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Executives

Brent Anderson – Vice President-Investor Relations

Steven J. Hilton – Chairman and Chief Executive Officer

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

Analysts

Nishu Sood – Deutsche Bank Securities, Inc.

Michael Rehaut – JP Morgan

David Ira Goldberg – UBS Securities LLC

Stephen S. Kim – Barclays Capital

Joel Locker – FBN Securities

Ivy L. Zelman – Zelman Partners LLC

Dan M. Oppenheim – Credit Suisse Securities LLC

Adam P. Rudiger– Wells Fargo Securities LLC

Will Randow – Citigroup Global Markets Inc.

Alex Barron – Housing Research Center LLC

Michael J. Rehaut – JPMorgan Securities LLC

Meritage Homes Corporation (MTH) Q4 2013 Earnings Conference Call February 5, 2013 10:30 AM ET

Operator

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

At this time, I would like to turn the conference call over to Mr. Brent Anderson, Vice President of Investor Relations. Sir, you may begin.

Brent Anderson

Thank you, Jamie. Good morning, everyone. I’d like to welcome you to our analyst conference call today. Our fourth quarter 2013 ended on December 31 and issued our press release this morning with our results before the market opened. If you need a copy of the release or the slides that accompany our webcast, you can find them on our website at investors.meritagehomes.com or by selecting the Investor link at the bottom of our home page.

Look at Slide 2 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 from the expectations due to various risk factors. For information regarding those risk factors, please see our press release and our most recent filings with the Securities and Exchange Commission, specifically our 2012 Annual Report on Form 10-K and our more recent 10-Qs. Our 2013 10-K should be available by the end of this month.

Today’s presentation also includes certain non-GAAP financial measures as defined by the SEC, so to comply with SEC rules we’ve provided a reconciliation of these 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 Vice President and CFO. We expect our call to run about an hour and a replay of the call will be available on our website within an hour or so after we conclude the call. It will remain active for 30 days.

I’ll now turn the call over to Mr. Hilton to review our fourth quarter results. Steve?

Steven J. Hilton

Thank you, Brent. I welcome everyone on this call and thank you for your interest in Meritage Homes.

We’ll start on Slide 4,

2013 was a second year of a recovery in housing market and homebuilding continued to be a significant driver of the economic growth for the United States. Household formations grew as more buyers demonstrate their confidence and an improving economy and employment trends. We expect those trend to continue which spells opportunity for us in the homebuilding industry in general.

Capitalizing on those positive market trends, we successfully executed on several key initiatives for growth in 2013 and beyond. We broadened our geographic footprint by entering the national market, a top 15 market for homebuilding activity to the acquisition of a highly regarded local builder. We further expanded our Southeast region, grown our positions in Raleigh, Charlotte and Tampa markets that we entered a couple of years ago and more than doubled our combined annual sales from those markets over the prior year, resulting in greater diversification.

We grew our active community count to 188 at year end, 19% more than we had a year ago and slightly ahead of our expectations earlier last year. We achieved strong double-digit growth in units, prices in total dollar values across orders closing the backlog. In fact, our total order value in closing revenue reached their highest levels in more than five years and total value of our ending backlog was equal to approximately 40% of total 2013 home closing revenue.

Additionally, we raised approximately $280 million through notes offerings to further strengthening our balance sheet provided additional capital for growth. We invested approximately $565 million in land and development and contracted for more than 11,200 new lots during the year. We ended the year with approximately 25,700 lots or a five-year supply not including homes under construction or completed at year end. All that positioned us well for additional growth this year and for years to come.

Slide 5. Our fourth quarter 2013 results capped of by strong year for Meritage Homes. We delivered year-over-year increases in home closing, orders and backlog, both in terms of units and total dollar value, expanded our margins considerably and leveraged overhead to drive accelerated earnings growth. Our fourth quarter 2013 home closings increased 18% and average prices on closings rose 24% which drove a 47% increase in home closing revenue.

Total order value increased 17% year-over-year for the fourth quarter as orders were up 3% and average prices rose 13% over 2012. It was our 11th consecutive quarter of year-over-year growth in orders and we are encouraged by the fact that our orders increased month-to-month during the quarter and the year-over-year comparisons also improved each month. Even before the addition of orders from our new National Division. Any backlog was up 43% in total value with 26% increase in units and a 14% increase in average prices.

Slide 6. Home price increases and cost efficiencies contributed to our 430 basis point increase in the fourth quarter home closing gross margins, expanded 23.2% in 2013 from 18.9% in 2012. With that gross margin gain and our increased home closing revenues we produced 80% increase in our fourth quarter closing gross profit over last year. In addition to the increase in home closing gross margin, additional operating leverage contributed to our fourth quarter pre-tax margin increasing 570 basis points to 12.2% of total revenue in the fourth quarter of 2013 compared to 6.5% in 2012.

We picked up 60 basis points to a decrease in commissions and selling expense to 6.8% from 7.4% last year. Another 30 basis points came from a decrease in G&A, to 4.6% of closing revenue and 110 basis points drop in interest expense from 1.5% in the fourth quarter of 2012, to 0.4% in 2013.

Comparing our fourth quarter net income in 2013 and 2012 is more difficult due to a large tax benefit in 2012. We had a $91.3 million swing in the provision for income taxes due to a $71.5 million net tax benefit in 2012, compared to $19.8 million provision for income taxes in 2013, which resulted in net earnings of $46.1 million in the fourth quarter of 2013 compared to $95.1 million in 2012. The tax benefit in 2012 was primarily due to the reversal of our majority of our deferred tax asset valuation allowances.

Turning to Slide 7. Orders per community were down from 2012 and both in the third and in the fourth quarter of 2013 partially due to a slowing in the rate of growth for the market as a whole and partially due to our conscious decision to raise prices in some communities where we are still selling far above our expected levels. By raising prices we increased our total order value and margins and we partially offset the lower orders per community by growing our community count also.

