Meritage Homes' CEO Discusses Q1 2013 Results - Earnings Call Transcript

Apr.24.13 | About: Meritage Homes (MTH)

Meritage Homes Corporation (NYSE:MTH)

Q1 2013 Earnings Call

April 24, 2013, 10:30 am ET

Executives

Brent Anderson - VP, Investor Relations

Steve Hilton - Chairman & CEO

Larry Seay - EVP & CFO

Analysts

Michael Rehaut - JPMorgan

Dan Oppenheim - Credit Suisse

Stephen Kim - Barclays Capital

Ivy Zelman - Zelman & Associates

David Goldberg - UBS

Stephen East - ISI

Adam Rudiger - Wells Fargo

Joel Locker - FBN Securities

Jade Rahmani - KBW

Alex Barron - Housing Research Center

Will Randall - Citigroup

Jay McCanless - Sterne Agee

Susan Berliner - JPMorgan

Operator

Good morning and welcome to the Meritage Homes First Quarter 2013 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

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

Brent Anderson

Thank you, Maureen. Good morning everyone. I would like to welcome you to our analyst conference call. Our first quarter ended on March 31st and we issued a press release with the results before market opened today. If you need a copy of the release or the slides that accompany our webcast today, you can find them on our website at investors.meritagehomes.com or by selecting the Investors link at the bottom left side of our home page.

Turning to slide two of our presentation, our statements during this call and the accompanying materials contain projections and forward-looking statements, which are the current opinions of management and subject to change. We undertake no obligation to update these projections or opinions.

Additionally, our actual results may be materially different than our expectations due to various risk factors and for information regarding those risk factors, please see our press release and our most recent filings with the SEC specifically our 2012 Annual Report on Form 10-K.

Today’s presentation also includes certain non-GAAP financial measures as defined by the SEC and so to comply with their rules, we have provided a reconciliation of those non-GAAP measures in our earnings press release.

With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes and Larry Seay, our Executive VP and CFO. We expect our call to run about an hour and a replay of the call will be available then on our website within an hour or so after we conclude the call. It will remain active for 15 days.

I will now turn the call over to Mr. Hilton to review our first quarter results. Steve?

Steve Hilton

Thank you, Brent. I would like to welcome everyone to our call today. We had an all round positive first quarter. We continue to achieve significant gains in virtually every key metric we have targeted and across all Meritage state during the first quarter of 2013.

Home closings increased 39%. Average sales prices on home closings were up 17%, average sales prices on closes were up 17%. Home closing revenue increased 62%. Our home closing gross profit margin increased 230 basis points year-over-year and 60 basis points sequentially from the fourth quarter to 19.5%.

Commissions and other selling costs were down 150 basis points. General and administrative expenses were down a 130 basis points. Interest expense was down 210 basis points and the net effect of all these gains resulted in diluted earnings per share of $0.32, a 47% improvement over last year’s $0.15 per share loss.

Turning to slide five. In addition, we increased both our community count and orders per community. We generated 35% more orders in total during the first quarter of 2012 and ended with a backlog value 89% higher than a year ago. I believe our strong performance is due to sound strategies and operational execution as well as healthier market conditions as this is the second year in a row the spring selling season has gotten off to a strong start for our eight consecutive quarter of year-over-year order growth.

We believe that job growth in many of our markets is creating demand and buyers have been pulled in to new homes due to relatively low inventories of used home for sale. Current home owners are also taking advantage of low interest rates and high affordability to move up. All that demand is pushing prices higher. However, homes don't sell themselves; you have to have right locations, attractive designs, comparative prices and a compelling presentation to win sales. If we put together all of those elements of success as many of you saw demonstrate during Analyst Day last month. I am very pride of our people and of what they have accomplished.

We have been an aggressive buyer of demand selling the best locations in our markets. We opened 24 new communities in the first quarter to replace the 14 communities we sold out during the quarter ending the quarter with a 168 communities; the most we have had in almost four years. If our pace of orders keeps up as we are projecting, we will sell a lot of more communities that we plan to open in the second quarter, so in May and June with flat or slightly lower active community count. However, we expect the total to grow again in the second half of 2013 ending the year with about a 185 active communities.

In addition to increased community count, our pace of orders increased to 9.5 per average community for the quarter, a 27% increase over the last year’s average of 7.5 even as we raised prices in many communities, which we believe points it's desirability of the Meritage Homes communities.

The net result was a 35% increase in total orders with an average sales price 25% higher in the first quarter of 2012 and total order value increase of 69% year-over-year. Those gains are also against very difficult comps as our first quarter 2012 orders were up 36% over 2011 and Meritage reported among the highest order growth in orders per community in the first quarter last year. We are pricing our homes and limiting the number of lots we’re releasing for sale in some communities to better manage our order volumes relative to our production capacity and to maximize our profit from those communities.

Turning to slide six; we grew orders closing the backlogs in every one of our states year-over-year with increase in orders per community average prices in most. Orders have accelerated over the last year where quarterly levels, now that we haven't seen in most states for many years back in 2005 or earlier in some cases. Despite having 22% fewer communities opened on average in the first quarter of 2013, California’s orders were up 68% over 2012 with a 27% increase in average sales price or a 113% increase in total order value. Inventory is extremely tight in California down to two or three months in most of the markets and affordability is still high and prices are rising rapidly.

