Meritage Homes Corp (MTH) 2014 Q1 法說會逐字稿

Good morning, and welcome to the Meritage Homes first quarter 2014 earnings conference call.

(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, Chad. Good morning, and welcome everyone to our analyst conference call today. We issued our first quarter release results before the market opened today. If you need a copy of the release or the slides that accompany our webcast, you can find them on our website at investors.meritagehomes.com, or by selecting the investor relations link at the bottom left of our home page. If you refer to slide 2 of our presentation, I'll give the normal, customary, cautionary language. Our statements during the 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 those projections or opinions.

Our actual results may also be materially different than our expectations due to various risk factors listed and explained in our press release and most recent filings with the Securities and Exchange Commission, specifically our 2013 annual report on Form 10-K. Today's presentation also includes certain non-GAAP financial measures as defined by the SEC, so we have provided a reconciliation of those non-GAAP measures to the closest GAAP figures within our earnings press release. With me today to discuss our results are Steve Hilton, Chairman and CEO, and Larry Seay, Executive Vice President and CFO of Meritage Homes. We expect the call to run approximately an hour, and the replay will be available on our website approximately one hour after we conclude the call, and it will remain active for 30 days. I'll now turn it over to Steve to review our first-quarter results. Steve?

Thank you, Brent. I'd like to welcome everyone and thank you for your interest in Meritage. We will start on slide 4. We reported our quarter -- we reported another quarter of strong revenue and earnings growth with the second highest quarterly pre-tax earnings we generated in last 7 1/2 years. We grew home closing revenues by 23%, combining a16% increase in average prices, with a 5% increase in closing volume. Our home closing gross margin improved 330 basis points over last year to 22.8%, resulting in a 44% increase in our gross profit on home closings as prices on homes have increased more than our costs of land and construction. Commissions and other selling costs were down 20 basis points, and our G&A expenses were down 60 basis points from last year's first quarter. Interest expense dropped 80 basis points, to only 7/10 of a percentage of total closing revenue. The net effect of these improvements drove our pre-tax margin to 9.7% for the first quarter of 2014, a 480 basis point increase from the 4.9% pre-tax margin reported last year. Our first-quarter net earnings increased 111% to $25.4 million or $0.62 per diluted share in 2014, compared to $12 million or $0.32 per diluted share in 2013.

Looking at slide 5. Closing revenue grew across all three regions, and five of the six states where we have operated continuously in both 2013 and 2014. Our East region led with a 70% growth in home closing revenue over last year's first quarter. Both Florida and the Carolinas were up 59% over last year. The central region, comprised of our Texas markets, followed with a 30% year-over-year increase in home closing revenue. And total home closing revenue increased 4% in our West region, with Arizona up 26%, and Colorado up 24%, while California was 12% lower than the first quarter of 2013, when it had led the Company with 172% increase in home closing revenue over 2012.

Slide 6. Both our total order value and backlog value grew year-over-year, largely due to increases in our average prices compared to 2013, hough our total orders were nearly as high as last year's first quarter, which was up 35% over 2012 making it a difficult comparison Total order values grew 7% to $555 million, our second highest quarterly order value since the first quarter of 2007. Texas generated A $61 million increase in total order value, 47% higher than in 2013. For the company as a whole, our 8% increase in average selling price, more than offset the 1% decline in total order volume for the first quarter of 2013. Orders increased month to month during the quarter, and percentage increases over 2013 also improved from January through March, even before the addition of orders from our new national division.

Traffic levels also built during the first quarter. Total orders for 15 -- of 1,525 homes in the first quarter of 2014, represented a third highest quarterly orders for Meritage in the last six years. Only the first two quarters of 2013 were higher, which made for difficult comparisons. We grew our community count by 13% year-over-year to 189 at March 31, compared to 168 in March 31 of last year. It was a 16% increase in average number of communities opened during the quarter, offsetting the decline in orders per community. We sold 8.1 homes per community on average for the first quarter of this year. It was our second best sales pace in the first quarter of the last seven years, next to the 9.5 homes sold per community in the first quarter of 2013. The second quarter of 2013 was even higher, at 9.8 orders per community, which will make for a difficult comp for next quarter. Those were the two highest quarters of average sales per community since the peak of the last cycle in early 2006. Our ending backlog value was 25% higher at the end of the quarter, than it was a year earlier, with units and backlogs up 15%, and our average price up 8%.

