Meritage Homes Corp (MTH) 2016 Q4 法說會逐字稿

Good morning and welcome to the Meritage Homes fourth-quarter 2016 analyst conference call

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Brent Anderson, VP of investor relations. Please go ahead.

Thank you, Chad. Good morning and welcome to our analyst call to discuss our fourth-quarter and full-year 2016 results which we issued in a press release before the market opened today. 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 investor relations link at the bottom of our homepage.

Referring to slide 2 of our presentation for our customary cautionary language. Our statements during this call and the accompanying materials contain productions and forward-looking statements reflecting the current opinions of management. These projections are subject to change and though we may update them from time to time, we are not obligated to do so.

As forward-looking statements, they are inherently uncertain, and our actual results may be materially different than our expectations. We have identified various risk factors that may influence our actual results. They are listed here and explained in our most recent filings with the securities and exchange commission specifically our 2015 annual report on form 10-K and our subsequent 10-Qs.

We provided a reconciliation a certain non-GAAP financial measures referred to in our press release or presentation as compared to the closest related GAAP measures. With me to discuss our results today are Steve Hilton, Chairman and CEO of Meritage; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer of Meritage homes.

We expect the call will 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 two weeks. I will turn it over to Mr. Hilton to review our fourth-quarter results.

Thank you, Brent, and welcome to everyone participating on our call today. 2016 was another year of strong revenue and earnings growth for Meritage, and we are encouraged that 2017 has started out strong. We closed 7,355 homes for the year, including our milestone 100,000 home and generated a 19% increase in home closing revenue topping the $3 billion mark for the first time since 2006.

Our net earnings increased 16% over 2015, and we ended the year with $1.4 billion in shareholders equity. We expect to expand on that growth in 2017. We made significant progress on our strategy to target the returning entry-level and first-time home buyers that have been mostly absent from the recovery to this point.

We put nearly 11,000 lots under contract during 2016, most of which are in communities that will be targeted to this buyers segment, and we are continuing to aggressively pursue such communities. We designed dozens of new plans for homes in those community to add to our product library that are in line with today's buyer preferences but are more efficient to build with quicker cycle times than our traditional product.

Turning to slide 5. We have pursued a growth strategy for Meritage homes since starting the Company 31 years ago and have executed that strategy successfully increasing Meritage's market share through strategic expansion, diversification and product innovation. In just the last six years we have more than doubled our sales driving a compounded annual revenue growth of approximately 28% and almost tripling our shareholders' equity during that time.

We are at 16 of the top 20 homebuilding markets recognized for the long-term growth potential, and we are one of the largest builders in Phoenix, Denver, and San Francisco's East Bay area, Austin and Orlando with the goal of becoming a top 10 builder in all of our markets. At the start of this decade we undertook an initiative to expand our presence in the southeastern US for greater diversification and long-term growth.

We selected six highly ranked markets Raleigh, Charlotte, Nashville, Atlanta, Greenville, and Tampa, which we entered through a series of acquisitions and startups from 2011 to 2014. Since completing these acquisitions we have been executing a deliberate strategy to position the East region for long-term success.

That has included hiring talented teams and making leadership changes where we needed to, providing these teams with the capital and support they need, carefully selecting the best locations for our communities and designing a uniquely competitive set of product offerings for the region that are consistent with our brand.

It was a major undertaking that has taken longer than anticipated, but we believe it positions the region for long-term success, and we are very close to having all the pieces in place today. While those markets are already -- have already enhanced our growth over the past five years, they represent even greater potential for our future growth.

Turning to slide 6. Outside of the East region we continue to invest in our markets in the West and Texas. We temporarily slowed our acquisitions of new land in Houston during 2015 and early 2016, but over the past couple of quarters we have reaccelerated our investment into new communities in Houston as it has stabilized particularly in the first-time home buyers segment. We ended the year with almost 30,000 lots under control, an increase of more than 2,000 lots during 2016.

Turning to slide 7, 2017 has gotten off to a good start. We will get the final January orders later today, but based upon early results we expect them to be 8% to 10% higher than 2016's January orders despite a lower community count coming into the year which indicates our sales base was up year over year.

While we are projecting slightly lower year-over-year closing volumes for the first quarter of 2017 due to a lower backlog entering the year, we expect to increase our community count for the first half of the year to drive significant year-over-year growth in the second half of this year. We are projecting total new home deliveries of approximately 7,500 to 7,900 and closing revenues of $3.1 billion to $3.3 billion for the year.

