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Meritage Homes Corporation (NYSE:MTH)

Citi 2012 North American Credit Conference

November 15, 2012 1:00 pm ET

Executives

Steven J. Hilton – Chairman and Chief Executive Officer

Larry W. Seay – Executive Vice President and Chief Financial Officer

Unidentified Analyst

We are going to get started with Meritage. It’s a pleasure to welcome Steve Hilton, Larry Seay, and Brent Anderson from Meritage. I think we’re going to try to keep this as conversational; it’s kind of a hybrid between a fireside chat and a formal presentation. I think maybe the place I want to start the conversation. Steve, can you talk a little bit about what differentiates Meritage from the other builders in your opinion. So I may go to the last slide and then we’ll just keep jumping around?

Steven J. Hilton

First, I want to thank you for inviting us again to this conference. I mean (inaudible) begin personal thanking of my wife, because she gets to go shopping every time we come here. We don’t have these great stores out in the….

Unidentified Analyst

(Inaudible)

Steven J. Hilton

No, the combination for shopping and our stock price going down over the last couple of weeks have been very painful. But we will persevere. I’m pretty proud of what we’ve accomplished at Meritage. We’ve been in business for 27 years and I’ve been with the company since day one, and we really I think done a good job, getting ourselves through this last downturn, and we’ve improved the business in a lot of areas.

Number one, we’ve got a really good footprint, I believe for recovery. We operate in 11 of the top 20 housing markets, 15 markets in total across the South and Western United States. These are the markets that I think are going to have the best job growth long-term, and also going to have the best recovery and we can see that already, what we’ve seen in California, Arizona, Florida, and some of these other markets have been facing a pretty dramatic recovery.

Secondly, what makes us different is our industry leadership. I think we’re a company of innovation, and I'm not talking about just innovation in Green, but I’m talking about innovation and what's other ways that we run our business whether it’s our product, whether it’s how we motivate and train our people, what we do on the sales force and our sales office sort of whole variety of ways, but let me spend a quick moment and talk about that Green.

I believe Meritage Homes’ segment standard for energy-efficient home building. And we're going to talk about that a little more, I think some of your questions David, but we build homes that are 50% more energy efficient in a typical resale home. And when it comes down to having a conversation with a buyer in the sales office about buying our home or buying our competitors home or buying a resale home, we think we win that conversation, because we don't charge extra necessarily as an option for these Green features, we include them in the price of the home. And that becomes very compelling proposition, and I think it shows up in our sales per community which are amongst the best, amongst all the move up builders out there.

Next, Brent to go back to last slide, talked about the, what we've done as far as processes, our underwriting today is better than it's ever been before, we are not operating or might exceed our plans like we may have been doing 10 or 15 or 20 years ago. Today, we do a lot to really in-depth formal analysis of the housing market and every submarket that we are interested in buying land, and we fine tune our product through exhausted consumer research, and we were very employ focused culture.

Our earnings growth I think will separate us from a lot of our competitors as those recoveries starts to take hold. In the period of 2001 to 2006, we have some of the strongest earnings growth of all the public homebuilders and expect that we will have a very strong earnings growth, again we and our peers going forward.

And lastly, it’s our strong balance sheet. We have a very conservative balance sheet, net debt-to-capital of 38%, all of our debt termed out very long with away maturities for at least five years, and I’m pretty proud of where we are with our liquidity, our $380 million of cash and with this balance sheet, it allow us to do as the market continues to recover. So hopefully it answers your question David.

Unidentified Analyst

Yeah. So it also brings up a bunch of question. It’s really interesting to talk about sales and sales training as an area where you see yourself differentiated. And the reason I say it is, the green product, you guys are clearly the leader, right, I mean you’ve developed the best product. But people are going to catch up to you, subcontractors maybe, maybe…?

Steven J. Hilton

Maybe, we think…

Unidentified Analyst

If somebody really wanted to, they could, right it’s hard to add intellectual property around that right?