Turning to slide 7. Our Texas and Southeastern markets grew enough to offset the decline in total order value from our Western markets showing the benefit of our strategic diversification. Texas generated a 47% increase in order value over 2013's first quarter, and our East Region, Southeast region produced 17% year-over-year growth as our new markets in the Carolinas and Florida contributed significantly to our totals. Texas has been growing for the last nine quarters with increases across all key operating metrics, units, ASPs, and total order -- total value on orders, closings, and backlogs. For the first quarter of 2014, orders were up 26% due to a 10% increase in community count, and a 15% increase in orders-per-average active community. In addition, ASPs rose 16% which resulted in its 47% increase in total order value. Total backlog value was up 85% year-over-year at the end of the first quarter for Texas.

The high-pitched sales -- the sales high-pitched pace of sales in our Western region have slowed in recent quarters, after experiencing robust demand, and significant increase in home prices over the last two years. Demand in California and Colorado also remained strong -- did -- I'm sorry, demand in California and Colorado has remained stronger than in Arizona. Our orders in California were up 25 -- I'm sorry, our orders in California were 25% lower than the intense first quarter of 2013, when we sold an average of 19.6 homes per community for the quarter, our highest sales pace since the third quarter of 2005. Our sales pace in California during the first quarter this year, was still the highest in the Company, at an average of 12.2 orders per community. Our average community count there increased 22% over last year's first quarter, as a result of us securing good land positions in this key market over the last couple of years. And our ASP was up 19% year-over-year, offsetting most of the decline in orders, so our total order value was down just 10%.

New home sales in Arizona have softened in recent quarters, and home prices there have moderated. The reduced FHA loan limits, and stricter underwriting standards are likely behind some of the dampening in the demand overall, in addition to fewer investors in the market. The supply of homes in the Phoenix market has come up to about 3 1/2 months from approximately a 2 month supply a year ago. So that's still low, relative to what is considered a normal supply of approximately six-month sales. We remain confident in the long-term growth of the opportunities in Arizona. Our sales pace in Arizona was slower through the first quarter, order volume declined 28%, compared to the first quarter of 2013. An 8% increase in our average sales price offset some of that decline. We adjusted prices in several communities, and increased incentives in several more in February, which took net pricing back to approximately the same levels as in the second quarter of 2013 in some communities. Since our costs have remained relatively flat during that time, we expect our margins in Arizona to come down somewhat over the next couple quarters, although they remain quite healthy, at or above historical averages.

First quarter 2014 orders were down 12% in Colorado compared to 2013, with an average of 9.2 orders per community, above the Company average, and a 17% increase in average active communities during the quarter. Total order value was only 4% lower than in 2013, since our average sales price in Colorado was up 10%. We believe that the severe weather and the Super Bowl effected Denver during the early part of the first quarter. We increased total orders in our Eastern region -- our Southeastern region, but we call it the Eastern region by 22%, with a 43% increase in average active communities, partially offset by a 15% decline in average orders per community. That was most evident in the Carolinas where we nearly doubled our community count, though our average sales price per -- sales per community was down 40% for the quarter, some of that which may have been weather-related, resulting in a net 17% increase in total orders. Total order value was up 27% after an 8% increase in our Carolinas ASP.

Florida was relatively flat compared with the first quarter of 2013, with a small single-digit price -- single-digit percentage increases or decreases in sales pace, average community count, and average prices resulted in 3% fewer orders, and 6% less total order values in the same quarter last year. We focused on growing our new national operations and have been successful with that over the last couple of quarters, since completing our acquisition in Nashville, even though it still represents a small percentage of our totals. With that, I will turn it over to Larry to review a few other highlights for the first quarter. Larry?

Thanks, Steve. Our backlog conversion rate was 60% in the first quarter of 2014, compared to 71% last year. And approximately one-third of our closings were from specs, our homes that had previously been started before going under contract. It's been trending down as we have been focusing our resources on new builds under contract, but we have been actively increasing the number of spec starts recently, especially since our relatively low inventories of homes available for sale in most of our markets. We have increased our specs by approximately 33% over the last year, to a total of 802 as of the end of the quarter, compared to 604 a year ago in March. That translates to an average of 4.2 specs per community for the first quarter of 2014, up from 3.6 in 2013.

Moving to slide 8. We invested approximately $163 million in land and development during the first quarter of 2014, primarily to replace the lots brought into production during the quarter, and open new communities. We increased our lot supply modestly during the first quarter, contracting for approximately 1,520 new lots, to bring our total to 25,800 lots under control as of March 31, 2014, an increase of almost 4,800 lots since March 31, 2013, and about 100 lots more than where we ended 2013. That represents a 4.9% years supply of lots at the end of the first quarter of 2014, compared to about 4.6% years supply a year ago, based on trailing 12 months closings. Approximately 73% of the new lots put under contract in the first quarter were purchased and 27% optioned. Most of our net additions were in Texas, Florida, and California, specifically, Dallas, Fort Worth, Austin, Southern California, and Tampa. We didn't add any lots in Arizona or Colorado, where we already have deep pipelines of lots. In addition to the lots counted in those total lot supply figures, we had almost 2,700 homes completed or under construction, which include pre-sold homes, model homes, and spec homes started, but not yet sold at the end of the quarter.