We are projecting gross margins in line with 2016 as we foresee no easing of land or construction costs over the near term. With our projected top-line growth we expect that to translate to a 6% to 12% increase in pretax earnings. We focused on improving our overhead leverage in 2016 to help offset the impact of higher land and construction costs that have reduced our home closing margins.

We expect further improvement in our operating leverage in 2017 and have a target of 10.5% to 11% for SG&A as a percentage of closing revenue this year. Based on the market conditions we are experiencing today and the quality of our people, I'm confident that we can achieve these projections. I'll now turn it over to Phillippe to provide some additional color on the trends in our various markets.

Thank you, Steve. We saw solid demand across many of our markets last year especially in the West and Texas. Our overall absorption pace in 2016 was equal to 2015's pace. The principal reason for our single digit order growth was lower community count which I will address.

The decisions we made to limit our acquisitions of new communities in 2015 and the delays in openings of a number of communities 2016 resulted in a 4% decline in our ending community count for the year, which was evident in our year-over-year order comparisons to 2015. Part of that was due to a strategic decision we made at the end of 2015 to totally revamp our home designs in the southeast and create a robust and cohesive regional products library consistent with the Meritage brand.

That strategy has many advantages for the long-term but is time-consuming. The redesign included about 60 floor plans and three foundation types for 30s, 40s, 50s and 60 foot wide lots, both single-family and town homes, one-story and two-story towns and homes with and without basements or crawl spaces with multiple options and elevations. In the end, this process required a few more iterations than anticipated to get everything dialed in as we wanted it to be before rolling out the new product.

This level of a product refresh is not something that occurs frequently, so we decided to take our time to get it right as we hope to use these offerings and the derivatives for the next 5 to 10 years. We purposely delayed some community openings in our southeastern markets to incorporate these new designs rather than open them with legacy product. We are now very close to completing that process and expect to rollout this new product as we open up new communities in that region.

We are targeting approximately 5% growth in our total community count for the Company by year end 2017. I'll provide some additional order details by region beginning on slide 7 with the West region which has the strongest order trends in the fourth-quarter and for the year in total.

Slide 8, West region's demand increased sales pace. Total orders within our West region were up 8% over the prior year in the fourth quarter of 2016 led by a 24% increase in Arizona. Phoenix has been particularly strong, and we are very well positioned with a right product and great locations.

Most of our new communities and [digs] are targeting the first-time buyer, and we've had great success with our new live now homes. We included all of our standard Meritage energy efficient features and benefits on those homes but at an affordable price for first-time buyers. We are starting more specs, offering more move in ready homes and have simplified the option selections to streamline the entire process for the buyer.

We had strong sales in the fourth quarter in Phoenix and Tucson. Excluding our Active Adult Communities fourth-quarter orders increased almost 40% in Arizona. Colorado produced 10% order growth for the fourth quarter despite having a third less communities on average than we had in the fourth quarter of 2015.

Colorado still has the highest absorption pace in the Company at 11.6 orders per average community in the fourth quarter and more than 44 per community for the full year 2016 compared to our Company average of approximately 29 in 2016. We have continued to see strong demand there despite higher home prices. We are in the process of reloading our communities in Colorado and contracted for more than 1,000 new lots in a dozen communities during 2016, which should be coming online in 2017 and early 2018.

In California demand is stronger in our communities in north than in the south where pricing is still a hurdle. The excessive rain in north impacted December sales, but despite those challenges, our total order volume value was up 4% for the full year, and we grew our committee count setting the stage for additional growth in 2017.

Slide 9. Demand in our Texas markets continued to be good. Austin and Dallas/Ft Worth had a particularly good fourth quarter and were the strongest Texas markets for the year. We saw better than expected demand in Houston during the year as oil prices improved and stabilized.

The Texas region saw strong demand in December and delivered a 5% increase in fourth-quarter orders and an 8% year-over-year increase in total order value. We've increased our community count in Texas last several quarters, and we invested more aggressively in 2016 than we did in 2015 so we are expecting continued growth in the region in 2017.

Slide 10. We had mixed results in the East region as each market faced unique circumstances and are in a slightly different position in completing the strategic transition that Steve explained. Overall, our decline in the fourth quarter 2016 orders in the East reflected a lower community count.