Steven J. Hilton

Right.

Unidentified Analyst

But sales trading I think is very interesting, because it’s much harder to put a finger on and to see it. So can you talk about how do you train your salespeople, how do you send them correctly? What do you do without given away the secretes off? What do you do that makes it really different when everybody else is doing?

Larry W. Seay

Well, I think the first thing we do is, we hold them accountable, we hold them accountable for following up and qualifying and demonstrating to every unit of traffic that comes into our community. We expect our sales group with front center, we expect them to be energetic, enthusiastic. We expect them to sell the house. We’re not sitting around, waiting for people to give us the order, and I think if they had set a high standard. And I think some of our peers don't do the same thing, but I think we are very aggressive in that area. We put in place a CRM program called the Salesforce.com, a lot of you probably familiar with the leading CRM in the world. We've actually quite a bit of money put that in place a couple of years ago. And we are very diligent, it's very transparent, we can see exactly what's happening with every prospect in our system.

We built a call center, we call it a contact center, when a lot of companies were getting rid of their contact center eliminating their contact center. 20% of our sales now come through our call center, okay. All Internet leads, all website leads, all telephone leads all go into the central call center. We have people there for 18 hours a day that are answering questions, they are setting up appointments, they are guiding people to communities we are very aggressive about that, we spend a lot of money on marketing. And we wanted to see worlds marketing dollars are going and making sure that we’re getting our return on them. So without getting involved in a lot of detail here at this point, I can tell you that we’re very aggressive about our approach to sales.

Unidentified Analyst

So clearly your sales rate has been higher. I think absorption wise been a lot of other builder that’s clearly one way you can see the benefit of the product and the sales trending.

Steven J. Hilton

Right.

Unidentified Analyst

Can you look at hit ratios, do you think you have a higher hit ratio of leads?

Steven J. Hilton

You mean conversion ratio?

Unidentified Analyst

Exactly.

Steven J. Hilton

Yeah I mean that’s hard to measure because we’re really taking the sales persons work for what the traffic really is. I mean we can’t actually sit out there and count every unit of traffic and some of the traffic is accounted and some of it doesn’t. So we kind of moved away from that metric it’s not being reliable measure of the effectiveness of our sales program.

Unidentified Analyst

It’s interesting to see earnings growth as one of the ways that you differentiate it. And I think the reason that’s interesting to me is, we’re almost starting to see builders differentiate themselves a little bit right? We have some builders that had publicly said we’re going to be return on capital focused. If it means slower growth and less earnings, we’d rather have higher return on capital and structure – doesn’t walkway from deals we can’t structure it certain way, to maximize return on capital. And then we have some builders that are clearly are very, very focused on earnings growth and just putting to the most volume they can especially as the market improves here. Where do you think Meritage stands relative to that distinction?

Steven J. Hilton

Well, clearly in the last cycle, we had both. I think we led in the return on capital and in earnings growth and that’s because we have access well a lot of options.

Unidentified Analyst

Right.

Steven J. Hilton

Either options that we got from developers to buy lots or we bought in third-party land bankers to lots for us, and so if there is an option. Today, we don’t have either of those. While developers can’t get financing to develop lots and sell it to us, we got to develop them ourselves and we don’t have these third-party land bankers who would come in and put the camp of the (inaudible) back to us on a right option. So as much as I’d like to improve the return of on capital and naturally it will return as we generate more earnings, that’s not my first and foremost objective, my first and foremost objective is to grow earnings while managing our risk in the way I’m managing our risk is by not increasing our debt-to-capital ratio.

And I think because that we are in markets they’re going to grow faster than other markets, we will then to grow our earnings faster than other builders that are maybe more diversified than we are, because I think outside the markets, we were in Texas, every other market run is a very high growth market and will exceed significantly with the national average.

Unidentified Analyst

Yeah. I want to make sure I understand the commentary, you’ve brought debt-to-cap down, you’ve termed up the debt maturities very, very nicely.