Florida achieved a 58% orders growth and 30% increase in ASP for a 106% increase in total order value. We are now the largest builder of single family homes in Orlando and building our business in Tampa.

Colorado grew orders 55% combined with the 21% increase in ASP or 87% increase in total order value. We have communities in some of the highest growth areas around Denver and our new and exciting designed on energy efficiency is resonating well with buyers in that market.

Arizona posted 28% orders growth and a 28% increase in ASP or 64% increase in total order value. Phoenix continues to be a hotbed of activity and prices have risen considerably in the last year yet homes are still very affordable relative to income levels.

Texas grew at a slower place generating a respectable 9% increase in orders with ASPs up 11% or a 20% increase in total order value for the first quarter of 2013. Our overall ASP of the company was up 25%, primarily due to the faster growth in our highest price State California, Colorado the Carolinas and Florida where our average prices are $380,000 to $425,000 or more compared to an ASP of about $260,000 in Texas. Those four states made up 45% of our first quarter orders in 2013 compared to 37% in 2012. We have sold out of Las Vegas so we will cease operations there except for ongoing warranty support after we close the 21 homes in backlog.

We have grown our Carolinas operations significantly in the last year since opening at the end of 2011 and now have a solid presence in that market. We did the first quarter with 11 communities and 69 orders compared to four communities and 33 orders there a year ago, as we are just beginning to ramp up operations. Over the last 12 months, our newer Carolinas market produced more than twice as many orders as the Nevada market that it replaced.

Turning to slide seven; we entered the quarter with over 21000 total lots under control, 22% more than a year ago and slightly higher than what we started the first quarter. We are being aggressive but prudent in our acquisitions of land from new communities. We invested approximately $75 million in land and development during the first quarter of 2013, putting approximately 1600 new lots under contract. We expect to ramp that up quite a bit through the remainder of the year, based upon a healthy pipeline of potential new positions and expect to invest up to $600 million in land development for the full year of 2013. With that I will turn it over to Larry to review a few other highlights of the first quarter. Larry?

Larry Seay

Thanks Steve. Moving to slide 8 due to high demand a greater percentage of orders have been dirt starts rather than spec homes and more are larger are more upscale homes that take longer to build. So our cycle times are elongating. As a result our conversion rate declined to 71% from 83% year-over-year in the first quarter and it may continue to come down a little more before stabilizing. With that conversion rate we reproduced a 62% increase in home closing revenue and a 230 basis points pickup in our home closing gross margin during the first quarter, generating an 83% increase in gross profit dollars. Excluding interest amortized and cost of sales, our home closing gross margin improved by 260 basis points to 21.0% in 2013 compared to 18.4% in the first quarter of 2012.

Our commissions and other sales costs increased at a much slower pace than revenue. They were up only 36%, while general and administrative expenses increased just 34% compared to our 62% increase in closing revenue. Interest expense decreased by 2.2 million or 2.1% our first quarter revenue in 2013 compared to 2012, as we capitalize more interest in inventory under development. As a result of that leverage, our pretax margin increased by 710 basis points year-over-year to 4.9% in 2013 compared to a negative 2.2% in 2012. After reversing most of the valuation allowance against our deferred tax asset in the fourth quarter last year, we began to record a tax provision this year even though we won't be paying cash taxes as we offset them with our deferred tax assets. The tax provision for the first quarter of 2013 also includes approximately $2.1 million of net tax benefit from tax credits for the energy efficient features in our homes closed during 2012, in the first quarter of 2013 due to a tax law change that became effective at the beginning of 2013.

We're expecting additional energy tax credits during 2013, which we estimate will reduce our effective tax rate to approximately 34% for the rest of the year. We began breaking our financial services revenue, expenses and our operating results statement this quarter for additional disclosure, even though the amounts are relatively small. It includes our share of net earnings from unconsolidated mortgage joint ventures as well as revenues and expenses of our title operations.

Slide nine; turning to our balance sheet, we ended the year with 453 million in cash and cash equivalents, restricted cash and securities compared to 277 million at March 31, 2012. The March 31, 2013 balance was reduced by 83 million this month after we retire the remaining amount of $100 million, 7.731% notes due in 2017, which follow the issuance of 175 million of new 4.5% notes due in 2018. We will record a related loss on early retirement of debt of approximately 3 million in the second quarter, which will reduce our diluted EPS by approximately $0.05. Our net debt-to-capital ratio at March 31, 2013, was 37.6%, compared to 38.1% at December 2012, and 40.4% a year ago at March 31, 2012.

With that amount of cash and our moderate leverage ratio, we believe we have the adequate capital for additional growth. With that, I will turn it back over to Steve before we begin Q&A. Steve?

Steve Hilton

Thank you, Larry. Last month, Meritage received the EPA’s Energy Star 2013 Partner of the Year Award for sustained excellence for innovation and contributions to energy efficiency and environmental protection. We just took that step further with something we introduce on Monday, [first] day 2013.