Moving to slide 9. We ended the first quarter of 2014 with $338.7 million in cash, cash equivalents, investments and securities, with no restricted cash, up from $363.8 million at December 31, 2013. We eliminated the restrictions on cash when we expanded our credit facility. In January 2014, we issued approximately 2.53 million shares of common stock for net proceeds of approximately $110 million, which we intend to use for working capital, and to fund growth, including potential expansion in new markets, and/or expansion of our existing markets. That may include acquisition of other homebuilders. Our net debt-to-capital ratio at the end of the quarter was 36.6%, compared to 39.1% at December 31, 2013, and 37.6% at March 31, 2013.

Our total real estate inventory increased to $1.54 billion at March 31, 2014, compared to $1.41 billion at December 31, and $1.15 billion at March 31, 2013. Approximately half of that increase was due to homes under construction, including specs, and about half was due to our additional investment in land and development. With that, I will turn it back over to Steve before we begin Q and A.

Thank you, Larry. In summary, we are pleased with our results for the first quarter of 2014. We grew our closings and revenue, expanded our home closing gross margin and gross profit, increased our community count, both within our existing markets, and expansion markets, and reinvested in new communities to replace the lots in which we started homes during the quarter. We also maintain a strong balance sheet credit metrics, which was recognized by Moody's rating agency, who upgraded our corporate debt rating during the quarter. Going forward, we plan to deploy cash through investments for additional growth, while keeping our debt ratios within a prudent range. Given an improving economy, we believe the home building market will continue to grow, and Meritage will continue to grow both revenues and earnings.

We remain committed to our forecast of approximately a 210 to 220 active committees by year-end 2014. Based on the trends and sales pace, and prices that we experienced in the first quarter, we are projecting that our gross margin will be relatively flat for the year as a whole, trending down over the remaining quarters, due to less pricing power, and higher land costs than last year. However, our increased revenue and overhead leverage should offset that such, that we expect our pretax margin to remain relatively flat throughout 2014, and in-line with last year's full-year, pretax margin, and the earnings will grow throughout the year, even considering a higher tax rate for this year. With that in mind, we believe we continue to achieve earnings growth for several years, with revenue growth driven mainly by additional communities, and earnings growth through increased revenue and operating leverage. We thank you for your attention. We will now open it up for questions. The operator will remind you of the instructions. Operator?

Thank you.

(Operator Instructions)

Michael Rehaut, JPMorgan

Thanks. Good morning, everyone.

First question I had was on the trends that you saw in Arizona. You mentioned home prices have moderated, and I guess have come back to 2Q, 2013 levels. I was wondering if you could give us a degree of magnitude there? And also, you mentioned that pricing may be coming in line versus 2Q, 2013, and the fact that margins are --I'm sorry, costs have been flattish during that time, why you would expect margins to come in? Is it more due to the land cost creeping up? Or just some thoughts around that?

In the Phoenix, and Arizona in general, we've probably increased incentives in the neighborhood of $10,000 to $15,000 on average. And may impact our margins here by about 3%. When we talk about flattish margins, we're really not talking exclusively about the Arizona markets. We're talking about the impact of all of our markets.

Arizona -- some of our land positions are a little older here, so we were probably achieving significantly above average margins here. Other areas around the country, our land positions are newer, at a higher basis, and we may have more pricing pressure, or cost pressure, in some of those markets. Certainly than we do in Arizona, where the market is cooling off.

So that's what leads us to believe that the margins going forward are going to be relatively flattish, because of the impact of what has happened in Arizona, and the marginal pricing power that we have in a lot of other markets -- markets with higher land costs.

I appreciate that clarification.

I guess just on that, looking at some of your diversification benefits; with Texas doing particularly well right now, and perhaps there is some offset there, it would appear that with margins maybe coming in a little bit over the next two or three quarters, there's still -- it appears that you are still expecting margins solidly above 20%, that can stabilize maybe in the 21%, 22% range.

Just wanted to know if that's fair; and how your current underwriting, if that is also targeting that type of minimum 20% type of number.

That's a reasonable assumption, and our underwriting, any new land acquisitions, must be in line with that.

Larry, do you have anything you want add to that?

No, I would agree that the 21% to 22% gross margin range is what we are shooting for now, and depending upon how various markets do, we could be a little higher or a little lower. It's good to see that markets like Texas are coming back.

