Meritage Homes Corp (MTH) 2013 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Meritage Homes fourth-quarter 2013 earnings conference call. All participants will be in a listen-only mode.

(Operator Instructions)

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

(Operator Instructions)

Please also note today's event is being recorded. At this time, I would like to turn the conference call over to Mr. Brent Anderson, Vice President of Investor Relations. Sir, you may begin.

Thank you, Jamie. Good morning, everyone, I would like to welcome you to our analyst conference call today. Our fourth-quarter 2013 ended on December 31, and we issued our 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, you can find them on our website at investors.meritagehomes.com, or by selecting the Investors link at the bottom of our home page.

If you look at 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 from the expectations due to various risk factors.

For information regarding those risk factors, please see our press release and our most recent filings with the Securities and Exchange Commission, specifically our 2012 annual report on Form 10-K, and our more recent 10-Qs. Our 2013 10-K should be available by the end of this month. Today's presentation also includes certain non-GAAP financial measures as defined by the SEC, so to comply with SEC rules, we have provided a reconciliation of these non-GAAP measures in our earnings press release.

With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes, and Larry Seay our Executive Vice President and CFO. We expect our call to run about an hour and our 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 the call over to Mr. Hilton to review our fourth-quarter results. Steve?

Thank you, Brent. Welcome to everyone on this call and thank you for your interest in Meritage Homes.

We will start on slide 4. 2013 was the second year of a recovery in the housing market, and homebuilding continued to be a significant driver of the economic growth for the United States. Household formations grew, as more buyers demonstrated their confidence in improving economy and employment trends. We expect those trends to continue, which spells opportunity for us and the homebuilding industry in general.

Capitalizing on those positive market trends, we successfully executed on several key initiatives for growth in 2013 and beyond. We broadened our geographic footprint by entering the national market, a top-15 market for home-building activity through the acquisition of a highly regarded local builder. We further expanded our Southeast region, growing our positions in Raleigh, Charlotte, and Tampa markets, that we entered a couple years ago, and more than doubled our combined annual sales from those markets over the prior year, resulting in greater diversification.

We grew our active community count to 188 at year end, 19% more than we had a year ago, and slightly ahead of our expectations earlier last year. We achieved strong double-digit growth in units prices in total dollar values across orders, closing the backlog. In fact, our total order value and closing revenue reached their highest levels in more than five years, and total value of our ending backlog was equal to approximately 40% of our total 2013 home-closing revenue.

Additionally, we raised approximately $280 million through notes offerings to further strengthen our balance sheet and provide additional capital for growth. We invested approximately $565 million in land and development and contracted for more than 11,200 new lots during the year. We ended the year with approximately 25,700 lots, or a five-year supply, not including homes under construction or completed at year-end. All that positions us well for additional growth this year and for years to come.

Slide 5. Our fourth-quarter 2013 results capped off a strong year for Meritage Homes. We delivered year-over-year increases in home-closing orders and backlog, both in terms of units and total dollar value; expanded our margins considerably; and leveraged overhead to drive accelerated earnings growth.

Our fourth-quarter 2013 home closings increased 18%, and average prices on closings rose 24%, which drove a 47% increase in home-closing revenue. Total order value increased 17% year over year for the fourth quarter, as orders were up 3% and average prices rose 3% over 2012. It was our 11th consecutive quarter of year-over-year growth in orders, and we are encouraged by the fact that our orders increased month to month during the quarter and year-over-year comparisons also improved each month, even before the addition of orders from our new national division. Ending backlog was up 43% in total value, with a 26% increase in units and a 14% increase in average prices.

Slide 6, home price increases and cost efficiencies contributed to our 430-basis-point increase in fourth-quarter home-closing gross margins, expanding to 23.2% in 2013 from 18.9% in 2012. With that, gross margin gain and our increased home-closing revenues, we produced an 80% increase in our fourth-quarter closing gross profit over last year.

In addition to the increase in home-closing gross margin, additional operating leverage contributed to our fourth-quarter pretax margin, increasing 570 basis points to 12.2% of total revenue in the fourth quarter of 2013 compared to 6.5% in 2012. We picked up 60 basis points through a decreasing commissions and selling expense to 6.8% from 7.4% last year. Another 30 basis points came from a decrease in G&A to 4.6% of closing revenue and a 110-basis-point drop in interest expense from 1.5% in the fourth quarter of 2012 to 0.4% in 2013.

Comparing our fourth-quarter net income in 2013 to 2012 is more difficult, due to a large tax benefit in 2012. We had a $91.3-million swing in the provision for income taxes, due to a $71.5 million net tax benefit in 2012, compared to a $19.8-million provision for income taxes in 2013. Which resulted in net earnings of $46.1 million in the fourth quarter of 2013, compared to $95.1 million in 2012. The tax benefit in 2012 was primarily due to the reversal of a majority of our deferred tax asset valuation allowances.

Turning to slide 7. Orders per community were down from 2012 in both the third and the fourth quarter of 2013, partially due to a slowing in the rate of growth for the market as a whole, and partially due to our conscious decision to raise prices in some communities where we were still selling far above our expected levels. By raising prices, we increased our total order value and margins, and we partially offset the lower orders per community by our growing our community count also.