We build queue homes in our Sedella community and in Goodyear, Arizona using 7 inch thick insulated concrete panels that replace the need for field building, insulation, house wrap, under (inaudible) black paper and window-casements. The panels arrived on a small truck pre-cut and assemble by the factory and were unloaded by hand that morning. One crew erected the walls for both the homes in just one day, completely insulated with all the necessary penetrations and window-casing complete. The panels are heavily insulated and structured with steel and concrete, making the homes more precise stronger and more durable.

Additionally a vein is included to be termite proof, rock proof, mould proof, watertight, air [impermeable], healthier, quieter and safer and super energy efficient. We plan to do additional research to evaluate our future use of this product, after we complete the prototype in phase, but it looks promising at this point and we are excited with the potential opportunities for Meritage and our home owners.

Turning to our summary, we are pleased with our results for the first quarter and expect we will continue to grow and increase earnings throughout the remainder of the year. There are many factors indicated the home building market continue to grow for a least the next several years and we believe Meritage is well-positioned to capture much of that growth. In the strong demand environment we have shifted our focus a little bit more towards maximizing price and margin to drive profitability, as land and labor markets are more constrained. Based on our projections we are opening new communities coupled with the modest increase in average sales per community and higher sales prices.

We have projected approximately a 40% to 45% year-over-year increase in home closing revenue for each of the three remaining quarters of 2013. Assuming some additional improvements in margin, we have been impacted by rising construction cost and operating leverage demonstrated in our first quarter results, we would anticipate earnings per diluted share in the range of $2.20 to $2.45 for the year, representing approximately 300% to 400% increased in pretax earnings.

Thank you for your attention, we will now it up for questions. The operator will remind you the instructions, operator.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instruction) Our first question is from Michael Rehaut of JP Morgan, please go ahead, sir.

Michael Rehaut - JPMorgan

First question I had was on gross margins and appreciate maybe the difficulty of getting granular to a degree, but I believe last quarter you talked about your hope or expectations to get to a 20% gross margin by the end of the year. I wanted to know if that is still the case or if given that at least your [EBITDA] expectations your margins were higher than what we were looking for 1Q that you might think you’d be able to exceed that 20% number?

Steve Hilton

Well, I am certainly a little more bullish about margins this quarter than I was last quarter. We have been able to raise our prices consistently particularly in the west and we are getting a much better handle on our cost. So I believe that we will finish the year with at least a 20% gross margin average for the entire year. And by the end of the year, our gross margin should be above 20%. So I'm much more optimistic about the direction of the margins than I was last quarter.

Michael Rehaut - JPMorgan

Also I believe you mentioned sales pace per community being from according to your guidance modestly above, modest increase in average sales for community for the rest of the year. This quarter you are up I believe solidly above, we have a 27% average absorption increase versus a year ago. The comps get -- do get a little bit tougher I believe, but you know when you say going from 27 to perhaps a modest increase for the rest of the year, are you still thinking double digit, is it too difficult to say, I mean, certainly the spring is unfolded pretty well so far?

Steve Hilton

Well, it’s hard to put a number on it. I hate, I wouldn't want to venture you know into a specific number, but I can tell you that we have opportunity in Texas, particularly to increase our sales per community. I think that that market continues to get stronger and we have better positions coming online later in the year and in the next year. So I'm feeling optimistic that the Texas is going to help us increase our sales per community for the entire company.

Michael Rehaut - JPMorgan

And just one last one if I could, community count guidance, I apologize I just joined a little bit, is there any update to that or reiteration in terms of your outlook by the end of the year?

Steve Hilton

We said that we expect to be flat or slightly lower for the next quarter as we sold out of some communities faster than we expected, but for the year we expect to be around a 185 communities which is slightly lower than we said last quarter because we are selling out of some of these older communities faster than we expected and newer communities are taking a little longer to get online. It’s not because of our inability to buy land or find land; it’s just more about elongating cycle times and selling out communities quicker.

Operator

Our next question is Dan Oppenheim of Credit Suisse. Please go ahead.

Dan Oppenheim - Credit Suisse

Thanks very much. I was wondering if you can talk about in terms of the communities if you look at it in the west you are seeing community counts are declining over the course of the quarter and you talked about sort of the -- what's happening overall, how you think about that in terms of the whether new communities are coming online is going to replace some of those in the west or is it more in terms of new communities continue to come on in the east?

Steve Hilton

Well, I think it’s both. I think we will bounce back in the west. We certainly blew through a lot of lots in California faster than we expected. You know it’s really taking off out there, but we have a lot of new communities coming online, particularly in northern California you know later in the year and the same for Arizona. But you know the southeast is a big growth engine for us and as we ramp up Charlotte, Riley and Tampa. Our community count should increase in all those markets which will help us drive that top line community count number.

Dan Oppenheim - Credit Suisse

Got it, great. And then second question would be in terms of the think, if we think about to see the cost side with some of the increase coming through, how do you, if we kind of adjust for mix in terms of what you are seeing, what do you think is coming through in terms of the -- on the pricing side versus on the construction cost right now in terms of the overall?

Steve Hilton

I would say, you know, I am not sure I understand your question correctly, but you know about half of our price increases are given way to cost increases.

Dan Oppenheim - Credit Suisse

That’s helpful.