The net effect was the total order value continued to grow despite fewer sales per community and our home closing revenue and gross profit increased in an even greater rate. We expect to continue to grow our community count and expect that the sales space will pick up again as a spring selling season gets underway this month.

Turning to Slide 8. Looking at the west region. We grew our total order value and backlog value across the Board in every state except California where our total order value was down 24%, after selling out communities [naturally] can replace them in California for most of 2013. We managed to increase our active community count there during the fourth quarter and it was up 11% over 2012. California is the best example of where we raised prices aggressively to intentionally slow the sales pace or the pace of sales. Though they still have the highest orders per community of any of our States, 8.5 in the fourth quarter of 2013.

We also increased our community count in home prices in Arizona so orders were up 3% and total order value grew 10% year-over-year even though orders per community were down 4%. The same was true in Colorado where our community count was up 30% year-over-year more than offsetting a 16% in decline in orders per community and increased our Colorado orders by 9% year-over-year in the fourth quarter. Total order value increased even more and due to the higher average prices.

Looking at our Central region or our Texas region. Our central region is represented by Texas which achieved positive comparisons in all metrics for the fourth quarter of 2013 versus 2012. Orders were up 12% due to an 8% increase in communities and a 5% increase in orders per average active community, in addition ASPs rose 22% which resulted in a 37% increase in total order value. We believe we still have a lot of opportunity in Texas and we’re looking to further grow our position in Texas this year.

Looking at the East region. We’ve been growing our East region by expanding to new markets and opening more communities. And we produced the largest increases in that region compared to others. Florida still made up 58% of the East region’s fourth quarter order value though we more than doubled our community count in the Carolinas and increased total order value by 169% year-over-year, with our growth rate there in our recent addition of the national market our total East region active community count grew by 68% year-over-year for the fourth quarter driving a 38% increase in orders despite few orders per average community.

Total order value for the East region grew 57% for the fourth quarter as our ASPs also increased by 13% year-over-year. Our overall strategy to grow our earnings is to increase our home closing revenue and further leverage our overhead expenses while maintaining margins at or above our targets. We are doing that by opening new communities in our existing markets where we have a high degree of confidence that we will achieve our targeted sales pace, prices and margins and supplementing that by expanding new markets that have good growth potential as we did through our acquisition in Nashville and in our earlier startup divisions in Raleigh, Charlotte and Tampa. We have proven our success in executing that strategy.

With that I'll turn it over to Larry to review our few of our other highlights for the fourth quarter. Larry?

Larry W. Seay

Thanks, Steve. Turning to Slide 9. We reported net earnings of $124.5 million for the full year of 2013 which included a $53.2 million of provision for income taxes compared to 2012’s net income of $105.2 million which included a net tax benefit of $76.3 million primarily due to the reversal of most of our allowance against deferred tax assets in the fourth quarter of 2012.

Our income before taxes increased 516% year-over-year mainly due to 24% increase and closings in a 21% increase in average closing prices which drove at 51% increase in home closing revenue. A 360 basis point improvement in home closing gross margin or an 80% increase in home closing gross profit. And a 160 basis points combine improvement in selling plus general and administrative expenses and demonstrating our operating leverage, we also reduced our interest expense by $9.2 million or 120 basis points from 2012 to 2013.

Slide 10. Despite a competitive land market we have been able to find and acquire great communities in some of the best submarkets at prices allow us to hit our underwriting targets. We invested approximately $185 million in land and development during the fourth quarter of 2013 to continue to grow the business for a total of $565 million in land and development expenditures in 2013.

We also began using land banking again in 2013 to secure lots under option contracts. We made deposits of $28 million on lots that we acquire through land bankers which allowed us to defer an estimated $177 million of acquisition and development spending that we incurred over time as we purchased lots under those option contracts instead of incurring it upfront. We contracted for approximately 1,900 new lots during the fourth quarter bringing our total to 11,200 new lots put under contract in 2013. We ended 2013 with approximately 4,900 more lots then at the end of 2012. A total of 25,700 lots under control, 500 of those came from our acquisition of Phillips Builders of Nashville in August.

We increased our lot positions across the Board in every state, including a 35% increase in California which has had very strong demand and a 17% increase in Texas especially in the Houston market which is growing rapidly. And a 43% increase in our lots in Florida where we are one of the larger builders and have been very successful on growing our business in both Orlando and Tampa.

We have maintained approximately 4.5 to 5 year supply of lots for the last several years and ended 2013 with approximately 4.9 year supply of lots based on our trailing 12 months closings. In addition to the lots counted in those total lots supply figures, we had almost 2,400 homes completed are under construction which included presold homes, model homes and approximately 770 spec homes started but not yet sold at quarter end, an average of 4 specs per community.

Turning to Slide 11. We ended the year with $363.8 million in cash and cash equivalents plus securities an increase of $68 million over our December 31, 2012 balance and we completed a follow-on stock offering in January of 2014 that raised an additional $110 million bringing our total yearend total cash and securities to approximately -- $474 million on a pro forma basis. We completed two offerings of senior notes during 2013 for a total of approximately $280 million in net proceeds and new issue of $175 million, 4.5% notes during 2018 and a $100 million add on to our 715 notes due 2020 which we sold at a premium to yield 5.875%.

We used approximately $100 million to retire our 2017 notes bearing a higher interest rate and invested some of the proceeds into real estate. At year end our net debt to capital ratio was 39.1%, compared to 8.1% at December 31, 2012. It would have been 31.2% on a pro forma basis after taking into account the stock offering in January 2014. We also increased our revolving credit facility to $200 million during 2013 providing additional liquidity for growth but we have not borrowed against that credit line since it was instituted.

We simultaneously eliminated the restrictions on cash by moving our letters of credit facilities under our secured revolver which is why we have a zero balance in restricted cash on our balance sheet at December 31, 2013.

Our total real estate inventory increased to $1.4 billion at December 31, 2013 a $292 million increase over the prior year. And mostly due to our land acquisitions and development.