The net effect was the total order value continued to grow, despite fewer sales per community, and our home-closing revenue gross profit increased at an even greater rate. We expect to continue to grow our community count and expect that the sales pace will pick up again, as the spring selling season gets underway this month.

Turning to slide 8. Looking at the west region. We grew our total order value and backlog value across the board in every state except California, where our total order value was down 24% after selling out of communities faster than we could replace them in California for most of 2013. We managed to increase our active community count there during the fourth quarter, and it was up 11% over 2012.

California is the best example of where we raised prices aggressively to intentionally slow the sales pace or the pace of sales. Though they still had the highest orders per community of any of our states, 8.5 in the fourth quarter of 2013.

We also increased our community count and home prices in Arizona, so orders were up 3% and total order value grew 10% year over year, even though orders per community were down 4%. The same was true in Colorado, where our community count was up 30% year over year, more than offsetting a 16% decline in orders per community, and increased our Colorado orders by 9% year over year in the fourth quarter. Total order value increased even more due to the higher average prices.

Looking at our central region or our Texas region, our central region is represented by Texas, which achieved positive comparisons in all metrics for the fourth quarter of 2013 versus 2012. Orders were up 12% due to an 8% increase in communities and a 5% increase in orders per average active community. In addition, ASPs rose 22%, which resulted in a 37% increase in total order value. We believe we still have a lot of opportunity in Texas, and we are looking to further grow our position in Texas this year.

Looking at the east regions, we have been growing our east region by expanding into new markets and opening more communities. We produced the largest increases in that region compared to others. Florida still made up 58% of the east regions fourth-quarter order value, though we more than doubled our community count in the Carolinas and increased total order value by 169% year over year.

With our growth rate there and our recent addition of the national market, our total east region active community count grew by 68% year over year for the fourth quarter, driving a 38% increase in orders, despite fewer orders per average community. Total order value for the east region grew 57% for the fourth quarter, as our ASPs also increased by 13% year over year.

Our overall strategy to grow our earnings is to increase our home-closing revenue and further leverage our overhead expenses, while maintaining margins at or above our targets. We are doing that by opening new communities in our existing markets, where we have a high degree of confidence that we will achieve our targeted sales pace, prices, and margins, and supplementing that by expanding to new markets that have good growth potential, as we did through our acquisition in Nashville and our earlier start-up divisions in Raleigh, Charlotte, and Tampa. We have proven our success in executing that strategy.

With that, I will turn it over to Larry to review a few of our other highlights for the fourth quarter. Larry?

Thank you, Steve. Turning to slide 9. We reported net earnings of $124.5 million for the full year of 2013, which included a $53.2-million provision for income taxes, compared to 2012's net income of $105.2 million, which included a net tax benefit of $76.3 million, primarily due to the reversal of most of our allowance against deferred tax assets in the fourth quarter of 2012. Our income before taxes increased 506% year over year, mainly due to a 24% increase in closings and a 21% increase in average closing prices, which drove a 51% increase in home-closing revenue; a 360-basis point improvement in home-closing gross margin, or an 80% increase in home-closing gross profit; and a 160- basis-point combined improvement in selling plus general and administrative expenses, demonstrating our operating leverage. We also reduced our interest expense by $9.2 million, or 120 basis points, from '12 to '13.

Slide 10. Despite a competitive land market, we have been able to find and acquire great communities in some of the best sub-markets, and prices allow us to hit our underwriting targets. We invested in approximately $185 million in land and development during the fourth quarter of 2013, to continue to grow the business for a total of $565 million in land and development expenditures in 2013.

We also began using land banking again in 2013 to secure lots under option contracts. We made deposits of $28 million on lots that we acquired through land bankers, which allowed us to defer an estimated $177 million of acquisition and development spending that we incurred over time, as we purchased lots under those option contracts instead of incurring it upfront.

We contracted for approximately 1,900 new lots during the fourth quarter, bringing our total to 11,200 new lots put under contract in 2013. We ended 2013 with approximately 4,900 more lots than at the end of 2012, a total of 25,700 lots under control; 500 of those came from our acquisition of Phillips Builders of Nashville in August.

We increased our lot positions across the board in every state, including a 35% increase in California, which has had very strong demand; and a 17% increase in Texas, especially in the Houston market, which is growing rapidly. And a 43% increase in our lots in Florida, where we are one of the larger builders and have been very successful in growing our business in both Orlando and Tampa.

We have maintained approximately a 4.5- to 5-year supply of lots for the last several years and ended 2013 with approximately 4.9-year supply of lots based on our trailing 12-months closings. In addition to the lots counted in those total lot supply figures, we had almost 2,400 homes completed or under construction, which included pre-sold homes, model homes, and approximately 770 spec homes started but not yet sold at quarter end. An average of four specs per community.

Turning to slide 11, we ended the year with $363.8 million in cash and cash equivalents plus securities, an increase of $68 million over our December 31, 2012 balance. And we completed a follow-on stock offering in January of 2014 that raised an additional $110 million, bringing our total year-end total cash and securities to approximately 774 -- $474 million on a pro-forma basis.