We're really seeing a little bit of return to the old regional market structure of home building, where you had some markets that, in some period of time, were a little bit stronger, and some markets that were a little weaker. And you are starting to see that kind of dynamic come back into the homebuilding markets today.

Great, and just one quick one, last one.

The tax rate is 36%. Is that a number that we should use going forward on an ongoing basis as we think about the full year 2014 and 2015?

Yes. Let me give you a little color on that.

Essentially, our federal tax rate is 35%, but when you throw the states in there, that's about another 4%. But you back out the manufacturing deduction, which is running at around 3%, it gets you back to get 36% number.

Last year we were low because we had two things going on. We had about a 5% or so benefit from reversing the rest of our state valuation allowance. And then we also had about a 2% in energy credits. This year, Congress hasn't passed the extension of the energy credits, so we can't count that yet. We're hopeful that sometime during the year they pass that, and we will be able to get another about 2% benefit from those energy credits. But today, we can't take that.

So that's why the rate is at 36% and not a 34% number, which it wouldn't be a more round with tax credits.

So 36% for the time being is the number to use.

Thanks, Larry.

(Operator Instructions)

Ivy Zelman, Zelman and Associates

Hello guys, good morning. It's actually Alan on for Ivy.

Larry, in terms of the gross margin, if I look back at what you had said last quarter, you had a similar guidance for flattish margins for the full year. But in January, you were implying that there would be a sharper drop-off in the first half of the year, which is typical from seasonality, lower closings. And then margins would build through the year. With very little sequential pressure in the first quarter, it would seem like the margin might have come in a little bit stronger than you were expecting back in January.

And on the flip side to that, to get to a flat number for the full year, it implies about 200 basis points of deceleration through this year, which seems like a pretty large number and especially if the incentive and pricing power is most apparent in Phoenix, which is really about 10% of your backlog.

I guess the question I have is, when you look at the margins of your homes in backlog, is that 200 basis-point decline, is that already what you see in your backlog? Or are you prospectively thinking about orders over the next few months which might come in, in weaker margins than what you are in backlog today?

I guess I would say, for the first quarter it did come in a bit stronger than I had anticipated. Obviously, it was sequentially down from December.

I think we are looking at the backlog and we're looking at what our expectations are for the rest of the year. It's a little of both. It's not just the backlog, but we're also looking at what subdivisions are coming on line, and what the ability we have to raise prices, and new projects with new higher land basis, and factoring all of that into the decline. I guess I want to emphasize, we think we're coming back to average margins that are in that normal 21%, 22% range.

But we are getting the improvement of better overhead leverage, and that's really offsetting, which is why we think that the pre-tax margin is going to be relatively flat throughout the year, and zero in at around that 10% range consistent with last year's.

I think, Larry, it would be fair to say right now, looking at our backlog, that we most certainly believe that in the next quarter we are going to see some gross margin decline.

Is it going to be in that 200 basis point range or not?

I don't know if it's going to be that much. Most likely it's not going to be that much, but it's going to be -- it's going to start to tilt the other way next quarter. I think it's also fair to say now that the street estimates for our earnings for next quarter, we think are a tad aggressive. Because this is where we think the gross margins are going to start to tilt the other way, probably due to the fact that the incentives that we have been offering in Phoenix now for more than a quarter -- a little more than a quarter -- are starting to kick in.

Having to sell more specs, and for all of the reasons we already articulated, we just don't have the pricing power in that quarter in the backlog, so we think the gross margins will start to come down a little bit, certainly in the next quarter.

I appreciate that.

And a follow-up is -- Steve, I think you made a comment that year-over-year order numbers improved through the quarter, I was curious if you might be to quantify that and give any early read on April so far?

I'll give you some specific numbers. So we've sold 409 houses in January; we've sold 489 houses in February. So that is about a 20% increase month-to-month. We've sold 627 houses since March, almost another 20%-plus. First few weeks of April, pretty much on line with what our expectations are; looking good against last year, although we had the Easter holiday this last weekend. It was a little slower weekend.

But we are expecting a big weekend this weekend, and hey, to the finish of the month. Cautiously optimistic about what we're seeing in the second quarter.

Thanks a lot.

Dan Oppenheim, Credit Suisse

Thanks very much.

Wondering if you can, given all the comments in terms of margins and such, in coming down quarters, I think, likely people are wondering, in terms of how much of the incentives and the land costs and such -- maybe you can talk to clarify a bit, just based on regional mix. And if we look at last year, margins in the West were 23.5%, versus Central at 19.6%. Given the order trends, clearly the lot is probably regional mix coming through.

Can you help to put some color around the margins, based on how much of that is the regional shift versus pricing power, versus land and such?

