Meritage Homes Corp (MTH) 2013 Q1 法說會逐字稿

Good morning, and welcome to the Meritage Homes' first quarter 2013 earnings 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, please go ahead, Sir.

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

Turning to slide 2 of our presentation, our statements during this call and the accompanying materials contain projections and forward-looking statements which are the current opinions of management and subject to change. We undertake no obligation to update these projections or opinions. Additionally, our actual results may be materially different than our expectations due to various risk factors and for information regarding those risk factors, please see our press release and our most recent filings with the SEC, specifically our 2012 annual report on Form 10-K. Today's presentation also include certain non-GAAP financial measures as defined by the SEC and so to comply with their rules we have provided a reconciliation of these non-GAAP measures in our earnings press release.

With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; and Larry Seay, our executive VP and CFO. We expect our call to run about an hour and a replay of the call will be available then on our website within an hour or so after we conclude the call. It will remain active for 15 days. I will now turn the call over to Mr. Hilton to review our first-quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone to our call today. We had an all-around positive first quarter. We continue to achieve significant gains in virtually every key metric we have targeted and across all of Meritage state during the first quarter of 2013. Home closures increased 39%. Average sales prices on home closings were up 17% -- I'm sorry, average sales prices on closings were up 17%. Home closing revenue increased 62%.

Our home closing gross profit margin increased 230 basis points year over year and 60 basis points sequentially from the fourth quarter to 19.5%. Commissions and other selling costs were down 150 basis points. General and administrative expenses were down 130 basis points. Interest expense was down 210 basis points. The net effect of all these gains resulted in diluted earnings per share of $0.32, a 47% improvement over last year's $0.15 per share loss.

Turning to slide 5. In addition, we increased both our community count and orders per community. We generated 35% more orders in total that in the first quarter of 2012 and ended with a backlog value 89% higher than a year ago. I believe our strong performance is due to sound strategies and operational execution, as well as healthier market conditions, as this is the second year in a row that the spring selling season has gotten off to a strong start, but our eighth consecutive quarter of year over year order growth. We believe that job growth in many of our markets is creating demand and buyers are being pulled into new homes due to relatively low inventories of used homes listed for sale. Current homeowners are also taking advantage of low interest rates and high affordability to move up.

All that demand is pushing prices higher. However, homes don't sell themselves. You have to have the right locations, attractive designs, competitive prices, and a compelling presentation to win sales. We have put together all of those elements of success, as many of you saw demonstrated during Analyst Day last month. I'm very proud of our people and what they've accomplished. We've been an aggressive buyer of land in some of the best locations in our markets. We opened 24 new communities in the first quarter to replace the 14 communities we sold out during the quarter, ending the quarter with 168 communities, the most we've had in almost four years.

If our pace of orders keeps up as we are projecting, we'll sell out of more communities than we plan to open in the second quarter, so we may end June with flat or slightly slowly active community count. However, we expect the total to grow again in the second half of 2013, ending the year with about 185 active communities. In addition to increased community count, our pace of orders increased to 9.5 per average community for the quarter, a 27% increase over last year's average of 7.5, even as we raised prices in many communities, which we believe points to desirability of the Meritage Homes communities. The net result was a 35% increase in total orders with an average sales price 25% higher in the first quarter of 2012 and total order value increase of 69% year over year. Those gains are also against fairly difficult comps, as our first quarter 2012 orders were up 36% over 2011, and Meritage reported among the highest order growth in orders per community in the first quarter last year. We are pricing our homes and limiting the number of lots we are releasing for sale in some communities to better manage our order volumes relative to our production capacity and to maximize our profit from those communities.

Turning to slide 6. We grew orders, closings and backlogs in every one of our states year over year, with increase in orders per community and average prices in most. Orders have accelerated over the last year, and we are at quarterly levels now that we haven't seen in most states for many years, back to 2005 or earlier in some cases. Despite having 22% fewer communities open on average in the first quarter of 2013, California's orders were up 68% over 2012, with a 27% increase in average sales price, for 113% increase in total order value. Inventory is extremely tight in California, down to two or three months in many -- most of the markets, and affordability is still high though prices are rising rapidly. Florida achieved a 58% orders growth and a 30% increase in ASP for 106% increase in total order value. We are now the largest builder of single-family homes in Orlando and are building our business in Tampa.

Colorado grew orders 55%, combined with a 21% increase in ASP, for an 87% increase in total order value. We have communities in some of the highest growth areas around Denver, and our new and exciting product designs and energy efficiency is resonating well with buyers in that market. Arizona posted 28% orders growth and a 28% increase in ASP, for a 64% increase in total order value. Phoenix continues to be a hotbed of activity and prices have risen considerably in the last year, yet homes are still very affordable relative to income levels. Texas grew at a slower pace, generating a respectable 9% increase in orders, with ASP's up 11%, for a 20% increase in total order value for the first quarter of 2013.

