I'm not talking about anything like what we got involved in in past cycles. We also got involved in these large joint ventures, particularly in Las Vegas, with a lot of other builders that caused significant impairments, so we're not do that again, as well. 100 lots, 200 lots, 300 lots is a far cry from 1,000- to 2,000-lot deal that we invested capital in the last cycle. We're not do that. When the option market comes back, and there is some rumblings out there that certain people are getting back into the land banking business, then if the prices are reasonable, we are going to take full advantage and we will try to option more lots. Just as we did before. But at the moment, there are just -- are not any really available.

Okay. I want to go back to some of the comments that were in the press release, where it says that -- it sounded like, we were taking some pricing, but you mentioned that those price increases were being offset by material and labor and costs. Some of your other peers that have reported this week seem to suggest that they were getting a better spread difference there. It was -- one of my thoughts was maybe, given your footprint, and you're in some more highly competitive markets and maybe seeing some more elevated cost pressures than some of the more diversified builders. So I was wondering A -- if you thought that was a correct interpretation, or B -- if not, what was the differences?

No. No doubt. You are right on the money. The markets that have the highest price increases and the highest sales increases are going to have the highest cost increases. It is not because the materials cost any more in those markets or labor costs any more, it is just that the contractors can get it because there is fewer of them and they are driving these increases. A builder like us is in 14 or 15 markets is not as diversified as others that are in 35 or 45 markets, and may not experience the same cost pressures across the board. So, yes. That is the issue, but that said, we're going to do a better job in 2013 to mitigate those cost increases by expanding and diversifying our subcontractor base and other measures we think that will help us keep our costs in line.

Okay. Thanks for taking my questions.

Thank you, Adam.

Stephen East, ISI Group.

Good morning, guys. Steve, how comfortable are you all with your balance sheet leverage? You're at 38% now. I guess I am interested in where you're comfortable taking it. Given you all are somewhat unique in that you grew through -- in the boom through land banking and then in the bust, you've really taken all the land onto your balance sheet. How you look at it today, your preferences there? And then, how close is the land banking market to being able to utilize that at a reasonable cost for you all?

Over the long, long term, I prefer to keep our leverage where it is today. But in the short term, I am comfortable taking up into the mid-40%s, if opportunities present themselves that require us to do that. But I also believe that a year from now there will be some land banking going on in a meaningful way, and we will be able to take advantage of that, and that will help us with our growth. Like I said, there is a lot going on behind the scenes in the land banking world. But nothing has really happened yet, but I think it will. One of the greatest lessons learned from the downturn is how companies manage their debt. We do not know how long the cycle will be, but we'd certainly know now it's a cyclical business. We have to manage our balance sheet accordingly.

Okay. I've got a different question, but just following up on that. You were something like 90% option and 10% loaned. One -- do you feel like getting back to that level makes sense, or is it a more balanced approach? Then the other thing I was just -- you talked about sustainability of growth in California. Similar -- if you could give a similar comments on Colorado, and then just an update on the Phoenix market, given all of the moving pieces there?

I think the land banking met -- the numbers are kind of academic. We couldn't get back to the 80% or 90% optioned if we wanted to because it is just not available.

Okay.

Ask me that question a year from now and I'll -- and maybe my answer might be different. But I cannot forecast something that is not there. Or not available to us. If we get to a fraction of that in the next couple of years, I would be happy because today there is just very little land banking opportunity.

Okay.

We've gone back into Sacramento. We've made some significant purchases there. We think that market is going to be good. We were pretty much shut down there, excepting for a couple stores. We have a lot of new stores opening there. I'm really bullish about what that's going to do for our northern California business. We have got our first communities opening in Orange County in the next quarter or so. And Rancho Mission Viejo -- I am excited about that.

We have been very aggressive in Colorado. We have several multi-product line communities opening, particularly in the northern part of Denver. This year we just opened one that's called Leyden Rock. It is off to a really good start in the northwestern part of the Denver market. Phoenix just continues to be a very strong market. We have a very diversified geographic footprint here between the East Valley and West Valley. Very much squarely focused on the move-up market. Like I said a couple times before, we made a lot of good land buys in the back half of 2011 and early 2012 that we think are going to pay solid dividends for us in this year and beyond.

Okay. Thank you. Are you metering sales in Phoenix right now?

A little bit. Not much. In a few East Valley communities, yes, but not in all communities.

Okay. Thanks.

Thank you.

Will Randall, Citigroup.

Thanks for taking my question, and a great quarter. I wanted a little bit more color on the lots piece. Maybe I missed it in the slides, but curious where your class D lots stand. I think last quarter was around 1,500. In addition, it looks like you increased your lots in California by 800. Was that more northern? I guess that is my first question.

Larry you want to take the class D? I don't know.

Sure. We have not bought any lots in class D markets, so that number is going down. It probably hasn't gone down a whole lot, but it's certainly dropping. And what was the second half of the question about lots in California?

Yes. Looks like you guys increased your count by 800 lots in California quarter over quarter. I imagine that is a lot of northern California, but I'm just curious if you're burning out on southern California. You mentioned, in particular, Rancho Mission Viejo, which, obviously, is Orange County, if I remember correctly. Could you go through that piece on lot mix in terms of where you're growing in California?

Well, more so northern California than southern. But with that said, we have a strong push on to acquire more lots in southern California and grow our base there. But, in 2012 we certainly bought more in the north than in the south.