In Florida, we had a significant number of highly successful communities close out during the year and experienced delays opening several other communities. That resulted in a 15% decline in average active communities and 21% fewer orders for the fourth quarter of 2016 compared to 2015. Demand at the upper price points slowed during the year.

We are focused on acquiring and opening more communities at lower price points this year to meet the growing demand for those homes. We also closed out several high-volume communities in Tennessee that reduced orders in the fourth quarter of 2016 compared to 2015. However, we plan to grow our community count in Tennessee significantly this year which should drive additional order growth in 2017 and beyond.

Several community openings were delayed in the Carolinas and Georgia where we are discontinuing the legacy product that we acquired with Legendary Communities and replacing it with plans from our new Meritage product library for the east region. We expect those plans will be more appealing to consumers and more efficient to build and therefore more profitable.

Additionally we turned over sales agents and management in Atlanta during the quarter, and that disruption had a temporary impact on the performance for the quarter. As Steve noted, the development of new products for our regional library in east was a massive undertaking that has taken longer to complete than we anticipated, but we believed it was the right decision to position us for long-term success in that region.

While total orders for the east region were down 27% year over year in the fourth quarter, our full-year 2016 orders there were marginally higher than 2015 despite a decline in community count. With our new teams and product in place we are projecting strong order growth in 2017 after opening new communities and increasing our total east region community count during the first half of the year.

I will now turn it over to Hilla for some additional details on our financials.

Thank you, Phillippe. I will review some additional details from our income statement, key land and balance sheet metrics and our first-quarter outlook. Starting on slide 11, our net earnings for the fourth quarter of 2016 were in line with the fourth quarter of 2015 as our increased home closing revenue was mostly offset by lower home closing margin and lower land closing profit.

Fourth-quarter home closing revenue increased 15% year over year on a 10% increase in volume and a 4% increase in average closing price. Our average closing price was $414,000 in the fourth quarter of 2016, and based on the 432 ASP and our backlog this trend will continue in the near term. The average prices of our move-up homes are still rising even as we are opening more entry-level plus communities at lower price points.

That mix which includes a shift towards higher ASP geographic markets provides additional revenue while we make the transition to grow our business in the entry-level and first-time buyer segments. At 17.9% our first-quarter home closing gross margin -- our fourth-quarter home closing gross margin was up sequentially from the third quarter and lifted our full-year home closing margin to 17.6%.

As a Steve noted we are projecting flat home closing margins for the full year 2017 which will be higher in the back half of the year than in the first two quarters due to increasing leverage on higher volumes throughout the year. We were pleased to have achieved a 60 bps improvement in our full-year 2016 SG&A expenses as a percentage of home closing revenue.

As we have covered previously our new commission structure in 2016 was partially responsible for that, and we carefully managed our G&A expenses to generate additional leverage. We expect to further improve our leverage in 2017 as we grow our closing revenue and implement additional cost control initiatives.

Financial services profit increased 7% in the fourth quarter and 14% for the full year driven by increased home closing volumes. We had a minimal amount of interest expense for the fourth quarter of 2016 as we capitalized near all interest incurred to additional land and homes under development. Our income tax rate was 32.1% in the fourth quarter 2016 compared to 30.5% in the fourth quarter of 2015 compared to -- at timing of recognition of energy tax credits.

We were not able to take those credits in 2015 until the fourth quarter when legislation was passed extending the credits for both 2015 and 2016. In 2016, we therefore took those credits each quarter for qualifying homes. Since Congress has not yet renewed the energy tax credits for 2017, we will be using an effective tax rate of approximately 34% to 35% until they do. While we still expect that to happen we cannot assume so for GAAP reporting or for financial modeling.

Based on those expectations, we are projecting approximately 1,400 to 1,475 home closings with closing revenue of $585 million to $625 million for the first quarter of 2017 and pretax earnings of $22 million to $26 million. Turning to slide 12, we ended the year with $132 million of cash and $15 million drawn against our revolving credit facility.

Our cash balance declined $131 million from last year as we invested it into homes and lots to support organic growth. Our total real estate inventory increased by $324 million in 2016, over 2015. Our net debt-to-capital ratio remained within our target range of low to mid 40%, ending at 41.2% at December 31, 2016, compared to 40.4% at year end 2015.