Our overall ASP for the Company was up 25%, primarily due to faster growth in our highest priced states, California, Colorado, the Carolinas and Florida, where our average prices are $380,000 to $425,000 or more compared to an ASP of about $260,000 in Texas. Those four states made up 45% of our first-quarter orders in 2013 compared to 37% in 2012. We have sold out of Las Vegas so we will cease operations there except for ongoing warranty support after we close the 21 homes in backlog. We have grown our Carolinas operation significantly in the last year since opening at the end of 2011 and now have a solid presence in that market. We ended the first quarter with 11 communities and 69 orders compared to four communities and 33 orders there a year ago, as we are just beginning to ramp up operations. Over the last 12 months, our newer Carolinas market produce more than twice as many orders as the Nevada market that it replaced.

Turning to slide 7. We ended the quarter with over 21,000 total lots under control, 22% more than a year ago and slightly higher than where we started the first quarter. We are being aggressive but prudent in our acquisitions of land for new communities. We invested approximately $75 million in land development during the first quarter of 2013, putting approximately 1,600 new lots under contract. We expect to ramp that up quite a bit through the remainder of the year, based upon a healthy pipeline of potential new positions and expect to invest up to $600 million in land development for the full year 2013. With that, I'll turn it over to Larry to review a few other highlights of the first quarter. Larry?

Thanks, Steve. Moving to slide 8. Due to high demand, a greater percentage of our orders have been dirt starts rather than spec homes and more are larger -- are more upscale homes that take longer to build. So our cycle times are elongating. As a result, our conversion rate declined to 71% from 83% year over year in the first quarter, and it may continue to come down a little more before stabilizing. With that conversion rate, we were produced a 62% increase in home closing revenue and a 230 basis point pick up in our home closing gross margin during the first quarter, generating an 83% increase in gross profit dollars. Excluding interest amortized and cost of sales, our home closing gross margin improved by 260 basis points to 21% in 2013 compared to 18.4% in the first quarter of 2012.

Our commissions and other sales costs increased at a much slower pace than revenue. They were up only 36%, while our general and administrative expenses increased just 34% compared to our 62% increase in closing revenue. Interest expense decreased by $2.2 million or 2.1% of first-quarter revenue in 2013 compared to 2012, as we capitalize more interest to inventory under development. As a result of that leverage, our pretax margin increased by 710 basis points year over year to 4.9% in 2013 compared to a negative 2.2% in 2012. After reversing most of the valuation allowance against our deferred tax asset in the fourth quarter last year, we began to record a tax provision this year, even though we won't be paying cash taxes, as we've offset them with our deferred tax assets.

The tax provision for the first quarter of 2013 also includes approximately $2.1 million of net tax benefit from tax credits for the energy-efficient features in our homes closed during 2012 and the first quarter of 2013 due to a tax law change that became effective at the beginning of 2013. We are expecting additional energy tax credits during 2013, which we estimate will reduce our effective tax rate to approximately 34% for the rest of the year. We began breaking out financial services revenue, expenses and operating profit in our operating results statement this quarter for additional disclosure, even though the amounts are relatively small. It includes our share of net earnings from unconsolidated mortgage joint ventures, as well as revenues and expenses of our title operations.

Slide 9. Turning to our balance sheet, we ended the year with $453 million in cash and cash equivalents, restricted cash and securities, compared to $277 million at March 31, 2012. The March 31, 2013, balance was reduced by $83 million this month after retired the remaining amount of our $100 million 7.731% notes due in 2017, which follow the issuance of $175 million of new 4.5% notes due in 2018. We will record a related loss on early retirement of debt of approximately $3 million in the second quarter, which will reduce our diluted EPS by approximately $0.05. Our net debt to capital ratio at March 31, 2013, was 37.6% compared to 38.1% at December, 2012, and 40.4% a year ago at March 31, 2012. With that amount of cash and our moderate leverage ratio, we believe we have the adequate capital for additional growth.

With that, I'll turn it back over to Steve before we begin Q&A. Steve?

Thank you, Larry. Last month, Meritage received the EPA's Energy Star 2013 Partner of the Year Award for sustained excellence for our innovation and contributions to energy efficiency and environmental protection. We just took that step further with something we introduced on Monday, Earth Day, 2013. We built two homes in our Sedella community in Goodyear, Arizona, using seven-inch thick insulated concrete panels to replace the need for field building insulation house wrap under stucco black paper and window casements. The panels arrived on a small truck, precut and assembled by the factory, and were unloaded by hand that morning.

