Meritage Homes Corp (MTH) 2015 Q1 法說會逐字稿

Good morning and welcome to the Meritage Homes first-quarter 2015 earnings conference call. All participants will be in a listen-only mode.

(Operator Instructions)

Please also note this event is being recording.

I would like to turn the conference over to Mr. Brent Anderson, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Rocco.

Good morning and welcome to our analyst call to discuss our first quarter results. We issued a press release before the market opened and if you need a copy of the release or the slides that accompany this webcast, you can find them on our website at investors.meritagehomes.com or by selecting the investors link on the bottom left of our home page.

On slide 2, I'll review 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 also be materially different than our expectations due to various risk factors which are listed and explained in our press release and our most recent filings with the Securities and Exchange Commission specifically our 2014 annual report on form 10-K. Today's presentation also includes certain non-GAAP financial measures as defined by the SEC, but we have provided a reconciliation of those non-GAAP measures to the closest gap figures within our earnings press release.

Turning to slide 3, with me today to discuss our results are Steve Hilton, Chairman and CEO; Larry Seay, our Executive Vice President and CFO; and Phillippe Lord our new Executive Vice President and Chief Operating Officer of Meritage Homes. We expect this call to run about an hour and a replay will be available on our website approximately one hour after we conclude the call. It will remain active for 30 days.

I'll now turn it over to Mr. Hilton to review our first quarter results, Steve.

Thank you, Brent.

I'd like to welcome everybody that listened to this call and thank you for your interest in Meritage Homes. The spring selling season kicked off earlier than usual this year as we indicated when we announced our January orders growth of 48%, which certainly got 2015 off to a good start. Our continuing strong growth this quarter reflects improvement in the overall home building market, as well as the result of our strategic decisions to expand in promising new markets over the last few years and grow our community account which allowed us to capture additional sales as the economic recovery continued and demands for homes increased. As our newer markets mature, we believe they will not only contribute more sales and top line growth, but will also improve their margins and provide us additional overhead leverage at a consolidated level to drive future earnings growth.

Turning to slide 4, our first quarter 2015 highlights included strong top line growth with a 27% increase in home closing revenue over the first quarter of 2014, including a 20% increase in home closings and a 6% increase in average sales price. Even stronger ORA growth, with 30% increase in units and a 41% increase in total value and ending backlog value that was 33% higher than it was a year ago.

Our top line growth was led by the east region which had a 64% increase in home closing revenue over the first quarter of 2014. As a result the east region expanded 31% of our total 2015 first quarter home closing revenue up from 24% last year of total home closing revenue while our west region dropped to 42% of our first quarter 2015 home closing revenue from 47% in the first quarter of 2014 as it grew at a slower pace -- slower 8% pace.

Net earnings for the quarter were down 35% year over year primarily due to anticipated declines in our gross margin overhead leverage which Larry will review in more detail. Despite those declines in our strong order growth and expected improvement in our margins and leverage, give us more confidence in achieving our projections for the year.

But first I'd like to introduce Phillippe Lord our New Chief Operating Officer to review our order trends. We recently promoted Phillippe from the position of Region President responsible for our divisions in California, Arizona, and Colorado. Prior to that he established our strategic operations group at Meritage, which are responsible for market research, housing analytics, and the land acquisition underwriting process that was key to our success coming out of the downturn. Many of you have met him during our analyst days or conferences.

I'll now turn it over to Philippe, Phillippe.

Thank you, Steve. I am honored to join you here today.

Meritage is very well positioned and I'm optimistic about our opportunities for continued growth and improved profitability. I look forward to meeting many of you in the future.

Order trends; slide 5, our consolidated orders for the first quarter of 2015 increased by 30% over 2014. This was driven by the combination of 21% more actively selling communities and a higher number of average sales per community than last year. Our average sales prices also continued their upper trend though at a more moderate pace. Our ASP on orders reached a company all-time high of 396,000 in the first quarter of 2015 9% higher than a year ago which pushed our total order value up by 41% compared to the first quarter of 2014. The order trends were positive in all of our markets.

In the west sales picked up considerably in Phoenix this quarter, which was a welcomed improvement as Phoenix was one of our most challenged markets last year. Arizona orders were up 26% in the first quarter of 2015 compared to 2014. It appears that buyers have recalibrated their expectations, incentives have stabilized, and buyers have more confidence in the market resulting in the start of a stronger spring selling season.

