Meritage Homes' CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.23.14 | About: Meritage Homes (MTH)

Meritage Homes Corp (NYSE:MTH)

Q1 2014 Earnings Conference Call

April 23, 2014 10:30 AM ET

Executives

Brent A. Anderson – Vice President of Investor Relations

Steven J. Hilton – Chairman and Chief Executive Officer

Larry W. Seay – Executive Vice President and CFO

Analysts

Michael J. Rehaut – JPMorgan Securities LLC

Alan Ratner – Zelman & Associates

Dan M. Oppenheim – Credit Suisse Securities LLC

Nishu Sood – Deutsche Bank Securities, Inc.

Stephen F. East – International Strategy & Investment Group LLC

Frida Jonsson – Barclays Capital

Eli C. Hackel – Goldman Sachs & Co.

Adam P. Rudiger – Wells Fargo Securities LLC

Will Randow – Citigroup Global Markets Inc.

Joel T. Locker – FBN Securities, Inc.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

Operator

Good morning and welcome to the Meritage Homes First Quarter 2014 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 note this event is being recorded.

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

Brent A. Anderson

Thank you, Chad. Good morning, and welcome everyone to our analyst conference call today. We issued our first quarter release results before the market opened today. 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 Relations link at the bottom left of our home page.

If you refer to Slide 2 of our presentation, I'll get the normal, customary, cautionary language. Our statements during the 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 those projections or opinions.

Our actual results may also be materially different than our expectations due to various risk factors listed and explained in our press release and most recent filings with the Securities and Exchange Commission, specifically our 2013 Annual Report on Form 10-K.

Today’s presentation also includes certain non-GAAP financial measures as defined by the SEC, so we’ve provided a reconciliation of those non-GAAP measures to the closest GAAP figures within our earnings press release.

With me today to discuss our results are Steve Hilton, Chairman and CEO; and Larry Seay, Executive Vice President and CFO of Meritage Homes. We expect the call to run approximately an hour and the replay will be available on our website approximately one hour or after we conclude the call. And it will remain active for 30 days.

I’ll now turn it over to Steve to review our first quarter results. Steve?

Steven J. Hilton

Thank you, Brent. I’d like to welcome everyone and thank you for your interest in Meritage. We’ll start on Slide 4, we reported our quarter, we reported another quarter of strong revenue and earnings growth the second highest quarterly pre-tax earnings we generated in the last seven and half years. We grew home closing revenues by 23% combining a 16% increase in average prices with a 5% increase in closing volume. Our home closing gross margin improved 330 basis points over last year to 22.8% resulting in a 44% increase in our gross profit on home closings as prices on homes have increased more than our costs of land and construction.

Commissions and other selling costs were down 20 basis points and our G&A expenses were down 60 basis points from last year’s first quarter. Interest expense dropped 80 basis points to only seven tenth of a percentage of total closing revenue. The net effect of these improvements drove our pretax margin to 9.7% for the first quarter of 2014, 480 basis points increase from the 4.9% pretax margin reported last year.

Our first quarter net earnings increased to 111% to $25.4 million or $0.62 per diluted share in 2014 compared to $12 million or $0.32 per diluted share in 2013.

Looking at Slide 5. Closing revenue grew across all three regions and five of the six states where we have operated continuously in both 2013 and 2014. Our East region lie with a 70% growth in home closing revenue over last year’s first quarter both Florida and the Carolinas were up 59% over the last year.

The Central region comprised of our Texas markets followed with a 30% year-over-year increase in home closing revenue. And total home closing revenue increased 4% in our West region, with Arizona up 26%, and Colorado up 24%, while California was 12% lower than the first quarter of 2013, when it led the company with 170% increase in home closing revenue over 2012.

Slide 6. Both our total order value and backlog value grew year-over-year largely due to increases in our average prices compared to 2013. Though our total orders were nearly as high at last year’s first quarter, which was up 35% over 2012, making it a difficult comparison. Total order value grew 7% to $555 million, our second highest quarterly order value since the first quarter of 2007. Texas generated $61 million increase in total order value, 47% higher than in 2013.

For the company as a whole, our 8% increase in average selling price more than offset the 1% decline in order volume for the first quarter of 2013. Orders increased month-to-month during the quarter and percentage increased over 2013 also improved from January through March, even before the addition of orders from our new National Division.

Traffic levels also built during the first quarter. Total orders for – of 1,525 homes in the first quarter of 2014 represented the third highest quarterly orders for Meritage in the last six years. Only the first two quarters of 2013 were higher, which made for difficult comparisons. We grew our community count by 13% year-over-year to 189 at March 31, compared to 168 in March 31 last year. It was a 16% increase in average number of communities opened during the quarter offsetting the decline of order per community.

We sold 8.1 homes per community on average for the first quarter of this year. It was our second best sales placed in the first quarter of the last seven years next to the 9.5 homes sold per community in the first quarter of 2013.

The second quarter of 2013 was even higher at 9.8 orders per community, which will make for a difficult comp for next quarter. Those were the two highest quarters of average sales per community since the peak of last cycle in early 2006. Our ending backlog value is 25% higher at the end of the quarter than it was the year earlier with units in backlog is up 15% on our average price up 8%.