One crew erected the walls for both the homes in just one day, completely insulated with all the necessary penetrations and window casings complete. The panels are heavily insulated and structured with steel and concrete, making the homes more precise, stronger, and more durable. Additionally, advantages include the termite proof, rot proof, mold proof, watertight, air impermeable, healthier, quieter, safer, and super energy-efficient. We plan to do additional research to evaluate our future use of this product after we complete the prototyping phase, but it looks promising at this point and we are excited about the potential opportunities for Meritage and our homeowners.

Turning to our summary. We are pleased with our results for the first quarter and expect we will continue to grow and increase earnings throughout the remainder of the year. There are many factors indicating that the homebuilding market continue to grow for at least the next several years, and we believe Meritage is well positioned to capture much of that growth. In this strong demand environment, we have shifted our focus a little bit more towards maximizing price and margin to drive profitability, as land and labor markets are more constrained. Based on our projections for opening new communities, coupled with a modest increase in average sales per community and higher sales prices, we are projecting approximately a 40% to 45% year over year increase in home closing revenue for each of the three remaining quarters of 2013. Assuming some additional improvements in margin, we are being impacted by rising construction costs and operating leverage demonstrated in our first quarter results, we would anticipate earnings per diluted share in the range of $2.20 to $2.45 for the year, representing approximately a 350% to 400% increase in pretax earnings.

Thank you for your attention. Will now open it up for questions. The operator will remind you of the instructions. Operator?

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Michael Reinhardt, JPMorgan.

Nice quarter. First question I had was on gross margins and appreciate maybe the difficulty of you getting granular to a degree, but I believe last quarter you talked about your hope or expectation to get to a 20% gross margin by the end of the year. I wanted to know if that is still the case, or if, given that at least relative to our expectations, your margins were higher than what we were looking for in 1Q, that you might think you'd be able to exceed that 20% number?

Well, I'm certainly a little more bullish about our margins this quarter than I was last quarter. We've been able to raise our prices consistently, particularly in the West, and we're getting a much better handle on our cost. So I believe that we will finish the year with at least a 20% gross margin average for the entire year and, by the end of the year, our gross margin should be above 20%. So I am much more optimistic about the direction of the margins than I was last quarter.

Also I believe you mentioned sales pace per community being -- from quoting your guidance -- modestly above -- a modest increase in average sales per community for the rest of the year. This quarter, you are up, I believe, solidly above -- we have a 27% average absorption increase versus a year ago. The comps do get a little bit tougher, I believe. But when you say, going from 27% to perhaps a modest increase for the rest of the year, are you still thinking double digit? Is it too difficult to say? Certainly the spring is unfolded pretty well so far.

Well, it's hard to put a number on it. I hate -- I wouldn't want to venture into a specific number, but I can tell you that we have opportunity in Texas particularly to increase our sales per community. I think that market continues to get stronger and our -- and we have better positions come in online later in the year and end of next year. So I'm feeling optimistic that Texas is going to help us increase our sales per community for the entire Company.

Just one last one if I could. Community count guidance? I apologize -- I just joined a little bit -- is there any update to that or reiteration in terms of your outlook by the end of the year?

We said that we expect to be flat or slightly lower for the next quarter, as we've sold out of some communities faster than we expected. But for the year, we expect it to be around 185 communities, which is slightly lower than we said last quarter, because we are selling out of some of these older communities faster than we expected and newer communities are taking a little longer to get online. It's not because of our inability to buy land or find land, it's just more about elongating cycle times and selling out of communities quicker.

Dan Oppenheim, Credit Suisse.

I was wondering if you can talk about that in terms of the communities, if we look at it in the west, you are seeing community counts are declining over the course of the quarter. You talked about what's happening overall. How are you thinking about that in terms of the -- where the new communities are coming online. Is it going to replace some of those in the west? Or is it more in terms of new communities continue to come on in the East?

I think it's both. I think we will bounce back in the west. We certainly blew through a lot of lots in California faster than we expected. It's really taken off out there. But we have a lot of new communities coming online, particularly in northern California, later in the year. And the same for Arizona. But the southeast is a big growth engine for us. As we ramp up, Charlotte, Raleigh, and Tampa, our community count should increase in all those markets, which will help us drive that top line community count number.

The second question would be in terms of the -- if you think about the cost side with some of the increases coming through. How do you -- if we try to adjust for mix in terms of what you are seeing, what do you think is coming through in terms of the -- on the pricing side versus on the construction cost right now in terms of overall?

I would say, I'm not sure if I'm answer your question correctly, about 50% of our price increases are giving way to cost increases. So--

That's helpful.

Yes. The remaining 50% is split between margin improvement and land pricing, land cost increases. So I believe our margins are up 230 basis points or so year over year. I think that's reflective of that metrics I just laid out.

