Meritage Homes Corp (MTH) 2014 Q2 法說會逐字稿

Good morning and welcome to the Meritage Homes second quarter 2014 earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

Please note this event is being recorded, I would now like to turn the conference over to Brent Anderson; Mr. Anderson, please go ahead.

Thank you Jessica, good morning everyone, welcome to our conference call today. We issued our press release this morning with the second quarter results before the market opened. If you need a copy of the release or the slides that will accompany our webcast, you can find them on our website at Investors. MeritageHomes.com, or you can go to the main webpage and select the investor relations link at the bottom.

If you turn to slide 2, I'll refer you to the customary cautionary language. Our statements during this call and the accompanying materials contain projections and forward-looking statements which are the current opinions of management and are subject to change. We undertake no obligation to update these projections or opinions. Our actual results may 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 and our first-quarter report on Form 10-Q.

Today's presentation also includes certain non-GAAP financial measures as defined by the SEC, so we 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 VP and CFO of Meritage homes. We expect the call to run about an hour and a replay will be available on our website approximately an hour after we conclude the call. It will remain active for 30 days. I'd now like to turn the call over to Mr. Hilton to review our second quarter results. Steve.

Thank you Brent. I'd like to welcome everyone to our call today. We announced our agreement to acquire Legendary Communities a couple weeks ago and I'm anxious to talk more about that, but since this is after the end of the quarter hasn't closed yet, we'll discuss our results for the quarter before getting into the acquisition and why we are so excited about it. We will start on slide 4.

As evidenced by the recently reported starts and permits data, the US housing recovery has entered a more stable, slower growth phase than we saw in 2012 and the first half of 2013. However total starts and permits are still well below their historical levels so we expect to see many years of growth to get back to the more normal levels. We were quite pleased to show year-over-year growth across nearly every key operating metric for the second quarter of 2014, in addition to sequential growth over the first quarter, considering that market conditions were generally not as strong in the second quarter this year as they were a year ago.

We increased net earnings by 25% through a combination of higher revenues, margins and operating leverage. Our home closings increased by 4% and home closing revenue by 15% for our eleventh consecutive quarter of year-over-year growth in home closing revenue. Average closing prices were up 12% mainly due to mix which helped drive our revenue growth and 40 basis improvement proof in our home closing gross margin to 21.9% for the quarter. With some moderate operating leverage we achieved a healthy pretax margin of 10.9%, a 240 basis point improvement, over 8.5% in last year's second quarter. Those are respectable results against difficult comparisons to last year's strong second quarter.

Turning to slide 5 -- our new home orders in backlog grew over the prior year on both units and total value, which is impressive considering our orders in backlog in the second quarter of 2013 were at their highest levels in more than five years. With modest growth in total orders and average sales prices, our company-wide backlog grew 12% in units and 18% in total value. Our average community count during the second quarter was up 9% year-over-year despite a 6% decline in average community count from the first quarter. We opened 13 new communities during the quarter but removed 27 from our active community count. The decline during the quarter was primarily due to administrative delays in getting approvals from municipal authorities to complete land development on schedule.

We are working hard to catch up and expect our total community count to rebound significantly in the third quarter as delayed committees come online. We anticipate we'll end the quarter at approximately 190 actively selling communities which we expect continued growth to the end of the year to approximately 205 to 215 communities. Those estimates are before taking into account the Legendary acquisition.

Turning to slide 6, our average sales per community during the second quarter increased over 2013 in every state except California and Arizona, though California sales pace was still the strongest in the company for the quarter, at 12.8%. Texas and the Carolinas generated the highest order growth in the second quarter. Demand in our Texas market increased with orders up 12% over last year -- while I'm sorry, while orders were up 12% over last year while our orders grew at 32% in the Carolinas. When combined with increases in our average sale prices, total order value grew 31% in Texas and 36% in the Carolinas.

Colorado also grew orders by 16% and total order value by 21% year-over-year. Arizona orders were down 28% from the second quarter of 2013 and demand had softened there despite a healthy economy. Florida orders were also down the second quarter which was entirely due to fewer communities opened during the quarter while our average sales per community increased there. We are expecting to add more than 10 net new committees in Florida during the third quarter. Our backlog value in Texas increased 67% over the second quarter of 2013, followed by a 45% increase in the Carolinas and a 31% increase in Colorado.

