Meritage Homes Corp (MTH) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Meritage Homes Third Quarter 2017 Analyst Conference Call. (Operator Instructions) Please note this event is also being recorded.

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

Thank you, Chad. Good morning, and welcome to our analyst call to discuss our third quarter and year-to-date 2017 results.

We issued the press release before the market opened today, and you can find it along with the slides that we'll be referring to during this call on our website at investors.meritagehomes.com or you can select the Investor Relations link at the bottom of our homepage.

I'll refer you to Slide 2 and remind you that our statements during this call as well as the press release and slides contain forward-looking statements, including our projections for 2017 operating metrics such as order trends, closings, revenue, margins, earnings and community count. Those and other -- any other projections represent the current opinions of management, which are subject to change at any time and we assume no obligation to update them.

Any forward-looking statements are inherently uncertain and actual results may be materially different than our expectations. We have identified the risk factors that may influence our actual results and listed them on this slide as well as in our press release and most recent filings with the Securities and Exchange Commission, specifically our 2016 annual report on Form 10-K and subsequent 10-Qs, we -- which contain a more detailed discussion of the risks.

We also have provided a reconciliation of certain non-GAAP financial measures related -- referred to in our press release and presentation as compared to the closest related GAAP measures.

With me today to discuss our results are Steve Hilton, Chairman and CEO; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer of Meritage Homes.

We expect to conclude this call within about an hour and a replay will be available on our website approximately an hour afterwards and remain active for 2 weeks.

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

Thank you, Brent, and welcome to everyone participating in our call today.

I'll begin on Slide 4. The third quarter of 2017 was certainly a memorable one with major hurricanes that hit Houston and Florida. We've been assisting the relief efforts, but we're relieved and grateful that our team members escaped injuries and our communities sustained little damage, although we did lose 2 to 3 weeks of sales and construction activity.

Even so, we still closed 9% more homes and sold 8% more homes than we did in the third quarter last year, which could have easily been double-digit gains without those disruptions. The increase in closings generated 9% growth in third quarter home closing revenue, which combined with improvements in our home closing gross margins and overhead leverage to drive an 18% increase in pretax earnings for the quarter.

Turning to Slide 5. We set out this year with 3 strategic initiatives to enhance our earnings performance. They included growing our community count, improving our gross margins and increasing our SG&A leverage with top line growth.

We grew our community count by 5% in the first quarter of this year and ended the third quarter with 6% more average active communities than we had a year ago. Our home closing gross margin improved to 18.1% from 17.7% last quarter and 17.8% in the third quarter of 2016. The improvement was driven by modest pricing power and cost management, good margins on specs and improved leverage of construction overhead expenses.

As has been widely expected in the aftermath of the storm damage, we've begun to receive notices of cost increases from some vendors and subcontractors, and we're actively negotiating with them to minimize the adverse impact on future margins.

We also improved our overhead leverage by 80 basis points compared to last year's third quarter. Total SG&A was 10.9% for the third quarter this year compared to 11.7% last year.

Commissions and other sales costs rose just 6% on a 9% increase in home closing revenue and our G&A expenses were actually down 5% year-over-year in absolute dollars despite higher closing volumes.

I'm proud of the determination and drive of our sales teams to deliver year-over-year growth in orders for the third quarter despite the disruptions caused by the storm.

I'll turn it over to Phillippe to discuss our sales trends in more detail by market. Phillippe?

Thank you, Steve. Demand has been solid this year and we were pleasantly surprised at how quickly buyers returned to our communities in Houston and Florida when we were able to reopen and traffic began to flow again.

The 8% order growth we achieved in the third quarter was primarily due to continued strong demand in Texas and the East. The year-over-year decline in our West region was mostly due to having fewer communities open there in second quarter '17 than in 2016 -- I'm sorry, third quarter '17 -- as robust demand resulted in several communities closing up faster than we could replace them.

I'll direct you to Slide 6.