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

Steven J. Hilton

Thank you Larry. In summary, we are pleased with our results for the fourth quarter and the full year 2013. We expanded into another new market making our four new markets in the last three years. We grew our community count both within our existing markets and expansion markets.

We expect to grow that again this year and in 2014 with approximately 210 to 220 active selling communities. Those actions result in growing our top line sales and revenue in combination with increasing home prices. We expect the rate of increase in home prices and order volumes to be more modest this year as the pace of home sales moderates. We may have to keep cost increases to lower than the increases on our home closing revenue which has expanded our home closing gross margins beyond our expected targets.

Moderating sales pace and smaller increases in home prices will keep home closing margins from increasing much beyond where we are today and we expect them to return to more normalized levels over time. At the same time, we’ve improved our balance sheet strength and improved our credit metrics and further diversified our business going forward as we deploy cash to invest for growth we expect our debt ratios to increase or remain with a prudent and comfortable range.

Our success is the direct result of the quality of our employees, they worked hard to achieve these results and I want to thank them for their dedication and focus on winning our customer’s trust every day.

Meritage Homes was recently named one of the most trusted builders in America based on surveys by Lifestory Research. We believe in the high range in customer satisfaction also lead to improved performance and return for our shareholders.

Housing market fundamentals remained strong and we believe the housing market can continue to grow for the next several years. We are confident that Meritage will also continue to grow our earnings through our top line growth and our operating leverage.

Thank you for your attention. We’ll now open it up for questions and the operator will remind you of the instructions. Operator?

Question-and-Answer Session

Operator

We will now begin the question-and-answer session (Operator Instructions) Our first question comes from Nishu Sood from Deutsche Bank. Please go ahead with your question.

Nishu Sood – Deutsche Bank Securities, Inc.

Thanks. And a strong finish to the year guys. But, my first question I wanted to ask was on the guidance, you made a few comments about gross margins, you folks were I think the first builder to give guidance again in the recovery, so you haven’t said anything beyond your general comments about margins so, just wanted to dig into that a little bit more what’s the reason for that is it uncertainty on the margin side, is it the slowdown in order pace in the second half of 2013. So, is there anything you’re willing to say about 2014 beyond that margin commentary?

Steven J. Hilton

We had a slower 2014 or a slower 2013 second half as everybody did, and I think we just want to wait and see what happens over the next couple of months with the kickoff of the spring selling season. We’re cautiously optimistic, traffic is good. We think it’s going to be a good spring selling season, but we don’t want to get too specific probably until the next quarter. And you can look for more detailed guidance from us at that time.

Nishu Sood – Deutsche Bank Securities, Inc.

Got it, and anything in January that you’re seeing that gives you reason for optimism or otherwise?

Steven J. Hilton

We had a tough comp in January, January 2013 was up 55% in orders over January 2012. Our January 2014 sales were I would say flattish what we did in 2013. So, traffic remained strong and we’re hoping that that’s going to result in an increase in sales here in the coming months I think people are just taking a little bit longer to pull the trigger on the home buying decision than they were a year ago there was much more urgency in the market a year ago as prices were rising a lot quicker, prices that are now rising more modestly and that’s slowing down the buying process.

Nishu Sood – Deutsche Bank Securities, Inc.

Okay, thanks a lot.

Steven J. Hilton

Okay.

Operator

Our next question comes from Michael Rehaut from JP Morgan. Please go ahead with your question.

Michael Rehaut – JP Morgan

Thanks, good morning everyone and nice quarter. Just to understand in terms of some of the order trend commentary and I appreciate all the frankness Steve as always. You mentioned I think in your preannouncement and reiterated here that you did see the improvement sequentially I believe month-to-month during 4Q, at the same time on a sales pace basis 4Q versus 3Q I think your average absorption went from negative 5% in 3Q to negative 12% in 4Q so I was curious in terms of just zeroing on the sales pace did sales pace show on a year-over-year basis improvement throughout the quarter, or is that more just on an overall order basis so that perhaps October-November saw the worse of the year-over-year declines and but it does seem like the declines on a comp basis I guess continued into January. So is there any commentary around the intra-quarter sales pace year-over-year trends?

Larry W. Seay

The absolute numbers increased throughout the quarter as we said. And our community count increased throughout the quarter. So I would say our sales spread community declined somewhat through the quarter. Would that be a fair statement Larry?

Larry W. Seay

Yes, we haven't computed it on a month-to-month basis on a rate basis we really only do that on a quarterly basis, because there is a little [no ways] as community sellout and come on during the quarter it's kind of hard to do it on a month-to-month basis. But I would say generally speaking Steve's comments right.

Michael Rehaut – JP Morgan

And then I guess just talking about January obviously it's one month and it's the smallest month of the quarter, but with orders is it flattish, I assume obviously that's the number of orders and, is it fair to extrapolate also that sales pace might be in this kind of down double-digits at least for January and do the comps get at any easier as the quarter progresses?

Steven J. Hilton

No, they don’t, I mean the absolute numbers increases pretty significantly in February and March, but again we got more stores opening and we have great positions. So it’s our internal forecasts are to -- are certainly to improve upon what we’re able to do last year in the first quarter.

Larry W. Seay

Yes, I think sales per community for the first quarter will probably be off from the first quarter of lot last year but you got to remember, we said we raised sells prices extensively over the last 12 months. So, to some extent with that purposely done. On the other hand, obviously we’d like to see increases in sales per community.

Michael J. Rehaut – JPMorgan Securities LLC

Alright, now I appreciate that. And then just lastly the gross margin commentary when you talk about perhaps your kind of more or less at least on a near-to-medium term basis kind of at the higher end of what you would expect to achieve and you would expect more of a return to normal.

It’s a fair that maybe interpret from your marks that current margins, gross margins and backlog are in and around 4Q levels, but perhaps as we get in to the back half of 2014 you might start to see a little bit of that slow move back to what you’d expect to be more normal?

Steven J. Hilton

Larry go ahead and take that one.