We completed two offerings of senior notes during 2013, for a total of approximately $280 million in net proceeds, a new issue of $175 million 4.5% notes due in 2018 and $100 million add-on to our 7.15 notes due 2020, which we sold at a premium to yield 5.875%. We used approximately $100 million to retire our 2017 notes bearing a higher interest rate, and invested some of the proceeds into real estate.

At year end, our net debt-to-capital ratio was 39.1%, compared to 8.1% at December 31, 2012. It would've been 31.2% on a pro-forma basis after taking into account the stock offering in January of 2014. We also increased our revolving credit facility to $200 million during 2013, providing additional liquidity for growth, but we have not borrowed against that credit line since it was instituted.

We simultaneously eliminated the restrictions on cash by moving our letters of credit facilities to under our secured revolver, which is why we have a zero balance in restricted cash on our balance sheet at December 31, 2013. Our total real-estate inventory increased to $1.4 billion at December 31, 2013, a $292-million increase over the prior year, and mostly due to our land acquisitions and development.

With that, I will turn it back over to see Steve before we begin Q&A.

Thank you, Larry.

In summary, we are pleased with our results for the fourth-quarter and the full-year 2013. We expanded into another new market, making our four new markets in the last three years. We grew our community count, both within our existing markets and expansion markets.

We expect to grow that again this year and in 2014 with approximately 210 to 220 active selling communities. Those actions resulted in growing our top-line sales and revenue in combination with increasing home prices. We expect the rate of increase in home price and order volumes to be more modest this year, as the pace of home sales moderates.

We managed to keep cost increases lower than the increases in our home-closing revenue, which has expanded our home-closing gross margin beyond our expected targets. Moderating sales pace and smaller increases in home prices will keep home-closing margins from increasing much beyond where we are today, and we expect them to return to more normalized levels over time.

At the same time, we have improved our balance sheet strength, improved our credit metrics, and further diversified our business going forward, as we deploy cash to invest for growth, we expect our debt ratios to increase but remain within a prudent and comfortable range. Our success is the direct result of the quality of our employees. They have worked hard to achieve these results, and we want to thank them for their dedication and focus on winning our customers' trust every day.

Meritage Homes was recently named one of the most trusted builders in America, based on surveys by Lifestory Research. We believe that the high rates in customer satisfaction also lead to improved performance and return for our shareholders. Housing market fundamentals remain strong, and we believe the housing market can continue to grow for the next several years. We are confident that Meritage will also continue to grow earnings for our top-line growth and operating leverage.

Thank you for your attention. We will now open it up for questions, and the operator will remind you of the instructions. Operator?

We will now begin the question and answer session.

(Operator Instructions)

Nishu Sood from Deutsche Bank.

Thanks, and strong finish to the year, guys.

My first question I wanted to ask was on guidance. You made a few comments about gross margins.

You folks were I think the first builder to give guidance again in the recovery. You haven't said anything beyond your general comments about margins, so wanted to dig into that a little bit more.

What is the reason for that? Is it uncertainty on the margin side? Is it the slowdown in order pace in the second half of 2013? Is there anything you are willing to say about 2014 beyond that margin commentary?

We had a slower 2014 -- or slower 2013 second half, as everybody did. And I think we just want to wait and see what happens over the next couple of months with the kick off to the spring selling season.

We are cautiously optimistic. Traffic is good. We think it's going to be a good spring selling season, but we don't want to get too specific probably until the next quarter. And you can look for more detailed guidance from us at that time.

Got it, and anything in January that you are seeing that gives you reason for optimism or otherwise?

We had a tough comp in January. January 2013 was up 55% in orders over January 2012.

Our January 2014 sales were, I would say, flattish with what we did in 2013. So traffic remained strong, and we are hoping that is going to result in an increase in sales here in the coming months.

I think people are taking a little bit longer to pull the trigger on home-buying decisions than they were a year ago. There was much more urgency in the market a year ago, as prices were rising a lot quicker - prices that are now are rising more modestly, and that is slowing down the buying process.

Okay, thanks a lot.

Thank you.

Michael Rehaut from JPMorgan.

Thanks. Good morning, everyone, and nice quarter.

So I understand in terms of some of the order trend commentary -- and appreciate all the frankness, Steve, as always. You mentioned, I think, in your pre-announcement and reiterated here that you did see an improvement sequentially, I believe, month to month during Q4.

At the same time, on a sales-pace basis, 4Q versus 3Q, I think your average absorption went from negative 5% in 3Q to negative 12% in 4Q. I was curious in terms of zeroing in on the sales pace, did sales pace show on a year-over-year basis improvement throughout the quarter?

Or is that more on a overall order basis, so that perhaps October, November saw the worst of the year-over-year declines? But it does seem like the declines on a comp basis continued into January.

So just any commentary around the intra- quarter sales pace year-over-year trends.

The absolute numbers increased throughout the quarter, as we said. And our community count increased throughout the quarter. So I would say our sales per community declined somewhat through the quarter.

Would that be a fair statement, Larry?