Orders decreased 6% in the West, corresponding with a 7% decline in average community count compared to last year's third quarter, while the overall orders pace for the region was consistent. Orders were up slightly in Arizona, where a 6% increase in absorptions offset a 5% decline in average community count. Demand remained strong in Phoenix, where our entry-level homes under FHA loan limits are selling well. We have a healthy supply of lots to meet that demand at the current pace for selling with many more entry-level communities slated to open in 2018.

Orders were down 7% from 2016 in California, with 7% fewer communities opened on average during the third quarter this year. As we noted last quarter, we've been reloading our lot supply over the last couple of years and plan to open several new communities in Northern California over the next few quarters after delays caused by the heavy rains there in the spring. Thankfully, none of our communities have been directly impacted by any of the wildfires in Northern or Southern California.

Despite continued strong demand in Denver, our third quarter orders were 24% lower than last year in Colorado due to a combination of 14% fewer active communities on average through the quarter and a 12% decline in absorptions through our average -- though our average absorptions of 3.2 per month in Colorado were still the highest in the company. We have a solid pipeline of new communities that we're planning to open, including several over the next few quarters.

While orders were down 6% for the region, total order value was only down 4% since our average order price increased 2%. Average sales prices in the region are starting to temper despite recent -- decent pricing power as Arizona is contributing a larger percentage to the region's results. And we have been shifting more towards lower price, faster-selling communities aimed at the first-time buyers.

Slide 7. Texas continues to be our best performing region due to strong demand across all markets there. Our third quarter orders were up 22% over the third quarter of last year in Texas, reflecting a 26% increase in average communities opened during the quarter, offset by a slight decrease in average absorptions.

All of our Texas markets were up over last year's third quarter, including Houston, which rebounded quickly after the hurricane passed and flooding subsided. The first question people ask when visiting any of our communities was, did you flood here? And when they confirm we didn't, they're ready to buy.

A large part of our success has been due to the strong pivot we've made toward more entry-level products in Texas, especially evident in Austin's order numbers this year. Because of that success at lower price points, our average sales price in Texas was down 2% year-over-year.

Slide 8. Our East region orders were up 13% over last year's third quarter, primarily due to increased absorptions. Our average orders per community were up 12% year-over-year. Part of that is due to our new products in our new communities, which have been well received by buyers and part of it is improved sales management and execution.

Florida, Georgia and South Carolina orders were up 20% or more over the third quarter of 2016, with double-digit improvement in absorptions on top of average community count growth in Florida and Georgia, which has been a core focus for us this year.

Florida's growth is also benefiting from our successful offerings in the entry-level market. Overall, we're executing well on the entry-level growth strategy and are achieving a higher orders pace in our entry-level plus and LiVE. NOW communities, while earning comparable or better margins than our move-up communities.

We're projecting our community count at year-end 2017 will be relatively flat year-over-year due to earlier-than-anticipated closeouts of communities and longer-than-anticipated schedules to get our new communities opened and fully ready to sell, especially in California and Florida, but expect our total community count to be back where we were last quarter by mid-2018.

I'll now hand it over to Hilla to review our financials. Hilla?

Thank you, Phillippe. I'll recap our year-to-date results as well as key land and balance sheet metrics, beginning on Slide 9.

We generated $108 million in net earnings for the first 3 quarters of 2017, a 10% increase over the first 3 quarters of 2016. Our performance was primarily driven by a 6% increase in year-to-date home closing revenue and a 60 bps improvement in overhead leverage. Those gains were partially offset by a higher tax rate of 34% year-to-date 2017 compared to 31% in the first 3 quarters of 2016.

Congress has not renewed the energy tax credit for 2017, which reduced our 2016 tax rate. On a pretax basis, our year-to-date earnings were up 15% year-over-year. Our average closing price was $415,000 for the first 3 quarters of 2017 compared to $406,000 last year. General home price appreciation in many of our markets offset the mix shift that is occurring overall as we transition to sell more entry-level homes.

Our year-to-date home closing gross margin was 10 bps lower than the first 3 quarters of 2016, due entirely to the first quarter of 2017 coming in lower than last year, while we've achieved solid improvement sequentially in our second and third quarters' gross margin.