Turning to slide 7, our Texas and southeastern markets grew enough to offset the decline in total order value from our Western markets, showing the benefit of our strategic diversification. Texas generated a 47% increase in order value over 2013’s first quarter and our East region, Southeast region produced 17% year-over-year growth as our new market from the Carolinas and Florida contributed significantly to their totals.

Texas has been growing for the last nine quarters with the increases across all key operating metrics, units, ASPs and total value on orders closings and backlog. For the first quarter of 2014 orders were up 26% due to a 10% increase in community count and a 15% increase in orders per average active community. In addition ASPs rose 16% which resulted in its 47% increase in total order value, total backlog value was up 85% year-over-year at the end of the first quarter for Texas.

The high-pitched pace of sales in our western region has slowed in recent quarters after experiencing robust demand and significant increases in home prices over the last two years demand in California and Colorado also remained strong – I am sorry demand in California and Colorado has remained stronger than in Arizona.

Our orders in California were up 25 – I am sorry our orders in California were 25% lower than the intense first quarter of 2013 when we sold an average of 19.6 homes per community for the quarter. Our highest sales pace since the third quarter of 2005.

Our sales pace in California during the first quarter this year was still the highest in the company at an average of 12.2 orders per community. Our average community count there increased 22% over last year’s first quarter, as a result of the securing good land positions in this key market over the last couple of years and our ASP was up 19% year-over-year offsetting most of the decline orders, so our total order value was down just 10%.

New home sales in Arizona have softened in the recent quarters and home prices there have moderated. The reduced FHA loan limits and restricted underwriting standards are likely behind some of the dampening in the demand overall in addition to fewer investors in the market. The supply of homes in the piece market has come up to about three and half months, from approximately two months supply a year-ago. So that’s still low relative to what is concerned to normal supply of approximately six months sales. We remain confident in the long-term growth for the opportunities in Arizona.

Our sales pace in Arizona was slower in the first quarter, order volume declined 28% compared to the first quarter of 2013 and 8% increase in our average sales price offset some of that decline, we adjusted prices in several communities and increased incentives and several more in February, which took net pricing back to approximately the same levels as in the second quarter of 2013 in some communities.

Since our costs have remained relatively flat during that time we expect our margins in Arizona to come down somewhat over the next couple of quarters although they remain quite healthy at or above historical averages.

First quarter 2014 orders were down 12% in Colorado compared to 2013 with an average of 9.2 orders per community above the company average and 17% increase in average active comminutes during the quarter. Total order value was only 4% lower than 2013 since our average sales price in Colorado was up 10%. We believe that the severe weather and the Super Bowl affected Denver during the early part of the first quarter.

We increased total orders in our Eastern region, our Southeastern region, but we call it the Eastern region by 22% with a 42% increase in average active communities partially offset by a 15% decline in average orders per community. That was most evident in the Carolinas where we nearly doubled our community count though our average sales price per – sales per community was down 40% for the quarter some of that which may have been weather related resulting in a net 17% increase in total orders.

Total order value was up 27% after an 8% increase in our Carolinas ASP. Florida was relatively flat compared to the first quarter of 2013 with a small single-digit percentage increases or decreases in sales pace, average community count, and average prices resulted in 3% fewer orders and 6% less total order values in the same quarter of last year. We focused on growing our new Nashville operations and have been successful with that over the last couple of quarters since completing our acquisition in Nashville even though it still represents a small percentage of our totals.

With that I’ll turn it over to Larry to review a few other highlights for the first quarter. Larry?

Larry W. Seay

Thanks, Steve. Our backlog conversion rate was 60% in the first quarter of 2014, compared to 71% last year and approximately one third of our closings were from specs. Our homes that had previously been started before going under contract. It’s been trending down as we have been focusing our resources on new builds under contract, but we have been actively increasing the number of specs starts recently, especially since our relatively low inventories of homes available for sales in most of our markets.

We increased our specs by approximately 33% over the last year to a total of 802 as of the end of the quarter compared to $604 a year ago in March. That translates to an average of 4.2 specs per community for the first quarter of 2014, up from 3.6 in 2013.

Moving to Slide 8, we invested approximately $163 million in land and development during the first quarter of 2014 primarily to replace the lots brought into production during the quarter and open new communities. We increased our lot supply modestly during the first quarter, contracting for approximately 1,520 new lots to bring our total to 25,800 lots under control as of March 31, 2014 and increase of almost 1,400 lots since March 31, 2013, and about 100 lots more than what we ended in 2013. That represents a 4.9 year supply of lots at the end of the first quarter of 2014 compared to about 4.6 year supply a year ago, based on trailing 12 months closings. Approximately 73% of the new lots put under contract in the first quarter were purchased in 27% option.

Most of our net additions were in Texas, Florida and California specifically Dallas-Ft. Worth, Austin, Southern California and Tampa. We didn’t add any lots in Arizona or Colorado, but we already have eight pipelines of lots. In addition to the lots counted in those total lot supply figures, we had almost 2,700 homes completed or under construction, which include presold homes, model homes and spec homes started, but not yet sold at the end of the quarter.