Yeah, the remaining half is kind of split between margin improvement and you know land cost increases. So I believe our margins are up 230 basis points or so year-over-year and I think that’s reflective of kind of metrics I just laid out.

Dan Oppenheim - Credit Suisse

Thank you.

Larry Seay

Yeah, I might add that you know the price increase of about 17% for the quarter probably about two-thirds of that is through price increase now versus mix. So, that's improved as we are going to about increased prices more so. So if you say two-thirds of that price increase and do the math, it seems that you kind of can get back to that mark the margin improvement where we're seeing.

Dan Oppenheim - Credit Suisse

Thank you.

Operator

Our next question is from Stephen Kim, Barclays. Please go ahead

Stephen Kim - Barclays Capital

Thanks very much, guys. So with respect to following up on this price mix issue, it sounds like going forward you're going to be growing in some areas with the lower -- you know just regionally lower average price. So when you talk about pricing being a little bit more flat, I just want to make sure are we talking about negative mix shift from just being a regional distribution being offset by real sort of likely basis on a like-for-like basis?

Steve Hilton

I don't know that we state that prices are going to flat, I mean Larry did you?

Larry Seay

No, I don't think prices are going to be flat and prices are going to slow go up, may be the rate of increase will be a little more modest and you are right to the extent that Texas picks up a little bit that may bring the average down just due to mix, but we still see the rest of the country continuing to grow rapidly and I actually don't think the overall mix of Texas to the rest of the country is going to shift towards Texas, I think Texas will continue to shrink a little bit it just, it will roll a bit faster but still be growing a bit more slowly than some of our other states. So I don't I see average sales price continuing to go up because of mix and I also see continuing to go up because we are continuing to raise prices.

Steve Hilton

I think appreciation is starting to accelerate more so in the southeast, it's been a little bit behind the west, so I see prices getting stronger over the next year in the southeast markets.

Stephen Kim - Barclays Capital

That’s great, that’s (inaudible) helping for, but thanks to that clarification on the price. Second question I have related to your metrics based land acquisition programs, I was in the queue what you described that land in the United States and I guess I was wondering if you could help us understand where you may have deployed the system around the country, where you are not already operating and how quickly it takes you to, how quickly you can ramp up this system to help your purchasing decisions in a new market?

Steve Hilton

Well, we are using certainly in every market that we are in and it’s helped us tremendously now to finally end that underwrite land. And I don't want to name specific markets, but we are looking at a whole list of markets that we are considering entering in some fashion over the next year and we’re using that intelligence to help underwrite opportunities and find the best markets to enter and the best way to enter them and where there are niches and opportunities we can take advantage of.

So I definitely see growth on the horizon for us from markets that we’re not in. In addition as I continue to say we have these premium markets in the southeast that were relatively small and when you need to get bigger as quickly as possible and this tool is going to help us accomplish that.

Larry Seay

Yes, Steve, it’s relatively easy for us to go up and expand the data we buy to include new markets and we have done that, so we are using our proprietary programs that help us identify the better and new markets and what some markets and lots that would be good to buy in new markets and making sure we are paying the fair price for.

Operator

Next question is Ivy Zelman from Zelman & Associates. Please go ahead.

Ivy Zelman - Zelman & Associates

Good morning and congratulations guys for exciting results. Just to clarify and then I will ask my question if I can separate. Your guidance last quarter was for order growth for 2013 between 20% to 25%, so is that still your target Steve or are you pushing price so harder so it is going to [learn] a growth?

Steve Hilton

I think that I am still on target if not a touch better but I think that’s what we expect to be.

Ivy Zelman - Zelman & Associates

Well, now my question and I think I appreciate the clarification; when we look at your product and your focus move up maybe you can help us, is there for the company a policy on including or excluding contingency also; you might actually write contingent sales contract, or you just sort of include it in your orders, that's the first question, so assuming just to say what and how you do those and if you can answer that first for me please?

Steve Hilton

We do not include contingent sales in the order numbers that we give out to the public.

Ivy Zelman - Zelman & Associates

Okay, do you actually write them though and…?

Steve Hilton

Yeah, we do write them. We do write them, but we don't record them in our sales counts.

Ivy Zelman - Zelman & Associates

That's helpful. So as you were writing them maybe you can just start to be trend in contingent sales right now, because we recognize that there's a lot more demand, so are you seeing a decline in your interest in writing them because you don't have to and then I'll ask the next question?

Steve Hilton

No I don't think there's been much of a change, I mean I think we've taken a little different approach over the last several years; I mean we vigorously qualify our buyers and you know run them through the mortgage company before we even write a contract whereas other builders might write the contract and get them on paper for us and then really see how qualified they are and they would have a maybe higher cancellation rate. Our cancellation rate is you know in some respects ridiculously low and I think maybe we are probably even we are too conservative on that front because we don't write that many people of that we don't think are going to make it and maybe we can be more aggressive in choosing our sales by…..

Ivy Zelman - Zelman & Associates

(Inaudible)

Steve Hilton

Yeah, but that helps us also with our margins because we have less cancellations which means we have less discounting etcetera.