As Steve mentioned, we're expecting to incur some cost increases in the aftermath of the hurricanes as a result of increased demand for materials and labor, though we're doing our best to minimize these increases as we focus on getting our backlog homes closed on time. Potential labor delays could dampen the improvement we would have otherwise expected in the fourth quarter this year that we still believe we can leverage increased closing volumes to generate a 17.5% to 18% home closing gross margin in the fourth quarter and achieve our prior guidance for full-year 2017 gross margin, consistent with 2016, despite the weather-related disruptions this year.

We hit our 2017 target of 10.5% to 11% SG&A leverage in the third quarter of 2017 as we brought our SG&A expenses down to 11% of home closing revenue for the first 3 quarters of 2017 from 11.6% in the first 3 quarters of 2016.

We expect our SG&A percentage to be even lower in the fourth quarter as we effectively leverage higher closing volumes and make progress towards our long-term goal of 10% to 10.5%.

Our interest expense for the first 3 quarters of 2017 was down 31% year-over-year, due to greater capitalized interest on the larger amount of assets under development, though it was nearly $1 million higher in the third quarter this year over '16 due to the issuance of $300 million of new senior notes in June. With this new debt in place, we anticipate higher interest expense in the fourth quarter of the year from the additional interest on the new senior notes.

Slide 10. We used most of the proceeds from the new issuance to pay off borrowings under the credit facility and completely retire all $126.5 million of our convertible senior notes, which we completed in September. On a go-forward basis, that will result in a reduction of approximately 2 million shares from our diluted share count.

We ended the quarter with $115 million of cash and $25 million drawn against our revolving credit facility. Our net debt to cap ratio increased slightly, but it's still within our target range of low to mid-40%. We ended the current quarter at 43.6% compared to 41.2% at year-end 2016.

Part of our cash usage was invested in additional spec inventory as we have more specs in our entry-level communities than we typically carry in our move-up communities to allow those buyers to move in quicker. Our spec strategy allows us to build faster and more efficiently, while locking in lower costs in this rising cost cycle. 48% of our closings in the third quarter of '17 were from spec compared to only 40% in the third quarter of 2016, reflecting more spec sales within our entry-level and LiVE. NOW communities. We ended the third quarter with 1,957 specs completed or under construction, which was approximately 7.8 specs per community, compared to 1,531 a year ago or an average of 6.5 per community. Approximately 27% of total specs were completed at the end of September 2017 compared to about 21% at September 2016.

Turning to Slide 11. We secured more than 2,400 additional lots during the quarter, of which approximately 70% were for entry-level communities and we spent $286 million on land and development during the quarter, bringing a total year-to-date investment in land and development to approximately $771 million compared to $667 million through the third quarter of last year. We're expecting to spend about $1 billion on land and development this year, which is the most we've ever spent annually and expect that pace to moderate over the next couple of years.

We had approximately 33,300 lots at quarter-end, which equates to about 4.4-years supply of lots based on trailing 12-month closings, with 2.9-year supply of owned lots. After having invested heavily in land and development over the last 2 years, we have all of the lots we need to meet our plan in 2018 and about 90% of what we believe we need for 2019.

With that, I'll turn it back over to Steve to discuss our full-year outlook.

Thank you, Hilla. Concerning the results we achieved in the first 9 months of the year and the expected impacts from the hurricanes, we are modestly reducing our closing and revenue guidance, while tightening our 2017 earnings expectations after our strong third quarter performance. We expect to deliver approximately 7,600 to 7,800 homes and closing revenue of $3.15 billion to $3.25 billion for the year.

Midpoint is about 100 fewer closings than we had previously projected for the year since it will be difficult to make up for those lost sales due to the hurricanes and convert them to closings in the fourth quarter, which is already our highest volume quarter.

On that level of closings and revenues, we are tightening our expectations for approximately $235 million to $245 million in pretax earnings with full year 2017 gross margin in line with 2016.

In summary, we are pleased with the results we achieved in the third quarter of this year and the progress we made on our strategic initiatives.