41% of our closings in the fourth quarter of 2016 were from spec inventories compared to 35% in the fourth quarter of 2015, reflecting more spec sales within our first-time buyer and live now communities. We ended the year with 1,692 specs completed or under construction compared to 1,270 a year ago.

An average of approximately seven specs per community in 2016 versus five in 2015 as we build additional specs for those entry-level communities. Approximately 29% of total specs were completed at the end of the year compared to 37% at the end of 2015, indicating that while we are starting more homes in our entry-level plus communities most are selling before they are completed.

With that, I'll turn it back over to Steve.

Thanks, Hilla. In summary, we were pleased with the revenue and earnings growth we generated for 2016 and are projecting additional growth in 2017. With the community count growth we expect in the first half of the year, and solid orders already in January, we are projecting strong orders and closings in the second half of 2017 and beyond.

The key drivers for the housing market remain positive including job growth, consumer confidence, increasing household formations, low interest rates, and good affordability in most markets. We are well positioned in our markets and have developed new products that we can deliver at lower price points to meet the growing demand for first-time buyers.

And we are continuing to execute on the strategy for long-term growth that we believe will deliver significant value to our shareholders. We will explain this in more detail during our analyst day on March 14 in New York City at the New York Stock Exchange. Contact Brent Anderson for more information.

We are dedicated to delivering a life built better for all of our customers. That is our brand promise and something we strive to provide in all of our homes. Thank you for your interest in Meritage homes and for supporting our growth and success. We will now open it up for questions and the operator will remind you of the instructions. Chad?

(Operator Instructions)

Ivy Zelman, Zelman & Associates.

Hello, good morning. Thank you for taking my question. Recognizing you have done so well with transition to really going to entry-level and congratulations on the entry-level plus and live now products. Maybe, Hilla, can you tell us roughly if we're looking at the fourth quarter what percent of orders would that represent? And I have a follow-up.

Sure. Our orders in the fourth-quarter are about 23%, 24% from the entry-level product. But our ending community comp was actually closer to 28%. Since we closed, we opened some communities disproportionately later in the quarter so you should be able to see a large percentage of our order volume coming from those communities in 2017.

So to be clear, 28% of our communities are facing the entry-level buyer -- entry level plus buyer, and our goal still remains that by the end of 2018, 35% to 40% of those communities will be facing the entry-level buyer. And we expect the sales from those communities to be even a higher percentage of our total orders.

Got it. Thanks for that. I appreciate it. I think, Phillipe, you mentioned we saw the higher and price points being maybe less robust activity and recognizing too, I think, Hilla, though you said the mix is benefiting you on revenues.

So thinking about on a go forward look is you are shifting mix and you're working to reposition herself, I think there is a lot of questions round the impact if we have an inflating economy which is good for job growth and all of the things that come with that, what the interest rate impact is. I know that recognizing you don't have a crystal ball on what the impact is with respect to where rates are going to be, but we have had quite a rate move.

So when we think about that higher end sluggishness, is that due to rates, Phillipe? Is that the because people are being a little bit more careful, and the lower end consumer is going to be more resilient because it is more lifestyle driven and they just need the shelter, relative to what is available?

So maybe, Steve or Phillipe, anybody want to comment, but just so I understand given the shift in the overall positioning of the Company, rates are having or will have an impact as it has more of the impact right now, Phillipe, that you're seeing already on that higher and that you commented was a bit lower or sluggish I don't remember your exact word, and then what does it do to the entry-level product where you are positioning as rates rise?

My specific comment about the sluggishness at the higher price point was isolated to Orlando. We have seen the south American buyer have been impacted by what is going on over there so that slow down a little bit specifically in Orlando. I wouldn't say the rest of our markets we are really seeing anything like that occur.

So we are still seeing strong demand in Texas, and California, Arizona, and out east with the exception of Orlando at the higher price point. As it relates to the interest rate impact on live now ELP the first-time home buyer, we are priced so below everything especially in the affordable price point we are just seeing that demand really surge, and there is tremendous urgency being created with the interest move.

We think that thing has a long way to run really where we are positioning into the market. I don't know if Hilla wants to comment or Steve.