Moving to Slide 9, we ended the first quarter of 2014 with $338.7 million in cash, cash equivalents, investments and securities with no restricted cash up from $363.8 million at December 31, 2013 we eliminated the restrictions on cash when we expanded our credit facility. In January 2014, we issued approximately 2.53 million shares of common stock for net proceeds of approximately 110 million which we intend to use for working capital and to fund growth including potential expansion into new markets and/or expansion of our existing markets that may include acquisition of other homebuilders. Our net debt-to-capital ratio at the end of the quarter was 36.6% compared to 39.1% at December 31, 2013 and 37.6% at March 31, 2013.

Our total real estate inventory increased to $1.54 billion at March 31, 2014 compared to $1.41 billion at December 31 and $1.15 billion at March 31, 2013 approximately half of that increase was due to homes under construction including specs and about half was due to our additional investment in land 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 first quarter of 2014. We grew our closings and revenue expanded our home closing gross margin and gross profit increased our community count both within our existing markets and expansion markets and reinvested new communities to replace the lots in which we started homes during the quarter. We also maintain a strong balance sheet credit metrics which was recognized by Moody’s rating agency who upgraded our corporate debt rating during the quarter. Going forward we commit to deploy cash to investments for additional growth, while keeping our debt ratios within a prudent range given an improving economy we believe the homebuilding market will continue to grow and Meritage will continue to grow both revenues and earnings we remain committed to our forecasts of approximately a 210 to 220 active communities by year end 2014.

Based on the trends and sales phase and prices that we experienced in the first quarter we’re projecting that our gross margin will be relatively flat for the year as a whole trending down over the remaining quarters due to less pricing power and higher land costs than last year. However, our increased revenue and overhead leverage should offset that such. We expect our pretax margin to remain relatively flat throughout 2014 and inline with last year’s full year pretax margin and the earnings will grow throughout the year even considering a higher tax rate for this year, with that in mind we believe we continue to achieve earnings growth for several years with revenue growth driven mainly by additional communities and earnings growth through increased revenue and operating leverage.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Michael Rehaut with JP Morgan. Please go ahead.

Michael J. Rehaut – JPMorgan Securities LLC

All right thanks. Good morning everyone. My first question I had was on the trends that you saw in Arizona. You mentioned home prices have moderated and I guess have come back to 2Q 2013 levels I was wondering if you could give us a degree of magnitude there and also you mentioned that pricing maybe coming in line versus 2Q 2013 and the fact that margins, I’m sorry costs have been flattish during that time. Why you would expect margins to come in is it more due to the land cost creeping up or is it just some thoughts around that?

Steven J. Hilton

Well, in the Phoenix and Arizona in general we probably increased incentives in the neighborhood of $10,000 to $15,000 on average. And may impact our margins here by about 3%. When we talk about flattish margins we're really not talking exclusively about the Arizona markets. We're talking about the impact of all of our markets. Arizona some of our land positions are a little older here so we're probably achieving significantly above the average margins here. Other areas around the country our land positions are newer and have higher basis and we may have more pricing pressure or cost pressure and some of those markets. Certainly that we do in Arizona where the market is cooling-off. So that’s what lead us to believe that the margins going forward are going to be relatively flattish because of the impact of what has happened in Arizona and marginal pricing power that we have in a lot of other markets with higher land cost.

Michael J. Rehaut – JPMorgan Securities LLC

All right, I appreciate that clarification. I guess just on that looking at some of your diversification benefits with Texas doing particularly well right now. And perhaps there is some offset there, it would appear that with margins maybe coming in a little bit over the next two or three quarters. There is still it appears that you are still expecting margins solidly above 20% that can stabilize maybe in the 21%, 22% range. Just wondering that’s fair and how you’re current underwriting if that is also kind of targeting that type of minimum 20% type of a number?

Steven J. Hilton

That’s reasonable assumption and that is our underwriting, any new land acquisitions must be inline with that. Larry do you have anything, do you want to add to that.

Larry W. Seay

No, I would agree that, the 21% to 22% gross margin range is kind of what we are shooting for now and depending upon how various markets do we could - little a higher or little lower. And it’s good to see that markets like Texas are coming back we’re really seeing a little bit of return to the old regional market structure homebuilding where you have some markets that in some period of time were a little bit stronger and some markets are little weaker and you’re starting to see that kind of dynamic comeback into the homebuilding markets to that.

Michael J. Rehaut – JPMorgan Securities LLC

Great and just one quick one, last one. The tax rate of 36% is that a number that we should use going forward on an ongoing basis as we think about the full-year 2014 and 2015?

Larry W. Seay

Yes. Let me give you a little color on that. Essentially our federal tax rates 35%, but when you throw the states in there, that’s about another 4%. But you back out the manufacturing detection, which is running around 3% it gets you back to that 36% number. Last year we were low because we had two things going on we had about 5% our sale benefit from reversing other rest of our stake valuation allowance and then we also had about 2% in energy credits this year congress hasn’t past the extension of the energy credits. So we can’t count back yet. We are hopeful that sometime during the year they pass that and we’re able to get another – about 2% benefit from those energy credits, but today we can’t take that. So that’s why the – the rates at 36%, and not like a 34% number which would be more around with tax credits.