Larry W. Seay

Sure. For the full-year we kind of expect our gross margins to be consistent with 13 levels, maybe there will be up a little bit. But we generally expect them to be consistent on a full year basis. We are getting the point that we are seeing because things aren’t going up so rapidly, you are seeing normal seasonality start to develop. So, we will close fewer houses in the first quarter then the back half of the year.

So, you will start to see some of that normal lower margin in the first half of the year versus at the back half because volumes are normal. We are not leveraging construction overhead and some of those fixed cost in cost of sales. So, I would expect to see the first quarter margin be down a little bit from the fourth quarter and then kind of ratchet back up with the average being consistent with full year of 2013.

Michael J. Rehaut – JPMorgan Securities LLC

Larry that would still imply, you finished 2013 at a 22% gross margin and right now you are over 23%. It would seem to suggest unless you are really looking for a sharp drop off sequentially and you didn’t have that last year Q4 to 1Q that it would imply that back of the year you could see margins below the 22% mark.

Steven J. Hilton

Well, it’s hard to tell Michael because we just don’t know how strong the demand is going to be and how hard we will be able to push prices in the sales we are going to make in the late spring selling season in to the summer they are going to close in the back half of the year. So, that’s certainly a possibility, but it’s not a definite.

Michael J. Rehaut – JPMorgan Securities LLC

Okay.

Steven J. Hilton

We are looking through things what you are looking through.

Michael J. Rehaut – JPMorgan Securities LLC

Right. Okay I just want to make sure wasn’t anything in terms of expected change in mix or the fact that you already starting to see weakness in your current backlog.

Steven J. Hilton

No.

Michael J. Rehaut – JPMorgan Securities LLC

All right. One last one, tax rate in at 30% is that sustainable going forward or should it be kind of creep up from here?

Steven J. Hilton

Sure, that has been caused by reversing the remainder of our tax asset reserve relating to a couple of states and that was done mostly in the fourth quarter, so one of that about 30%, when you pull that out, I think on an ongoing basis, you will be more at say at 34% rate. That had about 4% or so impact on last year’s or 2013’s rate.

We still are getting benefits though from manufacturing deduction and energy credits which still lowers the effective rate from the statutory rate.

Michael J. Rehaut – JPMorgan Securities LLC

Great, thanks very much.

Operator

Our next question comes from David Goldberg from UBS. Please go ahead with your question.

David Ira Goldberg – UBS Securities LLC

Thanks, good morning guys.

Steven J. Hilton

Good morning.

David Ira Goldberg – UBS Securities LLC

My first question, Steve was on the cost of land banking and the decision to rely on land bankers for growth versus using your balance sheet and understood from a risk perspective the benefits from using options of land bank, but just trying to understand given your confidence about the recovery and your position in the recovery, how do you weigh that, given that capital markets financing right now is pretty expensive for you guys?

Steven J. Hilton

We can drive – even with the additional expense of land banking, we think we can -- it’s accretive to the bottom line and we can drive earnings per share faster by using these outside sources to hold our land. We did that very successfully during the last cycle and we achieved if not the best or highest growth rate, near the highest growth rate of any public builders and 80% of our land at one time was helped through land bankers and off balance sheet entities and it worked well for us and although I don’t see the capacity to be able do it.

During this cycle, we intend to take full advantage of what land banking sources are available to us and expect it to approach it just as we did last cycle.

David Ira Goldberg – UBS Securities LLC

Clearly we have been that there is been more sources of land banking capital in the last six months, 12 months, are there any markets in specific where you guys are finding that more available for you? I’d think if you can explain with pretty good example.

Steven J. Hilton

No, there is really only a few national players that are doing it in there and they are focused on most of the markets that we are in. So certainly a lot of talk about the capacity increasing, but we haven’t really seen that in a substantive way yet.

David Ira Goldberg – UBS Securities LLC

And then just a follow-up question; Steve I thought your comment about buyers taking a little bit longer to make that decision was really interesting one and certainly would underscore lot of what we have been hearing, I want to talk about how you train your sales people in that environment and how the sales conversation changes with the buyer, what can you do to help buyer confidence to help consumer confidence in decisions as you kind of look forward?

Steven J. Hilton

Well. We do what we have been doing for years. We have focused on great locations, our quality product, our energy efficiency, try to create urgency by showing limited supply in these great A&B markets that we have and we will just aggressively sell our product and our brand and that’s really all we can do.

And in main locations, we don’t have as much competition, it works better there, but in locations where we have a lot of competition it can be more challenging to get buyers off [defense]. But, as I said before, I do believe the decision process will decrease in length as we get deeper into the spring selling season and people get more focused on buying a new home.

Michael Rehaut – JP Morgan

Great. Thank you.

Operator

Our next question comes from Steven Kim from Barclays. Please go ahead with your question.

Stephen S. Kim – Barclays Capital

Thanks very much guys. Yes, so I guess my first question relates to the overall supply demand situation in the marketplace. Certainly, what we’ve seen over the last year and half has been the, frankly, inability of the builders to build and open up community as rapidly as perhaps the buyers would have liked, and that certainly ushered in an era of pretty significant price increases. As we head into 2014, what I thought has been interesting has been the fact that a lot of the builders are sort of targeting opening up some pretty strong community camps in 2014.

You’ve heard one of your other peers talking about being absolutely ready for the spring selling season meaning that they have a fair amount of specs ready to sell in the marketplace. I guess my general question is, do you believe that the industry is sort of entering 2014 with that sort of supply/demand imbalance being a little bit more in an equilibrium-type state? Are we in a situation where the upward pressure on pricing is likely to be more normal and sustainable in 2014 versus what we had seen over the last 12 to 18 months based on what you see in terms of inventory from your peers on the ground?

Larry W. Seay

Well, yes, certainly. I think we’ve been saying that and everybody has been saying that upward pressure on pricing is going to be more modest over the next few quarters because people have built up their inventory. They do have more communities in place. We’ve got more specs on the ground this year than we did last year, so we’re in a position to capitalize more on the spring selling season from a volume perspective than we were a year ago, so certainly the thesis you’ve outlined that builders have adjusted, I think it is true.