Demand continues to be healthy across all of our markets, especially for our entry-level and LiVE. NOW homes. More than ever, buyers appreciate they can get Meritage's quality, energy efficiency and advanced technology in affordably priced homes.

As we continue to execute on our strategy to serve the growing entry-level market, we foresee additional growth opportunities for Meritage. We are dedicated to our brand promise of delivering a life built better for all of our customers and we will continue to innovate and focus on customer satisfaction, which we expect to drive additional growth and shareholder value.

Thank you for your interest in Meritage Homes and for supporting our growth and success. We'll now open it up for questions, and the operator will remind you of the instructions. Operator?

(Operator Instructions) The first question will come from Michael Rehaut with JPMorgan.

First, I just wanted to drill down a little bit in terms of the success that you're starting to have with -- or have been having with the entry-level product that you've rolled out over the last 12, 18 months. I believe you mentioned that due to some solid sales trends, which is obviously a good problem, your community count, I believe you said would be flat year-over-year in the fourth quarter. I'm curious as you kind of look into 2018, I know it might be a little bit premature for guidance, but perhaps directionally, you could help us.

If the community count perhaps is a little bit lower or flattish year-over-year in 4Q, which would imply a down trajectory or a little bit more of a challenge to have growth in the first half of '18, how should we think about absorption counterbalancing that as you have more of that entry-level product come through? I notice absorption is up using average community count of about 2% year-over-year in 3Q, so will that have to accelerate a little bit? And is that kind of what you're thinking?

I mean, without getting too granular, we are focused on increasing our absorptions. We're -- we've been accelerating our exit from some of our lower margin, higher-priced communities, particularly in the West, that have put our community count growth under pressure out here. We had some above FHA higher-priced communities in Arizona and Inland, California that we're getting out of. And we're opening more and more entry-level and LiVE. NOW communities, which we think will help our absorptions. So although our community count growth is not as fast as we like, I do think there's possibilities for better absorptions and that's what we're really focused on.

And am I thinking about it right in terms of community count that -- did I catch that right that you said it should be flattish year-over-year for 4Q? And would that, as a result, result in a little bit of a year-over-year drag in the first half of the year?

It's going to be flat from the beginning of this year. So we'll end the year pretty much where we started it on a community count basis. I'm not sure we're ready to go into discussion about a drag into the first half of next year. Obviously, as entry-level becomes a more material portion of our both sales and closings mix, their absorptions pace is quite a bit higher than our traditional move-up products. So I think we're going to be able to manage through that even with a slightly lower community count than we had initially anticipated, although those communities are obviously in the pipeline and will be opening throughout 2018.

Okay, great. So I misheard that then you would be flattish in the mid-250s at year-end? So that's not as -- what I thought. Second question on the gross margins, you did a nice job in the third quarter is a little bit above our expectations, I believe what you were expecting as well. But at the same time, you called out for 4Q, maybe a little bit of a negative impact from labor and material costs coming out of the hurricane-impacted areas. I wanted to get a sense of -- as a result of that, do you expect 4Q gross margins to be a little bit down sequentially? And perhaps, you could give us a sense of -- from a basis point impact, what impact that labor -- higher labor and material costs -- just to quantify that from a margin impact on gross margins.

Mike, it's very difficult to pinpoint the precise margin at this point for the fourth quarter. It could be down slightly from where it was in the third quarter. On the other hand, it could be right on top of where it was in the third quarter. But in any event, it's going to be close. And I just don't want to hold out a precise number, that's why we continue to use the range.

We're not -- obviously, most of our homes that are going to be closing in the fourth quarter have already started construction, so the dollars are fairly well known. But I think we mentioned in our prepared remarks, in order to make sure that we're getting the labor to our job sites in this tightened environment post hurricanes, we're doing what we need to do to make sure you that the backlog is closing, so in some cases that may cause a slight uptick in labor, which is kind of why we're going to hover around where we were in Q3, but we don't have a definitive percentage. But we're very comfortable being at our full year 17.6% gross margin full year 2017 as well.