Michael J. Rehaut – JPMorgan Securities LLC

Okay. Thank you.

Larry W. Seay

Well, 36% of the time…

Michael J. Rehaut – JPMorgan Securities LLC

Great, thanks. Thanks, Larry.

Larry W. Seay

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Ivy Zelman with Zelman & Associates.

Alan Ratner – Zelman & Associates

Hey, guys good morning. It’s actually Alan on for Ivy. Larry just in terms of the gross margin if I look back at kind of what you had said last quarter, you had a similar guidance for flattish margins with the full year, but in January you’re kind of implying that there would be a sharper drop-off in the first half of the year. Which is typical from seasonality and lower closings and then margins would build through the year with very little sequential pressure in the first quarter it would seem like the margin might have come in a little bit stronger than you were expecting back in January. And on the flip side to that to get to a flat number for the full-year it kind of implies about 200 basis points of deceleration through this year which seems like a pretty large number and especially if that the incentive and pricing power is kind of most apparent in Phoenix which is really about 10% of your backlog. So I guess the question I have is when you look at the margins of your homes in backlog is that 200 basis point decline is that already what you see in your backlog or are you kind of prospectively thinking about orders over the next few months which might come in weaker margins than what you are in backlog today?

Larry W. Seay

Yes, I guess I would say for the first quarter it did come in a bit stronger than I had anticipated, but obviously it was sequentially down from December, but yes, I think we’re looking at the backlog and we’re looking at kind of order expectations are for the rest of the year. So it’s a little above, it’s not just the backlog that we’re also looking at what’s subdivisions coming online and what the ability we have to raise prices and new projects with new higher land bases and factoring all of that into the decline. And I guess I want to emphasize, we think we are coming back to average margins that are kind of in that normal 21%, 22% range, but we are getting the improvement of better over head leverage and that’s really offsetting which is why we think that the pretax margin is going to be relatively flat throughout the year and zero in and around that 10% range consistent with last years.

Steven J. Hilton

Right, I think Larry it would be fair to say right now looking at our backlog that we most certainly believe that’s in the next quarter we are going to see some gross margin decline.

Alan Ratner – Zelman & Associates

Is it going to be in that 200 basis point range or not…

Steven J. Hilton

I don’t know if it’s going to be that much, most likely it’s not going to be that much, but it’s going to be – it’s going to start to tilt the other way next quarter.

Alan Ratner – Zelman & Associates

Okay.

Steven J. Hilton

And I think that is also fair to say now that the street estimates for earnings for next quarter we think are that aggressive because this is what we kind of think gross margins are going to start to tilt the other way probably due to the fact that the incentives that were now we’ve been offering in Phoenix now for more than a quarter or little more than a quarter are starting to kick in and having some more specs and our – for all the reasons we already articulated, we just don’t have the pricing power in that quarter in the backlog. So we think the gross margins will start to come down a little bit certainly in the next quarter.

Alan Ratner – Zelman & Associates

Gotcha and I appreciate that and follow up is Steve I think you made a comment that the year-over-year order numbers improved through the quarter was curious if you might be able to quantify that and given nearly read on April so far?

Steven J. Hilton

Well so, I’ll give you some specific numbers we sold 409 houses in January, we sold 489 houses in February, so that’s about a 20% increase month-to-month and we sold 627 houses in March so almost another probably another 20% plus, first few weeks April pretty much online viewer expectations are looking good against last year although we have the Easter holiday this last week and also little slower weekend but we’re expecting a big weekend this weekend and having to the finish of the month. So, cautiously optimistic about what we’re seeing in the second quarter.

Alan Ratner – Zelman & Associates

Thanks a lot.

Steven J. Hilton

Okay.

Operator

Our next question comes from Dan Oppenheim with Credit Suisse.

Dan M. Oppenheim – Credit Suisse Securities LLC

Thanks very much. I’m wondering if you can I think given all the comments in terms of margins and such since of coming down and of course I think likely people also wondering how much something centers in the land cost but maybe you can talk to little bit just based on regional mix and then if you look at last year margins from the West were 23.5% versus Central of 19.6% and so given the order trend through lot is probably as regional mix coming through can you just help to put some color on the margins based on how much of that is the regional shift versus pricing power versus land.

Steven J. Hilton

And I’m not sure really want to get that granular about giving a margins by region I mean Larry, what your.

Larry W. Seay

Yeah, it obviously shows up in our segment reporting but its being driven by margin erosion in the West from the issues we talked about being offset to some extend by improvement in Texas and the Southeast although less so in the Southeast more sell in Texas so that’s the story I am not – we are not going to we haven’t disclosed at this point the specific numbers and I can’t give them over the phone here but that’s what going on.

Dan M. Oppenheim – Credit Suisse Securities LLC

Great, okay. And then you touch in terms of the land purchases in such and doing more in terms of Texas and other markets could not buying and Arizona how if you look at the lands this integrate now and hopefully talk about Arizona having suggestions but how do you look at the overall land portfolio right now in the different markets and where you would like to invest in the next couple of years?