Stephen S. Kim – Barclays Capital

Yes. And the reason why I asked it that way is because I think there’s been a little bit of noise last year, I mean certainly over the summer, we saw that big increase in interest rates, for example, that created a little bit of a psychological impediment, and then you also had the government shenanigans and whatnot. So I think that the – trying to focus on the inventory aspect of it, in particular it was where I was going with that question, but thanks for your answer.

And then my follow-up is sort of related to that. We’ve heard from some builders talking about the fact that the sales activity has been stronger than I think what you’ve sort of indicated you’re seeing in your communities, and I was curious as to whether or not you think that -- or if you’re seeing any of your peers being a little bit more aggressive in terms of setting base prices or maybe being a little less aggressive on lot premiums, so not incentives or ramping up incentive per se, but perhaps being a little bit more aggressive in the overall price package to drive volume through their doors, whether you’re seeing any indications of that yet so far this year?

Larry W. Seay

No, I have not seen that. I think people continue to be focused on margins over volume, and I haven’t seen a lot of discounting or tweaking of prices to focus more volume I think we’re committed to holding serve, if you know what I mean.

Stephen S. Kim – Barclays Capital

Yes.

Steven J. Hilton

And even at lower volume levels, at these prices, we can be more profitable than decreasing prices and increasing volume.

Stephen S. Kim – Barclays Capital

Yes, well, that’s very encouraging and good to hear. Last question is over the last few years, you’ve really invested pretty significantly in your infrastructure at the corporate to be able to integrate these acquisitions that you’ve recently done. Can you give us a sense for your sense of the ability of the organization you’ve created to absorb additional operational footprint, to enter new market either through acquisition or through de novo expansion, sort of where you think we are in terms of having stretched your capacity to the limit. Are we maybe – do you still have plenty of headroom left in other words?

Steven J. Hilton

Well, absolutely we are in a very good position to add additional divisions or builders in new markets. We’re prepared for that, and that’s what we are expecting to do. We have much stronger management team, a stronger culture, a more centralized operating platform, we have better analytics, better market intelligence, and we’ve got quite a bit of cash on our balance sheet right now and quite a bit of liquidity, so when the right opportunities become available, we are certainly prepared to take advantage of those.

Stephen S. Kim – Barclays Capital

Great. Thanks a lot guys.

Steven J. Hilton

Thank you.

Operator

Our next question comes from Joel Locker from FBN Securities. Please go ahead with your question.

Joel Locker – FBN Securities

Hi, guys. Good morning.

Steven J. Hilton

Good morning.

Joel Locker – FBN Securities

Just was looking at your gross margins and obviously they are strong for the fourth quarter, but wanted to see what the variance was between, say regions on what they were in California versus say Texas and Arizona?

Steven J. Hilton

Larry?

Larry W. Seay

Sure, obviously Texas – excuse me California has been booming, and our margins in California, and I think traditionally people’s margins in California have been the strongest. On the flip side, I think traditionally margins in Texas have been generally lower than the rest of the country. So I think that that still holds true. I do expect some of the California margins to come down a bit, but on the other hand, we’re seeing Texas margins improve as we bring on new sub divisions there.

So, I don’t want to get into specifics about what the actual percent spread is, but that gives you an idea if you’re trying to model, that volume in Texas produces a little bit lower gross margin than something in California. Arizona’s margins have been very strong too, not quite as strong as California’s. Does it answer your question?

Joel Locker – FBN Securities

Yes, yes, thanks a lot Larry. Of the 18 communities you had in California that were opened at the beginning of the fourth quarter, and you guys -- how many of those did you raise prices . I mean roughly?

Steven J. Hilton

I don’t know if we have that.

Larry W. Seay

Yes, I can’t tell you how many, some of them were opening in the fourth quarter and some of them were continuing, and it’s hard for me to say, which ones of the continuing ones we raised prices and what percentage. Again, it’s been more competitive and it’s been a little harder to push prices, but again California is still very strong.

Joel Locker – FBN Securities

Right, and then just the last question on, do you have a percentage of what your fourth quarter delivery price was as a lot cost expense?

Larry W. Seay

So, you’re saying what cost was as a percent of closing revenue.

Joel Locker – FBN Securities

Right, if you were at [360] (ph) and it was a $90,000, lot cost would be 25% of the purchase price. I just wanted to know if you had a figure for the fourth quarter number?

Larry W. Seay

Yes, hang on for just a second. I can find it for you, if you give me. The direct lot cost is around 20%.

Joel Locker – FBN Securities

Around 20%. All right thanks a lot guys.

Operator

(Operator Instructions). Our next question comes from Ivy Zelman from Zelman & Associates. Please go ahead with your question.

Ivy L. Zelman – Zelman Partners LLC

Good morning. Great quarter guys, good year. There is a lot of focus around the margin, and I think Joel’s last question Larry on the lot prices as a percent of ASP at 20%, can you just talk about 2013 for the full year, how much lot prices were up relative to 2012?

Larry W. Seay

I’m not going to have that statistic and that detail for you Ivy. I do think that our lot prices, our total margins are benefitting from a bit lower land cost because of great buys we have made over the last two or three years, and I think you are going to see that lot cost number rise a bit and that’s why Steve and I are cautious about forward-looking margins because we are going to have some margin erosion from that lot cost creeping up, and I don’t have specific comparisons for you from 2012 to 2013 right off the top of my head.

Steven J. Hilton

Just to add to that, I think you could expect that to go up 150 basis points from 2013 to 2014.

Ivy L. Zelman – Zelman Partners LLC

Lot costs, you’re saying?

Steven J. Hilton

Yes.

Ivy L. Zelman – Zelman Partners LLC

I appreciate you are being cautious on margin, and I think what hopefully you can convey to everyone is that you are not really anticipating getting further pricing or are you including some mid-single-digit type price appreciation to hold margins. What do you need to have in pricing to get to the consistent year-over-year margin performance or are you assuming no pricing?