And we're still selling specs today as we speak that will close this year and we're very much focused on that. So thanks, Mike.

And that will be from Alan Ratner with Zelman & Associates.

Nice quarter. So you guys, obviously, are seeing a nice move into entry-level and I think that's certainly benefiting your results. And I think the cost pressures, I'm sure we'll hear a lot more about from other builders as well. But I'm just curious if you could talk a little bit about the pricing power you've seen at entry-level. On one hand, it seems like the demand is really strong, but on the other hand it seems like you need to be extra careful about not pushing too hard, given the affordability constraints of a lot of those buyers. So just curious if you do see higher costs, what do you think, your ability to pass those costs are on to consumers? And maybe just talk a little bit about how aggressive you've been raising prices so far on the entry-level communities you've opened this year?

Yes -- this is Phillippe. We are seeing pricing power at the lower price point. Definitely able to stay ahead of our costs absolutely. The key to our entry-level, again, is just the FHA. We kind of see that as a hard cap. And so if we are positioned below FHA, we're seeing pricing power up to that FHA point, where -- once we get to FHA, it can impact absorptions. But we are seeing pricing power at the lower price point and really strong demand.

And on that point, Phillippe, I mean if you look at your portfolio of entry-level projects, I mean, can you give us any indication of how close you are to the FHA limits in those communities? Is there room to run if you do need to push prices higher? Or are you kind of butting right up against them in most of your projects?

It's market by market, Alan. In some markets, we're positioned below and we can push it. In others, we're kind of tight there and kind of have to hold the line.

The next question comes from Paul Przybylski with Wells Fargo.

Steve, earlier this year, you thought a 50 basis point increase in annual gross margins was within the realm of possibility -- marching back towards that 19% to 20% range. Do you think that's still a good roadmap for us to use?

Yes, it's still what we're pushing towards, I mean, not for this year, but we're hoping to get some gross margin gains next year. That's what we're focused on every day here.

Okay. And then, I guess how are the absorptions and gross margins on the new East communities compared to the legacy portfolio in that region? And then what percent of the community cap there has been transitioned? How do you look at the trajectory of transitioning the remainder of it?

They're better. They're higher. You know we're not getting the volume yet that we need, so the construction overhead is somewhat of a drag. But as we get more and more new communities on, we'll be able to leverage that overhead better which is -- which certainly factors into the gross margin. But it's a process that's going to play out over the next couple years and expect to get incremental improvement every quarter out of that region.

The next question will be from Stephen Kim of Evercore ISI.

This is actually Chris Shook on for Steve. Congrats on this other quarter. I just wanted to follow up on cash flow and land spend as a percentage of revenue thinking. Last quarter you mentioned that you want to refocus on cash flows as you're trying to catch up from under-purchasing lots. Just wondered whether this thinking has changed at all?

Yes. So -- I don't think that we are not focused on cash flows. We're always focused on cash flows, we're very, very hyper-focused on making sure that we don't kick up over our comfort zone for our net debt to cap ratio, although we did realize that we had built up quite a bit of cash and we had the need to refill our depleted pipeline of lots. So I think we've done a very good job over the last 2 years getting us back to where we need to. So at this point, we need to replace the lots that we're selling and provide enough of a growth trajectory to align with our internal forecast, but we're no longer trying to also replace an under-purchasing for prior years.

So we mentioned a $1 billion estimated purchase for this year is the highest we've ever had in the history of the company. So we're very excited. And on a go-forward basis, knowing that we don't need to replace that in under-purchased year, we'll be seeing something a little bit more tempered than that.

Yes, we're really focused more on improving our asset turns, so I think we can get more volume out of our communities going forward without spending more money on land. And so we're projecting next year's land spend to be about the same as this year's. Even though we have a higher asset base. And we think that can drive revenue growth for us into '19 and beyond.

And then as you expand your entry-level communities, are you looking at any potential M&A or bolt-on opportunities to grow within existing markets or expand into new ones?