Okay. Then just my follow up. I was hoping you could talk about the merchant builder model, because I found it quite interesting that you guys generated some of the highest returns in equity over the last cycle, as well as stock returns. And really, it's just trading off higher asset turns for a bit lower margins. Can you talk about your philosophy today on that?

This is what we've been talking about in the previous call and before the with the rolling options. A lot of those high ROA numbers were a byproduct of our ability to buy lots on a rolling option. Going forward, we hope that will return and we'll be able to do some more of that, but at the moment, there is not a lot of that available. That said, I think we're going to be able to grow our earnings as good or better than everybody else because of the markets that we are in and because of the land that we have and our overall company strategy. I think ROAs are going to become a little bit more pedestrian in this cycle than they were in the last, just because the off-balance sheet opportunities just are not available

Appreciate the time, and great quarter.

Thank you.

Jeremy Pinchot, Gilford Securities.

Thanks again for taking the call. Good job on the quarter. Absolutely. Most of my questions have been answered for sure. A little more detail potentially on cost inflation versus price increase? Do you guys have the numbers on a square-footage basis for that?

I do not think so. Larry?

We do not provide those. There is a lot of issues with measuring construction costs, because people change the spec level of a house, so you can have the same plan, but maybe you've taken some stuff out, so it looks like the cost per foot went down, or you added stuff in. So it looks like it went up. So it's very hard for us to give out publicly those kinds of numbers and give anybody any relative sense about what is really going on. So we tend to speak in terms of yes -- this is how much of the price increase was mix versus real price increase and how much of the percentage was offset by cost increase. As we've said earlier in the call, about 3% of the 7% increase was driven by true price increase. A great majority of that 3% was offset by cost increase of one kind or another.

Do you break out that one kind or another by lumber, labor, or give any sort of color on how we might look at that?

Steve, do you want to answer that, or do you want me to do it?

No. Go ahead, Larry.

Sure. What Steve said earlier, a lot of it comes through in the form of labor, but is not necessarily the people working in the field who get a higher price. Sometimes it is that, but a lot of times it is just a higher markup that the owner of the business is driving in order to increase their profits. That's the labor component of it, and certainly, that's probably the most significant piece of it. The other pieces of it -- we are seeing lumber increases, drywall increases, and concrete increases as the three major building components that have had the most inflation.

Okay. Great. Thank you. That is helpful. A quick follow-up to a previous question. Any update on how you feel your energy efficiency marketing sales pitch is resonating with buyers? Has that started to gain more traction?

Yes. I think it is resonating quite well because if you look at our average sales per community, it is quite strong amongst the move-up builders. I think that is because of our energy efficiency, and our ability to pull buyers from the resale market. We are quite pleased with what we've been able to achieve with that strategy.

And you're still communicating the cost savings that they get in one of your homes versus an existing home? Is it -- (multiple speakers)?

Absolutely. We spend a lot of time training our sales people on how to sell that. We have a new generation of a learning center that we are going to be rolling out in our 100- plus new communities this year that we think people are going to really be blown away by. It's a very cool demonstration for people to see all the energy-saving features that go into the home. And for them to be able to quantify the savings means to them. If you cannot sell it, it doesn't make a lot of sense to put it in. We're really focused on how we communicate that to the customer.

Great. Thank you very much. I appreciate it. Again, good job in the quarter.

Thank you.

Alex Barron, Housing Research Center.

Good morning, guys. Great job.

Hello Alex.

I wanted to ask you, Steve, if you could -- I guess you guys are probably the closest and most knowledgeable about the Phoenix market. I just wanted to get your take on what you're seeing there? What you expect for this year? At the end of last year, it seemed to me like the market was taking a little bit of a breather after a strong start at the beginning of last year. And then I went to a forum where lots of participants said they were expecting a 50% type of increase this year. Just kind of wanting to get your take?

I don't know if we are going to see 50% this year, but I think we are going to see something that is not too far from that. Clearly, the East Valley, Southeast Valley in particular, the Gilbert, Chandler, Mesa area is very, very strong. I don't think it's really abated that much. We have got a couple new communities opening -- we've opened there recently. We are metering out sales because we have waiting lists for -- of buyers.

We have open communities in the in the west side that have also been successful. I'm not seeing the same swell of activity in the peripheral markets -- in Buckeye, in south Goodyear and Maricopa, that we are seeing in the more closer end markets, but that said, those markets are improving as well. To the extent that we have communities in those areas, they are going to contribute to our 2013 results. It has cooled off a little bit, but it is still very strong, and it is still better than other markets.

Okay. Thanks. I wanted to get your -- if you've had any change of heart about exiting Vegas and any other markets that you're planning to enter this year?

No. No change of heart on Vegas. We are looking at some other markets. Whether we will enter one this year or not, I don't -- I cannot tell you. I really do not want to comment on what those markets are.

Okay. Last one -- are you guys seeing an increasing amount of people coming from -- who have been renting foreclosures and coming back to buy houses from you guys?

Yes. That is a substantive part of the buyer pool today. We continue to be quite surprised how many people there are that know precisely when they get out of the penalty box. They want to get right back into the housing market and buy a new home. We are seeing quite a few buyers that fit the profile.

Any sense of a percentage of your buyers that fit that?

Maybe around 20%.

Okay. Thanks.

Okay. Thank you very much. That will wrap up our comments for this call. I appreciate everybody's participation. We look forward to talking to you next quarter. We are hoping that 2013 is going to be a great year. Thank you very much.

Thank you very much, sir. The conference is now concluded. We thank you all for attending today's presentation. You may now disconnect and have a great day.