Turning to slide 7 -- now I'd like to talk about our agreement to acquire Legendary Communities. Legendary Communities will be our second acquisition in the last 12 months following our acquisition of Phillips Builders in Nashville last year. We have been looking for additional growth opportunities in the southeastern United States after having successfully entered the Raleigh, Charlotte, Tampa and Nashville markets in just the last few years.

With the acquisition of Legendary, we pick up two new markets with significant operations and excellent growth potential. Legendary primarily builds in Atlanta and the Greenville, Spartanburg markets where we don't actually, we don't currently operate and additionally have operations in Charlotte that will be rolled into our existing division there. They build primarily for move-up buyers, as we do, and closed approximately 500 homes in 2013 for approximately $156 million in home closing revenue. At June 30 they had approximately 200 orders in backlog and 40 active selling communities which we expect to add to our active community count at the end of the third quarter. Legendary controls more than 4000 lots today mostly through option contracts and many which were acquired at distressed prices. In addition they have a robust pipeline of opportunities to acquire additional lots in Atlanta and in the other markets.

Turning to slide 8. We're enthusiastic about the markets we gained with Legendary. Atlanta was the second-largest home building market in the US, based on permits activity in 2013 which means Meritage will be in 14 of the top 20 markets in the US. In addition to being the second-largest market for single family home building permits in 2013, Atlanta permit activities are expected to grow approximately 75% by 2015 and median home prices have been increasing. The market is home to 16 Fortune 500 companies and is expected to add 140,000 jobs between 2014 and 2015.

Turning to slide 10. Greenville-Spartanburg is also a growing market that's been flying under the radar, so it represents an attractive opportunity for us. The Greenville-Spartanburg corridor is the second largest urban region in South Carolina and serves as the economic and political center of the state's10 county upstate region. The market has a diverse mix of professional and well-paying manufacturing jobs and is expected to add 12,000 jobs by the end of 2015. Legendary has been very successful in this market and is the largest private builder with a dominant position there. We expect the acquisition to close in August and are establishing a new southern region to initially include Georgia and South Carolina as well as Tennessee with our regional offices to be in Atlanta.

Jay Thrower will be our regional president based in Atlanta. Jay has a successful track record as a homebuilder in these markets Under his leadership and with the support of our high-quality experience management team and employee base at Legendary Communities, we expect this region to grow significantly faster than the company as a whole, in excess of 20% annual growth, in closings and revenue in 2014 and 2015 adding meaningful accretion to our future earnings. With the additional earnings growth potential that represents for Meritage you can see why I'm excited about this acquisition.

Now I'll turn it over to Larry to review a few other highlights for the second quarter. Larry?

Thanks Steve. Turning to slide 11, I'll provide some additional details to explain our second quarter operating results. We held commissions and other sales costs steady at 7.2% of home closing revenue in the second quarters of 2014 and 2013, while reducing our general and administrative expenses to 4.9% from 5.0% of total closing revenue in 2014 compared to 2013. Our interest expense dropped to $1.4 million from $4.5 million in the last year second quarter as we capitalized approximately $13 million of interest incurred to homes and lots under development. We're quickly approaching the point where we will capitalize all of our interest incurred and have 0% interest directly expensed.

Other income included net income increase of approximately $3 million related to various legal settlements in the second quarter of 2014. Our effective tax rate was 36.5% in the second quarter of 2014 compared to 27.0% for the same period last year. The second quarter of 2013 included a tax benefit of approximately $2.6 million primarily due to federal energy tax credits and the partial reversal of our deferred tax asset valuation allowance in California. The 36.5% is closer to our normal expected tax rate for 2014 assuming there is no extension of the federal energy credit for 2014.