Steven J. Hilton

Well, I feel very good about our land portfolio in general. I think we’ve got a strong land position in Arizona, Colorado and Texas. In Florida we bought quite bit a land in Tampa in the last couple of quarters to build our business there but certainly our main focus is on the Southeast and on California. And those are the two places that we’re working hardest to buy land today but we don’t feel under any in order demand of pressure to buy a land because we think we have a reasonable land book and we think we can be choosy and look for the best locations to make the best sense for the company.

Dan M. Oppenheim – Credit Suisse Securities LLC

Grate, thank you.

Operator

Next question is from Nishu Sood with Deutsche Bank.

Nishu Sood – Deutsche Bank Securities, Inc.

Thanks. First question I wanted to follow-up on Dan’s question about land supply. If you look at the broader land lot supply numbers they have flattened out over the past few quarters on a year supply basis they’ve flattened out as well. So, my question was is that does that reflect some slow down in aggression on land purchases and development activity because of the softness in housing demand or does that you are in that four to six year target range that you talk about sometimes and is just a reflection of a getting to that range?

Steven J. Hilton

It’s probably a little of both. I mean we couldn’t buy land in Arizona because we didn’t seen land at the matter underwriting criteria, that may change over the next couple of quarters but on the other hand as I said earlier we are real comfortable with our the number of lots and the number of communities that we have here we feel we had to buy any lots. So unlike other builders in the market here that are be in a more aggressive than we chose to be and then we’re also looking all new markets, there are several new markets we are interested in, we are holding back some capital to be able to deploy in those markets when we find the right opportunities at the right time. And that will have an impact on our land position certainly. So I think there is a whole variety of factors that influence our strategic allocation of capital in our land spend.

Nishu Sood – Deutsche Bank Securities, Inc.

Got it, thanks. And other question I wanted to ask was about ASPs clearly you had a very strong tailwind from both mix shift to move our product and the strong pricing trends you have seen in the past few years, so the ASP increase and you pointed out for this quarter as well has helped to offset any weakness in volume numbers, now if you look ahead the pricing trend has closed what as we’ve been talking about. And hopefully we get some return of the first time buyer to the market continued health and driving housing recovery. So that strong tailwind might even turn into a bit of a headwind does that imply a shift then and how you began to think about volumes may be little bit more of a volume focus and to maintain the trend in the overall order value?

Steven J. Hilton

No I think we like to try bring our ASPs down across the country beginning relatively high, I don’t see anything on the horizon that gives me a lot of excitement that the first time buyers coming back but may be there is a niche there for that, we call the first time buyer plus in between move up and first time buyer a little higher price point but clearly we’re more focused on smaller plans now that come on to the FHA caps and that we can be more successful with in a raising price in a raising interest rate market. So we’re clearly trying to focus over long-term that’s not going happen over the next few quarters certainly to try to manage our ASP to either constant or lower level.

Nishu Sood – Deutsche Bank Securities, Inc.

Okay, great thanks.

Operator

The next question is from Stephen East with ISI Group.

Stephen F. East – International Strategy & Investment Group LLC

Thank you. Good morning guys.

Steven J. Hilton

Good morning.

Stephen F. East – International Strategy & Investment Group LLC

Steve if could dig in a little, following what Nishu was asking and maybe burrow down a little bit, you talked some about what you all were seeing in Phoenix, if you could talk a bit more what you think you are seeing in Phoenix, California and then Texas which is going the opposite direction and really how does your strategy differ in each of those markets price versus pays I think you mentioned buying land aggressively in California is that more along the coast or sort of the strategy to fit what is going on with each markets.

Steven J. Hilton

Well, I wouldn’t put California and Phoenix in the same boat or in the same bucket.

Stephen F. East – International Strategy & Investment Group LLC

Okay.

Stephen F. East – International Strategy & Investment Group LLC

Clearly, even Southern California in my opinion is stronger than Phoenix right now, we are having decent absorptions even in the Inland Empire ins some of our – in most of our communities, Northern California is certainly stronger than Southern California maybe excluding coastal positions.

Again, we are not a very good brome of that because we only have one community in the Orange County, the rest of our communities are in the Inland Empire, but I’m still really bullish on California, we want to find more communities in both the East Bay, Orange County and the Inland Empire.

We are focused a little bit more on infill; we bought one of our first really how these high density infill pieces in a place called MontClair right on the committal rail line last month. So we are focused on other position in that area, so to the extent that we can find land positions in California to meet our underwriting standards, we have a big green light out there.

And as far as Arizona and Phoenix, I don’t want to paint the picture of the markets bad, because its not, we are still selling homes here, we sold 6 homes in Phoenix last month, we would have liked to sell 85 or 90 homes, but we are still making good margins on those 65 houses and sales in Phoenix built throughout the quarter and I expect them to continue to build this month through the second quarter.

We just have to deploy a little bit more of incentive strategy here and its become a little more competitive, I think the FHA limits did knock some people out of the market, particularly those called boomerang buyers who had a foreclosure, now that are going to have to wait a little bit longer under the conventional rules to buy a home lets say its in the $350,000 to $400,000 price range because the new tax are lower and they cant make up the difference and down payment on FHA.

And then I also believe that homebuyers in Phoenix now have a little more selection, because more home have come on the market, there is less investors out there pursuing them and now they have more of a choice between new and used home where before they were kind of blocked out of the resale market and we’re pushed into our market.