We have not computed it on a month-to-month basis on a rate basis. We really only do that on a quarterly basis.

Because there's a little noise as communities sell out and come on during the quarter, it is hard to do it on a month-to-month basis. But I would say, generally speaking, Steve's comment is right.

Okay, and then talking about January, obviously, it is one month and it is the smallest month of the quarter.

But with orders you said flattish, I assume obviously, that is the number of orders. And is it fair to extrapolate also that sales pace might be in this down double digits, at least for January? Do the comps get any easier as the quarter progresses?

No, they don't. The absolute numbers increases pretty significantly in February and March.

But again, we've got more stores opening, and we have great position. So it is our internal forecasts are certainly to improve upon what we were able to do last year in the first quarter.

I think sales per community for the first quarter will probably be off from the first quarter of last year, but you have got to remember we raised sales prices extensively over the last 12 months. So to some extent, that is purposely done. On the other hand, obviously, we would like to see increases in sales per community.

Right, I appreciate that.

Lastly, the gross margin commentary, when you talk about perhaps you're more or less at, at least on a near- to medium-term basis, at the higher end of what you would expect to achieve; and you would expect more of a return to normal.

Is it fair to interpret from your remarks that current margins, gross margins and backlog are in and around 4Q levels, but perhaps as we get into the back half of 2014, you might start to see a little bit of that slow move back to what you would expect to be normal?

Larry, go ahead and take that one.

Sure, for the full year, we expect our gross margins to be consistent with 2013 levels. Maybe they will be up a little bit, but we generally expect them to be consistent on a full-year basis.

We're getting to the point that we are seeing, because things are not going up so rapidly, you are seeing the normal seasonality start to develop. So we will close fewer houses in the first quarter than the back half of the year.

You'll start to see some of that normal lower margin in the first half of the year versus the back half because volumes are lower, and we are not leveraging construction overhead in some of those fixed costs in cost of sales. I would expect to see the first-quarter margin be down a little bit from the fourth quarter and then ratchet back up, with the average being consistent with full year of 2013.

Larry, that would still imply if you finish 2013 at a 22% gross margin, and right now you're over 23%, it would seem to suggest unless you are really looking for a sharp drop-off sequentially and you did not have that last year 4Q to 1Q, it would imply that back half of the year you could see margins below the 22% mark.

It is hard to tell, Michael, because we just don't know how strong the demand is going be and how hard we are going to be able to push prices. And the sales we're going to make in the late spring selling season into the summer, they're going to close in the back half of the year.

So that is certainly a possibility, but it is not a definite.

Okay.

I'm looking through the same crystal ball that you're looking through.

I wanted to make sure it wasn't anything in terms of expected change in mix, or the fact that you are already starting to see weakness in your current backlog.

No.

One last one, tax rate in at 30%, is that sustainable going forward? Or should it be -- creep up from here?

Sure that is being caused by reversing the remainder of our tax asset reserve relating to a couple of states. And that was done mostly in the fourth quarter. So you were more at about 30%.

When you pull that out, I think on an ongoing basis, you will be more at, say, a 34% rate. That had about a 4% or so impact on last year's, or 2013's rate. We still are getting benefits, though, from manufacturing and energy credits, which still lowers the effective rate from the statutory rate.

Great, thanks very much.

David Goldberg from UBS.

Thanks. Good morning, guys.

Good morning.

My first question, Steve, was on the cost of land banking and the decision to rely on land bankers for growth versus using your balance sheet. And understood from a risk perspective the benefits from using options off a land bank.

But trying to understand, given your confidence about the recovery and your position in the recovery, how do you weigh the two, given that capital market's financing right now is pretty inexpensive for you guys?

We can drive -- even with the additional expense of land banking, we think we can -- it's accretive to the bottom line. And we can drive earnings per share faster by using these outside sources to hold our land.

We did that very successfully during the last cycle. And we achieved, if not the best or the highest growth rate, near the highest growth rate of any public builders.

And 80% of our land at one time was held through land bankers and off-balance-sheet entities, and it worked well for us. Although I don't see the capacity to be able to do it during this cycle, we intend to take full advantage of what land-banking sources are available to us and expect to approach it just as we did last cycle.

Clearly, we have been hearing that there has been more sources of land banking capital in the last 6 months, 12 months. Are there any markets in specific where you guys are finding it more available for you? I would think Phoenix would be a pretty good example.

No, there are really only a few national players that are doing it; and they're focused on most of the markets that we are in. So there is certainly a lot of talk about capacity increasing, but we haven't really seen it in a substantive way yet.

Just a follow-up question, Steve. I thought your comments about buyers taking a little bit longer to make that decision was a really interesting one, and certainly would underscore a lot of what we've been hearing.

I want to talk about how you train your sales people in that environment and how the sales conversation changes with the buyer. What can you do to help buyer confidence to help consumer confidence in the decision as you look forward?

We do what we have been doing for years. We focus on our great locations, our quality product, our energy efficiency, try to create urgency by showing limited supply, in these great A and B markets that we have. And we just aggressively sell our product and our brand.