Moving to slide 12, for the first half of the year we generated a 50% increase in net earnings on an 18% increase in home closing revenue demonstrating our earnings power far exceeding our top line growth. Our home closing gross margin of 22.3% year-to-date was up 170 basis points over 2013 reflecting higher selling prices for homes, better direct cost control and construction overhead leverage. Commissions and other sales costs year-to-date were a constant 7.4% of home closing revenue both general and administrative expenses were down 30 basis points as a percent of total closing revenue. Our pretax margin for this for six months of 2014 improved 330 basis points to 10.3% from 7.0% in 2013.

Moving to slide 13. We put approximately 2200 new lots under contract in the second quarter which exceeded our activity in each of the two previous quarters and ended the quarter with approximately 25,800 total lots under control, an increase of approximately 14% compared to a year ago. That maintains approximately a 4.8 year supply of lots relative to our trailing 12 months closings. I'll note that we have added no new lot positions in Phoenix this year.

We invested approximately $146 million in land and development during the second quarter of 2014 bringing our total land spend for the first half of the year to about $310 million. As Steve mentioned, Legendary controls over 4000 lots and has a robust pipeline for additional lots in Atlanta. We will include their lots in our reported total lot supply at the end of the third quarter assuming we close during the quarter.

Moving to slide 14, we ended the quarter with $291 million in cash, cash equivalents and securities compared to $364 million at year-end 2013 as we deployed capital for additional growth primarily in work in process inventory and lots controlled. Our homes under contract, under construction increased $108 million and our homesites, either finished or under development, increased by $77 million over our year-end 2013 balances. Our net debt-to-capital ratio at June 30, 2014 was 37.6% compared to 39.1% at December 31, 2013 and 37.2% a year ago at June 30, 2013.

We do not plan to do any capital market transactions to complete the acquisition of Legendary Communities. Assuming approximately $130 million of cash outlaid for Legendary, our pro forma net debt-to-capital ratio for June 30, 2014 would be approximately 42.2%. We are very pleased to be upgraded by all three major rating agencies during the first half of this year. And with that I will turn it back over to Steve before we begin Q&A.

Thank you, Larry. Overall we were pleased with our results for the second quarter and expect to continue to grow and increase our earnings for the remainder of 2014. We are looking forward to completing our acquisition of Legendary Communities next month and are continuing to look for additional opportunities to grow within our current markets and potentially expand into new markets for Meritage.

Our successful track record of growth and earnings expansion through 14 previous acquisitions and start ups gives us confidence in our ability to grow profitably and we are well-capitalized to finance additional growth. I thank you for your attention and will now open it up for questions, the operator will remind you of instructions. Operator?

(Operator Instructions)

Our first question comes from Michael Rehaut with JPMorgan.

Thanks good morning everyone, and congrats on the acquisition. The first question I had was on gross margins and I'm sorry if you covered this before but gross margins came down a little bit sequentially. I think you'd been pretty upfront with the street in terms of your expectations for gross margins maybe to come out in -- come down on sorry a little bit into the back half.

Do you see any further kind of, you know, gradual downward movement? And perhaps you could also talk about how you're thinking about gross margins a little bit past the second-half given some of the comments by one of your competitors this morning regarding their own approach to gross margins and incentives and sales pace.

No, I think we stand by what we said last quarter. It's kind of playing out exactly as we expected and we expect this year to finish up pretty flattish from what we saw last year, and not much more to say on that. Larry, you want to add to that?

Yes, I think we'll see just a little bit of additional margin decrease with the back half of the year but it should be much less substantial than this last quarter decrease. So on average we can still wind up around the 22% we had last year it could be a little below it could be a little above. We just don't know yet.

Okay. Secondly, on the SG&A you had a little bit of leverage versus a year ago, on 15% top line growth, you're taking in Legendary and you're obviously, you're continuing to grow the business. How are you thinking about SG&A for the next six, eight, twelve quarters, where do you think that should fall out on a more steady state basis perhaps as following perhaps some upfront costs that you might incur in terms of, you know, the community ramp up?

You know SG&A has been higher than we desire, and it's been you know a bit frustrating for us. But take into account that we have four pretty small markets that we've entered, I mean pretty small operations you know looking at Charlotte, Raleigh, Tampa and Nashville where we have a full team in place in every market, and the volumes really haven't gotten to the level yet to be able to leverage that overhead. And the fact that we are going to be opening up a lot of new communities and ramping up has really kept our SG&A kind of stubbornly high.