California was once again our strongest market with 13.8 average sales per community in the first quarter of 2015 compared to an average of 12.2 last year, well above our company average of 8.6 orders per community in the first quarter this year. California's orders grew 31% over the first quarter of 2014. Most of the improvement has been driven by our communities up north where we continue to position ourselves closer to the bay area. Two of our South Bay communities close to San Jose performed exceptionally well this quarter.

Colorado capitalized on strong demand as well, with 11.5 average sales pace per community and a 52% increase in orders over the last year's first quarter. We continue to benefit from a tight resale market. The lack of supply remains the primary catalyst for strong new home activity. This is particularly true in the northern Colorado sub markets where we have a number of new communities.

Texas orders were down 12% due to 18% fewer actively selling communities in the first quarter of 2015 than we had a year ago. However, our average sales pace per community increased to 9.3 this quarter from 8.6 in the prior year and our average sales prices in Texas were 18% higher in this year's first quarter than in 2014; though our total order value in Texas for the first quarter was down just 4% from 2014. I'll also note that our sales in Houston remained healthy throughout the first quarter and we're consistent with last year. We have yet to experience the steep falloff and demand that many people fear with lower ORA prices. We remain cautious and are monitoring conditions very closely.

Our east regions orders more than doubled in the first quarter this year compared to last year, benefiting from the addition of two new markets in Georgia and South Carolina during third quarter 2013. We experienced the strongest growth in North Carolina where orders increased 83% over 2014 followed by Florida's 43% growth and Tennessee's 38% increase over last year's first quarter. Our strong order growth in the first quarter to translate to strong closing growth over the next couple of quarters.

I'll now turn it over to Larry for some additional details of our first quarter results.

Thanks, Philippe.

Turning to slide 6, I'll provide some additional details regarding our home closings margins first. Our first quarter 2015 home closing gross margin was 18.5%, compared to a 22.8% in the first quarter of 2014. We expected most of that decline due to the higher land prices in the last couple of years that we've experienced that are bringing margins back in line where they are underwriting targets as they work their way through the income statement.

Some of the decline was also expected due to less appreciation in home prices during the latter half of 2014 than we experienced in 2013 which had driven our margins well above our target levels. We have discussed both of these trends many times in the last year. In addition to those, a higher percentage of our closings came from the east region where our margins are still quite a bit lower than the west so the shift in our mix of revenue further reduced our home closing margins.

The shift in the first quarter closing revenue from our more mature divisions in the west to our newer divisions in the east is evident in the table on slide 6. Two things are clear here, west region margins are quite a bit higher in the east region. This is not only true due to regional differences, but also reflects the fact that many of our markets in the east are still relatively new and getting their operations up to speed.

It can take quite a while to get your operations dialed in when you're in an industry with a long lead cycle, such as home building. There are extra selling and marketing costs associated with setting up new divisions and for rebranding, retraining, and integrating systems over the first couple of years in acquired divisions. Margins should improve as those expenses are reduced and we develop deeper trade relationships that should reduce our direct costs and improve construction efficiencies.

We also had the negative impact of purchase accounting adjustments in our legendary acquisition, which reduced our east region gross margins by 130 basis points. More significantly than the 40 basis point impact on our consolidated level gross margin, that should dissipate over the next couple of quarters. Second, gross margins also declined year over year in both the west and east regions. Most of that was due to higher land costs that we couldn't offset with home price appreciation in the latter half of 2014.

Our margins also reflected increased incentives in the latter part of 2014 on some sales in Phoenix, one of the most impacted, by lowering of FHA loan limits last year. In Tampa, where we sold some excess spec inventory, considering the robust sales in our western markets in the first quarter of this year and our expectations that margins in our east region will improve as we move forward, we anticipate our consolidated home closing gross margins will increase through the remainder of the year and allow us to achieve our target of approximately 20% gross margin for the year.

Moving to slide 7, net earnings per diluted share were $0.40 for the first quarter of 2015, compared to $0.62 in the first quarter of 2014, primarily due to lower gross margins which we've already explained and lower leverage on overhead expenses this quarter compared to a year ago. The additional overhead expenses for our two new divisions as well as other expenses related to our expanded communities caused our SG&A to be higher as a percent of first quarter 2015 revenue.

In addition, $2.1 million of G&A expenses were accelerated into the first quarter due to a change in the vesting of equity awards for certain long-term Senior Executives and Board Members. Excluding that non-cash equity charge, our total G&A expense as a percent of revenue in the first quarter of 2015 were consistent with our first quarter of 2014.