Steven J. Hilton

Right.

Unidentified Analyst

Do you lever up a little bit from the year, because do you think you’re under levered or do you think you have the kind of right capital structure now to support the growth that you think is the optimal growth path.

Steven J. Hilton

I don’t think we need the additional capital. I’ve talked about on our conference calls that we want to finish this year with between 160, 165 communities and we want to grow by next year to 200 communities. We’ve got $380 million of cash on our balance sheet certainly we are going to generate significant return of earnings next year. I just want to pull out a number of $100 million.

Unidentified Analyst

Yeah.

Steven J. Hilton

That means if you want to keep $100million, $150 million of liquidity on our balance sheet, we’ve got $250 million to $300 million to spend. And every single deal we pay cash for and build our whip with cash in our model so for, so it’s going to be $5 million or $6 million per community. We can easily grow our community count 50, 60, 70 communities from here without any additional capital, and then we are going to be into retained earnings to finance our business going forward from there.

Unidentified Analyst

Correct.

Steven J. Hilton

So long story, short, I don’t see any need for additional capital for the next few years. Our growth was to be even more than that and maybe so, but I think one of the lessons learnt from the past as you got to manage your growth prudently. I think growing at 50% annual rate like we do in ‘04 or ’05 or ‘06 period was pretty hard on the business. But 25%, 30% growth rate maybe even a little bit more, I think is very manageable and I think we’ve got the capital to do that.

Larry W. Seay

Yeah. Yeah David if I could add that I think we’ll try to keep that the capital ratio on our net debt to capital ratio on that 40% to 45% kind of in the low end of the 40s. And the other way we can also grow is we do think land banking will start to come back. We’re getting calls from people who are thinking about getting back in the business. So if growth tends to be on the higher end of the range we can bring capital in that way off balance sheet and spread our risk and have the land bankers think of land holding risk.

So this is the fastening topic that may be we can turn a little bit of time on land bankers. Clearly we’ve seen one public builder start relationship with the private equity shop, go on start land banking with them. We heard – I think it was certainly (inaudible) talking about the difficulties in levering up on land banking side, because of the risk weighted assets in Basel III its harder for land bankers to caught and be able to – so my question to you is, do you think fundamentally there is a shift in who the land bankers are at this time around. Is it going to be different entities, is it the same people, does the relationship change, do the required returns change in that business.

Steven J. Hilton

I think that people are going to change. I think some of the people who are land banking are not around today. I think there will be new people that came to business, I think the pricing is going to be higher, but if it’s because too high won’t be some will be that interested in. It’s going to have to be in a low teens, unleveraged rate for us to get interested in if its going to be equity type returns and it’s not really going to be something that we are going to pursue.

So I think it’s going to take time. I don’t think it’s going to happen quickly. And I think sooner or later, the banks will again lend to these types of entities that have real credit and real strength and real collateral, and that’s a little ways down the road. In the meantime, we are going to be putting lots on our balance sheet they are going to be paying cash for.

Larry W. Seay

And David, I think you will see more funds coming into the business and they have different pools of capital, which they can provide the leverage themselves internally. I think you will see some of the rural state funds that have bought land over the last several years start to sell those and maybe they will start to sell them on terms. And then you do have some other people who survived to had an efficient capital structure that get their money from endowments and other kinds of patient money that will come back and start doing business again.

Unidentified Analyst

Maybe we can spend a little bit of time talking about the Green product, again you guys are I think the innovator of the public builders in the Green product and energy. Are you finding a lot of builders trying to catch you or do you think that the kind of okay, where they are and you guys is keep kind of capturing that client?

Steven J. Hilton

I mean the truth is there is a cost of this. It’s costing us, a few thousand dollars a house on average, and you can argue that’s come out of a margin and maybe that’s why our margins are little lower and maybe some others, I don’t think so. I think at the end of the day, our margins are going to be higher than most builders. But I think why no one has followed us and copied us because they don’t have the courage to spend the money.