We think over time it's going to come down and we don't expect that much corporate overhead or you know high-level management overhead for the Legendary acquisition so we do think that will help us to some degree bring the number down a little bit. But meaningful decline is probably still a year away.

Great thank you

You'll probably see some modest continued decline as we go through the year and have higher revenue but not significant decline

One last quick one Larry, any sense of what the purchase accounting impact might be as you close out Legendary? I guess if you're doing it in August it might have a limited impact in third-quarter but maybe you know 3Q, 4Q what that might be?

We're not going to get a lot of earnings accretion for Legendary in 2014 that you will come in 2015. We only have five months that it's going to be impacting the full-year.

In addition as you know when purchase accounting the whip under construction in pre-pre sold whip winds up being written up so you don't realize the full gross margin benefit. So that's going to decrease the ability to add meaningful accretion in 2014 so it's mainly going to come in 2015.

I guess I would also add that we do expect to book a little bit of goodwill in the transaction you know maybe $20 million or $25 million of goodwill. Not a meaningful number for the company as a whole but we will have a little just a little bit of goodwill booked.

And any sense of that purchase accounting Larry what that number might be?

The write up in whip or -- whip generally gets written down to a margin of anywhere from fairly normal if it's just started backlog if it's finished backlog it could be half of the normal gross margin, so it's hard to say. I don't think from for the company as a whole it's going to have a meaningful impact on our total gross margin percentage, just slightly. So I guess I wouldn't worry about it too much from a total company projected margin standpoint.

Thank you very much

Thanks

(Operator Instructions)

Please remember if you do have questions please limit them to one question with one follow-up. The next question comes from Will Randow with Citigroup.

Hey, good morning and thank you for taking my questions. On last quarter's call you talked about Phoenix slowing quite a bit adding incentives. Can you talk about how that's influenced your margin in the quarter and where Phoenix sales are at kind of for the month of June and if you have a July look?

So you know Phoenix sales -- let's see, in April they averaged about 2.5 sales per community. We had a pretty big dip in May, it was down to like 1.5 and then it rebounded to about 2.5 again in June. Incentives have increased probably on average about 5% in Phoenix. So our margins have come down you know substantively here.

I can't really tell you about July yet, the last week of the month is always the most important week and we have a lot of things pending. So I certainly know July's going to be better than it was in May. Will it equal June? I can't tell you. I think the market has bottomed out and I think we kind of found the bottom of the market and we've got to see it start to improve and get back to where it was before.

Thanks for that. And then on kind of a for-demand pace, where are you seeing things tracking and I apologize if I didn't hear it the first few weeks of June year-on-year?

I'm sorry the first few weeks of July you mean?

July yes sorry

I don't want to give too much commentary on July like I said because I just don't know yet what's going to happen the last week. You know it's probably on pace with what we did last July maybe a touch better but you know it is too early to make that prediction.

Okay thanks

One important thing to point out is as Phoenix has been slower Texas has really been coming back both in volume and in margin so that's helping offset a bit of the slowness in Phoenix. And the rest of our business in the Southeast and in California still remains pretty darn good too. So fortunately that's offsetting the Phoenix slowing.

Yes, just to pile on what Larry said, our business in Houston has been really strong. We had four months in a row we sold more than 100 homes so we are really excited about that. And our business in all the other three Texas markets has been improving as well. So Texas is really compensating for the slowdown we saw in Arizona and a little bit in the inland empire.

Thanks again and good progress and we'll wait for things to pick back up.

Thank you

Our next question comes from Nishu Sood with Deutsche Bank

Thanks I wanted to ask about Legendary to bring you into some new markets 40 communities I think you mentioned 4000 lots. So I wanted to understand given the size of the acquisition relative to your current operations how it might impact fundamentals. Steve, you already talked about SG&A a little bit just wondering how might affect ASP's and gross margins and beyond the purchase price impact that Mike was asking about earlier?

I think their ASP is pretty close to what ours is, maybe a little bit less. Their gross margins are right in line with ours in some cases potentially even a little bit more. We may try to bring the gross margins down a little bit to increase their absorptions.