Our eyes are always open for those kind of opportunities. I'd say the same thing as I said in the past that we have a lot of opportunity in our existing markets, particularly in the South to grow those businesses and gain market share. And even in our longer or older more mature markets, like Phoenix and Dallas and Houston, we can grow our business in those markets. So our primary interest is organic, internal growth, but our eyes are open to opportunities. If one comes along that makes sense, we can definitely pursue that. But there's nothing on the horizon at this moment.

The next question is from Nishu Sood with Deutsche Bank.

So just following up on the gross margin, the cost pressure, the labor and the materials pressure. I think you laid it out pretty clearly for 4Q. Broader question, in an event like this -- post the storms, obviously, the pressures accumulate. And people, I think, are thinking different thoughts about the trajectory of that. Depending on rebuilding activity and people talk about obviously insurance fund flows, et cetera. When do you think the cost pressures peak? Are we seeing that now in the fourth quarter? Or given rebuilding timelines, do you expect that to kind of bleed into first quarter? Obviously, seasonality plays a role in it as well, with potentially greater closings in 4Q. So Steve, how do you think about that, that unfolding and when the peak in those pressures might be and when it might begin to recede?

It's too hard to tell. I mean, I don't think this is a national event, I think it's a regional issue. And I think it's probably more in Texas than it is in other markets. A little concerned down the road about Northern California, what the pressures are going to be up there. After those fires, a lot of houses got burned down up there that are going to have to be rebuilt. But -- and I think that's a couple of few quarters out at least, if not longer.

So I think the Florida cost pressures are really focused on the fourth quarter. Houston is going to play out over several quarters. But again, these are multiple cost pressures and not so much national.

Got it. Got it. Okay. Turning to Texas. Obviously, you've had great success there in opening new communities, opening new entry-level communities as well. And obviously, there was some effect on the absorptions this quarter because of the storms. But still if I look at the absorption pace, the kind of the mid-6s, it's about 1 below the East region and 2 below the West region. How should we think about the potential of your Texas communities from an absorption perspective? I would have expected that with the entry-level mix, it might even be higher-turn communities, might even get both the East and West region. Is that where it could head? Or is there -- are they smaller committees, is that what holds it back? How should we think about that?

It's Phillippe. The pivot to LiVE. NOW and ELP in Texas has really only occurred primarily in Austin, although we're starting to move that way in Houston. We had some things happening in Dallas and San Antonio's always been a pretty strong entry-level market. So we're well positioned there. But I think as we pivot further into that segment with Dallas and Houston, you should expect our absorptions to go up and be more comparable to what you're seeing in the East and the West. I mean, where we pivoted in Austin, our absorptions per community is very strong in the LiVE. NOW. So I think that's what you should expect to see.

The next question is from Susan Maklari with Crédit Suisse.

This is Chris Kalata on for Susan. I just wanted to drill in a little bit deeper on to those communities that are approaching...

Can you speak up a little bit?

Yes, sure. Hear me now?

Yes.

Yes.

So I just wanted to drill in a little deeper onto those communities that are hitting those FHA limits. When you go into conversations with suppliers on price increases, what portion of those increases do you guys expect to realize? Looking back historically, what have you typically been able to push back on?

I mean, I don't think that it really matters by community. I mean, obviously, in the entry-level community, we have a more simplified building model, less -- or more specs, less options, less floor plans. And so that allows us to mitigate our cost because of the business model. But we don't push -- we aren't able to push back any harder in those communities than we are in our other communities.

Okay. So then, on the affordability side, are you expecting that given that hard cap on price, that you'll be able to still drive your expected closing growth in those regions?

Yes. I mean, I think it's all about what we pay for the land quite frankly. If we can buy lots that can support the price point, that's really how we position those communities and then we manage our costs very carefully to try to remain below FHA. There's lots of things you do there. But generally, we're able to, in our entry-level communities thus far, push our pricing to manage our costs and still stay under FHA.

The next question will be from John Lovallo of Bank of America.