And that is really all we can do. And in many locations, we don't have as much competition; it works better there; but in locations where we have a lot of competition, it can be more challenging to get buyers off the fence.

As I said before, I do believe the decision process will decrease in length as we get deeper into the spring selling season and people get more focused on buying a new home.

Great, thank you.

Stephen Kim from Barclays.

Thanks very much, guys.

My first question relates to the overall supply/demand situation in the marketplace. Certainly, what we have seen over the last year-and-a-half has been the, frankly, inability of the builders to build and open up communities as rapidly as perhaps the buyers would have liked. And that certainly ushered in an era of pretty significant price increases.

As we head into 2014, what I thought has been interesting has been the fact that a lot of the builders are targeting opening up some pretty strong community counts in 2014. And you have heard one of your other peers talking about being absolutely ready for the spring selling season, meaning that they have a fair amount of specs ready to sell in the marketplace.

My general question is, do you believe that the industry is entering 2014 with that supply/demand in balance being a little bit more in an equilibrium-type state? Are we in a situation where the upward pressure on pricing is likely to be more normal and sustainable in 2014 versus what we had seen over the last 12 to 18 months, based on what you see in terms of inventory from your peers on the ground?

Certainly, I think we have been saying that. Everybody has been saying that the upward pressure on pricing is going to be more modest over the next few quarters because people have built up their inventory. They do have more communities in place.

We have more specs on the ground this year than we did last year. We are in a position to capitalize more on the spring selling season from a volume perspective than we were a year ago.

So certainly, the pieces you outlined that builders have adjusted, I think, is true.

The reason why I ask it that way is because I think there has been a little bit of noise last year. Certainly over the summer we saw that big increase in interest rates, for example, that created a little bit of a psychological impediment; and then you also had the government shenanigans and whatnot.

I think that the trying to focus on the inventory aspect of it, in particular, was where I was going with that question. Thank you for your answer.

My follow-up is related to that. We have heard from some builders talking about the fact that the sales activity has been stronger than, I think, which you have indicated you are seeing in your communities. And I was curious as to whether or not you think that -- or if you are seeing any of your peers being a little bit more aggressive in terms of setting base prices, or maybe being a little less aggressive on lot premiums?

So not incentives, or ramping up incentives, per se, but perhaps being a little but more aggressive in the overall price package to drive volume through their doors. Whether you are seeing any indications of that yet so far this year?

No, I have not seen that. I think people continue to be focused on margins over volume, and I haven't seen a lot of discounting or tweaking of prices to focus more volume.

I think we are committed to holding serve, if you know what I mean. And even at lower-volume levels, at these prices we can be more profitable than decreasing prices and increasing volume.

That is very encouraging and good to hear.

Last question is over the last few years, you have really invested pretty significantly in your infrastructure at the corporate to be able to integrate these acquisitions that you have recently done.

Can you give us your sense of the ability of the organization you have created to absorb additional operational footprint, to enter new market, either through acquisition or through de novo expansion? Where you think we are in terms of having stretched your capacity to the limit? Do you still have plenty of headroom left, in other words?

Absolutely. We're in a very good position to add additional divisions or builders and new markets; we are prepared for that, and that's what we are expecting to do.

We have a much stronger management team, a stronger culture, a more centralized operating platform. We have better analytics, better market intelligence; and we've got quite a bit of cash on our balance sheet right now and quite a bit of liquidity.

When the right opportunities become available, we are certainly prepared to take advantage of those.

Great, thanks a lot, guys.

Thank you.

Joel Locker from FBN Securities.

Hello, guys. Good morning. Was looking at your gross margins; and obviously, they were strong for the fourth quarter. But wanted to see what the variance was between regions on what they were in California versus, say, Texas and Arizona.

Larry?

Sure. Obviously, California has been booming, and our margins in California -- I think traditionally people's margins in California have been the strongest.

On the flip side, I think traditionally margins in Texas have been generally lower than the rest of the country. So I think that still holds true.

I do expect some of the California margins to come down a bit. But on the other hand, we're seeing Texas margins improve as we bring on new subdivisions there.

So I don't want to get into specifics about what the actual percent spread is; but that gives you an idea if you're trying to find the model, that volume in Texas produces a little bit lower gross margin than something in California.

Arizona's margins have been very strong, too, not quite as strong as California's. Does that answer your question?

Yes, thank you, Larry.

Of the 18 communities you had in California that were open at the beginning of the fourth quarter, how many of those did you raise prices in roughly?

I don't know if we have that.

I can't tell you how many. Some of them were opening in the fourth quarter, and some of them were continuing. And it is hard for me to say which ones are the continuing ones we raised prices and what percentage.

Again, it has been more competitive, and it has been a little harder to push prices. But again. California is still very strong.

The last question. Do you have a percentage of what your fourth-quarter delivery price was as a lot cost expense?

You are saying what lot cost was as a percent of closing revenue?

Right, if you're at 360 and it was a $90,000 lot, the cost would be 25% of the purchase price. I wanted to know if you had a figure for that fourth-quarter number.

Yes, hang on for just a second. I can find it for you if you give me. Around -- the direct lot cost is around 20%.