Their absorptions per community are probably a little less than ours. So as a private builder of their more focused on you know total dollars, you know, more so than volume. So I think overall none of the metrics really would impact us, you know, either way. I think they will fall really tight in line with our's.

Got it and second question -- Steve longer-term focused, last quarter I think the quarter before that you mentioned the need for, you know, ASPs had gotten you know quite high. And the looking ahead in terms of rising rates and you know broadening of the market you talked about the need to get ASPs down through smaller floor plans and wanting to fit under the FHA cap, etc. I wanted to ask for your updated thoughts on that the ASPs did seem to flatten out a little bit but what are your thoughts on that now?

Nothing's really changed is not something that's going to happen in a quarter or two, more of a longer-term proposition. And you know we are still focused on that and our opinions really haven't changed. We have got to keep our ASP closer to 350 and you know as we look at new land going forward and a lot of our markets, we are trying to drive to that point so same thing I said last quarter.

So I guess what I meant was, have you had success in recasting current communities with new floor plans? Or is this just more of a as you just described a thought process for evaluating new land acquisitions?

Yes as you said is more forward. We are not going to change any of the communities we have now to introduce new product or smaller plans. I mean it's tweaking a little bit around the edges but is more for a forward-thinking strategy.

Okay great thanks

The next question comes from Stephen Kim with Barclays

This is actually Freda on for Steve I did have a question on your land spend strategy. I mean if you look at where land spend has been trending the first two quarters of this year. The first quarter was 40% of revenues tailing down to about 29% of revenues.

So just as the housing market at large I think in general has been below expectations as people coming into the year has that impacted you know how much land you're willing to spend on this year? And then you made some interesting commentary that you guys had spent land to maintain like the 4.8 years worth of land supply. So is that kind of a commentary that you're not necessarily looking to be you no longer land at this point in the cycle?

No we're being careful about our land purchases. We're not trying to go longer than we already are.

There are certain markets we are not buying land in right now you know Arizona primarily being the biggest one. We think land prices are pretty high in most markets but there are still deals to do that make a lot of sense. And we knew we had the Legendary acquisition coming and we are going to pick up a lot of lots with that. So we are taking more of a pinpoint, strategic approach to buying land.

Okay great. And then just looking to the Florida market. I see both of the other regions nothing was super surprising but in Florida orders were down a bit down year-over-year in ASPs, was that mostly a function of just closing out of communities? And if so could you talk a little bit more about what future community openings are like in the region?

You know we've been a little bit delayed in getting some communities online in Florida, particularly in Tampa. We have a new division down there and only have a couple stores open this last quarter but we got a whole bunch of stores coming. I think were going to have 10, more than 10 net new communities in Florida opening this quarter, both in Tampa and in Orlando.

So we've got very strong market share and dominant position in Orlando and we are looking to build upon that with some additional product and penetrate some new sub markets. So I'm not concerned you know about Florida at all and very optimistic about what we are going to be able to do there.

It's strictly a community count issue and the sales velocity remains strong and the sales price is simply a mix issue with some of the higher selling communities selling out. So Florida remains a strong market for us.

Okay great thanks guys

Thank you

The next question comes from Ivy Zelman with Zelman and Associates

Hi good morning guys it's Alan on for Ivy and congrats on the Legendary deal it's exciting to see the expansion in the Southeast for you. Steve just a first question clarifying the community count guidance in your release, the 190 target to be up by the end of the Q3. How should we think about the progression through the quarters, is that going to be more back half weighted or are you already seeing the growth in it for the first three weeks of July?

You know quite a bit is going to come in August but a lot will come in September. And we are pushing hard but you know is not exact science and we are just committed to be there by the end of the quarter. But I can't tell you precisely when these communities are going to open up and deliver sales. Certainly we have an internal calendar year you know precisely which communities are going to open which week but it doesn't always quite work out that way and can vary.

Got you. In the second question along the lines of the Legendary deal. In both of those markets the Greenville and Atlanta markets now you're going to be going up head-to-head with DR Horton, who out this morning spoke about increasing incentives in many of their markets since specified Atlanta and Greenville specifically. But what your strategy as the deal closes and you go into those markets?