Ivy Zelman - Zelman & Associates

That's really helpful; I guess then my next question for you Steve is one where I just relate to understanding existing home market; your buyers for the most part, move up buyer has to sell a home, so would you have anyway with your analysis to determine if they have already listed their house or are they in fact listing it once they determine that they love one of your home, is it a chicken and the egg, we are just trying to understand the new home market can actually serve as the leading indicator to improvement and the availability of existing homes on the market?

Steve Hilton

That's a good question, I don't have the answer to I think its something I want to get my arms around, I mean I know back in the go-go days of the mid 2000s people were buying homes from us and then they were putting their home up for sale and they were selling it very quickly. There wasn’t a lot of risk that they couldn’t sell their existing home. For the most part what we've seen you know in prior quarters is they sell their house first then they come buy a house from us. If that's just in and out I don't know but I will have the answer to that for you by the next quarter and that's something we are going to take a deep dive into and look at.

Ivy Zelman - Zelman & Associates

And then just lastly if I can sneak another one in; you know when you think about your pricing and I think Larry commented on or maybe you did the amount of offset to the pricing because its cost inflation. If you look at the expectations of margins going forward, is there any reason why we as an analyst community should believe there is a cap on gross margins as long as you are getting home price in inflation that's greater than let's assume your cost inflation, is there no cap I guess on the opportunity for gross margins, mathematically makes sense let's think about it that way but what would you say to that?

Steve Hilton

I wouldn't say there's a cap, but I would say it continues to be a balance between volume and margin and you know certainly like in the Western States we are focused more on margin than volume, but in other states like Texas, you know, we're still pushing volume because our sales per community still aren’t where we want to be.

Ivy Zelman - Zelman & Associates

No, I appreciate that. I am just thinking generally overtime. So we're being about the company, let’s assume you are getting price across the board and you are getting the volume that justify it; is it safe to say there is no reason to assume that if you hate your peak gross margins, that that would be a limiting factor there because a lot of the analysts are saying your company is already at peak margins and therefore not necessarily you guys in general. So I am just curious on how we as analyst community should be thinking about margins on a longer-term sustainable basis?

Steve Hilton

Well, I don't think margins are peaked by any stretch. I think I got a ways to go, but I hate to pin myself down to a particular number, but I don't think there is more upside in margins.

Operator

Our next question is David Goldberg of UBS. Please go ahead.

David Goldberg - UBS

First question, it's kind of in line with was I think Ivy was kind of getting towards, but the question really is obviously you guys do very, very extensive demographic studies and in doing so do you think about some sort of affordability cap as prices rise. So we're having rapid price increases; obviously low rates are helping to fuel price increases. Do you get concerned at some point where homes are just less affordable for your buyer segment and kind of where do you think that might be relative to where we are?

Steve Hilton

I don't know what that number is but that would be the number one metric that I would be watching. Coming out of the last cycle, I mean that was the metric we were watching closely enough and we would have been watching it; we could have taken steps to avoid some of the carnage that we incurred over the last cycle. So we're looking at affordability in every market and every submarket extremely, every day we are looking at that and that’s the speedometer on our dashboard that we are chasing.

But that said, as much as prices have gone up, affordability is still at a historic lows, of course a lot of that is because of interest rates. Sooner or later rates are going to go up and so we have to be mindful that and I think we are and that’s why we are focused on more A&B locations than going into the outer markets. I think the thing that people aren’t really talking a lot about is that the entry level business at least from my vantage point really has been recovered to the degree that the mover market is and the interest and see what happens out there, but affordability is one metric to watch and we still feel very good about it.

David Goldberg - UBS

But suffice to say that in a rising rate environment and rising price environment there is some sort of cap at some point?

Steve Hilton

Obviously; I mean as rates go up you might see initial flurry of buyers coming in and get off the fence because they want get it before it's gone; but rising rates will slowdown demand and we got to be careful about that.

David Goldberg - UBS

So, thank you for that. That’s great color and then Steve you’ve done a really great job and Larry you’ve done a great job in the past couple of calls talking about off balance sheet financing options, land banking, the market for options and I see in your prepared comments you talked about, and I think Larry might have mentioned it, having enough balance sheet to be able to really fuel growth and to fund growth in the future. And I am wondering if you can talk about, give us may be some more color around how much you can grow given the current balance sheet given what’s going on from last balance sheet financing and land banking, if some are financed option kind of positions, how big you think you can get given the current dynamics of the balance sheet?

Larry Seay

Well, I think we can get a lot bigger and we have a lot of liquidity of course and we have a lot of borrowing capacity; we certainly, we wanted to I am not saying that this is our plan, but we could go into capital markets, so I think we have a lot of room to grow; the opportunities are there. As it relates to our balance sheet, we did close our first land banking transactions with independent third party quote land bankers. These are people that do not think but provide money for builders to control lots and they are entitled to the lots and they sell back to us at predetermined price based upon IRR calculation that we mutually agree to; we closed our first one or two deals this last quarter. We have several more that are in close this quarter; about $600 of land plan in development plan for this year; we’re budgeting between $15 million and $35 million of op balance sheet transactions, so it’s relatively small, it’s maybe 10% of our acquisition to development. But we expect that number to grow and we see that coming back into the business although there can be a lot less of them than we’re working for, so we see that is a way to help us continue to grow our business with additional capital on our balance sheet.