Unidentified Analyst

Yeah.

Steven J. Hilton

But at the end of the day, I think we sell more houses, and I think it differentiates us from the resale housing market and it differentiates us from other builders. And also that the cities, and towns and municipalities love it, and a lot of times, we get into deals, but we wouldn’t have gotten into without having this differentiator, and this is part of our culture, part of our innovation and I think people rally around it, people love to work for us, because I think we’re doing the right thing and customers rave about it and I think it’s about building our brand.

Unidentified Analyst

Yeah.

Steven J. Hilton

And this is the center piece of that. Clearly, (inaudible) installation cost three times what probably less bad installation cost and of course we can mitigate that cost through things that we do to design into the home, but I’m not really worried about brand X, Y, or Z jumping in and following us because there are going to the buy work already.

Unidentified Analysts

I am going to lot more question with that, I have obviously a bunch more questions, I was thinking Steve…

Steven J. Hilton

I’ve always started just kind of move a builder.

Unidentified Analysts

And clearly you’ve shown flexibility to kind of take the product up, or take the product down based on where demand is. But I still think about U.S and move the builder primarily is that right or are you going to be more of move up builder, or is it kind of remained pretty flexible.

Steven J. Hilton

I think we're going to be given more of move our builder tomorrow than we are today. I think in 2009, 2008, 2009, 2010 we try to reposition ourselves a little bit more towards the entry level, because we thought those were the only people that were going to buying houses that was going to be as Renter Nation, is going to buy entry level homes and I think we were mistaken. The strength clearly today is more in the move up sector than it is in the entry level sector not this in our opinion and we think that’s the safest place to be and that’s also the place that we know the best

Unidentified Analysts

Yeah.

Steven J. Hilton

And I think that’s the place where we can capture the most margin, so I think when it comes to design and when it comes to floor plans and when it comes to interest in merchandising and decorating, I think that’s where we are really good at, coupled that with the Green I think we can continue to the leader in the move up sector.

Unidentified Analysts

Does it worry you at all that the entry level isn’t leading the recovery but it’s more move up focused in-terms of the sustainability of it.

Steven J. Hilton

I mean it’s worrisome but I think there is still a lot of pent-up demand people out there that ready to move up as soon as they can sell their house they will and I think we have a pretty significant amount of time, before that becomes a real issue and during that time hopefully the entry level sector will yield more and their credit will get repair in those buyers will eventually become tomorrow’s mover buyers.

Unidentified Analyst

If we think about the land market today and the competitiveness of the land market, where do you guys think you have great land teams, where do you think you need a little help maybe where you are not in the great land team position are there markets like that, where do you think you really have a leadership position?

Steven J. Hilton

I think we have great land teams everywhere. I think clearly California is a market there, we don’t have – much history and beyond the late 90’s relatively new comer in the last 15 years to California. We don’t have those deep relationships particularly in places like Orange County or in the Bay area in Northern California that maybe some of our competitors have. There are California companies and they’ve been building out there a lot longer then we have, but we are starting to make those relationships.

Unidentified Analyst

Yeah.

Steven J. Hilton

Rancho Mission Viejo in South Orange County is a community we’ve been trying to get into for 15 years and I am proud to say that we are building there now, or we are going to be building there shortly. We are going to have our first community. We are talking to The Irvine Company about being in their community. We are talking to some long time Orange County developers to get into Orange County. So, I think we are going to have our presence there. In the mean time we are not going to retrieve from our Inland Empire presence because we built a franchise there and we are going to continue to grow it and we’ve got a great Northern California niche. Northern California position and we are going in the Sacramento in a significant way because that’s going to be an important California market. It’s got some of the lowest resale inventory in any market in the country, but we have absolutely strong roots in Texas, we have great land acquisition people there. I think we are the best in the Business in Arizona, clearly some of our newer markets in Raleigh, Charlotte, Tampa were untested and – but we are going to have to prove down to our self, but to the homebuilding community and to land development community that we have good land people there, but I have a lot of confidence in our ability to stock the shelves and supply the land that we need to grow.