Steven J. Hilton

I think we are assuming that we are going to get some price appreciation to offset that increase and lot cost to be able to hold our margin as Larry said earlier in 2014 for the full year as against 2013.

Ivy L. Zelman – Zelman Partners LLC

Can you frame a pricing. How much pricing is expected to hold margins Steve?

Steven J. Hilton

Well enough to offset the increasing cost, so probably a couple points, would you say Larry?

Larry W. Seay

I guess I divide that into two points. One is, the pricing needed to cover our current lot cost for all the lots we control. That’s factored in already at the current prices that we’ve underwritten our projects to. So, we’re comfortable that that pieces cover where you can’t cover it is, whether it might be construction cost escalation, and that’s where we essentially assume that sales price increases are going to cover any construction cost escalation, but our flattish, maybe slight increase in gross margins already factoring in the lot costs that we have tied up that’s going to be producing in 2014 and the sales prices relating to those based off current sales prices.

Ivy L. Zelman – Zelman Partners LLC

That’s helpful. And you have had a lot of commentary about your trends and your thoughts on the spring selling season, can you go around sort of your footprint and just talk about the dynamics of the different markets recognizing you’ve got some new markets as well, there has been obviously a lot of cold weather in the Southeast and just Phoenix is one market, where we have heard from builders that it has been a little bit softer. And as you kick off into the spring selling season, what are the bright spots that you anticipate for 2014 and where are the areas that you are more concerned about and if you could take us around that would be helpful.

Steven J. Hilton

Well, West-East California is very, very strong. We’ve had strong demand across the board so far in January, our biggest challenge in California is just to find additional communities and to be able to grow our footprint there.

But demand as it seem to be a real issue in California. In Phoenix, it was kind of mixed bag in January. At some communities, that outperformed and did extraordinarily well and we had others that we were a little disappointed in.

But overall, Phoenix wasn’t too far off of what our expectation was. Colorado, I think everybody took off for Super Bowl. The weather and the football was a big distraction up there, and we didn’t see there the kind of action in Colorado that we wanted to.

But I think that’s going to come back this month. All indications from our people are that everybody is back and focused. Texas, very strong across the board, met our expectations. Orlando, very good month. Tampa, we don’t have a lot of stores open. We kind of gapped out a little bit. We’ve got a lot of things coming up later in the year. Raleigh and Charlotte were probably a little slower than we anticipated.

Ivy L. Zelman – Zelman Partners LLC

Steve that’s very helpful in recognizing obviously there is a long few weeks ahead of us for the quarter. But given the strength and some of the markets as supposed to some of the softness, would you anticipate in the areas where it is softer that you might want to use incentives to move inventories especially where you have a lot of communities that are being opened and you want to capture absorption there, or will you be more firm and wait for demand given the constraints on the resale market.

Steven J. Hilton

I think we are going to be more inclined to wait for it, but we will use incentives on a limited basis as we need to in specific communities, but we are very much intent on holding our margin.

Ivy L. Zelman – Zelman Partners LLC

Okay, I appreciate it. Thank you.

Steven J. Hilton

Thanks.

Operator

Our next question comes from Dan Oppenheim from Credit Suisse. Please go ahead with your question.

Dan M. Oppenheim – Credit Suisse Securities LLC

Thanks very much. Steve I guess along the lines in terms of some of the activity there at the start of this year, you talked about the difficult comp from January of last year and the first quarter, but in some ways California is the real issue both in the first quarter last year and now in the sense that in the first quarter of last year you were at 19.6 homes per community in California, which was 140% above the company average ex-California there.

And so, I guess I’m wondering and so as California has cooled a bit from the way that it was at that time, how much of what you’re thinking about in terms of the absorption in this the start of this year is really -- so just that California more normal absorption versus absorption down sort of across the board there?

Steven J. Hilton

Well, I mean we are kind of looking at California as kind of a catch-up year trying to get our community count and our positions restocked, but we think we are going to make up for that shortfall there in Texas and in the Southeast. We’ve got much better land positions going into 2014 than we had going into 2013 in Texas, and our margins in our communities are much better there than they were a year ago at this time. So, we expect to offset the lack of store growth in California with Texas and with our additional communities in the Southeast region.

Dan M. Oppenheim – Credit Suisse Securities LLC

I guess, I mean more in terms of the absorption, just in terms of that seems to be the greatest issue in terms of the challenge for the first quarter, I am just trying to think regionally if the orders were January flat, how much that is just more normal absorption in California with the rest of the country staying relatively flat absorption year-over-year?

Steven J. Hilton

The absorption, the year ago were outsized, so --.

Dan M. Oppenheim – Credit Suisse Securities LLC

Right.

Steven J. Hilton

The absorptions this year are more normal, and maybe a little below normal, and as we go into the spring season, maybe they are going to gravitate back more towards normal.

Larry W. Seay

You are absolutely right that Texas and the Southeast are improving on their absorptions, and it’s offsetting the slowdown from extremely high absorptions in California and maybe a little bit in Arizona too, and they are gravitating more toward the norm. Obviously, when you are talking about the fourth quarter, seasonal slowing causes them to be lower than the average for the year and as you get in to the spring selling season we should start to exceed the average and outperform the average because we will be in the strong selling season of the year.

Dan M. Oppenheim – Credit Suisse Securities LLC

Thank you.

Operator

Our next question comes from Adam Rudiger from Wells Fargo Securities. Please go ahead with your question.

Adam P. Rudiger– Wells Fargo Securities LLC

Hi, thank you. So, I haven't heard as much from you guys as of late in terms of the energy efficiency products and the differentiation there. I was wondering if you thought that perception in the marketplace may have narrowed a bit relative to peers or you have been marketing that less relative to peers.

Steven J. Hilton

No, I think certainly our peers are catching up. Everybody is getting more aggressive about energy efficiency. It doesn’t mean we are less enthusiastic or less focused on it. I think we are continuing to invest in our learning centers. They are better than anybody else by far. We are doing a lot of training around that. It’s a big part of our sales process. We just announced that the international builder show, a new national contract with SunPower for solar, which is going to be a big part of our push to try to drive more solar sales through our system as an add--on option for our home. So, it is still important, but yes clearly the competition is narrowing the gap.