Let me just add on we did see a substantive decline in our traffic in November and December after the interest rates rose. But that has rebounded totally, and our traffic in January has been very strong. (multiple speakers)

Great. That is some good news, Steve, and obviously your January orders reflect that. If you were to take a step back a minute and talk with the Legendary acquisition and the repositioning of the product in the southeast and the time it takes and it has taken longer and obviously it sounds like there are great things to come. How do you better manage expectations within the operating -- day-to-day operations with making sure that given your conveying measure -- being measured on Wall Street that you don't have further delays and disappointments? And what can we look forward to assume that those are not going to be continuous issues where we are just being told it is great news and your repositioning, but is disappointing to the timing?

I hear you loud and clear. Clearly we made some mistakes in integrating that acquisition and our entry into the five markets in the South. But we have learned a lot from them, and I think we put ourselves in a position for future success. Changing out all the product was a daunting task as Phillipe has already discussed.

It took a lot longer than we expected to implement it. We are still implementing it. But we are well on our way to completion, and we made eight acquisitions in the cycle between the mid-1990s and the mid-2000s, and for the most part we integrated all of those very successfully, but for some reason, for multiple reasons, these acquisitions that we made recently in the South, we didn't do as good of a job.

But I think going forward we will be better. We will be better off for it, and we are expecting big things from the south over the coming years.

Good luck. Thank you for taking my questions. I appreciate it.

Michael Rehaut, JPMorgan.

Thanks. Good morning, everyone. First question I had was on the guidance with the revenue growth gross margins SG&A if you does kind of put through the model the $3.2 billion flat gross margins and SG&A leverage at the midpoint you get homebuilding EBIT bit growth of a little over 15%. So I was curious what are the drivers perhaps below the line item, below homebuilding operating profit that is suppressing that's growth down to the pretax earnings guidance range.

I can give a little bit more insight. When we are modeling at this level we are not assuming any other items that are nonrecurring. Anything related to land, anything related to pick up and JV income, any incremental pickups from interest expense that is going to be capitalized.

So for consistency we are modeling both as nonexistent while they may occur during the year it is probably not prudent to build those into a financial model. So if you're running the numbers compared to prior year there is some differences in our actual results versus how the financial model should work.

Maybe we can walk through it line by line, Hilla, but I have kind of taken out the other income benefit. The interest expense I assume is being fully capitalized at this point. Your tax rate is that -- well that is your pretax guidance so the tax rate doesn't matter. We can review off-line, perhaps.

The second question I had was on order cadence. Steve, I think you just mentioned in previous answer you had some fall off in traffic in November, December. I was curious if there was any impact on order trends as it progressed through the quarter if you think about that down 5% for the full quarter, what was it month-by-month?

I don't know if I have those. But I can tell you that December was off significantly. I believe that October was slightly down from last year. November was slightly up, but December it fell off. And that is consistent with the traffic that we experienced.

This is Phillipe. We were essentially flat through October, and November. And then December was really the month where we were down.

Okay. That's helpful. And one last one, just on gross margins expecting it to be flat, or in line with the 2016, and I guess still citing some cost pressures. What would be the offset to those cost pressures that would allow you to hold the gross margin line if it is some of the benefits from the reorganization in the South?

And I guess looking forward, Steve you've talked about focus on perhaps getting the gross margin level back to prior years. How do you think about that particularly given an increased mix on first-time, which typically does carry everything else equal to lower margin but faster turn type of a proposition?

I will answer part of the and I will let Phillipe as a part of it, but I think we are very positive with some of the early returns we have gotten on our new product costs. Our new product has come in at the lower costs than our old product and surprisingly we could even get a better price because the product is better which will allow us to drive higher margins and offset some of the price pressure that we are experiencing.

We are also bringing on new communities in Colorado that are coming on at higher prices with the market has been appreciating there. Phoenix margins are improving. The market of Phoenix is really strengthening and Tucson.

So we are able to push some pricing increases through to help with the margins. So there's a lot of good things happening.

Just really quick. Normally we turn somewhere between 25% to 35% of our communities over in any given year so there are quite a few falling off and coming back on. So some of both that are falling off reflect underwriting that was done before we had the knowledge of the significant increases in construction costs and labor costs.

So the new product that's rolling on has been underwritten with these assumptions, and the entire underwriting structure already accommodates the current environment. We realize there could be continuing tightening and that should be adjusted for by what enormous market would normally give you on a 1 to 4 ratio on ASP to labor.

So we should be able to cover the continuing tightening or any further tightening with just incremental increases. But the new product that is rolling on this year has already had those assumptions baked in.

Great. Thanks guys.

Stephen East, Wells Fargo.