You are forecasting you said above average growth in Greenville and Atlanta. So is it going to be a situation where you're looking that kind of take share right out of the gate? Or what are your local people telling you as far as the more recent trends in those markets given Horton's commentary this morning?

Well above average growth in the region mostly in Atlanta and Nashville.

Okay

We are the number one builder with the acquisition of Legendary in Greenville. And certainly Horton's going to have a big position there not only with their own stores but with their acquisition of Crown. We think we will compete well with them, we've been competing well with them, and we don't expect to see any fall off in business there in Greenville and expect to grow with market.

But we are going to be focusing most of our efforts going forward on building the Atlanta business. There's a ton of opportunity in Atlanta, many sub markets in Atlanta that we are not in we want to get into and the pie is way big enough for everybody. Horton can get theirs and we can get ours and I think we can both do really well and not to mention all the other builders there that we will be competing against.

As far as the margin outlook in both of those markets and once you move past the purchase accounting I think more out into 2015 and beyond. Are those markets you would expect to achieve kind of corporate average margins in?

Yes, equal to or better. I would say.

Great thanks a lot

Okay

The next question comes from Adam Rudiger with Wells Fargo securities

Hi this is Joey Matthews on for Adam. You just mentioned Steve some talk in Atlanta that you want to get into, should we interpret that to mean that you're going to be putting more capital to work in Atlanta in addition to the Legendary deal? Or does the Legendary deal include the lots where you're looking to --

Absolutely we'll be putting more capital into Atlanta. You know we are buying this as a platform to grow starting 0.9 and ending point -- and you know I'm as bullish about Atlanta as almost any market in the country.

So the Legendary deal is about eight years supply that seems definitely higher than your average, company average. I guess what you -- how big of a piece of your total company do want Atlanta to be?

Number one we can grow their deliveries significantly which will bring the year's supply down definitely. And number two is that they've got very little money tied up in a lot of those lots the option deposits are very small so there's very little risk to the balance sheet with a lot of those options they have and a lot of those lots have appreciated during the money.

I don't really look at it that way I think we can get to our thousand units in Atlanta in a relatively short period of time over the next few years. And we'll have to build a lot supply there because the lot supply pipeline much bigger in Greenville.

Great. Shifting over to California, absorptions are down about 30% year-over-year. How are you feeling about that market? Is it just kind of comparisons just really tough from last year or is it truly getting weaker?

No, it's not a demand issue. It's more of an issue of buying land that makes sense and getting stores online opened up. If you look at our absorptions, they exceed the company average there have been over 12 per quarter that's very good.

Our margins are still really good there. So it's just about us being able to penetrate the market in a deeper way and it's been challenging. But we had quite a few stores opening up this quarter as part of that getting back to 190 or so and feel very good about California.

Okay, good luck, thanks

Thank you

The next question comes from Paul Przybylski with ISI group

Good morning this is Paul Przybylski on for Stephen East. I was wondering if we could get some color on your monthly order progressions throughout the quarter and if June was down sharply from May?

We sold 580 homes in April, dipped down to 522 in May. And we actually went up we had a little better June than we did in May and we did about 545 in June.

Okay, and you mentioned incentives have increased about 5% in Phoenix. Were there any other markets where you know increased incentives?

No. Not in a meaningful way.

Okay and then going back to California, can you give us some compare, contrast the differences between Northern California and Southern California? And then coastal versus what's going on in the inland empire?

Our Northern California business continues to be the strongest of the two. We have got several positions opening up in the south bay that we're really bullish on that we think are going to deliver some pretty good results going forward. Southern California was a bit of a community count issue but there's still pretty good demand there.

We are trying to you know push our business in Southern California to become a little more urban. We have a couple urban communities in the pipeline coming on the next several quarters. But you know as I said earlier demand in California is still pretty strong so it's more of us getting our supply in line than finding the demand

Where would the urban locations be located?

Like the 210 corridor commuting into LA, into downtown LA. People commuting in the Pomona, Claremont area out there in into LA.