Adam P. Rudiger– Wells Fargo Securities LLC

Okay. And then regarding the recent capital raises and the potential for additional growth opportunities, you were pretty vocal in the past that you are focusing on the Southeast. Is that still kind of the focus or you have to (inaudible)?

Steven J. Hilton

It’s not the only markets we are looking at. I don’t want to give you a whole list of every market we are looking at, but clearly there are some key market in the Southeast that we are not in that we want to be in, and we are looking at those pretty aggressively, but we are also looking at some markets in the west that we would like to enter and potentially some end market opportunities, so, a lot of things on the table right now.

Adam P. Rudiger– Wells Fargo Securities LLC

Okay. The rest of my questions have been answered. Thanks.

Operator

Our next question comes from Will Randow from Citi. Please go ahead with your question.

Will Randow – Citigroup Global Markets Inc.

Hey good morning and thank you for taking my question.

Steven J. Hilton

Good morning.

Will Randow – Citigroup Global Markets Inc.

I apologize if you went over this, but I don’t know if you can comment on your adjusted gross margin in your backlog as well as your expectation for capitalized interest as a percentage of sales in 2014?

Larry W. Seay

So, we did kind of cover this. I think we were saying that, again we think margins for 2014 are going to be consistent, and even though we have good margins and backlog, the first quarter because you have seasonally slowing deliveries, you have a little bit less leverage to fixed components and cost of sales like construction overhead and land development. So, you should see sequentially first quarter margin to be a little bit down from the fourth quarter, and then they would improve through the year, but still on average would be about comparable to 2013.

Will Randow – Citigroup Global Markets Inc.

And just to clarify you meant that on an unadjusted basis, but what from an adjusted basis?

Larry W. Seay

Adjusted being excluding interest or --?

Will Randow – Citigroup Global Markets Inc.

Excluding interest, yes.

Larry W. Seay

We don’t look at it that way very much. Obviously, we are capitalizing more interest, and interest appears in two places as part of a lot. We don’t break that interest out normally, and we just consider it part of the lot, we do breakout interest that is in construction. So, I can really only talk about that piece of it, but we are capitalizing more interest, but we are also increasing volume. So, the percentage of interest running through cost of sales is actually coming down as a percentage of revenue even though we are capitalizing more just because we are leveraging the interest, so, our specific numbers I can’t give you that over the phone.

Will Randow – Citigroup Global Markets Inc.

Okay thanks. Thanks for that.

Steven J. Hilton

Okay. I want to clarify an earlier point that was made about the question that was asked about the lot cost. Larry said earlier, he was asked about what our lot cost was as a percentage of revenue for the fourth quarter and for the full-year, and he said the answer was about 20%, and I chimed in and said that we expect in 2014 that number to increase about 100 to 150 basis points to about 21% to 21.5%, but we expect it to compensate for that through increased prices that would allow us to maintain our margin from 2013 to 2014. So, I think there might have been some confusion around that, and I just wanted to clarify that.

Will Randow – Citigroup Global Markets Inc.

And just as a follow-up Steve, I always appreciate your views on the land market. Given that it appears a lot of builders are pushing heavily, particularly in the Southeast and obviously Texas, are you seeing land prices there more competitive and do you believe your peers had inflation in their numbers there?

Steven J. Hilton

I can’t speak from my peers what they are doing. I know out West, it sure seemed like a lot of people were including appreciation in their assumptions when they were buying land, particularly earlier last year. I’m not sure what people are doing later in the year, but land is competitive everywhere, and just it is competitive in the Southeast and it’s competitive in the Texas area, certainly it’s probably even more competitive in the West, but that’s not to say we are not to compete for land everywhere else because do.

Will Randow – Citigroup Global Markets Inc.

That’s sort of Southeast you’ve seen no sequential change in terms of competitiveness?

Steven J. Hilton

I mean there’s no retreat going on. I mean everybody is jockeying for market share and competing for land.

Will Randow – Citigroup Global Markets Inc.

Thanks for that. Great quarter guys.

Steven J. Hilton

Thanks.

Larry W. Seay

Thank you.

Operator

Our next question comes from Stephen East from ISI Group. Please go ahead your question.

Stephen East – ISI Group

Thank you. Well I don’t think I have any more gross margin questions that would be useful for you all. So, I’m more concerned at the end of the day anyway with op margin, and you think you can hold your gross margin. You haven’t really talked about what type of leverage. You had tremendous leverage on the SG&A this quarter. What do you think as you look into 2014, what type of operational leverage you can get off that?

Steven J. Hilton

Go ahead Larry.

Larry W. Seay

Okay. So again I think our operating leverage story will be a slight improvement or flat, but we don’t expect to get a lot more operating leverage going forward. It’s possible we will get some. So, I think it’s fairly consistent from 2013 to 2014.

Stephen East – ISI Group

Okay. I appreciate that. And then Steve all as you look at 2014, one, how much do you think you will spend on land and then also just more generally how do you think about -- do you think about either/or land spend in M&A or are they separate buckets for you all?

And then on land banking itself there is always a lot of controversy around that, and people aren’t always quite sure why you do it, but is that an alternative to a joint-venture type of project?

Steven J. Hilton

No land banking joint ventures are really quite different. I mean land joint ventures were used more for large scale land development in the past cycle or builders teaming up to divide up a large piece of land, then we create a joint-venture. So, we’re not seeing that much of that kind of activity going on right now nor are we interested in a lot of that. I think our land spend for this year will probably be a little bit more than it was last year, maybe in the $600 million to $700 million range on a cash basis, and for land banking, maybe as much as $200 million, and I really see that as a separate and distinct bucket from M&A. In the M&A, we do – we might probably be on top of that, and we’ll have to spend a little more to maintain and continue to grow our lot count and to build to produce the kind of growth rates that we’re hoping to achieve.