Around 20%. Thank you.

(Operator Instructions)

Ivy Zelman from Zelman & Associates.

Good morning. Great quarter guys, good year.

There's a lot of focus around the margin. And I think Joel's last question, Larry, on the lot price as a percent of ASP, at 20%, can you talk about 2013 for the full year, how much lot prices were up relative to 2012?

I am not going to have that statistic and that detail for you, Ivy. I do think that our lot prices, our total margins are benefiting from a bit lower land cost because of the great buys we have made over the last two or three years.

I think you're going to see that lot cost number rise a bit. And that's why Steve and I are cautious about forward-looking margins because we are going to have some margin erosion from that lot cost creeping up.

But I do not have specific comparisons for you from 2012 to 2013 right off the top of my head.

Just to add to that, I think you could expect it to go up 150 basis points from 2013 to 2014.

Lot cost, you are saying?

Yes.

I appreciate you are being cautious on margin. I think what, hopefully, you can convey to everyone is that you are not really anticipating getting further pricing?

Or are you including some mid single-digit-type price appreciation to hold margins? What do you need to have in pricing to get to the consistent year-over-year margin performance, or are you assuming no pricing?

We are assuming that we are going to get some price appreciation to offset that increase in lot cost to be able to hold our margins, as Larry said earlier, in 2014 for the full year as against 2013.

Can you frame the pricing? How much pricing is expected to hold margin, Steve?

Enough to offset the increase in cost. So probably a couple points would you say, Larry?

Yes, I guess I divide that into two points. One is the pricing needed to cover our current lot cost for all the lots we control. That is factored in already at the current prices that we have underwritten our projects to. So we are comfortable that that piece is covered. ¶

Where you can't cover it is where there might be construction cost escalation, and that is where we essentially assume that sales price increases are going to cover any construction cost escalation. But our flattish, with maybe a slight increase of gross margins already factoring in the lot costs that we have tied up that is going to be producing in 2014 and the sales prices relating those based off current sales prices.

That is helpful.

You've had a lot of commentary about your trends and your thoughts on the spring selling season. Can you go around your footprint and talk about the dynamics of the different markets, recognizing you've got some new markets as well, where there has been a lot of cold weather in the Southeast?

And Phoenix is one market where we have heard from builders that it has been a little bit softer. And as you kick off into the spring selling season, what are the bright spots that you anticipate for 2014? And where are areas that you're more concerned about?

If you could take us around, that would be helpful.

West, East, California is very, very strong; we had strong demand across the board so far in January.

Our biggest challenge in California is to find additional communities and to be able to grow our footprint there. But demand doesn't seem to be a real issue in California.

In Phoenix, it was a mixed bag in January. We had some communities that outperformed and did extraordinarily well, and we had others we were a little disappointed in. But overall, it wasn't -- Phoenix wasn't too far off of what our expectation was.

Colorado, I think everybody took offer Super Bowl; it was the weather, and the football was a big distraction up there. And we didn't see the kind of action in Colorado that we wanted to, but I think that's going to come back this month. All indications from our people are that everybody is back and focused.

Texas, very strong across the board, met our expectations.

Orlando, very good month. Tampa, we don't have a lot of stores open. We're gapped out a little bit. We've got a lot of things coming up later in the year.

Raleigh and Charlotte, we're probably a little slower than we anticipated.

Steve, that is very helpful in recognizing obviously there is a long few weeks ahead of us for the quarter.

But given the strength in some of the markets as opposed to some of the softness, would you anticipate in the areas where it is softer that you might want to use incentives to move inventory, especially where you have a lot of committees that are being opened and you want to capture absorption there? Or will you be more firm and wait for demand, given the constraints on the resale market?

I think we are going to be more inclined to wait for it. But we will use incentives on a limited basis, as we need to in specific communities. But we are very much intent on holding our margin.

Appreciate it, thank you.

Dan Oppenheim from Credit Suisse.

Thank you very much.

Steve, along the lines in terms of some of the activity there at the start of this year, you talked about the difficult comp from January of last year in the first quarter.

But in some ways, California is the real issue, both in the first quarter of last year and now, in the sense that in the first quarter last year, you were at 19.6 homes per community in California, which was 140% above the Company average, ex-California there.

Wondering, so as California has cooled a bit from the way that it was at that time, how much of what you're thinking about in terms of the absorption and the start of this year is really that California more normal absorption versus absorption down across the board there?

We're looking at California as a catch-up year, trying to get our community count and our positions restocked. But we think we're going to make up for that shortfall there in Texas and in the Southeast.

We've got much better land positions going into 2014 than we had going into 2013 in Texas, and our margins in our communities are much better there than they were a year go at this time. We expect to offset the lack of store growth in California with Texas and with our additional communities in the Southeast region.

I meant more in terms of the absorption, in terms of the -- that seems to be the greatest issue in terms of the challenge for the first quarter.

I was trying to think regionally, if the orders for January were flat, how much of that is more normal absorption in California, with the rest of the country staying relatively flat absorption year over year?

Absorptions a year ago were outsized, so the absorptions this year are more normal and maybe a little below normal. And as we go into the spring season, maybe they are going to gravitate back more towards normal.