David Goldberg - UBS

And would you give us some kind of idea what kind of financing, what kind of cost of financing that was for the land banking and kind of what maybe what that IRR hurdle was that you guys baked in.

Steve Hilton

Well, less than 15% you know on the low to mid teens you know 12% to 15% kind of the numbers we are talking about you know in that range.

Operator

Our next question is Stephen East of ISI.

Stephen East - ISI

Steve if we look at cost more broadly, just not only what you are seeing on the construction side going vertical but also what you are seeing in land on a year-over-year basis and what that implies in your deals that you are doing, but also on your SG&A expectations you were running about half the rate of sales increase. Could you just sort of look at those three buckets and tell us; one, what you are seeing on the vertical side and how much could also land and where you think the SG&A will go.

Steve Hilton

Land continues to go up. I think that's the most pressure we are getting on our cost side is certainly on our land, even though land is only approximately a quarter of the house price or construction costs is closer to 50%, there's much more price pressure on land than there is on construction. I do think we are doing better dealing with construction costs than we were a quarter a few quarters ago or kind of getting our arms around that more and construction costs increases are starting to moderate and we are continuing to leverage our G&A, we are kind of projecting SG&A to settle in at about 12.5% for the year.

Stephen East - ISI

Can you put some color around on the land you know on a blended basis what you all are seeing across the country and then also on the construction cost just roughly what percentages you are seeing going up.

Steve Hilton

Larry I don't know that we have any land do we?

Larry Seay

No unfortunately Stephen these numbers vary from market to market and sometimes we’ll see a cost increase in one market that will be more significant during a quarter and other markets won't have them so they kind of go in waves a bit, so its really hard to provide any definitive percentage increase. And I guess I will go back to what Steve was saying earlier of the true sales price increase we had this quarter, roughly half of it gotten eaten up in correct construction cost increases and about a quarter of it was lot. So about a quarter fell to the growth to improving gross margins, but if you have to put it down any further in that.

Steve Hilton

Yeah, I would say then if this helps you Stephen, construction cost on average went up between 8% and 10% over the last year for us and I would say some markets were as high as 15% or 16% and some markets were only like 3% or 4% with the company wide the average was 8% to 10%. I expect it to be lower than that over the next four quarters than over the last four quarters.

Stephen East - ISI

Steve that's also as a percent on direct construction cost, it’s not a percent of sales. And then you know changing gears as these markets are coming back and you already are even able to do some land and banking deals, etcetera that's probably implies that we are starting to see some funding for the smaller builders as well. Is that actually happening?

Steve Hilton

Yeah, we're seeing more smaller builders particularly in Texas and the southeast. I am not seeing as many of them getting a foothold in the west. I think these high land prices and I think the banks are still pretty tied out here in the west. You know, I don’t see in Phoenix or in California as much.

Stephen East - ISI

Can I sneak in one more? You talked about your new panel construction. Could you just run through that again and sort of what you all are, what it gives you and that type of things?

Steve Hilton

Well, it's basically an all in one exterior wall for our homes. So instead of having to come out and frame it and then sheet it on the outside with foam or plywood, it all comes in one piece and all we got to do is pour concrete on the top of it. It goes up faster. It's a much better product. The installation is all included. It's more air tight. You know, it's stronger because of the concrete and steels that’s in it. It keeps out dust, keeps out bugs and other things. So in my opinion, it's a revolutionary innovation in home building. So the technology has been around for a while, but builders haven't figured out how to do it in a cost efficient way, the way it can really compete with the stick framing and/or block construction that you see particularly down in Florida. But I think we have a vendor that we've been working with, that’s been spending a lot of money on R&D on this and has kind of perfected the science of design and building these systems that it now is cost effective with conventional framing or block construction, and we think this technology is going to accelerate and we expect to be one of the first national builders to be using it upon a large scale basis provided that the research group that were doing pans out and I am confident that it will and some of you might see quite a bit next few years.

Stephen East - ISI

Okay. Would it be cheaper or would it just be more efficient improve your cycle times build be in a more air tight home that type thing?

Steve Hilton

Yeah. I don't think it's going to be cheaper, I think it's going to be on par and I think it's just, customers’ going to get a better product, more energy efficient all the other things are laid out and then it's going to help us with our cycle times.

Operator

As a reminder, we are asking questioners to limit themselves to a single question and one follow-up in order to allow everyone in the queue an opportunity. Our next question is [Rob Hanson, BB]. Please go ahead.

Unidentified Analyst

Hi just a guidance related question, you gave the revenue figure what is the breakout going to be in terms of your average sales price and then closing volumes that drives that revenue figure?

Steve Hilton

Larry go ahead.

Larry Seay

I don't know we are ready to provide that but Steve made a comment about sales, our sales guidance last quarter was in the 20% to 25% range and I think our sales guidance remains in that and the closing volume guidance would be very similar to that may be a bit higher on a percentage basis and the rest of it is being made up in sales price increases.

Unidentified Analyst

Okay, and then just you guys start to breaking out the financing services income, I just want to see why you started breaking that out and should we be reading this as at some point you are going to have your own mortgage operations and move away from the joint venture?