Stephen East – ISI Group

Okay.

Larry W. Seay

Steven could I comment on. You said that some people are confused about why we do it. To ,us it’s a no brainer of why we do it. Sure, it costs a little bit more, but we’re caring 90% of the land asset off balance sheet on a non-recourse basis that we can walk from any time there’s downside on market conditions, and that certainly leverages our return on asset and our return on equity now. We won’t be able to do as much this cycle as last cycle because of availability, but it’s like a no brainer about why it makes sense and why people continue to question the wisdom of land banking is beyond me. It’s a no brainer.

Steven J. Hilton

You are able to leverage your overhead, you are able to just do more with less money and grow faster.

Stephen East – ISI Group

I agree with that, and I assume as the cycle matures, would you gravitate more and more toward land banking?

Larry W. Seay

To the extent we can.

Steven J. Hilton

Yes, nothing is holding us back from doing land banking now other than the capacity of land banking.

Stephen East – ISI Group

Okay.

Steven J. Hilton

If there was more capacity, we will be doing more land banking.

Stephen East – ISI Group

All right, fair enough

Steven J. Hilton

We are really doing as much as we can relative of the capacity that’s out there right now.

Stephen East – ISI Group

Okay, all right. And then just the last question I had, mortgage issues, are you all seeing anything, any impact from QM or the new FHA limits where most builders have said they haven’t really seen it, but then on a lot of markets like Southern California, et cetera, FHA limit seem to be causing some problems there. What are you all seeing?

Steven J. Hilton

Yes, not really. We haven’t seen any impact yet, but I still think it’s too early to tell. I think ask me that on the next quarter’s call, and I will be able to tell you more, but right now that hasn’t really been an issue.

Stephen East – ISI Group

Okay, thanks a lot guys.

Steven J. Hilton

Thank you.

Operator

Our next question comes from Alex Barron from Housing Research Center. Please go ahead with your questions.

Alex Barron – Housing Research Center LLC

Hey good morning and strong quarter guys.

Steven J. Hilton

Thank you.

Alex Barron – Housing Research Center LLC

I wanted to ask you, I guess last year it was kind of a slam dunk to be raising prices, because as you said the sales pace was outsized. This year, I guess sales pace is in the range of two or three, how do you think it’s possible for builders to continue to raise prices other than just to try to cover costs, how are you guys thinking about that?

Steven J. Hilton

Well, again homebuilding is a localized business. We have some communities that are doing better than two or three, and we have some communities that are doing worse in those where demand is stronger and competition is weaker, and we have a stronger market position where we will take advantage of that raised prices.

In other communities, where it’s more competitive and we have less demand, we’re not going to be able to raise prices, and we have to even offer some incentives, so I can’t paint it with a broad brush, I just got to approach this on a store-by-store basis.

Alex Barron – Housing Research Center LLC

Got it, and in terms of the -- I guess the incentives or around fourth quarter, would you guys say those were, say higher than in previous quarters throughout the year or were they just may be of a different form, but may be roughly the same amount?

Steven J. Hilton

Yes about the same, I mean may be a smidge higher than they were earlier in the year, I mean in the second or third quarter, but not enough to get excited about.

Alex Barron – Housing Research Center LLC

Got it, thanks Steve.

Steven J. Hilton

Yes, thank you.

Operator

And we have a follow-up question from Michael Rehaut from JP Morgan. Please go ahead with your question.

Michael J. Rehaut – JPMorgan Securities LLC

Thanks, I appreciate it. And just following on the clarification, I guess on the gross margins, lot costs, and pricing that you expect to offset that, just I guess to even further understand those comments, when you talked about that you expect pricing to increase prices to compensate for those higher land costs, are those prices that you’ve more or less already achieved that are either in backlog or the prices that as you went through 2013 and achieved a lot of those price increases, it kind of sets you up for again either what’s in backlog or what you’re currently selling at, or you expect to open the communities that you expect to open that that’s the pricing that you expect to offset or is it future price increases that you expect you need to realize in the first half of 2014?

Larry W. Seay

Steve, you want to take that.

Steven J. Hilton

I guess the answer is yes. It’s mostly already kind of baked in, so 40% of our – what was the metric – we already have 40% of our 2013 sales in our backlog, those prices are kind of already set, in some cases higher than they were earlier in 2013.

Michael J. Rehaut – JPMorgan Securities LLC

40% in 2014 you mean Steve, right?

Steven J. Hilton

Right, right.

Michael J. Rehaut – JPMorgan Securities LLC

Okay.

Steven J. Hilton

Yeah 40% in 2014, and certainly a lot of these communities are already opened and doing business with higher prices. They give us the margin equivalent to 2013, so I don’t think it’s a tremendous amount of risk that we cannot achieve those prices that are a bit higher to offset the 100-basis point to 150-basis point increase on land cost.

Michael J. Rehaut – JPMorgan Securities LLC

All right, I mean it’s just obviously it’s a critical distinction to this answer, what you are talking about in terms of your expectations for gross margins isn’t contingent on 2014 home prices going up x percent?

Larry W. Seay

No.

Steven J. Hilton

No.

Michael J. Rehaut – JPMorgan Securities LLC

Right, okay, thank you.

Larry W. Seay

There are a very few far out projects that maybe will come on in several quarters away that may be have a little bit of price appreciation needed, but the great, great, great majority of the projects, particularly the ones that are already selling and we already have those sales prices.

Michael J. Rehaut – JPMorgan Securities LLC

Perfect, thanks.

Steven J. Hilton

Okay, thank you.

Operator

And at this point, I’m showing no additional questions. I would like to turn the conference call back over for any closing comments.

Steven J. Hilton

Well, thank you for your attention to Meritage Homes’ fourth quarter and full-year earnings call, and we look forward to talking to you again in April for our Q1. Thank you very much.

Operator

Ladies and gentlemen that does conclude today’s conference call. We do thank you for attending. You may now disconnect your telephone lines.

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