I don't know if I really want to get that granular, about giving our specific margins by region. Larry, what are your --

It obviously shows up in our segment reporting. But it's being driven by margin erosion in the West from the issues we've talked about, being offset, to some extent, by improvement in Texas and the Southeast, although less so in the Southeast, and more so in Texas. That's the story. We have not disclosed at this point the specific numbers, and I can't give them over the phone here, but that's what is going on.

Okay. Then you talked in terms of the land purchases and such. And doing more in terms of Texas and other markets, but not buying in Arizona.

If you look at the land position right now, before you talked about Arizona having a sufficient slate, how do look at the overall land portfolio right now in the different markets? And where you would like to invest for the next couple of years?

I feel very good about our land portfolio in general. I think we have a strong land position in Arizona, Colorado, and Texas. In Florida, we bought quite a bit of land in Tampa in the last couple of quarters to build out our business there, but certainly our main focus is on the Southeast and on California. Those are the two places that we're working the hardest to buy land today.

We don't feel under any inordinate amount of pressure to buy land because we think we have a reasonable land book. And we think we can be choosy, and look for the best locations that make the best sense for the Company.

Great. Thank you.

Nishu Sood, Deutsche Bank

Thanks.

First question -- I wanted to follow up on Dan's question about land supply. If you look at the broader land lot supply numbers, they have flattened out over the past few quarters. On a year's supply basis they have flattened out as well. My question was, does that reflect some slowdown in aggression on land purchases and development activity because of the softness in housing demand? Or -- you are in that four- to six-year target range that you talk about sometimes. Is it just a reflection of getting to that range?

It's probably a little of both. We couldn't buy land in Arizona because we didn't see land that met our underwriting criteria. That may change over the next couple of quarters. On the other hand, as I said earlier, we are real comfortable with the number of lots and number of communities that we have here. We didn't feel like we had to buy any lots, unlike other builders in the market here that are being more aggressive than we choose to be.

And then we are also looking at a lot of new markets. There are several new markets we are interested in. We're holding back some capital to be able to deploy in those markets when we find the right opportunities at the right time. That will have an impact on our land position, certainly. I think there is a whole variety of factors that influence our strategic allocation of capital and our land spend.

Got it. Thanks.

The other question I wanted to ask was about ASPs. Clearly, you've had a very strong tailwind from both mix shift to move out product, and the strong pricing trends we've seen in the past few years. The ASP increase -- and you pointed it out for this quarter as well -- has helped to offset any weakness in volume numbers.

If we look ahead, the pricing trend has clearly slowed, as we've been talking about. Hopefully, we get some return of the first-time buyers to the market, continued health, and driving that housing recovery. That strong tailwind might even turn into a bit of a headwind. Does that imply a shift, then, in how you begin to think about volumes? Maybe a little bit more of a volume focus to maintain the trend and the overall order value?

I think we'd like to try to bring our ASPs down across the country. They are getting relatively high. I don't see anything on the horizon that gives me a lot of excitement that the first-time buyer is coming back. Maybe there is a niche there for the, what you call the first-time buyer-plus, in between move-up and first-time buyer; it's at a little higher price point.

Clearly, we are more focused on smaller plans now that come under the FHA caps, and that we can be more successful with, in a rising price and a rising interest rate market. We are clearly trying to focus over the long term. It's not going to happen over the next few quarters, certainly, to try to manage our ASP, to either a constant or a lower level

Great. Thanks.

Stephen East, ISI Group

Thank you. Good morning, guys.

Steve if I could dig in a little, following on what Nishu was asking, maybe burrow down a little bit. You talk some about what you all were seeing in Phoenix. If you could talk a bit more, what you think you're seeing in Phoenix, California, and in Texas, which is going the opposite direction? And really, how does your strategy differ in each of those markets -- price versus pace? You mentioned buying land aggressively in California -- is that more along the Coast? The strategy to fit what's going on with each market?

I wouldn't put California and Phoenix in the same boat or the same bucket. Clearly, even Southern California, in my opinion, is stronger than Phoenix right now. We're having decent absorptions, even in the Inland Empire in most of our communities. Northern California is certainly stronger than Southern California, maybe excluding the coastal positions. Again, we are not a very good barometer of that because we only have one community in Orange County. The rest of our communities are in the Inland Empire.

I am still really bullish on California. We want to find more communities in both the East Bay, Orange County, and the Inland Empire. We're focused more on infill. We bought one of our first real high-density infill pieces in a place called Montclair, right on the commuter rail line, last month. So we are focused on other positions in that area. To the extent that we can find land positions in California to meet our underwriting standards, we have a big green light out there.