Over the next several quarters we expect to gain additional overhead leverage from revenue growth, especially in the eastern markets which should improve our operating margins. On a side note we will incur approximately $3 million of compensation expenses in the second quarter of this year related to the previously announced departure of Steve Davis, our former Chief Operating Office, which will increase our G&A expenses for that quarter.

Now I'll provide a few other customary details. Our backlog conversion rate was 63% in the first quarter of 2015 compared to 60% for the first quarter of 2014. We expect our second quarter conversion rate to be a bit lower than the first quarter. 43% of our first quarter 2015 closings were from spec inventory compared to about one-third of our first quarter 2014 closings from spec inventory. We had approximately 100 specs at March 31, 2015 down from approximately 1250 at year end 2014. Approximately 45% were completed specs.

Moving to slide 8, we ended the first quarter of 2015 with $89.2 million in cash and cash equivalents and expanded our credit facility to $500 million during the first quarter of 2015 to provide additional liquidity for working capital requirements as we continue to fund the growth of the Company. $27 million was drawn on the facility at March 31, 2015. Our net debt to capital ratio was 43.6% March 31, 2015, remained within our target range and was consistent with where it was the end of 2014 at 42.9%.

Our total rolls to inventory increased to $1.94 billion at March 31, 2015 compared to $1.88 billion at December 31, 2014. Within that $65 million increase, our unsold or spec homes inventory declined by $50 million where homes under contract, under construction increased by $90 million and most of the $24 million increase in home sites went toward finished home sites as we completed the development of many lots and communities that will be coming online. We ended the quarter with approximately 29,300 lots, of which we owned about two-thirds and controlled the other third under option and purchase contracts.

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

Thank you, Larry.

In summary, we were pleased with our operating results for the first quarter of 2015 and are more confident in our projections for the year. Our orders, closings, and backlog all showed positive trends in units, ASPs, and dollar value. Our legacy markets are performing well and trends are improving with order growth being boosted by our new markets, and as our newer divisions become more established we expect their margins to improve and provide greater overhead leverage on a consolidated basis. We expect to end the year with approximately 250 to 260 actively selling communities.

I applaud our team for their hard work to secure and develop new communities, get them opened quickly, and help many more people realize their dream of homeownership. With the benefits of a healthy backlog value that's 33% higher than it was a year ago, 21% more actively selling communities and higher demand for homes than we had at this time last year we are expecting strong growth in 2015 orders and closings, seasonal higher closings in the first half and higher closings in the third and fourth quarters which should improve our overhead leverage.

We're currently projecting revenue growth of 25% to 30% for the full year, a gross margin of approximately 20%, and earnings of approximately $3.75 to $4 per diluted share for the full year with the benefit of better overhead leverage coming the back half of the year. We expect second quarter diluted earnings per share of approximately $0.64 to $0.68 per share and the second half results should significantly outperform 2014.

Thank you for your support and time today. We'll now open it up for questions. The operator will remind you of the instructions, operator.

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

(Operator Instructions)

Our first question comes from Ivy Zelman of Zelman & Associates. Please go ahead.

Good morning, guys, it's actually Alan on for Ivy. First off, congratulations to you, Phillippe on the well deserved promotion.

Thank you.

First question, just on the guidance, I think that obviously the full year guidance is certainly solid relative to expectations, but perhaps maybe some of the concern or skepticism is just on how much of that is backend loaded.

I guess if we look at your backlog conversion it's running, call it 60% to quarter, it's really based on at least the way I'm thinking about it on homes that are not yet in backlog, thinking about the margin improvement you expect to see in the third and fourth quarter, so I was hoping you could give us more color granularity on exactly what the drivers are to get the margin up a 200 basis points through the year.

I know the purchase accounting dissipates, I though that the expectation for the East margins to improve, but do you see something specific either on homes in backlog on the margins there that are significantly greater than what you delivered this quarter or just feedback from the field as far as pricing power that gets you comfortable with that type of trajectory through the year?

Well, it's a whole combination of things. Number one, we feel very bullish about the business right now. We have strong demand in many of our markets. Some of our markets in the West we're starting to have more pricing power, particularly in California and Colorado, although we don't have pricing power yet in Phoenix. We have volume here and we think pricing power is going to return in the back half of the year that will help us close some homes that will impact margin. Our business in Texas continues to be strong. Certainly we're keeping our eye on Houston but we had our best month ever in San Antonio, volume is getting stronger there, business in Dallas is pretty robust. We have a lot of new communities open up there.