I might add that, of the price increase of about 17% for the quarter, probably about two thirds of that is true price increase now versus mix. So that's improved as we [went about a] increased prices more so. So if you take two-thirds of that price increase and do the math, as Steve said, you can get back to that -- the margin improvement we are seeing.

Stephen Kim, Barclay's.

With respect to following up on this price mix issue, it sounds like going forward, you're going to be growing in some areas with a lower -- just from a regionally lower average price. So when you talk about prices being a little but more flat, I just want to make sure, are we talking about negative mix shift from just being your regional distribution, being offset by real price increases on a like-for-like basis?

I don't know that we said that prices are going to be flat. Larry, did you?

No, I don't think prices are going to be flat. I think prices are going to still go up, maybe the rate of increase will be a little more modest. And you're right, to the extent that Texas picks up a little bit. That may bring the average down just due to mix.

But we still see the rest of the country continuing to grow rapidly and I actually don't think the overall mix of Texas to the rest of the country is going to shift towards Texas. I think Texas will continue to shrink a little bit. It just -- it will grow a little bit faster but still be growing a bit more slowly than some of our other states. I don't -- I see average sales price continuing to go up because of mix and I also see it continuing to go up because we are continuing to raise prices.

I'd also add, I think appreciation is starting to accelerate more so in the southeast. It's been a little bit maybe behind the west. So I see prices getting stronger over the next year in those southeast markets.

Well, that's great. That's certainly what we've been hoping for. Thanks for that clarification on the price. Second question I had related to your metrics-based land acquisition program, which you described at length at the Analyst Day. I was wondering if you could help us understand where you may have deployed this system around the country where you are not already operating? And, how quickly it takes you to -- how quickly you can ramp up this system to help your purchasing decisions in a new market?

We are using it in every -- certainly in every market that we're in. It's helped us tremendously not only find land but underwrite land. I don't want to name specific markets, but we are looking at a whole list of markets that we are considering entering in some fashion over the next year. And we are using that intelligence to help underwrite the opportunities and find the best markets to enter and the best way to enter them and where there are niches and opportunities that we can take advantage of. So I definitely see growth on the horizon for us from markets that we're not in. In addition, as I've continued to say, we have these three new markets in the southeast that we are relatively small in and we need to get bigger in as quickly as possible. This tool can help us accomplish that.

Steve, it's relatively easy for us to go out and expand the data we buy to include new markets and we have done that. So we are using our proprietary programs to help us identify the better new markets and what sub-markets and lots that would be good to buy in new markets and making sure we are paying the fair price for them.

Ivy Zelman, Zelman and Associates.

Good morning and congratulations, guys. Pretty exciting to see your growth. Just to clarify and then I'll ask my question if I can separate. Your guidance last quarter was for order growth for 2013 between 20% to 25%. Is that still your target, Steve? Or are you pushing price a little harder so it is going to limit growth?

I think that's still our target, if not a touch better. But I think that's where we expect to be.

Now my question -- I appreciate the clarification. When we look at your product and your focus move-up, maybe you can help us. Is there for the Company a policy on including or excluding contingent sales? So you might actually write a contingent sales contracts but you just don't include it in your orders? That was the first question, assuming just to say what and how you do those. If you can answer that first for me, please.

We do not include contingent sales in our -- in the order numbers that we give out to the public.

Do you actually write them though and --

Yes, we do write them. We do write them but we don't record them in our sales counts.

So as you are writing them, maybe you can just talk to the trend in contingent sales right now, because we recognize that there is a lot more demand. Are you seeing a decline in your interest in writing them because you don't have to? And then I'll ask my next question.

No. I don't think there's been much of a change. I think we've taken a little different approach over the last several years. We vigorously qualify our buyers and run them through the mortgage company before we even write the contract. Whereas other builders might write the contract and get them on paper first and then really see how qualified they are and they would have a maybe a higher cancellation rate. Our cancellation rate is in some respects ridiculously low. I think maybe we are probably even -- we're too conservative on that front, because we don't write very many people up that we don't think are going to make it and maybe we could be more aggressive and choose our sales by pushing a higher -- (multiple speakers). But that helps us also with our margins, because we have less cancellations, which means we have less discounting, et cetera.

My next question for you, Steve, is one where just to relate to understanding the existing home market. Your buyers, for the most part, your move-up buyer has to sell a home. So would you have any way, with your analysis, to determine if they've already listed their house? Or are they, in fact, listing it once they determined that they love one of your homes. Is it a chicken and the egg? We're just trying to understand if the new home market can actually serve as the leading indicator to improvement in the availability of existing homes on the market.