Larry Seay

No, I don't think you should read that in it. I think we just felt it was a clear disclosure so people could see the amount of more last gross margin that’s been driven from home building and the margin that’s been driven from financial services and we did start off our title commodities so now we are not only mortgage JV but we have our own in-house title operation revenue too. So we kind of thought we were at a point where it made sense to show people what that was separately rather than netting it all in other income.

Operator

Our next question Adam Rudiger of Wells Fargo. Please go ahead.

Adam Rudiger - Wells Fargo

I wanted to ask about Steve you mentioned land cost inflation. I want to ask about how that compare to home price increases that you are taking now. So I guess ultimately the question I am asking is the land that you are signing up now with the gross margin and how that compares to what you are currently delivering. I guess it ties in to some of the early questions about caps on gross margins and where they can go?

Steve Hilton

Well, we are still underwriting the same gross margin, so we can’t realistically underwrite land with maybe a little bit appreciation between when we buy and when we open it to 20% plus gross margin we are not going to buy it. But again land in most cases only quarter or last of the house price, so for house prices are up 10% over the year land price effectively can go up 40% and we could still be in sync. And I would say in many cases, that's the case land prices have accelerated dramatically.

Adam Rudiger - Wells Fargo

Second question going back to and again kind of previously asked question, but orders per community if I look back at 304 you guys were doing even double the pace you are doing now. So I was wondering if that's, is that ever going to happen again or will you or are you going to cap that more and really drive margins, I'm just trying to gauge expectations and also could you comment on how widespread the allocating or limiting new lots is?

Steve Hilton

Well, I think I don't know if it was double, I think the peak of the market we were doing 4.5 sales per community per month which would translate to what is that 13.5 per quarter and we are at 9.5 right now for this quarter. So I don't expect to get back to that, but we do think we have a little bit of upside from where we are today for the reasons outlined before particularly improvement in Texas. And so you know can we get back to 10 or 11 sales per community per quarter, yeah probably.

Adam Rudiger - Wells Fargo

Okay. I think I was looking at just the first quarter numbers when you doubled that at 7 points. Any comments on how widespread the lot allocations are?

Steve Hilton

I'm sorry say that again.

Adam Rudiger - Wells Fargo

I was wondering if you could comment on any how widespread, I mean your press release says your commentary talked about limiting the new lots that you are making available for sales, how common that was?

Steve Hilton

I think it’s a small percentage of our total communities, I mean it’s California and Arizona, so you know.

Larry Seay

Maybe a bit of Florida.

Steve Hilton

Maybe, yeah, maybe it’s 15% or 20% of our total communities that we have you know caps employees, but we have other communities where we are you know closely monitoring our sales to price increase allocation so, but it’s mostly in the west.

Operator

Our next question will be Joel Locker, FBN Securities.

Joel Locker - FBN Securities

Just probably quick but just on Phoenix you mentioned basically that it’s still much more affordable to buy than rent, but you've seen the 25% say appreciation on assets in few months in home prices and probably flat in rent and with the abundance of the institutional investors coming online and trying to run out the foreclosures they bought after fixing up, have you seen any slippage of the buyers to I guess the absorption rate is only up 14% year-over-year say in Phoenix versus some of the other markets or less so and are you seeing a little bit of pressure from just [rental spec] and a little more sense?

Steve Hilton

It’s really apples and oranges because the guy who is buying a $300,000 house from us is not thinking about renting.

Joel Locker - FBN Securities

Right. I was saying maybe talking to some of the lower end you know the $200,000 homes in Phoenix, maybe your lower end product versus.

Steve Hilton

Yeah, we just don't have that -- we just don't have that much of that. And I was kind of alluding to it on the call; I'm just kind of surprised that some of these (inaudible) markets where the entry level homes haven't been stronger. I mean that said I have seen the (Deer Hordon) has a couple of communities here in Phoenix where they are killing and they are doing really well, but I haven't seen that widespread increase in sales absorptions in the entry level market and I'm not sure why, I think maybe it’s credit issues with those buyers.

But for us but for us, as I said before, this is particularly pertinent to your question but people are thinking why should I buy a 3,000 on Meritage Home and get everything I want on other homes. So I just continue renting for another year. It's just the opposite of that. People are saying, how can I not buy today? Buy a home at 300,000 and put $30,000 now, I am going to double my money in the year, why would, it's not hard decision.

Joel Locker - FBN Securities

Right. And I guess that’s follow up, do you think because of the three historical low mortgage rates that lot of these entry level buyers are actually move-up buyers because they are getting at 3.5% mortgage ratings instead of a 7% mortgage rate?

Steve Hilton

Yeah, maybe, maybe some of that. Yeah, we're seeing some first-time buyers that have high income earners, they are white collar, you know they are plus or minus 30 years old, their first home they are buying in the move-up segment.

Operator

Our next question is Jade Rahmani, KBW. Please go ahead.

Jade Rahmani - KBW

Thanks for taking the question. How does your targeted land spend for the year break up between land acquisition and development and can you on the acquisition side give the breakout between owned and options?

Steve Hilton

Well, I think it probably -- go ahead Larry.