You are absolutely right that Texas and the Southeast are improving on their absorptions, and it is offsetting the slowdown from extremely high absorptions in California, and maybe a little bit in Arizona too. And they are gravitating more toward the norm. ¶ Obviously, when you're talking about the fourth quarter, seasonal slowing causes them to be lower than the average for the year.

As you get into the spring selling season, we should start to exceed the average and outperform the average, because we'll be in the strong selling season of the year.

Thank you.

Adam Rudiger from Wells Fargo Securities.

Thank you.

I haven't heard as much from you guys as of late in terms of the energy-efficiency products and differentiation there. I was wondering if you thought that perception in the marketplace may have narrowed a bit relative to peers or if you have been marketing that less relative to peers?

No, I think certainly our peers are catching up. Everybody's getting more aggressive about energy efficiency. It doesn't mean we are less enthusiastic or less focused on it.

I think we are continuing to invest in our learning centers; they're better than anybody else's by far. We are doing a lot of training around that; it's a big part of our sales process.

We just announced at the International Builders Show a new national contract with SunPower for solar, which is going to be a big part of our push to try to drive more solar sales through our system as an add-on option for our homes. It is still important; but yes, clearly the competition is narrowing the gap.

Okay, and then regarding the recent capital raises and the potential for additional growth opportunities, you were pretty vocal in the past that you were focusing on the Southeast. Is that still the focus, or are you after the Nashville?

It's not the only markets we are looking at. We're looking -- I don't want to give you a whole list of every market we're looking at, but clearly, there are some key markets in the Southeast that we are not in that we want to be in.

We're looking at those pretty aggressively, but we're also looking at some markets in the West that we'd like to enter and potentially some end-market opportunities. A lot of things on the table right now.

The rest of my questions have been answered, thank you.

Will Randow from Citigroup.

Good morning, and thank you for taking my question.

Good morning.

I apologize if you went over this, but I don't know if you could comment on your adjusted gross margin in your backlog, as well as your expectation for capitalized interest as a percentage of sales in 2014.

We did cover this. I think we were saying that, again, we think margins for 2014 are going to be consistent.

And even though we have good margins and backlog, the first quarter, because you have seasonal slowing deliveries, you have a little bit less leverage of fixed components in cost of sales like construction overhead and land development.

So you should see sequentially first-quarter margins be a little bit down from the fourth quarter, and then they would improve through the year. But still, on average, would be about comparable to 2013

Just to clarify, you meant that on an unadjusted basis, but from an adjusted basis --

Adjusted being excluding interest?

Excluding interest.

We don't look at it that way very much -- so I can't -- obviously, we are capitalizing more interest, and interest appears in two places as part of the lot. We don't break that interest out normally; we just consider it part of the lot. We do break out interest that is in construction.

So I can really only talk about that piece of it. But we are capitalizing more interest, but we're also increasing volume.

So the percent of interest running through cost of sales is actually coming down as a percent of revenue, even though we are capitalizing more just because we are leveraging the interest. As far as specific numbers, I can't give you that over the phone.

Okay, thank you for that.

I want to clarify an earlier point that was made about a question that was asked about the lot cost.

Larry said earlier, he was asked about what our lot cost as a percentage of revenue for the fourth quarter and for the full year. He said the answer was about 20%.

And I chimed in and said that we expected 2014, that number to increase about 100 to 150 basis points to about 21% to 21.5%, but we expected to compensate for that through increased prices that will allow us to maintain our margin from 2013 to 2014.

I think there might've been some confusion around that; I just wanted to clarify that.

As a follow-up, Steve, I always appreciate your views on the land market.

Given that it appears a lot of builders are pushing heavily, particularly in the Southeast and obviously Texas, are you seeing land prices there more competitive? And do you believe your peers have inflation in their numbers there?

I can't speak for my peers what they're doing. I know out West, it sure seemed like a lot of people were including appreciation in their assumptions when they were buying land, particularly earlier last year.

I am not sure what people are doing later in the year, but land is competitive everywhere. It is competitive in the Southeast, and it's competitive in the Texas area.

Certainly it is probably even more competitive in the West, but that is not to say we don't have to compete for land everywhere else because we do.

So the Southeast, you've seen no sequential change in terms of competitiveness?

No, there's no retreat going on. Everybody is jockeying for market share and competing for land.

Thank you. Great quarter, guys.

Thank you.

Stephen East from ISI Group.

Thank you.

I don't think I have any more gross margin questions that would be useful for you all. I am more concerned at the end of the day anyway with Op margin.

You think you can hold your gross margin. You haven't really talked about what type of leverage.

You had tremendous leverage on the SG&A this quarter. What do you think as you look into 2014, what type of operational leverage you can get off that?

Go ahead, Larry.

Again, I think our operating leverage story will be a slight improvement or flat. But we don't expect to get a lot more operating leverage going forward.

It is possible we will get some. So I think it is fairly consistent from 2013 to 2014.

Okay, I appreciate that.

Steve, as you all look at 2014, one, how much do you think you will spend on land?