That's a good question and I don't have the answer to. I think it's something I want to get my arms around. I know back in the go-go days of the mid-2000s, people were buying a home from us and then they were putting their home up for sale and they were selling it very quickly. There wasn't a lot of risk that they couldn't sell their existing home. For the most part, what we've seen in prior quarters is they sell their house first and then they come buy a house from us. If that's shifting or not, I don't know, but I will have answer to that for you by the next quarter. That's something we are going to take a deep dive into and look at.

Lastly, if I can sneak another one in. When you think about your pricing and I think Larry commented on, or maybe you did, the amount of offset to the pricing because of cost inflation. If you look at the expectations of margins going forward, is there any reason why we, as the analyst community should believe there is a cap on gross margins? As long as you're getting home prices inflation that's greater than -- let's assume your overall cost inflation won't -- is there no cap on the opportunity for gross margins. Mathematically, it makes sense to think about that it way but what would you say to that?

I wouldn't say there's a cap. But I would say it continues to be a balance between volume and margin. Certainly, like in the western states, we are focused more on margin than volume. But in other states like Texas, we're still pushing volume because our sales per community still aren't where we want them to be.

I appreciate that. I'm just saying generally over time. So if we were thinking about the Company, let's assume you're getting price across the board and you're getting the volume that justifies it, isn't there -- isn't it safe to say there's no reason to assume that if you hit your peak growth margins that that would be a limiting factor then? Because a lot of analysts are saying, oh, the companies are already at peak margins and therefore not necessarily you guys but in general. I was just curious on how we as the analyst community should be thinking about margins on a longer term, sustainable basis.

Well, I don't think margins have peaked by any stretch. I think they've got a ways to go. But I'd hate to pin myself down to a particular number. But I do think there is more upside in margins.

Thanks and congratulations again.

David Goldberg, UBS.

Nice quarter, guys. My first question, it's kind of in line with what Ivy was getting towards, But the question really is, obviously you guys do very, very extensive demographic studies. In doing so, do you think about some sort of affordability cap as prices rise? We're having rapid price increases. Obviously low rates are helping to fuel price increases. Do you get concerned at some point where homes are just less affordable for your buyer segment? And where do you think that might be relative to where we are?

I don't know what that number is. But that would be the number one metric that I'd be watching. Coming out of the last cycle, that was the metric we weren't watching closely enough. If we would have been watching it, we could've taken steps to avoid some of the carnage that we incurred in the last cycle. So we are looking at affordability in every market and every sub-market extremely -- every day, we are looking at that. That's this speedometer on our dashboard that we're chasing.

But that said, as much as prices have gone up, affordability is still at historic lows. Of course, a lot of that is because of interest rates. Sooner or later, rates are going to go up. So we have to be mindful of that and I think we are. That's why we are focused on more [ANB] locations than going into the outer markets.

I think the thing that people aren't really talking a lot about is that the entry-level business, at least from our vantage point, really hasn't recovered to the degree that the move-up market is. It will be interesting to see what happens out there. But affordability is the number one metric to watch and we still feel very good about it.

But suffice to say that in a rising rate environment and a rising price environment there is some sort of cap at some point?

Oh, obviously. As rates go up, you might see an initial flurry of buyers coming in that get off the fence because they want to get it before it's gone. But rising rates will slowdown demand. And we've got to be careful about that.

So, thank you for that. That was great color. Then, Steve, you've done a really great job and, Larry, you've done a great job in the past couple of calls talking about off-balance-sheet financing options, land banking, the market for options and, Steve, in your prepared comments, you talked about -- and I think Larry might've mentioned it -- having enough balance sheet to be able to really fuel growth and to fund growth in the future. I'm wondering if you can talk about, give us maybe some more color around how much you can grow, given the current balance sheet, given what's going on from an off-balance-sheet financing, land banking, seller-financed option kind of position? How big do you think you can get, given the current dynamics of the balance sheet?

I think we can get a lot bigger and we have a lot of liquidity, of course. And we have a lot of borrowing capacity. We certainly -- if we wanted to -- I'm not saying we -- that this is our plan, but we could go into the capital markets. So I think we have a lot of room to grow if the opportunities are there.

As it relates to off balance sheet, we did close our first land banking transactions with independent, third-party, quote, land bankers. These are people that do nothing but provide money for builders to control lots and they own the -- they have title of the lots and they sell it back to us at predetermined price, based upon an IRR calculation that we have mutually agreed to. We closed our first one or two deals this last quarter. We have several more that are in the queue to close this quarter.

I'd have $600 million of land buying and development planned for this year. We're budgeting between $50 million and $75 million of off-balance-sheet transactions, so it's relatively small, maybe 10% of our acquisitions in development. But we expect that number to grow and we see these guys coming back into the business, although there's going to be a lot less of them than there was before. But we see that as a way to help us continue to grow our business with additional capital that's not on our balance sheet.