Thank you, I appreciate it.

The next question comes from Michael Rockland with Bank of America Merrill Lynch

Thanks, good morning everybody, thanks for taking the questions. Can you speak to lower FHA loan limits I know something that was instituted earlier this year. I would I obviously had an impact on certain areas, I think it affected your business in Arizona.

Can you talk about how those loans have affected maybe other regions like your positions in California? Especially given that you may be more oriented towards that the inland Empire then say Orange County or San Fran?

Larry you want to take that one?

Sure. That is one of the reasons that we contribute Phoenix in particular being a bit slower because the decrease in loan limits was higher fortunate to the average selling price in Phoenix for a new home. So that's one of the things that affected the Phoenix business.

Elsewhere it has had some impact but not a dramatic impact. But that is one of the reasons why our non-FHA VA business has increased. So over 70% of our homes that we are selling now are conventional finance homes and our down payments a little bit higher a lot of it driven not only by the down payment or excuse me the loan limit decrease but the cost increases of doing and FHA or be VA loan.

How about 70% compared to last quarter or last year let's say?

Well it was below -- conventional was below 50% year-and-a-half or so ago.

Got you, thank you for that Larry.

Second question historically the Company has used land banking for growth as opposed to using the balance sheet. Any change in what we've seen at the land bank and this may be a question asked a quarter or two ago, but have you seen any change with respect to land bankers and has there been any improvement there? And what's company's strategy with respect to land banking if and when we do start to see more notable improvement?

Steve I'll take that one too. We like land banking as we've used a lot in the past particularly last cycle, there are more land bankers coming back into the market or new land bankers being created. Still we would be using land bankers a lot more if there were more land bankers available. But it's a philosophy and strategy we believe in and you should plan on seeing our option controlled lot supply go up over time.

But we're in no way going to get anywhere close to where we were before as a percentage of our lots.

Correct

We are a long way away from there and we're continuing to try and source land bankers, but it's going to be a much smaller percentage of our lots under control.

Got it, thanks very much, good luck on the upcoming quarter

Thank you

The next question comes from Jade Rahmani with KBW

Thank you very much. I was wondering what kind of backlog conversion you think is reasonable to expect going forward? And if you expect absorptions to increase on a year-over-year basis in the back half?

I don't see any meaningful change in backlog conversion or absorptions going into the back half of the year. What do you think Larry?

Well you know obviously there's some seasonality to this question so because we tend to close more houses in the back half, our conversion rate goes up a little bit. I would expect that to be a little stronger in the fourth quarter than in the third quarter this year from what I can see.

So as far as sales pace goes, again seasonality would suggest that maybe sales per community would be a bit softer in the back half of the year. But you know considering that the first half has been softer, we'd hope that we would start to see some market improvement in the traditional slower sales pace would be more muted this year. But it's hard to see on -- that's just a conjecture statement.

Great, thank you, and secondly just the other income in the quarter it seem like it picked up can you was there anything specific that drove that?

Yes, we had two or three legal settlements where we picked up some miscellaneous income. So that's predominantly about $3 million of that number is from those the net impact of those legal settlements.

Okay, anything on the horizon you know in the next two quarters on those types of things?

No, it's really hard to guess when those things may or may not come in so it's hard to say.

Great, thank you.

The next question comes from Joel Locker with FBN Securities.

Hi guys Question on the community count, obviously the Legendary brings in 40 new committees but the absorption's been around 15 per year a lot lower then the Meritage communities. And, do you expect to maintain that 40 or if you pick up the absorption rates do think the Legendary footprint will shrink? And then at the end of the year you will have 205, or 210 plus 20, or will it still be 40 and end up say at 250?

I don't expect it to shrink I expect it to actually increase because we're going to try to get more communities going in Atlanta They're key positions so we lower the margins as such and match them up with ours and try to increase the velocity, I don't expect that high-level impact on community count.

So they affect 250 by the end of the year all in the including Legendary assuming.

245 to 260 somewhere in there is probably a good number.

Right, and do you have an early kind of look into what you want to increase community count off that number in 2015?

I don't have that yet but I'll be prepared to give you that next quarter.