And then also more generally, how do you think about -- do you think about either or land spend in M&A, or are they separate buckets for you all? And then on land banking itself, there's always a lot of controversy around that, and people aren't always quite sure why you do it. But is that an alternative to a joint-venture type of project?

No, land banking and joint ventures are really quite different. Joint ventures were used more for large-scale land development in the past cycle or builders teaming up to divide up a large piece of land that we could create a joint venture.

So we are not seeing that much of that activity going on right now, nor are we interested in a lot of that.

I think our land spend for this year will probably be a little bit more than it was last year, maybe in the $600 million to $700 million range on a cash basis; and for land banking, maybe as much as $200 million.

And I really see that as a separate and distinct bucket from M&A. And the M&A we do will probably be on top of that.

And we will have to spend a little more to maintain and continue to grow our lot count and to be able to produce the growth rates that we are hoping to achieve.

Stephen, could I comment on -- you said that some people are confused about why we do it. To us, it is a no-brainer of why we do it.

Sure, it costs a little bit more, but we're carrying 90% of the land asset off-balance-sheet on a nonrecourse basis that we can walk from any time there is downside on market conditions. And that certainly leverages a return on asset and a return on equity.

Now, we won't be able to do it as much this cycle as last cycle because of availability; but it is a no-brainer about why it makes sense. And why people continue to question the wisdom of land banking is beyond me. It's a no-brainer.

You are able to leverage your overhead. You're able to do more with more with less money and grow faster.

I agree with that. And I assume, as the cycle matures, will you gravitate more and more toward land banking?

To the extent we can.

Nothing is holding us back from doing land banking now, other than the capacity of land banking. If there was more capacity, we'd be doing more land banking. We're really doing as much as we can relative to the capacity that's out there right now.

The last question I had, mortgage issues.

Are you all seeing anything, any impact from QM or the new FHA limits where most builders have said -- I really haven't seen it. But then in a lot of markets, like Southern California, et cetera, FHA limits seem to be causing some problems there. What are you all seeing?

Not really, we haven't seen any impact yet; but I still think it's too early to tell.

Ask me that on the next quarter's call, and I would be able to tell you more. But right now, it hasn't really been an issue.

Thank you.

Thank you.

Alex Barron from Housing Research Center.

Good morning and strong quarter, guys.

I wanted to ask you, last year it was a slam dunk to be raising prices because, as you said, the sales pace was outsized. This year, the sales pace is in the range of 2 or 3.

How do think it's possible for builders to continue to raise prices other than just to try to cover costs? Do you have to -- how are you guys thinking about that?

Again, home building is a localized business. We have some communities that are doing better than 2 or 3, and we have some communities that are doing worse.

In those where demand is stronger and competition is weaker, and we have a stronger market position, we will take advantage of that and raise prices.

In other communities where it's more competitive and we have demand, we are not going to be able to raise prices. And we may have to even offer some incentives.

So I can't paint it with a broad brush. I've just got to approach it on a store-by-store basis.

Got it.

In terms of the incentives or around fourth quarter, would you guys say those were higher than in previous quarters throughout the year? Or were they maybe of a different form, but roughly the same amount?

Yes, about the same. Maybe a smidge higher than they were earlier in the year -- in the first, second or third quarter -- but not enough to get excited about.

Got it, thank you Steve.

Thank you.

Michael Rehaut from JPMorgan.

Thank you, appreciate it.

Following on the clarification on the gross margins, lot costs, and pricing that you expect to offset that, to even further understand those comments. When you talk about that you expect pricing to increase, prices to compensate for those higher land costs, are those prices that you have more or less already achieved that are either in backlog?

Or the prices that as you went through 2013 and achieved a lot of those price increases, it sets you up for, again, either what is in backlog or what you are currently selling at, or you expect to open the communities you expect to open, that is the pricing that you expect to offset? Or is it future price increases that you expect you need to realize in the first half of 2014?

I guess the answer is, yes; it's mostly already baked in.

So 40% of our -- what was the metric? We already have 40% of our 2013 sales in our backlog. Those prices are already set, in some cases higher than they were earlier in 2013.

40% of 2014 you mean, Steve, right?

Right.

Yes, 40% of 2014. And certainly a lot of these communities are already open and doing business with higher prices that give us the margin equivalent to 2013.

I don't think it's a tremendous amount of risk that we cannot achieve those prices that are a bit higher to offset the 100- to 150-basis-point increase in land costs.

Right, it's obviously it's a critical distinction that -- to this answer, you are not -- what you're talking about in terms of your expectations for gross margins isn't contingent on 2014 home prices going up X%.

No.

Thank you.

There are a very few far-out projects that maybe will come on in several quarters away that maybe have a little bit of price appreciation needed. But the great, great, great majority of the projects, particularly the ones that are already selling, we already have those sales prices.

Perfect, thanks.

Thank you.

At this point, in showing no additional questions, I would like to turn the conference call back over for any closing comments.

Thank you very much for your attention to Meritage Homes' Fourth-Quarter and Full-Year Earnings call. And we will look forward to talking to you again in April for Q1. Thank you very much.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.