Would you give us some kind of idea what kind of financing -- what kind of cost of financing that was for the land banking and maybe what that IRR hurdle was that you guys baked in?

It's less than 15%. It's in the low to mid-teens, 12% to 15%, that's kind of the numbers we're talking about, in that range.

Great color, thank you guys, very much.

Stephen East of ISI.

Congratulations, guys, as mentioned earlier, great quarter. Steve, as you look -- if we look at cost more broadly, just -- not only what you are seeing on the construction side going vertical, but also what you're seeing in land on a year over year basis and what that implies in your deals that you are doing, but also on your SG&A expectations you were running about 50% the rate of sales increase. Could you just look at those three buckets and tell us, one, what you're seeing on the vertical side and how much, but also land and where you think the SG&A will go?

Land continues to go up. I think that's the most pressure we're getting on our cost side is certainly on our land. Even though land is only approximately 25% of the house price, where construction cost is closer to 50%, there is much more price pressure on land than there is on construction. I do think we're doing better dealing with construction costs than we were a quarter or a few quarters ago. Were kind of getting our arms around that more and construction cost increases are starting to moderate. We're continuing to leverage our G&A. We're projecting SG&A to settle in at about 12.5% for the year.

Can you put some color around on the land -- on a blended basis, what you all are seeing across the country, and then also on the construction cost, just roughly what percentages you are seeing going up?

Larry, I don't know that we have that on land, do we?

No. Unfortunately, Stephen, these numbers vary from market to market. Sometimes we will see a cost increase in one market that will be more significant during a quarter and other markets won't have them. They kind of go in waves a bit. It's really hard to provide any definitive percentage increase. I guess I would go back to what Steve was saying earlier is of the true sales price increase we had this quarter, roughly 50% of it got eaten up in direct construction cost increases and about 25% of it was lost. So about 25% fell to the -- to improving gross margins. But it's hard to break it down any further than that.

Yes, I would say that if this helps you, Stephen, construction costs on average went up between 8% and 10% over the last year for us. I would say some markets were as high as 15% or 16%, and some markets were only like 3% or 4%. But for the company wide, the average was 8% to 10%. I expect it to be lower than that over the next four quarters than it's been over the last four quarters.

Steve, that's also as a percent of direct construction cost, it's not a percent of sales. Okay?

Changing gears, as these markets are coming back and you all are even able to do some land banking deals, et cetera, that probably implies that we're starting to see some funding for the smaller builders as well? Is that actually happening?

Yes, we are seeing more smaller builders, particularly in Texas, in the southeast. I'm not seeing as many of them getting a foothold in the west. I think these high land prices and I think the banks are still pretty tight out here in the west. I don't see them in Phoenix or in California as much.

Can I sneak in one more? You've talked about your new panel construction. Could you just run through that again and sort of what you all are -- what it gives you and that type of thing?

It's basically an all-in-one exterior wall for our homes. So instead of having to come out and frame it and then sheathe it on the outside with foam or plywood, it all comes in one piece and all we've got to do is pour concrete down the top of it. It goes up faster. It's a much better product, because it's -- the insulation is all included. It's more airtight. It's stronger because of the concrete and steel that's in it. It keeps out dust, keeps out bugs and other things.

So it's -- in my opinion, it's a revolutionary innovation in homebuilding. It has -- the technology has been around for a while. But builders haven't figured out how to do it in a cost-efficient way, where it can really compete with the stick framing and/or block construction that you see, particularly down in Florida. But, I think we have a vendor that we've been working with that's been spending a lot of money on R&D on this and has perfected the science of designing and building these systems that now it's cost-effective with conventional framing or block construction. We think this technology is going to accelerate and we expect to be one of the first national builders to be using it on a large-scale basis, provided that the research that we are doing pans out. I'm confident that it will and it's something you might see quite a bit in the next few years.

Would it be cheaper or would it just be more efficient and improve your cycle times, to build a more airtight home, that type thing?

Yes, I don't think it's going to be cheaper. I think it's going to be on par and I think it's just -- the customers going to get a better product, more energy efficient and all the other things I laid out and then it's going to help us with our cycle times.

(Operator Instructions)

Rob Hansen of DB.

Just a guidance-related question. You gave the revenue figure. What is the breakout going to be in terms of average sales price and then closings volumes that drives that revenue figure?

Larry, go ahead.

I don't know if we're ready to provide that. But Steve made a comment about sales, our sales guidance, last quarter, was kind of in the 20% to 25% range. I think our sales guidance remains in that and the closing volume guidance would be very similar to that, maybe a bit higher on a percentage basis. The rest of it is being made up in sales price increases.