The price spread between new and used is more important today than it was probably previously and we are going to be more mindful of that and our strategic operations team is looking that more carefully, particularly in new deals going forward, because I think the spread between new and used got a little too wide, but other than that I’m bullish on Phoenix over the long-term. I think this is the phenomenon that we’re dealing with here is going to be a temporary might last a few quarters or year, but I believe that going into 2015 we’re going to experience some more normal market in Arizona after things get more imbalanced.

Stephen F. East – International Strategy & Investment Group LLC

Okay. And then is Texas that’s been so strong do you push price more or what’s the strategy there?

Steven J. Hilton

Certainly we always try to push price, but Texas is much more competitive market and a lot of places that we do business there is more land, there is less barriers to entry. So you never been get the huge margins in Texas that you see in the Western markets or in the eastern market, northeastern market. So I think so that really we can get products we will but products are more focused on volume and price.

Stephen F. East – International Strategy & Investment Group LLC

Okay, all right and then it just the other question I had you are mentioned you were building more specs just I would like to understand where that is in your thought process there and then Larry for you – you mentioned gross margins will be flat I assumed you would get some leverage from your SG&A this year versus last year and maybe drive your up margin higher, but if hear you right you’re saying your up margin will also be flat just some clarity on that.

Larry W. Seay

Yes, our current expectations are that the gross margin will be flat compared to last year but that trend will be down a bit throughout the year or as the SG&A leverage will improved offsetting that gross margins declined so you wind up at a pretax margin being relatively flat throughout the year consistent with the last year that’s our current thinking.

Stephen F. East – International Strategy & Investment Group LLC

I got you okay in the specs.

Steven J. Hilton

We’ve increased our specs maybe 20%, 25% late last year going to the first quarter we thought we have need to have more specs on the ground for this spring selling season and we’re going to, we’re still evaluate in that we may drive that number down a little bit as we going to the later part of this year, but kind of had a conscious strategy particularly in certain markets that we need to have more homes available for those customers who didn’t want to wait for new build moving the market right now to moving quicker.

Stephen F. East – International Strategy & Investment Group LLC

Okay, thank you.

Steven J. Hilton

Thank you.

Operator

The next question is come Stephen Kim with Barclays.

Frida Jonsson – Barclays Capital

Hi, guys this is Frida on for Steve thanks for taking my question. And so the first question I had was on absorption rates I mean this quarter you had about 13% unicomm growth, flattish net orders. And I think ranges that decline is probably within the band of expectations of what people are looking for in terms of absorption this quarter across builders. And as we look to the back half of the year you’re looking for 20% to 28% high I think unicomm growth and order comps are going to get a lot easier in the back half. So my question is how are you thinking about what those adsorption rates could look like as we go throughout the year.

Steven J. Hilton

Well, I know that we are projecting any specific absorption rates, throughout the year I hope maybe in the second quarter a little bit higher than they were in the first and then will be going into the seasonal kind of slowing into the summer time and then we expect to surge in new communities to come on late in the third quarter into the fourth quarter of the year. So which is going to drive our growth for 2015, but it will be hard for me to tell you precisely right now what we think our absorptions are going to be over the next few quarters.

Frida Jonsson – Barclays Capital

Okay, thanks. And just a follow-up on Steve’s question on specs, could you provide a little bit more color on what – how that decision process goes into which community has more specs versus another. Is there a difference between the product lines that you have whether it’s the active adult versus the move-up. Is there any sort of a color on that would be helpful?

Steven J. Hilton

We execute that strategy from the ground up, we go into every community, we look at the sales pace of the community, we look what we survey the buyers, we have a robust consumer research function, we find out what the buyers are telling us, they are coming to the sales office what they are looking for and that goes into our equation, look at the competition, what are they doing as far as specs with their absorption rates. Certainly the price range has a lot to deal with it, we’re certainly building more specs at the lower end and we are at the higher end where people want to make more changes and some more minor design centers. So it’s a complex and ground up kind of strategy that we have and we just don’t wait for everyone – couple 100 more specs, so we take the process very seriously.

Frida Jonsson – Barclays Capital

Okay. Thanks for taking my question.

Steven J. Hilton

Thank you.

Operator

Next question is from Eli Hackel with Goldman Sachs.

Eli C. Hackel – Goldman Sachs & Co.

Thank you. Two questions, one just going back to incentives, obviously there has been a lot talk on the Phoenix there. What reactions have you seen from those incentives and do you think and if they are spending to any other market? And second just on the Florida is there any additional color in terms of the ASP being down year-over-year in that market, is that mix related or are there some incentives going on in that market as well? Thank you.

Steven J. Hilton

Florida, I think it’s pretty much mix related. Larry, let me know if you disagree, but…

Larry W. Seay

I agree.

Steven J. Hilton

We are not really doing anything significant for the centers there. In Phoenix are the incentives helping, are they increasing absorption, maybe probably not I think we just have to do one because the market demands and that’s what the competition is doing and if you want to continue to sell homes here, we are going to have to have those additional incentives in the market that we’re in right now. But I wouldn’t say the price is realistic were the more incentive that the more homes you are going to sell. I just think its part of what needs to be done right now to be relevant in the market.