As far as Arizona and Phoenix, I don't want to paint the picture that the market is bad, because it's not. We're still selling homes here. We've sold 65 homes in Phoenix last month. We would have liked to have sold 85 or 90 homes. But we are still making good margins on those 65 houses, and sales in Phoenix built throughout the quarter. I expect them to continue to build this month through to the second quarter.

We're just having to play a little bit more of an incentive strategy here, and it's become a little more competitive. I think the FHA limits did knock some people out of the market, particularly those, what they call boomerang buyers, who had a foreclosure. Now they are going to have to wait a little bit longer under the conventional rules to buy a home -- let's say it's in $350,000 to $400,000 price range -- because the new caps are lower and they can't make up the difference in down payment on an FHA.

And then I also believe that home buyers in Phoenix now have a little more selection because more homes have come on the market. There's less investors out there pursuing them, and now they have more of a choice between new and used homes, where before they were blocked out of the resale market, and were pushed into our market. The price spread between new and used is more important today than it was probably previously, and we're going to be more mindful of that. And our strategic operations team is looking at that more carefully, particularly in new deals going forward, because I think the spread between new and used got a little too wide.

Other than that, I am bullish on Phoenix over the long term. I think this is a phenomenon that we are dealing with here that's going to be temporary; might last a few quarters or a year, but I believe that going into 2015 we're going to experience a more normal market in Arizona after things get more in balance.

Okay. And then is Texas -- that's been so strong -- do you push price more? Or what is the strategy there?

Certainly, we always try to push price, but Texas is a much more competitive market than a lot of places that we do business. There is more land, there is less barriers to entry. You are never going to get the huge margins in Texas that you see in the Western markets, or in the Northeastern markets. I think, if we can get price, we will, but we're probably more focused on volume than price.

Okay. And then just the other question I had -- you all mentioned you were building more specs. Just would like to understand where that is, and your thought process there?

And then, Larry, for you -- you mentioned gross margins would be flat. I assumed you would get some leverage from your SG&A this year versus last year and maybe drive your out-margin higher. But if I hear you right, you are saying your out-margin will also be flat. Just some clarity on that?

Our current expectations are that the gross margin will be flat compared to last year, but the trend will be down a bit throughout the year. Whereas the SG&A leverage will improve, offsetting that gross margin decline. You'll wind up at a pre-tax margin being relatively flat throughout the year, consistent with last year. That's our current thinking.

I got you, okay. And the specs?

We've increased our specs maybe 20%, 25% late last year going into the first quarter. We thought we needed to have more specs on the ground for the spring selling season. We are still evaluating that; we may drive that number down a little bit as we go into the later part of this year. We've had a conscious strategy, particularly in certain markets, that we needed to have more homes available for those customers who didn't want to wait for new builds, and were in the market right now to move in quicker.

Thank you.

Stephen Kim, Barclays

Hello guys. This is Freda on for Steve. Thanks for taking my question.

The first question I had was on absorption rates. This quarter you had about 13% community count growth, flattish net orders. I think the range of that decline is probably within the band of expectations for what people are looking for, in terms of the absorptions this quarter across builders. As we look to the back half of the year, you're looking for 22% to 28% type active community count growth, and order comps are going to get a lot easier in the back half. My question is, how are you think about what those absorption rates could look like as we go throughout the year?

I don't know that we are projecting any specific absorption rates throughout the year. I hope maybe in the second quarter they are a little bit higher than they were in the first, and then we'll be going into the seasonal slowing into the summertime. And then we expect a surge in new communities to come on late in the third quarter into the fourth quarter of the year, which is going to drive our growth for 2015. It will be hard for me to tell you precisely right now what we think our absorptions are going to be over the next few quarters.

Okay. Thanks.

And just a follow-up on Steve's question on specs. Could you provide a little bit more color on how the decision process goes -- into which communities have more specs versus another? Is there a difference between the product lines that you have, whether it's the active adult versus the move-up? Is there any sort of color on that would be helpful?

We execute that strategy from the ground up. We go into every community and look at the sales pace of the community. We survey the buyers; we have a robust consumer research function; we find out what the buyers are telling us that are coming into the sales office -- what they're looking for. That goes into our equation. Look at the competition, what are they doing as far as specs with their absorption rates? Certainly the price range has a lot to do with it; we're certainly building more specs at the lower end then we are at the higher end, where people want to make more changes and spend more money in the design center.

It's a complex and ground-up kind of strategy that we have, and we just don't wave our wand and say, let's build a couple hundred more specs. We take the process very seriously.

Thanks for taking my question.

Eli Hackel, Goldman Sachs

Thank you. Two questions.