You guys started breaking out the financial services income. I just wanted to see why you started breaking that out and should we be reading this as at some point you're going to have your own mortgage operations and move away from the joint venture?

No, I don't think you should read that into it. I think we just felt it was a clearer disclosure, so people could see the amount of, more or less, gross margin that's being driven from homebuilding and the margin that's being driven from financial services. We did start up our own title company, so now we have not only a mortgage JV but we have our own in-house title operation revenue too so we kind of thought it was -- we were at a point where it made sense to show people what that was separately rather than netting it all in Other Income.

Adam Rudiger, Wells Fargo.

I wanted to ask about -- Steve, you mentioned labor -- land cost inflation. I wanted to ask about how that compared to the home price increases you are taking now. I guess ultimately the question I'm asking is the land that you are signing up now, with the gross margin in that, how that compares to what you are currently delivering? I guess it ties into some of the earlier questions about caps on gross margins and where they can go.

Well, we are still underwriting the same gross margin, so if we can't realistically underwrite land with maybe a little bit of appreciation between when we buy and when we open it to a 20% plus gross margin, were not going to buy it. But again land, in most cases, is only 25% or less of the house price. So for house prices that are up 10% over the year, land prices effectively can go up 40% and we could still be in sync. I would say, in many cases, that's the case. Land prices have accelerated dramatically.

Second question, going back to, again, kind of a previously asked question. But orders per community, if I look back at 2003, 2004, you guys were doing even double the pace you're doing now. I was wondering if that's -- is that ever going to happen again? Or are you going to cap that more and really drive margins? I'm just trying to gauge expectations. Also could you comment on how widespread the allocating or limiting new lots is?

I don't know if it was double. I think at the peak of the market, we were doing 4.5 sales per community per month, which would translate to, what is that, 13.5 per quarter? We are at 9.5 right now for this quarter. So I don't expect to get back to that. But I do think we have a little bit of upside from where we are today for the reasons I outlined before, particularly improvement in Texas. Can we get back to 10 or 11 sales per community per quarter? Yes, probably.

I think I was looking at just the first quarter numbers when you had doubled that at certain points. Any comments on how widespread the lot allocations are?

I'm sorry, say that again?

Just wondering if you could comment on any -- how widespread -- in your press release and in your commentary, you talked about limiting the new lots that you are making available for sale. I was wondering how common that was.

Oh, I don't -- I think it's a small percentage of our total communities. It's California and Arizona.

Maybe a bit in Florida.

Yes, maybe it's 15% or 20% of our total communities that we have caps in place. But we have other communities where we are closely monitoring our sales to price increase allocations. But it's mostly in the west.

Joel Locker of SBM securities.

I'll be quick. Just on the -- on Phoenix, you mentioned, basically, that it's still much more affordable to buy than rent. But you've seen a 25%, say, appreciation in the last 15 months in home prices and probably flat in rent and with the abundance of the institutional investors coming online and trying to run out the foreclosures they've bought after fixing them up. Have you seen any slippage of the buyers? I guess the absorption rate's only up 14% year over year, say, in Phoenix versus some of the other markets or less so. Are you seeing a little bit of pressure from just rentals making a little more sense?

It's really apples and oranges, because the guy who's buying a $300,000 house from us is not thinking about renting.

Right. I was saying some -- maybe talking to some of the lower end, the $200,000 homes in Phoenix, maybe your lower-end product versus the --.

We just don't have that much of that. I was trying to allude into it on the call. I'm just surprised that some of these peripheral markets where there is more entry-level homes haven't been stronger. That said, I have seen DR Horton has a couple communities here in Phoenix where they are killing it. They're doing really well But I haven't seen that widespread increase in sales absorptions in the entry-level market. I'm not sure why. I think maybe it's just credit issues with those buyers.

But for us, as I said before, and I don't know that this is particularly pertinent to your question, but people aren't thinking, well, should I buy a $300,000 Meritage Home and get everything I want in the new home, or should I just continue renting for another year or two? I think it's just the opposite of that. People are saying, how can I not buy today? I buy a home for $300,000 and I put $30,000 down, I'm going to double my money in a year. Why wouldn't -- it's not a hard decision.

I guess that follows up. Do you think because of the three historical low mortgage rates that a lot of these entry-level buyers are actually move-up buyers because they're getting a 3.5% mortgage rate instead of a 7% mortgage rate?

Maybe, maybe some of that. Yes. We are seeing some first-time buyers that have -- are high-income earners. They're white-collar, they are plus or minus 30 years old and their first home they are buying is in the move-up segment.

Jade Rahmani, KBW.

How does your targeted land spend for the year break out between land acquisition and development. Can you, on the acquisitions side, give the breakout between owned and options?

