Good morning and welcome to the Meritage Homes Second Quarter 2019 Analyst Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Brent Anderson, Vice President of Investor Relations. Please go ahead.

Thank you, Jeff. Good morning and welcome to our analyst call to discuss our second quarter 2019 results. We issued the press release yesterday after the market closed and you can find it along with the slides that we'll be referring to during this call on our website at investors.meritagehomes.com or select the Investor Relations link at the bottom of our homepage. I'll refer you to Slide 2 and remind you that our statements during this call as well as the press release and slides, contain forward-looking statements, including our projections for 2019 operating metrics such as home closings, closing revenue margins, as well as overhead and diluted earnings per share in addition to our expectations of our market trends. Those and other projections represent the current opinions of management which are subject to change at any time and we assume no obligation to update them. Any forward-looking statements are inherently uncertain. Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this slide, as well as in our press release and most recent filings with the Securities and Exchange Commission, specifically our 2018 Annual Report on Form 10-K and subsequent 10-Qs, which contain a more detailed discussion of those risks. We have also provided a reconciliation of certain non-GAAP financial measures referred to in our press release or presentation as compared to their closest related GAAP measures. With me today to discuss our results are Steve Hilton, Chairman and CEO of Meritage Homes; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer of Meritage Homes. We expect to conclude the call within an hour and a replay will be available on our website within approximately one hour after we conclude the call. It will remain active through May 8. I'll now turn it over to Mr. Hilton to review our second quarter results. Steve?

Thank you, Brent, and welcome to everyone participating on our call today. I'll begin on Slide 4. We had another solid quarter and are pleased with the results we delivered through the first half of 2019. We delivered strong year-over-year order growth, driven mainly by an increase in orders per community from our strategic service to lower-priced homes. Our total orders for the second quarter were 22% higher than last year and our year-to-date orders are up 14% over 2018. Our average community count was up just 2% in the second quarter of 2018 -- over the second quarter of 2018 and impressively our absorption rate of 10.6 orders per average community was up 19% higher than last year's 8.9 and sequentially better than our first quarter's absorption of 9.5. It was the highest quarterly absorption rate we've achieved in 13 years going all the way back to the second quarter of 2006. Turning to slide 5; clearly those results demonstrate that Meritage is in the sweet spot of the market with our LiVE.NOW homes designed for entry-level buyers as well as our first move-up homes that we've made more affordable. We had a 42% year-over-year growth in our entry level orders, 41% of our communities at quarter end and 52% of our orders in the second quarter of 2019 were entry level compared to 34% of the communities and 44% of the orders a year ago. Our orders paid for entry-level is about 1.5 times our average for all non-entry level communities mostly offsetting the corresponding declines in ASPs. We believe our absorptions in order growth demonstrates the commitment we made to re-engineer our operations to enable us to deliver homes at lower cost with faster cycle times more than just deciding to build smaller homes in small lots,…

Thank you, Steve. Demand was strong across our markets --- all markets outside of California, especially in the entry level space where we expect demand continue to be strong and we're well positioned with that in mind. Our orders for the second quarter of 2019 were up over the second quarter of 2018 for all three regions, and eight of the nine states where we operate, with the sole exception of South Carolina. I'll provide additional color beginning with the west region on Slide 7; our orders in the west region were up 31% over the second quarter of 2018, driven by an 18% increase in absorptions, coupled with an 11% increase in average active communities. We added nine more Live.NOW communities in the West during the second quarter. Arizona put up the strongest performance across the company. Our average absorptions there were 15.7 for the second quarter, up 45% year-over-year, which drove 40% order growth and 39% growth in total order value. Arizona is furthest along in making the strategic shift to entry level and first move-up, so our mixed in closing to our target and our ASP was down just 1% year-over-year. That is a good example of the revenue growth potential Steve described as we stabilize our mix of the company as a whole. While California remains the highest priced and most unaffordable and challenged market, our absorption of 10.1 this quarter, we're not too much lower than the company average of 10.6. Absorptions were down 20% from last year with our average community count in California increased by 37% year-over-year. The net 9% order growth was partially offset by a 6% decline in ASP, resulting in 3% growth in total order value for California. We have rebuilt our community count in Colorado over the past year.…