We're excited about what's happening in the South. We think we're going to grow our margins there later in the year as Larry articulated. And as we mentioned that some of the purchase [accounting] is going to go away from the Legendary acquisition. We think the extra volume will allow us to leverage or [a rip] particularly the construction overhead which is in the gross margin line. So we feel pretty confident that we can deliver on our statement that we're going to have approximately a 20% gross margin. We're just not wavering from that.

I appreciate that. I guess to potentially try to get a little more quantification if you look at your 230 communities you've got, got open for sale right now, what percentage of those would you say you raised prices since the beginning of the year and give us some type of average of what that base price increase would look like.

Boy, it's hard to tell. I don't really think we have that number precisely to give you. Larry, I mean you agree with that?

I don't have that number, but we are seeing improved pricing and particularly some of the stronger markets as Steve said, but I don't have the specific number that we increased prices or what percent the price increase was.

Okay. Thanks a lot. Good luck.

Thank you.

Our next question comes from Stephen Kim of Barclays. Please go ahead.

Thanks, guys. Yes, I wanted to also sort of follow-up a little bit on that gross margin guidance about 20%. I just wanted to make sure I understood how you're thinking about that on a quarter-by-quarter basis, in particular are you talking about -- are you sort of basing that specifically around what you're seeing over the next couple of quarters or really are you talking about you think you're going to be at an exit rate of like 20%-plus as you end the year?

Well we are going to have to be above 20%, you know the back half of the year to make up the below 20% we're at now and we'll be at in the second quarter. So clearly to make the math work, we're going to have to get above that. That was the same that we saw last year. Our gross margins were higher in the last couple of quarters than they were in the earlier quarters if I'm correct. But we're looking at our backlogs and we're looking at the gross margins in our backlog and then we're looking at the pricing power that we have in homes that we're selling today versus homes that we sold a quarter or two ago. It's the mixture of both of those that gives us the confidence that we can hit the 20% number.

So I guess if you're looking at it based around pricing power you're seeing in the market today and so therefore for homes that you expect to be selling over the course of the next couple of quarters, if I could just shift to that slide you presented about the East margins versus the West margins you talked about the fact that the West margins are higher than the East margins but if I remember looking at that slide, there's been a fair amount of compression there and in fact I'm wondering, you know, the West margins at this point aren't all that much higher than the East margins.

So I'm wondering like are you talking specifically about improvement in pricing in the Phoenix market and California and Colorado which you alluded to but particularly the Phoenix market going forward into your guidance for 20% or is it mostly driven from increased volume in the East?

Well, it's both. I mean, as you know, we had real pressure on pricing from the second half of 2013 all the way through 2014 in inland California and in Arizona. That pressure is dissipating. We had strong order growth in the first quarter in both of those areas, and we believe as we get later into the year we're going to be able to start to gradually raise prices in those markets. So the combination of the volume, the price increases, the leveraging in the construction overhead, again some of the new markets in the East are also giving us better leverage.

We're getting better pricing power. We're getting better material costs. We're getting better labor costs. As we grow and synchronize our operations so all of that leads us to believe that we're going to be able to deliver on this 20% gross margin.

I think you need to realize that the closings in the first quarter came from the softer back half of 2014 where really all of our markets were being impacted by softer demand. All of our markets are being impacted by positive demand and particularly in the West last year we had really, really strong kind of off the charts margins which made, but particularly in Northern California which made the West higher. Northern California and California is still good but not as good.

But it's still benefiting from the improved market. So some of the West we expect to increase particularly in Northern California and Colorado, a little bit in Phoenix but not as much improvement in Phoenix in margins, but the combination of that is going to expand the West margins we've already talked a lot about the East margins and why that's going to expand. And Central we expect that to stay fairly flat, it'll probably have some improvement but not as much because it wasn't as impacted as much by the slower 2014.

Got it. Okay, that really helps clarify it. I guess what I'm hearing in there is that no, there's no anticipated mix shift in case the entry level buyer starts to come back stronger at the end of the year, right? You're not assuming that in your numbers either, right?

No, no.

Got it. Okay, great. Thanks a lot, guys.

Our next question comes from Michael Rehaut of JPMorgan. Please go ahead.