Larry Seay

Yeah, in the first quarter the breakout was about half and half between the land spend and development spend. And I think you will continue to see that go forward it’d be a much higher percentage than it was in the past. As far as options goes, Steve alluded that you know maybe we will 10% of our total land acquisition as a rolling option kind of deal versus a bulk purchase. So still the option is still a very small percentage, although we see that over the next couple of years improving or increasing significantly.

Jade Rahmani - KBW

Okay. And on the option deals you are looking at, are you seeing developers look to move beyond the sixth escalation clause and structured deals to include participation in future, price appreciation as it's beyond the fixed inflation rate?

Steve Hilton

In California may be but outside the California, we are not -- we wouldn't be entertaining those types of arrangements.

Larry Seay

It's really only in these very, very nice large master plan communities in California that you see that much.

Operator

Our next question is Alex Barron, Housing Research Center. Please go ahead.

Alex Barron - Housing Research Center

Good morning, guys, and congratulation on the quarter. I wanted to want to ask you folks a little bit more on SG&A and operating leverage. So you commented, if I get this correctly you commented that you thought revenues would be up about 40% or was it deliveries that would be up 40% the rest of the year?

Larry Seay

Revenues, we said would be about 40% to 45% for each of the next three quarters of ‘13.

Alex Barron - Housing Research Center

Okay. Then you have said you thought the SG&A would be about 12.5%, so should we think about that number more in terms of dollars, what you are thinking? I guess what I am trying to figure out is, we did break out the commissions versus G&A and I am trying to figure out like is the 19.7 million in G&A some sort of a more of a fixed number to should I think about it more that way or is that going to grow because you are adding headcount?

Larry Seay

Well, it obviously, our overhead is growing and we are having headcount, so you are going to see that number go up, but as we were talking about, it’s not going up and end, we’re near the pace of revenue. So you should -- that is what you are saying about the majority of the basis point improvement is holding G&A down.

On the other hand there are some components of selling costs, we are holding down too, so we are getting some leverage there but not as much. So most of that 100 basis point kind of improvement from that, we're at the first quarter going from like 13.5% to like 12.5% most of that’s going to be coming from G&A and a portion of their small portion from other sales costs.

Alex Barron - Housing Research Center

So I guess if I put it in other way, if your revenues would be higher because prices are higher and you can close more homes and or margins were higher we should see perhaps better than what you are saying?

Larry Seay

Correct.

Alex Barron - Housing Research Center

Okay, all right. That is helpful. And I guess another question that I have been getting a lot from people is everybody seems to be afraid that the cost increases are run away and you guys have talked about that and other people are saying well land costs are going up. I guess where do you see and what would need to happen for margins to start to get compress and when do you think that would happen, would that be like 2015 kind of thing and would it only happen or (rent) prices basically don't keep up?

Steve Hilton

That is a hard question to answer, I mean I do think the construction cost increases are moderating, I mean we think for us they are and so we don't think those are going to run away, I think those are controlling their sales pace and it helps that, and I think land prices in some markets have kind of peaked already and builders can continue to pay some of these ridiculous prices for land in some market. So we just going to have to see over the next year or two, I can't forecast a timeframe for when margins will start decelerating.

Operator

Our next question is from Will Randall, Citigroup.

Will Randall - Citigroup

I guess part one is color on, I would like to have some color on your elongated cycle time that you just talked about, is it just a longer land development or is it also driven by higher utilization of the labor force particularly in Phoenix.

Steve Hilton

I think its just taking longer to get houses built in particularly many of the western markets, slightly longer. And of course new communities are taking longer to get open because there's not enough plan checkers that are reviewing these plans in different cities and towns and taking longer to get them through the cities, and some of the contractors that build lots are getting backed up and so just as business picks up and gets stronger things are going to take a little longer.

Will Randall - Citigroup

So how should we think about that basically balancing between metering the sales pace pricing and potential appraisal issues.

Steve Hilton

You know we are not seeing a lot of appraisal issues right now in the middle upmarket. So, its not one of my major concerns. I think our conversion rate is still pretty high, 70% plus. It was 50% at the top of the last cycle, so I think we are still quite away above that and I'm able to go hold it you know near that number.

Operator

Our next question is Jay McCanless, Sterne Agee.

Jay McCanless - Sterne Agee

First question I had going back to the land banking that you were discussing, what impact should we expect from gross margins from those arrangements.

Steve Hilton

Very little. Very little because it’s still a very small piece of the pie and we are only doing it on communities where we think we got better than average margins so we can absorb that extra cost. But I certainly wouldn't say Meritage is getting back in the land banking business so their margins are going to be lower. I don't see that being the case at all.

Jay McCanless - Sterne Agee

Second question cycle times now versus where they were at the last peak.

Steve Hilton

I don't have that number in front of me, but been more focused on the backlogs conversion numbers. I think we are 71% this quarter and expect we can keep it there the next few quarters.

Operator

Our final question is Susan Berliner, JPMorgan. Please go ahead.

Susan Berliner - JPMorgan

I am sorry. My question was answered.

Steve Hilton

Okay, thank you very much for participating in our call today and we look forward to talking to you again next quarter. Have a good day.

Operator

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

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