Next quarter so --

They tend to operate their communities in like groups -- so they tend to share some of the services, share a superintendent among several communities and also share sales staff. And that results in a lower overhead cost per community and allows them to operate more profitably at a lower absorption rate. So Legendary may continue to operate at a somewhat lower absorption rate than our traditional communities although over time that may change.

Right, and then just on the SG&A going forward, do expect a little more leverage there? Based on some revenue growth or is it just kind of hitting the wall unless absorptions really pick up per community?

Yes we'll get a little leverage but it is going to be 20 basis points, 30 basis points, 40 basis points -- not going to be 50 basis points to 100 basis points. But certainly putting a couple hundred million dollars more revenue on it will give us a little more leverage

Right, thanks a lot guys

Thanks

The next question comes from Jay McCanless with Sterne Agee

I apologize if you've answered this already but assuming you get Legendary closed, what is the mix between first time move-up and luxury going to look like post-deal?

I mean I don't have that precise number, but I don't think is going to change from where it is right now. You agree Larry?

Agree. They have a very similar selling pattern to us as far as move-up versus first time. So when they blend into us it won't change the totals much

And where do you think you were at the end of the quarter, just on Meritage?

Again, I tend to say 80%, but maybe 75% to 80% is first-time move-up, second time move-up third time move-up and the rest of it is a combination of first-time active adult and luxury.

Nothing's really changed from the previous quarters.

Right

Okay that's good to hear you are right, thanks guys

Thank you

The next question comes from David Goldberg with UBS

Thanks for taking my call guys. I have a little bit of a theoretical question I guess for the first one.

And what I was hoping to get some more color on is you guys have a Legendary acquisition and if you kind of give us a little juxtaposition between how Meritage thought about acquisitions in the previous upturn versus this deal. And I know Steve you commented on the past and kind of how you thought about in the last Meritage being kind of a bank and a backup is for builders when you are doing deals and kind of moving away from that. Can you talk about how you look at this deal relative to prior deals in terms of strategy and approach to M&A?

Well it hasn't changed that much. We are always looking for making acquisition primarily for a new market. Somebody that has a solid land position that fits in with our land strategy, product that fits with our product.

We want a management team that's going to be around for a while and is complementary to the management in our Company that we all can get along and we see the world similarly. That's what we found with this company and we certainly have more centralized functions you know with regard to you know legal strategic research, national purchasing, marketing, those areas that we had seven, eight, nine years ago. So it's a little difference there but the main principles haven't changed in what were looking for.

We found it in Nashville and we found it with the Legendary and there are some others out there we are looking into as well so -- hopefully that answers your question

Yes it does and thank you for the color. I think as a follow-up to that it's interesting Legendary big land acquisition with a lot of control two options as you've mentioned, when you think about you guys are in a great position from a liquidity perspective.

But I'm just trying to think about as you start to work through these options, taking the land down, putting more permanent capital into the land as you build through and how do you guys think about the cap structure? How much can you grow given the current land position and if you keep doing deals, is it going to necessitate additional capital market transactions even if you're able to maybe buy the deals because they're relative land-like companies. As you look the growth of the land position and grow into them, is that going to require additional capital market transactions?

I don't think so. We are generating really good retained earnings, our net margins are still very high, pretty high based on historical standards. So we have good profitability.

And I think we got enough we are generating enough retained earnings to grow nicely and I do think land banking will increase to some degree which will give us some additional capital, and I'm not concerned. I feel very good about our balance sheet and our leverage and where we are at I don't think it's necessary for us to do additional cap-capital transactions. Unless there is a deal out there that we are really are excited about and really moves the needle and we need the capital will go to the capital markets but I'm not I'm not planning on any right now

As we grow our equity and drop our leverage it's always possible we could do a little bit of debt addition in order to kind of maintain our leverage at that moderate level. We like around that 40%-ish level, but it's not a mandatory thing to do. And we can certainly manage our growth and get good growth without doing anything.

That's very helpful, thank you guys

Okay thank you very much. I think that wraps up our call today we appreciate your attention and support of the Company. And we look forward to talking to you again next quarter.

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