It's actually Pete Galbo on for John. Steve, I was wondering if you could just give us a little bit of foresight going forward here. Historically, in the last cycle, you guys were one of the highest users of option lots among the builders. And you have a competitor out there now who is very publicly going kind of more towards the option lot model and you guys are sitting at around 35% today. I mean, do you have a target out there in terms of what you would look to do in terms of options? And how you think that might impact your return profile going forward?

Well, the reason we -- first of all, we closed 2 pretty significant land bank transactions in this last quarter or I think some -- one of them may have been October in Orlando, probably equaled about $70 million or $80 million worth of lots that we think are going to have great long-term results for us there -- but both really nice infill locations. But the spread between the cost to do traditional land making, which we did a lot of in the last cycle, and using our balance sheet is pretty wide and with our margins being where they are, we didn't want to do anything to put further pressure on those margins.

So we have kind of refrained from using land banking as aggressively as we've done in the previous cycle. And then the capacity really just hasn't been there for us to drive those land banking prices -- costs down. To the extent that we can find options from land sellers, certainly we want to take advantage of those as much as we can, but in most markets, particularly in the West, they're just not available. And there's a lot fewer available in Texas today than there was in the last cycle. So certainly, it's an area of focus for us. We'd love to do more options, to the extent that they're available and they don't hurt our margins, but just it's a factor of supply.

Got it. And Steve, et al, if you could ballpark kind of those -- the spread on the land banking et al. And then maybe one just modeling for Hilla. On the debt maturity in 2018, have you guys outlined at all whether or not you plan to refi that or pay it down with cash?

I mean, the land banking cost is generally in the 13% to 14% IRR range. And we're issuing bonds in the 5% to 6% range. So pretty big spread.

Right. As far as the 2018, I think we've mentioned it before, we're looking at a couple different options for Q1 2018 to take out those bonds. Most likely, we'll look at the market and see if they're still competitive and look to do something on the bond side there rather than taking it out with available cash or in our revolving credit facility, although we do have capacity in case the markets don't cooperate.

I just want to clarify one other data point about the community count discussion on an earlier question. I want to make sure that it was clear. We expect our full year 2017 community count, so as of December this year, to be where we started out this year, which is low 240s, not low 250s, just to clarify, okay?

The next question will be from Jade Rahmani with KBW.

Just regarding the labor shortages. Wanted to see if you've given any consideration to any innovative off-site solutions, basically pre-constructing part of the house off-site?

Yes. This is Phillippe. We're looking at a lot of different things, quite frankly, to help manage through the current labor environment. It's different types of framing approaches, panelization, other innovative ways to build off-site. So we've been exploring a lot of areas, running models on how to do that. In a couple of markets, we are doing that, like San Antonio, and we're actually looking at those opportunities everywhere where it makes sense and where we have the ability to execute it.

And can you give any color on the magnitude of margin benefit in San Antonio that you've experienced? And also, how widespread this initiative could become on a national basis?

Yes. I don't think it's as much about the margin as it is about the capacity and the cycle times, which certainly helps you leverage our field overhead which does help our margins. But it's not a real cost savings per se, it's about efficiency and it's about lower warranty costs, lower waste. And those type of things, which translates to higher efficiency for us.

And in terms of the cost increases that you've started to hear from vendors, can you give a sense of the magnitude of -- or range on a percentage basis?

Not really. Because it's -- depending on the market, sometimes depending on the submarket of the market. So we're experiencing different pressures in different areas from different trade groups and it's very hard to quantify that.

(Operator Instructions) Our next question comes from Carl Reichardt with BTIG.

I'm sorry if I missed this. What was the percentage of your orders this quarter that were either LiVE. NOW or EL plus or, however, you want to define entry-level or first time versus last year? And then same for deliveries, please.

So on the order side, everything that we consider our core market, which is entry-level or first-time move-ups, was about 75%, 76%, pretty much this entire year. Last year, that number was more 68%, 69% on the order side. On the closings, obviously, we have a little bit of a shift still. It's just a couple of percentage points down from that. If you're looking just at the entry-level LiVE. NOW group, that's moved up to about 34%, I believe, in closings for the third quarter of this year, up from about 30% just even last quarter.