One, just going back to incentives -- obviously, there's been a lot of talk on Phoenix, there. What reaction have you seen from those incentives? And if they are expanding to any other markets?

And second, just on Florida, is there any additional color in terms of the ASP being down year over year in that market? Is that mix-related or are there some incentives going on in that market as well? Thank you.

Florida -- I think it's pretty much mix-related. Larry, let me know if you disagree.

I agree.

We are not doing anything significant with incentives there.

In Phoenix, are the incentives helping? Are they increasing absorption? Maybe, probably not.

I think we just have to do them because the market demands it, and that's what the competition is doing. And if we want to continue to sell homes here, we're going to have to have those additional incentives in the market that we're in right now. But I wouldn't say that price is very elastic where the more incentives, the more homes you're going to sell. I just think it's part of what needs to be done right now to be relevant in the market.

Is it spreading to other markets, or is it pretty confined to Phoenix market?

I would say Phoenix and Tucson, and maybe a little active adult. I'd say Arizona, and I am not aware of any other markets that we're operating in that we're using any different incentives then what we were a quarter or two ago. If we are, they are very small; they are not really worth talking about. I think substantive incentives that we've changed are certainly here in Arizona.

Great. Thank you very much.

Adam Rudiger, Wells Fargo

Good morning. Thanks for taking my question.

I have two questions, both of which are a little bit longer-term in nature. The first is, Steve, based upon your commentary earlier in the call about lack of optimism towards the first-time buyer, I was curious about when you do your long-term planning, or you think about the next couple of years out, what you think that means for the overall market? I guess it's a backhanded way asking when you think the overall national housing market will reach that mythical normalized range everyone is looking for?

I am not the guy to be asking about that, because we're not a real big entry-level builder. I am not as close to those buyers as some of my peers would be. The handful of entry-level communities that we have that are more in peripheral locations, we're still getting a lot of turn-downs. We're still getting a lot of challenged-credit buyers. They either have a lot of student loan debt, or they have a lot of other consumer debt, and they want to buy a home, and then come up with a down payment, but they just can't qualify.

If credit eases a little bit, certainly that's going to help that segment of the market a lot. I haven't seen a lot of progress there yet in some of the markets that we are in. There is places where entry-level activity is improving, but on a whole -- don't want to be a [doomsdayer] about it either -- but on a whole, we are not the best judge of that, and the limited business that we have in that segment, we are not seeing a dramatic improvement.

Okay. Second question -- in your press release, you talked about future earnings growth will be driven by community count growth and operating leverage. I was curious on the operating leverage, what the potential opportunity there is in terms of how significant that leverage can be in a couple of years out?

Larry, you want to take that?

I think most of that should be read in that we're growing community count growth and growing top line by selling more houses. There could be some modest continued leverage over that which we are projecting for this year. I don't see it being a huge number. For last year, we were -- total SG&A was about 12.2%. We may see that the 40 to 50 basis points better this year, and maybe another 20 or 30 next year. So you're talking in that kind of range, not hundreds of basis points better.

Got it, thank you.

Will Randow, Citi

Good morning and thank you for taking my question.

Steve, there are two interesting phrases I picked up on, that I was curious on. You said for potential home buyers that didn't want to wait for new builds, and the price spread of new versus used. How much do you think a pickup in existing home sales inventory might be influencing buyers? Call it delayed traffic to order conversion?

A pickup in listing of resale inventory or new home inventory?

Resale.

As I said, I think, particularly in Phoenix -- I wouldn't translate this into other markets -- buyers have more choices now because there is more homes available for them to look at. And those that normally would have bought a resale home where they can move into relatively quickly, are now to some degree shying away from the new home market, where a year ago, we would've gotten them for sure. I think that is a factor. It's not the only factor, but it's one factor why the Phoenix market is off 25% to 35%.

Thanks for that.

And then, just thinking about mix -- over the next 12 to 24 months, you mentioned building out specs on the low end. But also, in your DFW market it was interesting how you are playing kind of all of the $300,000s and up price range for homes, versus $200,000s a year or two back. How do you think about mix for the next 12 to 24 months?

I think we're still going to be playing that $300,000 to $400,000 space, but we're going to try to play closer to $300,000 than to $400,000 in a lot of cases. And we're going to try to re-emphasize our smaller plans, than some of the big 4,000- to 5,000-square foot homes that we were selling at a relatively low price per square foot. Because after you add all of the options in those houses and so forth, they just don't qualify for FHA.

And as interest rates rise, assuming they will rise at some point, probably not in the foreseeable future, but over time they will rise, only to have a stronger part of our line-up at the lower price points. We're very cognizant of that. I don't think it's something that's going to materialize in the short term. I think it is more of a long-term goal.