Thanks. Good morning, everyone. The first question I had was on the East margin that you highlighted in terms of mix shift and some of the impact on the quarter. And you also kind of noted that in that region in particular, you have newer areas that you're operating in and as those come online and the region grows and gets them to scale, I wanted to know if you have a sense as you look at your plans over the next couple of years when do you think that, that East margin can kind of come up to company average as you would expect the buildout to be more in a fuller state?

It's hard -- I'll let Larry jump in here also but, it's hard to pinpoint exactly the date and time when that will happen. We're at different stages in different divisions. Some divisions we're farther along like Charlotte and Raleigh, we've been there a little bit longer but we have newer divisions like Nashville where we're bringing on a lot of new communities.

We're certainly pretty young and small in Atlanta we're bigger in Greenville but we're going to be bringing more of the Meritage systems and processes there that we think will help. It's -- Tampa as well is a market we need to improve our margins there. I'd say over the next couple years, 18 to 24 months margins will be improving. Gradually hopefully every quarter.

Right. Okay.

I agree with what Steve said. I guess I also point out that for the Legendary acquisition, we just moved into a new office there. We're in the middle of the computer conversion for Atlanta and Greenville. Some of that stuff does distract from operations. We are going to get that done over the next couple of three months, that conversion and get people focused on operations, but some of that stuff does have a little bit of a drag.

It's not only the cost but also the distraction. The other thing we mentioned is that we did sell some -- greater percentage of specs in Tampa and those specs we had overbuilt specs in Tampa so we have cleared out those specs and some of those specs were sold at a little lower price. So that was another kind of non-continuing drag in the first quarter that will go away and help the margins bounce back in the East.

What do you think that, that had specifically that, that particular issue in specs in Tampa on the on the margin overall, Larry?

I couldn't give you a basis point impact but it did have a little bit of a drag, too. We mentioned it in our script, but I don't have a specific basis point impact.

Right. I guess just last or second question, last question, you kind of always give great regional color and I'm sorry if you hit on this earlier but from a pricing and incentive standpoint, just curious if through the first three months and perhaps even into April are there any regions that you wanted to highlight in terms of pricing power, maybe a little better than expected or continuing to -- or rising at a solid pace that, would kind of in some ways perhaps drives your second half confidence or any areas markets from a pricing standpoint that are maybe a little softer than expected?

I think I went through that in pretty good strong detail with Alan in the first call but just to reiterate again, we have strong pricing power right now in Northern California. Certainly the inland communities in Southern California but we don't have that many of them. Denver pricing power is good although there's a lot of cost pressure there. Dallas we have several new communities opening in Dallas, strong pricing power there. To a lesser degree Austin and San Antonio although volumes are picking up there and in some of the markets in the South, the pricing power is pretty good. Some of our communities in Charlotte we've been raising prices.

And Orlando too is good.

In a limited in Orlando as well. Certainly we don't have the pricing power that we had in 2004 and 2005 but we are starting to see, you know, on a regional basis a little bit of pricing power.

Great. Appreciate it thanks for going over that again. Thank you.

Our next question comes from Stephen East of Evercore ISI. Please go ahead.

Thank you, good morning, guys. Steve, if we step back a little bit and look more at a macro type level, your capital allocation, et cetera, just a few things. Could you talk about what kind of land spend you think is going on this year and also you mentioned two-thirds owned, one-third option.

Are you purposely trying to option more or utilize land banking more to look more like you did, say, pre-bust versus post-bust and then also on the M&A side, you all have historically done a lot, what's the market look like, what's your appetite there and with your net debt at 43% or so, are you comfortable with that, I mean your stocks at a pretty high level. Would you put some equity out there to reduce your debt, just sort of the whole ball of wax if you will.

Okay. Larry, correct me if I'm wrong here but I think our budgeted land spend this year is probably between $800 million and $900 million and that's including land banking. To the extent that -- maybe it's not included in land banking, Larry --

It's about $900 million including land banking. We expect to land bank about $200 million in rough numbers. That's land banking. There are other options we get from seller-carry options which is what pushes that percentage up to kind of a third percentage including those.

Would you like to get that higher?

I think we would like to push that a little higher because it makes our asset turns better, our ROA better on the other hand, there's a limited availability of land banking so we're doing what we can, but we aren't expecting that percentage to go up a bunch we think it will be about, about the same.

So and in respect to your question about equity and debt, we have no equity offerings planned. I just don't see that in the near term. We're very comfortable with our debt-to-capital ratio. If anything I'd like it to be a point or two lower but we're comfortable with it exactly where it is right here. As far as M&A, our eyes are always open.