And then Phillippe, I just wanted to drill down a bit on the East absorptions, which up 13% is very good. And you mentioned part product, part execution. Can you talk a little bit about just the execution initiatives there and what's improved to help those absorptions?

Yes, absolutely. Primarily, on the sales floor, we've really evaluated our sales team across all those markets, but specifically in Greenville and Atlanta, which were the legendary acquisitions. We've hired a lot of new salespeople in those markets. We're training them, we're teaching them the Meritage way. We have some executive sales leadership currently in those markets, coaching training, developing, guiding, leading. And we're really focused on the management of our sales team and the talent of our sales teams in those markets. And we've made some improvements. We have a ways to go, because I think we can really do even better than we are doing, and I expect to see that translate over every quarter we get better and better. So that's mostly what's going on with the management and the execution.

And then, as you mentioned, the communities where we have opened with the new product and specifically, the ELP and LiVE. NOW communities, we are seeing much stronger absorptions. We opened up a few communities in Charlotte, a few communities in Raleigh, a few communities in Atlanta and we're seeing better absorptions out of those communities with our new product, than we were seeing in our legendary assets -- not -- sorry, legacy assets, not all legendary assets.

It's from Dan Oppenheim with UBS.

Just in terms of the comments about exiting from the lower-margin communities in the West where you're just getting the -- accelerating the closeouts there. And talking about how in the future you'll have better absorptions, as new communities open up. How much do you think the impact was in terms of the margin in the West; where it was still favorable this quarter, but how much impact do you think there was from just closing out of those lower-margin communities?

I think, previously, we talked about 30 bps of pressure on the margin, I'd say it's probably about the same. We'll be able to give you a better guidance on that next quarter because we're going to get through more of it this quarter, but it's probably about 30 bps.

It'll still be with us a little bit into 2018. By the end of 2018, it will be nominal.

Got it. Okay. And then in terms of the communities as they're opening up in 2018, I see you've talked in terms of the -- what the overall mix of communities will be but presumably the vast majority of what you'll have opening up in terms of the replacement communities will be entry-level, and so do you think about that in terms of having the potential to offset the lower community -- what could potentially be lower community count, otherwise, in terms of the higher absorption.

Absolutely. I mean, absolutely, that's what we've been saying is that the absorptions in those communities, historically over the last many quarters and going forward, are substantively higher than our move-up communities. And even though the community count growth hasn't been as strong as we had hoped, the absorptions from those communities are better, and that's going to drive the top line. It's also going to have real positive impacts on our SG&A, because the cost on a per-store basis isn't that much higher.

The next question will be from Alex Barrón with Housing Research Center.

Good job on the quarter. Just kind of wanted to talk a little bit about the tax rate. Hilla, do you have any guidance for the next quarter? And what drove the slightly lower rate this quarter? Sorry, if I missed that.

Sure. Yes, we didn't cover it. It's a great question, Alex. It's -- we're still targeting between 34% and 35% full-year effective tax rate. We had a slight decline in the tax rate this quarter. We were able to pull in some additional green energy efficiency rebates from prior years. As you know, the tax rate -- the tax fund has not been amended yet for 2017, so we can't recognize any of our 2017 closings. Although we still have a look back period, where we can go back and requalify some of our homes that maybe hadn't passed their qualification in prior years. So we're continuing to actively do that for '16 and '15 closings, which helped take down the rate this quarter.

Got it. And for the share count next quarter, it's still going to be going down a little bit, right?

Yes. So if you look at our full year -- at our full all-in share count, the result of the convert is going to reduce it by about 2.176 million shares. But a piece of that -- we took about 900,000 of it out during the second quarter, and the balance we took out this quarter: 1.3 million. So the diluted share count is kind of tough because it's taking average per day, but all in, our share count dropped by just under 2.2 million shares.

This concludes our question-and-answer session. I'd like to turn the conference back over to Steve Hilton for any closing remarks.

Well, thank you very much for your attention and participation in our earnings call this quarter. We look forward to talking to you again in February. Thank you very much.

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