Thank you. Good morning, Steve. One more question on the gross margin and maybe this is for Hilla, but as you look at the overhang from the FHA product in California and the Southeast how long does it take you to run through that? I assume the turnover in communities in the Southeast would run for all of this year and maybe part of next year. So just trying to understand the trajectory of those issues on the gross margin.

Sure. So we looked at our Q4 closings and the contribution from those FHA impacted communities, and it is impacting us about 30 bips in our margin. There is a 30 bip decline companywide from those FHA communities. There's enough units of the communities to probably expect similar trends for all of 2017, but after 2017 we drop pretty noticeably. We will have a negligible drag in 2018 from those communities.

All right. And the turnover in the Southeast. How long do you think that takes to work through the product?

I will let Phillipe answer that one.

This year every new community we open up has the new product planned for it. So that is going to happen this whole year, and we are pretty much going to turn over 50% to 60% of our communities in the South this year.

But the margin benefits from the new communities won't come until very late in the year. It is really more of a next year kind of event, and that is why we are guiding towards a flat margin for this year.

Yes. Sure. I understand. And then just sort of following on that, if you look at your land and development in 2017, what do you think it will be? And then can you give us a feel for your trajectory of community growth, and where it is going to be? Where you are putting your dollars to be more specific?

Geographically?

Geographically. Yes.

We are growing. We have capital allocated to most of the Company's geography for growth. We're trying to generate 5% community count growth this year which we think we have.

We are allocating big dollars into California right now trying to go to the California region. We continue to invest in Colorado heavily. Texas is in growth mode specifically in Dallas and San Antonio.

Out in the South, Atlanta and Charlotte are sort of markets of priority, but we are still looking at the other three as well. Orlando and Tampa we continue to look to grow. The dollars are distributed pretty well, and we want to grow in all of the markets.

Okay. And how much do you think you will spend this year?

I think last year we note on the slide we spent about $900 million in land and land development. We should be around the same ballpark maybe slightly higher.

Probably around $1 billion.

Okay. Thank you all.

Nishu Sood, Deutsche Bank.

Thanks. Steve, I think in your comments you mentioned January getting off to a good start. I think you said high single digits orders growth for the first month.

But in your press release, you talked about the community count drag leading to down year-over-year orders for the first quarter. So I was wondering if you could just reconcile that for us, please.

We exceeded our expectations a little bit so far in January. We still have two month to go. We just tabulated these results here in the last few hours because the month just ended last night. So I guess that there is a little bit of a disconnect there.

But it is too early to tell how the quarter is going to end up, because we are not -- we are opening some new communities but it is not enough new communities we are opening this month to really push the sales of forward.

We are also, coming up against a pretty tough comp in March. We had a phenomenal March in 2016, so we are hoping to be able to match it, but we are also trying to keep realistic, and we're going to push, but we are trying to make sure that we are managing.

The other thing, too, is that if you go back to last year, the negative 5% is very disappointing. We had hoped that we had done a lot better than that, but we also had a 23% order comp for the fourth quarter of 2016 which I think was a month the highest if not the highest of the entire group. So we had some very strong headwinds to overcome in Q4.

Got it. I appreciate that and another kind of moving parts question let's just go with the potential headwinds for the first quarter. Your backlog is slightly down to enter the year. And the first quarter faces the challenge of these comps and the lower community count. So it sounds like your order growth might not get going until maybe mid-to-late second-quarter.

But closings volumes are still expected to grow I think the midpoint is 5% or 6% or so. Given the labor environment, it would seem like the surge in sales would be to late in the year to drive closings growth, unless I am missing something.

Maybe with the turnover of the new product, does it deliver faster? Are you seeing labor ease up, or how does that turnaround happen in time to kind of drive the closing growth for the year?

Absolutely, it is all about the product. We are building more and more entry level product. More if it is spec oriented. We have more specs to go the number it is up significantly from where it was a year ago.

And that reduces the cycle times and allows us to sell homes later into the year. We expect that to be a big driver of our closings for this year and will position ourselves to be opening many entry-level plus communities this year, and when they open they will be completely stocked with inventory to close. And that is really one of the keys to dealing with this labor market.

We get a lot more positive reception from our contractor base if we can line build and have a much more predictable building cadence. And we can accomplish that with more spec homes. And so that is why I believe this year we can hit those numbers.