Thank you very much for your comments and time.

Joel Locker, FBN Securities

Thanks, guys.

Respectable quarter, considering the business environment we're in now. Just on your G&A -- did you have any one-time benefits to lower that? It just came in $3 million or $4 million lower than expected.

Nothing real significant. There's always a few true-ups that occur, but nothing material. It was, just, I think we've just done a little better job controlling overhead costs.

So do you think that run-rate of $21 million, $22 million range is sustainable? Or you think that will creep up back into the mid-20s?

Hard to say. Part of that, I guess, is you have the variable lumped in there, I think. Or are you just looking -- I guess you're just looking at G&A. I think it will creep back up. It may go back up a few million dollars over the year.

Thanks.

On the backlog conversion rate -- I guess that was lower than what people expected: 59.8%; first time you've been in the 50% range for a while. Do you think you can get that back in the low 60%s, or do you think it will be the high 50%s going forward?

We hope to keep it above 60%, I can tell you that. I would like to get back up at least a few points. We did have a little bit impact this quarter due to weather on some closings. And we missed some closings that we expected to get, so our conversion rate would've been higher. I'm hoping that we can push it back up.

Last question, on tally order -- California order ASP was up 9% sequentially. Was that just opening higher price point communities during the quarter for the most part?

Sorry, say that again?

The California ASP per order -- I think it went up 9% to $506, 000 or somewhere around there. Was that just a mix issue, where you increased the higher price point communities out there?

We did have some price increases out there, but most of it was due to mix.

Thanks a lot, guys.

We are running to about an hour's time. Would you like to take a couple more questions?

We will take one or two more.

Jade Rahmani, KBW

This is actually Ryan Tomasello on for Jade.

Going back to land purchases, where have you seen prices trend year to date? And could you comment on where you see gross margins shaking out for those new land deals?

Land trends are very local, and it's different in every market. Certainly, in some markets land prices, I think, have peaked, at least for now. In other markets, they're still going up. As you know, land prices are significantly higher this year than they were a year, or even two years ago, for sure. As far as gross margins, we won't buy any land that doesn't meet our underwriting criteria of delivering at least a 20%-plus gross margin. Certainly, some of the early land we got helped us get higher gross margins. But going forward, that's where we expect to be.

Great. Just on a bit of housekeeping item -- for interest expense spiked up a little bit from last quarter. Was there anything specific that drove that increase? And would it be safe to assume that, once you number as a run rate for the rest of the year?

Nothing in particular. Obviously, we did a bond issue a quarter or two ago. I think you will see that run rate come down a little bit as we continue to add assets under production. I don't necessarily see it going to zero this year, where we're capitalizing all of our interest. But I do see it trending down from last year. We were at about $15 million or so expense last year, and I think it will be a few million dollars lower than that this year, but I don't think it will go to zero

Great. Thanks

Jay McCanless, Sterne Agee

Good morning, everyone.

First question -- just wanted to ask about pricing power in the Central and East segment during the quarter? And how you're feeling about that for the rest of the year?

I think I made some comments about Texas. I think we do have some pricing power there, and we are raising prices in many of our communities, although it's not the kind of price increases you have seen in the West. They are much more modest, because the Texas markets are much more competitive. But we do have some opportunities, maybe down in Houston and in Austin for sure.

In the Southeast, a little bit of pricing power in some communities in Orlando, and a few spots in Charlotte and Raleigh, but nothing to get super excited about. I think prices there will be more reflective of our mix then they will of price increases.

But on the other hand, we are not experiencing any significant change in incentives in those markets. We're pretty comfortable where our gross margins are there going forward.

Okay, second question -- just want to talk about the mix for a second, because I believe last year you were looking at doing more in the higher end, the Monterey line, but today you're talking about maybe trying to go for some lower-priced floor plans. Can you talk about the interplay between those two? And if you are going to be going to some maybe lower-priced, smaller floor plans, are those homes still going to hit the same gross margin that maybe you originally underwrote that land to?

Absolutely. We don't think that moving on the price band has any impact at all on the gross margin, because again, we're not making a conscious, strategic change to jump down into the entry-level business. We're still a move-up builder. We're planning to remain a move-up builder; we're just doing some minor tweaks within some of our existing communities and some of our new communities to re-emphasize some of the smaller plans in the lineup.

Again, I don't think this is a watershed moment, or a real strategic change in what we're doing. Just some minor tweaking to our strategy.

Thank you.

Thank you.

I think that will be our last caller, Operator, and we will wrap it up here. I appreciate everybody's attention and participation with our conference call this quarter. I look forward to talking to you next quarter. Thank you.

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