Unidentified Analyst

Your new market expansion is because, Meritage probably six or seven years ago before the downturn would go out when they want to go to new market, find a builder they like there is a lot of times, buy a small builder, given back office, given capital, somebody who was really already kind of intrinsic in that market, now there is more organic growth in the market. So what was the change? What culture is that?

Steven J. Hilton

Our culture has changed. We really grew up over the last five, six, seven years to a more mature company, who has real systems and processes and solid underwriting and a real way of running our business that we believe and that we didn’t have, we’re more of a collection of companies 10 years ago. We are making an acquisition every year.

And as you said, corporate was a bank for this collection of companies. Today, that’s not the way we run our business, we have much more centralized approach. We have a more defined product platform. We have more people involved in the [Zion] product. We have less plans versus more, but these plans are well vetted through consumer research and we just run our business that’s more based upon solid underwriting in fact, and we just run a different kind of a shop than we had 10 years ago.

So I think as far as acquisitions go forward, we are always looking at acquisitions, but we won’t have our people, and but if we find acquisitions with the people who can fit into our culture, and there is a real marriage there. Then I think some of those make sense, but I think growing organically is a better way for us going forward.

Steven J. Hilton

It’s interesting you mentioned the word centralized. As it to me, that we started to talk about a little bit say, can you talk about the controls that you have at corporate, over in other words how centralized or de-centralized is your operation. How much power do you put in the hands of the people in the CO versus kind of controlling the corporate in terms of design, in terms of pricing, in terms of sales. How much oversight do you need to have and how much do you kind of leave it to your field operators and kind of plot their own course.

Steven J. Hilton

Well we’ve got our field operators to execute our strategy and we’ve designed our strategy at the corporate level. We do in cost of analysis every market a couple of times a year. We break down the market into submarkets, we find the healthy submarkets, the markets that have the best lowest level of resale inventory, have the best price appreciation, have the best demographics, et cetera, et cetera, et cetera, that we direct our field people or our land acquisition people to those sub markets when we turn to bring this land deals in those markets and meet our underwriting criteria.

We cleared our product on a regional level. You know how the individual cities designed product, as I said earlier we bet that product, we use our consumer research. Our marketing is all done on a regional level today, with corporate oversight, corporate approval.

A lot of our marketing is online so that’s being done centrally corporate, our contact centers is at corporate. We have regionalized our accounting functions, so it's a different business today than it was, six, seven, 10 years ago. We've kept the best people, we've trained those people. And we have centralized all those functions to make us more efficient and to eliminate and reduce our risk.

Unidentified Analyst

Is that something that you can (inaudible).

Steven J. Hilton

We got one of you, able to hear.

Unidentified Analyst

Is that something that can persist as the upturn continues?

Steven J. Hilton

Yeah.

Unidentified Analyst

In other words, you start to get more entrants into the market, you start to get more people who are more competition they start offering more features, they start changing their elevation, they start changing their floor plans.

Steven J. Hilton

They can’t and they won’t.

Unidentified Analyst

Okay.

Steven J. Hilton

And that’s not the way our businesses run and that’s not the way it’s designed. I don’t think we’re the only builder that operates this way.

Unidentified Analyst

No absolutely not.

Steven J. Hilton

I think there are several builders that are very successful that operate in same manner. We want to have an entrepreneur of the business, but we just don’t want guys out there in the divisions making decisions that affect our balance sheet and our income statement without consultation from leadership at corporate.

Unidentified Analyst

Yeah, absolutely.

Question-and-Answer Session

Unidentified Analyst

We have a question from the audience. I think we don’t have any now. So…

Larry W. Seay

Adam.

Unidentified Analyst

Thanks you guys.

Steven J. Hilton

Okay thanks a lot, I appreciate it.

Unidentified Analyst

You covered it all too well.

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