Well, I think it's probably -- go ahead, Larry. No, go ahead.

In the first quarter, the breakout was about half and half between the raw developed -- or between land spend and development spend. I think you will continue to see that go forward. It'll be a much higher percentage than it was in the past. As far as option goes, Steve alluded that maybe we'll do 10% of our total land acquisition as a rolling option kind of a deal versus a bulk purchase. It's still -- the option is still a very small percentage, although we see that over the next couple of years improving or increasing significantly.

On the option deals you are looking at, are you seeing developers look to move beyond a fixed escalation clause and structure deals to include participation in future price appreciation if it's beyond the fixed inflation rate? (multiple speakers).

Some in California maybe. But outside of California, we're not -- we wouldn't be entertaining those types of arrangements.

It's really only in these very, very nice, large master-plan communities in California that you see that much.

Alex Barron, Housing Research Center.

Congratulations on the quarter. I wanted to ask you folks a little bit more on SG&A and operating leverage. You commented that -- if I get this correctly, you commented that you thought revenues would be up about 40% or was it deliveries that would be up 40% the rest of the year?

Revenue, we said, would be about 40% to 45% for each of the next three quarters of 2013.

You said you thought the SG&A would be about 12.5%. So should we think about that number more in terms of dollars, what you're thinking? I guess what I'm trying to figure out is you did break out the -- you guys break out the commissions versus the G&A. I'm trying to figure out is the $19.7 million in G&A some sort of a more of a fixed number? Should I think about it more that way? Or is that going to grow because you're adding headcount?

Obviously, our overhead is growing and we are adding headcount. So you are going to see that number go up. As we were talking about, it's not going up at anywhere near the pace of revenues. So you should -- that's where you are seeing the majority of the basis point improvement, is holding G&A down. On the other hand, there are some components in selling cost we are holding down too. So we are getting some leverage there but not as much. Most of that 100 basis point improvement from that -- we are at the first quarter going from like 13.5% to 12.5%. Most of that's going to be coming from G&A and a portion of it, a small portion, from other sales costs.

I guess if I put it another way, if your revenues were to be higher because prices are higher or you can close more homes and/or your margins are higher, we should see perhaps better than what you are saying?

Correct.

Another question that I've been getting a lot from people is everybody seems to be afraid that the cost increases are run away and you guys have talked about that. And other people are saying, well, land costs are going up. Where do you see -- or what would need to happen for margins to start to get compressed and when do you think that would happen? Would that be a 2015 kind of thing? And would it only happen if home prices basically don't keep up?

That's a hard question to answer. I do think construction cost increases are going to -- are moderating. At least we think that for us they are. We don't think those are going to run away. I think builders are controlling their sales pace. It helps that. I think land prices, in some markets, have kind of peaked already. I don't think builders can continue to pay some of these ridiculous prices for land in some markets. We're just going to have to see over the next year or two. I don't -- I can't forecast a timeframe for when margins will start decelerating.

Will Randall, Citigroup.

Part one is color. I'd like to get some color on your elongated cycle times that you talked about. Is it just a longer land development or is it also driven by higher utilization of the labor force, particularly in Phoenix?

I think it's just taking longer to get houses built, particularly in many of the western markets, slightly longer. And, of course, new communities are taking longer to get open, because there's not enough plan checkers that are reviewing these plans in different cities and towns. It's taking longer to get them through the cities and some of the contractors that build lots are getting backed up. Just things -- as business picks up and gets stronger, things are going to take a little longer.

How should we think about that in the balance -- basically balancing between metering the sales pace, pricing and potential appraisal issues.

We are not seeing a lot of appraisal issues right now in the move-up market. It's not one of my major concerns. I think our conversion rate is still pretty high, 70% plus. It was 50% in the -- at the top of the last cycle. I think we are still quite a ways above that and I'm hoping to be able to hold it near that number.

Great quarter, by the way.

Jay McCandless, Sterne Agee.

First question I had, going back to the land banking that you were discussing. What impact should we expect on gross margins from those arrangements?

Very little because it's still a very small piece of the pie. We're only doing it on communities where we think we got better than average margins, so we can absorb that extra cost. But I certainly wouldn't say Meritage is getting back in the land banking business so their margins are going to be lower. I don't see that being the case at all.

Second question, cycle times now versus where they were at the last peak?

I don't have that number in front of me. But I've been more focused on the backlog conversion number. Seven -- I think we were 71% this quarter and I expect we can keep it there for the next few quarters.

Final question is Susan Berlinger, JPMorgan.

I'm sorry my question was answered. Thank you.

Thank you very much for participating in our call today. We'll look forward to talking to you again next quarter. Have a good day.

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