Eli C. Hackel – Goldman Sachs & Co.

Is it spreading to other markets or is it pretty confine to Phoenix market?

Steven J. Hilton

No, I’d say Phoenix and Tucson and maybe a little active adult, I’d say Arizona I don’t – no matter where if any other markets that we’re operating in that we’re using any different incentives then what we’re quarter or two ago, if we are they are very, very small, they are not really we’re talking about. So I think substantive incentives that we’ve changed are certainly here in Arizona.

Eli C. Hackel – Goldman Sachs & Co.

Great. Thank you very much.

Steven J. Hilton

Thank you.

Operator

Our next question is from Adam Rudiger with Wells Fargo.

Adam P. Rudiger – Wells Fargo Securities LLC

Hi, good morning. Thanks for taking the question. Two questions both of which are little bit longer term in nature and the first is Steve based upon your commentary earlier in the call about lack of optimism towards the first time buyers. I was just curious when you do your long-term plan and you think about the next couple of years out. What you think that means for the overall market and I guess the back ended way of asking when you think kind of the overall national housing market will reach that mythical normalized range that everyone is looking for?

Steven J. Hilton

I’m just not the guy to be asking about that because we are not a real big entry level builder and I’m not close source buyers is some of my peers would be. But handful of entry level communities we have there are more and peripheral locations still get a lot of turned downs. We’re still get a lot of challenge credit buyers either have lot of student loan debt or they have a lot of other consumer debt, they want to buy a home and they can come up with the down payment, but I just can’t qualify. So the credit eases a little bit as you know certainly that’s going to help that, that segment of the market a lot. But haven’t seen a lot of progress there yet in some of the markets we’re in there is places where they, where entry level activities improving but on a whole and I know it will be dooms day or about it either, but on a whole we’re not the best judge of that and the limited business that we have in that segment we’re not seeing a dramatic improvement.

Adam P. Rudiger – Wells Fargo Securities LLC

Okay, second question is in the press release you’ve talked about future earnings growth will be driven by community count growth and operating leverage I was curious on the operating leverage what potential opportunity there in terms of how significant that leverage can be couple of years out.

Steven J. Hilton

Larry, do you want to take that.

Larry W. Seay

Yes. I think most of that should be read in that we’re growing community count growth and growing top line by selling more houses. That there could be some modest continued leverage over that with we’re projecting for this year. But I don’t see as being a huge number for last year we were total SG&A was about 12.2% we may see that the 400, excuse me 40 to 50 basis point better this year and maybe another 20 or 30 next year. So you’re talking in that kind of range not, not 100’s of basis points better.

Adam P. Rudiger – Wells Fargo Securities LLC

Got it. Thank you.

Larry W. Seay

Thank you.

Operator

Next question is with from Will Randow with Citi.

Will Randow – Citigroup Global Markets Inc.

Hey, good morning and thank you for taking my question.

Larry W. Seay

Thank you.

Steven J. Hilton

Thank you.

Will Randow – Citigroup Global Markets Inc.

Steve there are two interesting phrases I picked on – curious and you said you didn’t for potential homebuyers you didn’t want to wait for new builds and the price spread of new versus used. How much do you think pick up in existing home sales inventory might be influencing buyers call it delayed traffic to order conversion?

Steven J. Hilton

Pick up in listing of the resale inventory or new home inventory.

Will Randow – Citigroup Global Markets Inc.

Resale, yes.

Steven J. Hilton

Well as I said, I think particularly in Phoenix I won’t transmit this to other markets buyers have more choice now because there is more homes available for them to look at and those that normally would have bought a resale home, so they can move into relatively quickly are now to some degree shine away from the new home market where year-ago got up to spare. So I think that is a factor, its not the only fact if it is one factor way the Phoenix market is off 25% to 35%.

Will Randow – Citigroup Global Markets Inc.

Thanks for that. And then just thinking about the mix over the next 12 to 24 months you mentioned building out specs on a low end but also like in your DFW market it was interesting how you are playing kind of all the 300’s and up price range for homes versus 200’s year or too back so how do you think about mix kind of for the next 12 to 24 months.

Steven J. Hilton

Well, I think we’re still going to planing that 300 to 400 space but we’re trying, we’re going to try to play close to the 3’s into 4 lot of cases and we’re going to try to reemphasize our smaller plans than some of the big 4,000 to 5,000 square foot homes we’re selling at a relatively low price per square foot because all the options in those houses and so forth it just don’t qualify for FHA and as interest rates raise some in the it will rise at some point probably not in the foreseeable feature but overtime they were raising only to have a stronger part of our line up at the lower price points we’re very cognizant to that. But I don’t think it something that’s going to materialize in the short-term I think its more of a long-term growth.

Will Randow – Citigroup Global Markets Inc.

Great, thank you very much for the comments in the time.

Larry W. Seay

Thank you.

Operator

Next question is from Joel Locker with FBN Securities.

Joel T. Locker – FBN Securities, Inc.

Thanks guys respectable quarter considering the business environment we’re now and just on your G&A did you help me one time benefit to lower that it was came in 3 million or 4 million over than expected?