Got it. Really helpful and one more if I could just on Houston, really encouraging to the investment and the turnaround. When Houston was slowing, it started at the higher price points and migrated downwards the mid to even the lower mid price points.

Where is the rebound that you're seeing price point wise, and I would imagine that is where the dollars are flowing. If you could just give us some color on the kind of nature price point wise of the stabilization or rebound that you're seeing there, please.

Well lower price points are certainly doing the best, and the higher price points in some markets are doing okay also particularly down the South in Sugarland and markets closer to that. Our junction rates are clearly down from where they were a year or two years ago. But we're still selling homes, and we're not -- we haven't had to increase the discounts there.

And the reload in Houston is occurring for us in the new land that is rolling out at that lower-price point.

We have some exciting things that we are going to be announcing in the future in Houston some infill locations that I think are going to reap dividends for many, many years to come. I'm very encouraged about that market.

Great. Thanks for the thoughts.

Stephen Kim, Evercore ISI.

Thanks very much. Just as a housekeeping item to follow-up, you had given some land spend guide for the this year, and I think you did $880 million this year could you give us a breakdown between acquisition and development on that land spend?

Yes. I think that we have it right here. Let me pull it. I think I have it for the quarter. I will connect with you later Stephen.

That is fine.

Land development was about $68 million of the $225 million with the balance being land purchases. We will get to a full year number on it.

Awesome. That is great. More broadly, my recollection is that the East region, which I assume -- the East region generally has some lower profitability than some of your other regions, and I assume the Southeast and some of the problematic communities in particular were probably the main culprit. I wanted to just verify that as you talk about having an acceleration in your year-over-year compares on orders in that region with the reset of the new product, is it your expectation that margins will be running in line with the Company average, or better, maybe when these new communities come online, or will they continue to sort of run a little bit below the Company average?

I would expect that they would be equal to or greater than the Company average. We underwrite to a 20% gross margin. The Company average right now is slightly less than 18%.

So I'm expecting that these new communities in the South, particularly in the South because our margins in Orlando are pretty good. That is part of the East.

But our new communities in the South area, particularly the five markets in the South I expect to be 18% or better. Hopefully closer to 20%. But as I said earlier, a lot of that is not going to impact the 2017 income statement because it is going to be coming later in the year.

I get that. Just so we can understand it's because without seeing the product in hand yet, we are just left to imagine. Can you give us a sense for the nature of the product reset? What in particular that you are doing differently, which you think will drive better reception with the consumer? And also particularly why that would result in a better margin profile for the Company?

One thing we are doing is we are using the same product with different elevations in all five markets. That allows us to really leverage our cost, and drive down our cost, and compare our cost from market to market and gives us a lot more efficiency. The market -- the product is just very fresh. It is very consumer facing.

We've done a lot of consumer research on what the buyers are looking for. It is reflected in the product. Some of the product we had before was pretty old.

And we have also really value engineered all of the product. The way that we do the roof trusses the way that we do the things behind the walls to make it more cost efficient.

Phillipe, do you want to piggyback on that?

I would add onto that the way the South works you have three different foundation types. You have a slab on grade, a crawlspace and a basement. We were able to design those three foundation types into all of the plans. Before we literally had a new plan for every foundation type.

Now we have one plan with three foundation types that we building across all five markets. So to Steve's point we can really tighten up the cost of the trade because it is kind of the same plan.

We are also able to really clean what we were putting into houses a from a spec level and design features to create some consistencies on the scale there. What we are doing in Nashville versus Greenville, versus Atlanta versus the two markets that we entered organically were very different and so being able to streamlined that really creates a better margin profile as well.

Okay. That is very helpful.

We will have a lot of pictures and a lot of details on what we were doing in these southern cities at our analyst day on March 14 in New York. Or if you want to come out for a visit we would be happy to meet you in the South and show it to you.

Sounds great. Thanks guys. I appreciate it.

Will Randow, Citigroup.

Hello, good morning, and thanks for taking my questions. I guess specifically as somewhat of a follow-up from Steve's question, as you shift towards more first-time buyer products how do you think about potentially changing your input costs? And specifically you guys are focused on spray foam. Is there any thought to changing that up? And similarly, how are you thinking about lumbar inflation for the overall business if we have these Canadian tariffs come through in April or a bit later?

We are still committed to spray foam. We will see what the new tax code brings us and will evaluate it at that time.