We're certainly looking at opportunities, but clearly we understand that it's important for us to get these smaller markets that we've moved into either through organic growth or M&A to get them up to scale so we can leverage our overhead. We're not happy with our overhead percentage where it is today. We would like to see it a point lower. The way we're going to get there is by getting these smaller markets bigger.

M&A unless we did something on a large scale doesn't really help us achieve that goal so it's not likely we'll be doing any M&A in the real short term. Again, our eyes are always open for transformational opportunities that are strategic and make a difference. I think I covered everything you asked on land spend, banking, M&A, and capital.

One clarification just to give you a little more clarity on SG&A. We were at kind of mid-13, a little higher than that this quarter for SG&A and we think we will probably bring that down to around somewhere between 11.5 to the high 11s for the average for the full year. And that's all part of the equation that gets us to our guidance forecast.

Okay. Thank you. That's helpful. And then the other thing, Steve, just asking the pricing question a little bit differently that's been asked, are you all comfortable now where your absorbs ion paces are and to the point it's a pretty balanced price-versus-pace or would you still like that to get higher and thus you'd sacrifice a little bit of price appreciation in the markets?

I certainly would like to see our pace over all of our markets on average be higher, but in no way do we have a strategy here that we're going to sacrifice margin for volume. We're going to take what the market will give us as far as price at a reasonable pace. I think a reasonable pace in most communities is three a month. So if we can get three sales a month and we can raise prices, we're pretty happy.

Got you. If I can sneak one other quick one in. On your community growth that you've talked about, is Texas -- are you restocking Texas or how are you looking at that market right now?

Well we've got a green light on for land acquisitions in Dallas, Austin, and San Antonio. We don't see any oil impact in those markets and we see a lot of relo's, a lot of national companies relocating to Dallas, Austin to a lesser degree and we're being very cautious and limited in land acquisitions in Houston.

Pretty much just keeping our ongoing communities running and restocked. We have, we're in a lot of master plan communities there where we buy 20 to 30 lots at a time from the developer. To the extent we're selling homes, we're just replenishing those but we're not going out to do any larger land development deals in Houston for sure.

The bouncing back of the community count in Texas is going to occur from already controlled and existing communities coming online for sales. So we don't need to spend a lot of money to get our community count back up to where it was a year ago in that kind of 70-ish plus range.

These are land deals that we purchased a year ago or even longer that will be coming online.

All right. Thanks a lot.

Our next question comes from Nishu Sood of Deutsche Bank. Please go ahead.

Thanks. I also wanted to ask about the community count and appreciate all the guidance and the color. You're talking about some pretty robust growth this year, close to 20%. That's a pretty significant acceleration from last year where I think absent the Legendary acquisition it would have been pretty modest growth.

What's the driver of that? Were there some deferrals from last year? Is it just things moving through the pipeline? What's the main driver behind the growth?

It's land that we've purchased over the last couple of years that is ripening and moving through the pipeline and stores are getting ready to open. There's nothing unusual in there. It should track pretty closely with our land spend.

Got it. I guess one of the things I was thinking about in asking that question was if we go back to a year ago in 2014, you also had fairly aggressive goals for community count growth last year, but at the end of the year, you looked back and the growth is mainly through Legendary. What were the factors I guess if you compare, you know, the aggressive plans last year a time ago to now? What might influence the outcome for this year?

I'm not really sure how to answer your question. The only thing that can change is we get held up by cities for permits or we run into some entitlement issues but for the most part, you know, everything that we're going to be opening between now and the end of the year is already well through the process and the only thing that could really impact it is construction delays or weather or things like that.

Again I feel pretty confident that we can deliver on that 250 to 260 ending community count for the year based upon what's in our pipeline and what's under development right now today.

Got it.

I guess I would also add that to some extent we anticipated Legendary happening and did cut back on some of the growth because we were spending the money there versus some place else and the percentage increase is only 9% to 14% from the beginning of the year to the end of the year depending if they use 250 or 260, so I wouldn't call that extremely aggressive, I think that's kind of normal growth.

Got it. And you also you addressed Texas in what Steve was just asking. In the balance of the country, where is most of the growth going to come? If you could just give us some color regionally.