Steven J. Hilton

Yes, nothing real significant there is always a few trips that occur but nothing material it was just I think, you just done a little bit better job controlling overhead costs.

Joel T. Locker – FBN Securities, Inc.

So you think that run rate on a $21 million, $22 million range is sustainable you think that will creep up back in the mid 20’s.

Steven J. Hilton

Hard to say part of that I guess part of that is you have the variable lump in there I think are you just looking this I just, you just looking at G&A I think it will creep back up. It may go back up a few million bucks over the year.

Joel T. Locker – FBN Securities, Inc.

Great, thanks and then on the backlog conversion rate I guess that was lower and what people expect at 59.8 versus you been in the 50 range for a while do you think you can get that back in the low 60’s or do you think it will just be kind of high 50’s going forward out in the fourth quarter?

Steven J. Hilton

We hope to keep it above 60 I can tell you that, let’s get it back up at least a few point so we did have a little bit of impact this quarter due to weather on some closing and we miss some closings we expected to get our conversion rate would have been higher. So I’m hope that we can push it back up.

Joel T. Locker – FBN Securities, Inc.

And the last question on Cali order, California order ASP was at 9% sequentially was that just opening higher price point communities during the quarter for the most part?

Steven J. Hilton

Sorry, say it again.

Joel T. Locker – FBN Securities, Inc.

The California ASP for order I think you went up 9% to make 506,000 or somewhere around there was that just mixed issue where you increase the higher price point communities out there.

Steven J. Hilton

Yes, I mean we did have some price increases out there but most of it was, will see the mix.

Joel T. Locker – FBN Securities, Inc.

All right, thanks a lot guys.

Larry W. Seay

Thank you.

Joel T. Locker – FBN Securities, Inc.

Okay.

Operator

Pardon me gentlemen we’re running two about an hours time would you like to take a couple more questions

Steven J. Hilton

Yes, we’ll take a one or two more.

Operator

Sure. Our next question is from Jade Rahmani with KBW.

Unidentified Analyst

Hi, this is actually Ryan (indiscernible) for Jade. Going back to land purchases, where we seen prices trend year-to-date and could you comment on where you see gross margins shaking out for those new land deals?

Steven J. Hilton

Well, land trends are very local and it’s different in every market I certainly in some market land prices I think a peak at least for now and other market they are still going up but as you know land prices are significantly higher this year than they were a year, even two years ago for sure. And as far as gross margin we won’t buy any land that doesn’t meet our underwriting criteria of delivering at least to 20% plus gross margin. So certainly some of the early land we got helped us to look at higher gross margins but going forward, that’s what we expect to be.

Unidentified Analyst

Okay, great. And then just on bit of housekeeping item for interest expense despite a little bit from last quarter, was there anything specific that drove that increase and would have be safe to assume the 1Q number as a run rate for the rest of the year?

Larry W. Seay

Nothing in particular, obviously we did a bond issue quarter two ago but I think you will see that run rate come down a little bit as we continue to add assets under production, I don’t necessarily see it going to zero this year what we’re capitalizing all our interest. But I do see it trending down from last year we were in about I think $15 million or so expense last year. And I think it will be a few million dollars lower than that this year, but I don’t think it will go to zero.

Unidentified Analyst

Okay, great thanks.

Larry W. Seay

Okay.

Operator

Thank you. Our next question is from Jay McCanless with Sterne, Agee.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

Good morning everyone. First question just wanted to ask about pricing power in the Central and East segment during the quarter and how you are feeling about that for the rest of the year?

Steven J. Hilton

I think I made some comments about Texas, I think we do have some pricing power there and we are raising prices in many of our communities although its not kind of price increases you have seen in the West, they are much more modest because the Texas markets are much more competitive. But we do have some opportunities may be down in Houston and in Austin for sure. And in the southeast a little bit of pricing power in some communities in Orlando and a few spots in Charlotte and Raleigh but nothing to get super excited about. So I think prices there will be more reflective of our mix and they will of price increases. And but on the other hand we are not experiencing any significant change in incentives in those market so we are pretty comfortable where our gross margins are there going forward.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

Okay, second question just want to talk about the mix for second because I believe last year you were looking at doing more and the higher end the Monterey line and stay you're talking about may be trying to go for some lower price for plans, Can you talk about the interplay between those two and if you’re going to be going to maybe some lower price, smaller floor plans are those homes still going to hit the same gross margin that maybe originally underwrote that land to?

Steven J. Hilton

Well, absolutely. Yes, we don’t think that moving on the price plan has any impacted all on the gross margin because again we’re not making the conscious strategic change that jumped down into the entry level business, we’re still a move-up builder, we plan to remain a move-up builder. We’re just doing some minor tweaks within our – some of our existing communities with some of our new communities to reemphasize some of the smaller plans in the line up. So again I don’t think this is a watershed moment or real strategic change from what we’re doing. Just some minor tweaking to our strategy.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

Okay, great. Thank you.

Steven J. Hilton

Okay. Thank you, I think that will be our last caller. Operator, we’ll wrap it up here. I appreciate everybody’s attention in participation with our conference call this quarter. And look forward to talking to you next quarter. Thank you.

Operator

Thank you, very much. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!