We can only control what we can control as it relates to the lumbar tariffs and any other tariffs we get put in place. That will have to be passed onto the consumer. There is not much we can do to hedge that.

We have a very progressive, forward-looking structure to how we buy our lumbar. With our trades we do have protection out three or four months. Beyond that I don't really know what we can do with regard to that.

This is Phillipe. As it relates to the input cost to our first-time home buyer I would just say less, not necessarily as expensive, we don't put as much in the house. So we are much more streamlined in what we are offering. So we take a lot of the complexity.

We are not offering any sort of our custom options or anything at that price point. So that allows you to control your cost lot better because the less inputs you're trying to manage with the trades, the better cost that you get.

Steve also touched on this earlier, but the consistency in the cadence in the entry-level plus any increases that we have to take on the construction hopefully would be mitigated by labor savings as we are offering them the consistency in the spec start that they are looking for.

Makes sense. As a follow up, thank you for the January color in terms of demand. Did you see any volatility in terms of incentives, cancellation rates, or closing versus list price ratios?

In January? No.

Thanks again guys.

John Lavalo, Bank of America Merrill Lynch.

Good morning, thank you for taking my call. The first question I guess you gave color on the January orders, and I think you mentioned that March was a tough comp, but I was just wondering if you could give us the actual monthly year-over-year comps in the first quarter for January, February, and March.

We can't give that information out. That is not normal practice for us.

If we have any additional color we can share progression throughout the month at the analyst day, but I think at this point to Steve's earlier comment we haven't even ratified the month disclosed 12 hours ago so we need a little bit more time to collect all of the data but early indications are positive.

I guess the second question would be, it doesn't appear that there is any impact from hurricane Matthew. Is that fair?

We are not using that as a reason why our sales were lower in the fourth quarter in the South, but clearly there was weekends where traffic was down to a minimum because it was raining like cats and dogs. So there was an impact, but it is not something that we are going to hang our hat on.

Okay. Thank you guys.

Thanks.

Alex Barron, The Housing Research Center.

Thank you guys. Just wanted to verify if I heard your pretax income guidance correctly. $22 million into $26 million?

For Q1.

Okay. So I was kind of working through the deliveries in revenues and try to figure out how you get there. Is there a margin like in operating leverage issue on your margin in the first quarter? It seems like that happened last quarter but I just -- last year but I just wanted to verify that was some of what is going on there.

I think we noted as is historical trend for us we are typically lower in the first half of the year and then we increased in the back half of the year as there is some variable components and margins in our overhead. We can certainly take the time to walk through the model dynamics in a follow-up call. But we didn't give any specific guidance beyond units, closings, revenues and pretax for Q1 at this point.

Okay. That is helpful. And then I guess just more general question with regards to the interest rates, and people and backlogs. Any comments on what you guys are seeing as far as any people who may be are trying to cancel because they no longer qualify and what you guys are able or willing to do (multiple speakers) prevent from happening?

We are not seeing much of that. That is not really been an issue. Cancellation rates really haven't changed.

Okay, that's good.

Thanks Alex. Do we have any other questions? I think that we have one more.

Jade Rahmani, KBW.

Hello this is actually Allyson Boyd on for Jade Rahmani. I had a follow-up question from earlier when you were talking about your product turnaround with your more spec sales, and I was wondering what percentage of delivery this past quarter were from spec sales.

I think we mentioned it was 41% this year versus 35% last year's fourth quarter, so we're definitely seeing a pick up there which we would expect, and it is positive of course, and we would expect to see that as we shift towards entry-level.

Okay. Great. I was also wondering if you had any comments about your recent joint venture with iStar and if you are looking at any other additional joint ventures currently?

Our recent joint venture with iStar is really exciting as the press release outlined. It's a phenomenal infill site here in Scottsdale, Arizona in our backyard. We think there's going to be deep demand. We have already gotten a lot of calls just from the press release, and the communities more than a year away from opening for sales. It is a $350 million plus project that I think will pay dividends to the [fees position] for years and years to come.

We are always looking at other opportunities. There's nothing I can really comment on today, but we try to be more opportunistic in all the market that we build and that happened to be a site that we are following for a long, longtime. It has sat dormant for the last eight years.

Great thank you so much.

I think that concludes all of our questions and comments for today, so we thank you very much for your participation in our fourth quarter earnings call, and we look forward to talking to you again next quarter. Have a great day.

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