We're at 61 communities right now in Texas. We think we're going to be in the mid-70s there. That's a big chunk of it. Probably not going to be growing community count in Arizona. We'll probably grow it a little bit in California. But a lot of it will probably come in the south, in Tennessee, Carolinas, and Georgia.

Got it. Great. Thank you.

Our next question comes from Susan McClaury of UBS. Please go ahead.

Good morning.

Good morning.

Building a little bit on Nishu's question there, it seems like your order trends in Arizona have definitely improved as we sort of moved through the last few months. Can you give us some color on what you're seeing there and how we should think about the opportunity there? I know, Steve, you just said you don't expect to open a lot of communities there but could you give us some on the ground details perhaps.

I'm going to toss that over to Phillippe and let him answer your first question Phillippe.

Thanks. Yes, we had seen a real stabilization in the market. It started occurring late Q4. Incentives have really stabilized. The retail market has stabilized from a supply perception and so really in January we saw a much stronger traffic in most of our stores at all price points and that traffic turned into stronger urgency and conversions through the first quarter.

So we're feeling very good that the market is stabilized. Steve mentioned earlier that we're not seeing a lot of pricing power, but the discounts being stabilized is a big deal. It helps sort of improve our margins when discounts aren't continuing to be moving around in the market and they're more stable. So we're seeing margins stabilize in Phoenix through Q1 and we expect that to hold true going forward. And potentially turning into pricing power.

Okay, that's perfect. And then taking sort of a broader approach, you recently announced that you're doing some net-zero homes and energy efficiency has been a big part of your story. Given the decline that we've seen in energy prices, have you seen any change in consumers' reactions to maybe some of the energy efficient initiatives or have you changed the way you're marketing them or talking to customers about them at all?

No. The decline in energy prices haven't really had much impact on utility costs, particularly electricity. Maybe some impact on gas, but our companies out in the west aren't lowering their rates, that's for sure. I don't think there's a connection between energy prices and new home energy efficiencies.

You know, we continue to sell our extremely energy efficient homes as they differentiator between ourself and the resale market and other new home competitors. It's a strength of ours, particularly when we're trying to close the sale. We've got some things we're working on in that area to even bolster our strategy but nothing new to announce today.

Okay, great. Thank you.

Thank you.

Our next question comes from Jade Rahmani of KBW.

This is actually Ryan Tomasello on for Jade thanks for taking my question. Just taking it a bit into the land market, just wondering if you could provide a bit more color on where you're seeing most attractive opportunities. Are you seeing better margins on the larger deals that require more development? How is the overall deal flow there currently?

Not necessarily. We're trying to stay away from the real large land development opportunities where we have multiple product lines. Those definitely can carry more risk. Certainly we do have a few but we're focused in California on more infill opportunities. We're spending more money on building our team that can do more infill attached communities closer to the water, closer to the bay, or closer to Orange County.

We have some strong opportunities we're pursuing certainly in Colorado, in many of the Texas markets outside of Houston and mostly in the south. So land is fully priced in most places. There's no bargains out there. But we have some real sharp people in our land acquisition teams throughout the country and we're still finding opportunities to fuel our growth.

Great. Thanks for taking my question.

Thank you.

Our next question comes from Jay McCanless of Sterne Agee please go ahead.

Good morning, guys. Larry, first question, could you talk about the sequential increase in interest expense from 4Q to 1Q and then relative to your guidance, how should we be thinking about that for the year?

Sure. What's happened, that number bounced up a little bit and it's being caused by us completing several projects that were under development so we have a lower percentage of underdevelopment land now sitting as finished lots versus a quarter or two ago. So that number is going to remain a little more elevated. I thought it would actually go down and stay lower and maybe approach zero.

Right now I don't think that, that's going to happen because of that percentage of underdevelopment versus development land. So that's a good story in that we have finished communities that can start selling, but it's causing us to expense directly a little more interest than we had thought and a little bit less is being capitalized. So I see that number staying up in that range that we had this quarter. Probably will go down a little bit through the year but it's not going to go to zero.

And then also on the EPS guidance for this year, does that include the one-time severance charge next quarter?

Yes, it does.

Okay. Then my last question, could you guys talk about Northern California a little bit? It seems that the market there, the existing home markets seem to be perking up, and I just want to see what you guys are hearing in the neighborhoods.

As Phillippe mentioned in his comments, Northern Cal is very strong we had a couple new communities open in the South Bay, Morgan Hill, Gilroy area, we had strong traffic, strong demand, strong pricing power. Our communities, we have one community out in the Central Valley.

We have communities along the corridor between the East Bay and Sacramento and then we have communities throughout Sacramento, all have had strong traffic and strong demand. Probably our best market in the entire company right now. You know, we're really excited about our business opportunity up there and we're going to have a great 2015 in Northern California.

Thanks, guys.

Thank you.

Looks like we have time for a couple more questions. Next up we have Mike Dahl of Credit Suisse. Please go ahead.

Hi. Thanks for taking my question. I wanted to go back to some of the earlier discussion about margins. I think, Steve, you guys have been one of the more open and kind of early in terms of talking about the impact from rising land costs and just curious what the guidance says now for margins to be up above 20% in the back half of the year.

How are the land costs as a percentage of sales price trending and is there anything that you're seeing differently in that on what's coming, what's opening over the next couple of quarters?

Well, what's opening the next couple of quarters will be land that we bought already and it's been in our pipeline now for probably over a year. Today's current land prices don't really affect what's going to happen this year. But certainly land prices are higher and we will have to get higher housing prices to offset that.

It varies by market and some markets it's attainable. We have a green light on. We're buying land. Other markets we're certainly being more cautious. The land market is certainly tighter than it was a year or two ago.

Steve?

Yes, go ahead, Larry.

If I could jump in here. A couple of things are causing that improvement. The most notable is leveraging construction overhead which is buried in cost of sales and therefore affects margins. So that leverage is helping us improve as we grow volumes through the year. The other thing is we have talked about particularly in the East about improving some of our operational metrics and direct construction costs.

So the other piece is some improvement particularly in the East on construction costs and then again generally speaking, we're talking about the market being stronger than last year and we are having improved pricing power so we are going to be able to increase and we have increased pricing in many of our markets this quarter. And we're projecting that to be able to continue that improved pricing metric.

Thank you. As a second question looking at the Southeast markets specifically, an area of investment for you guys and also a lot of others, I'm curious how you're thinking about with some of the community count ramps and competitively a good bit of community growth from some of the others. If you look out over the next 6, 12, 18 months, are you concerned about the level of competition that's out there in some of these markets or do you think the demand is strong enough that it shouldn't be an issue?

I'm not more overly concerned, you know, more so than any quarter before. Competition is strong but we have great locations and we have great people and great product so I'm not worried about that. I would like to clarify, though, I think I may have given the wrong perception about pricing. We don't put any appreciation in our proformas. We don't believe we have to get price increases to hit these margin targets that we have.

Certainly again we're looking at our backlog today and we're looking at the prices that we're at today and going forward, you know, that gives us comfort that we can hit these margin targets. I don't want to misconstrue to anybody that we are going to have to have house prices rise to make land deals work. That's really not what I'm implying.

Thank you.

Thank you good thank you.

And our next question comes from Will Randow of Citi.

Hi good morning guys. Thanks for fitting me?

Good morning.

Just two quick follow-ups. On gross margins particularly in Texas or Houston, we saw one competitor who breaks it out, their step-down year over year for the February-end quarter. Just kind of curious have you seen any pickup in incentives? I know you talked about it earlier. Or any step-down in gross margin in those markets?

Larry, what do you think? I don't think we have.

Yes, I agree. I don't think we have seen that.

Great. Thanks for that. Just one follow-up to the last set of questions. I remember back in 2013 a lot of the land deals -- and I think you guys have addressed that too were getting frothy from [HPAA] assumption. Sounds like that probably stepped down in California and Arizona markets. How would you characterize that?

Well, land prices haven't come down, but there hasn't been as much land acquisition activity and we certainly haven't bought any land in Arizona for well over a year now. And I think for some land deals to get moving, you know, housing prices will have to rise or builders that are willing to accept lower margins will buy the land. But I'm pretty comfortable with what we have in Arizona. We don't need any land.

We're still making a good gross margin on the land that we own for the most part. In California we're really more focused on infill opportunities where you have less competition from builders and we're able to get stronger pricing power. So, you know, land is -- there's still quite a bit of land that makes sense in a lot of other markets throughout the country.

Thanks again, guys and good luck on the year.

Thank you. Is this our last call operator?

This concludes the question and answer segment. I would like to turn it over to Mr. Hilton for any closing remarks.

Thank you very much for your interest and participation. We look forward to talking to you again next quarter. Have a great day.

Thank you, sir. Today's conference has now concluded. We thank you all for attending today's presentation. You may now disconnection.