Thank you, Phillippe. I'll provide some more detail on our P&L results as well as land and operating metrics. Beginning with Slide 12; Steve and Phillippe already covered how we've improved our operations to drive efficiencies and deliver more homes at lower cost. I'll highlight some of the impact of those improvement in our financial results so far this year. For the first half of the year, our home closing gross margin was 10 bps lower in 2019 than 2018 due to a one-time charge. We have the benefit of a $1.4 million warranty recovery that increased our gross margin in the first half of 2018. Excluding that item, our year-to-date 2019 gross margin would have been essentially flat with the prior year. SG&A expenses were consistent for the second quarter of 2019 compared to 2018. So they increased slightly as a percentage of home closing revenue due to the reduction in ASPs year-over-year. Year-to-date 2019 SG&A expenses were just slightly higher than 2018, mostly due to higher brokerage commission from incentives offered in late 2018 and early 2019. We also incurred severance costs of approximately $1.7 million and another $1.4 million for accelerated equity compensation this year that was pulled forward into Q1 from future period. The combined effect of these items accounted for the entire increase year-to-date in SG&A percentage. Interest expense increased $3.2 million for the second quarter and $7.1 million year-to-date compared to last year, primarily due to less interest capitalized asset under development, which is a result of faster construction times and turnover of inventory as part of our entry-level strategy. We expect higher interest expense to continue throughout 2019, but it should be eliminated early next year after the anticipated retirements of our notes due in 2020. The negative year-over-year earnings comparison was also…

Thank you, Hilla. In summary, we were pleased with our second quarter year-to-date 2019 results and believe we're further improving our business and differentiating our products in accordance with our strategy. In addition to changing our product mix, we're streamlining and simplify to drive greater efficiencies and profitability, which is valued by our customers, employees and trade partners. Demand for new homes remains healthy and we believe the demand we've seen so far this year reflects sustained positive macroeconomic factors for the housing industry. I'm proud of our entire Meritage team for putting our customers first and working hard every day to make the Company successful. We're confident in our ability to make the most of the opportunities ahead of us and we expect to continue to grow and deliver increased shareholder value. Thank you for your support of Meritage and we'll now open it up for questions, operator?

Thank you. We will now begin the question-and-answer session. [Operator instructions] The first question comes from Alan Ratner with Zelman & Associates. Please go ahead.

Hey guys, good morning and congrats on the great quarter and all the success with the strategy shift. It's really great to see. Steve, I guess my, the question I was hoping to drill in on a bit is just kind of thinking about the supply demand dynamic right now, clearly the order growth, very strong, it's apparent that the demand is there at this segment, you're pushing the entry level. If I look at some of the supply side of things, I mean your community count has drifted a bit lower here which is certainly expected given how strong the sales have been and your spec count is only up slightly year-over-year and that had been up quite a bit more over the last couple of quarters. So, where you sit today, I'm just curious how do you see the price versus pace dynamic playing out over the next few quarters? Because I think it's clear the sales environment, the spring has been very solid. Is there any risk that you and maybe some other builders might start to feel the pinch on the supply side a little bit like they experienced a couple of years ago when we saw a similar dynamic?

Well, thanks for the compliment first, and thanks for the question. We still have opportunities as we continue to change our mix for growth without community count growth, because we're opening more entry-level communities than we are move-up communities. but I would say, we haven't had a challenge finding entry-level land, we've bought, I don't know if we talked about the number of lots -- 75% of lots we bought last quarter, I think we bought over 25 -- bought around 2500 lots in the quarter, more for entry-level and are actually there, we bought 2500 last month. Yeah, we bought 4000 lots last quarter, 2500 entry level. So, we're still finding them. The challenge is just bringing them to market, getting them through the entitlement and development process and getting them open, but long term, we really feel like there is a long runway for LiVE.NOW product and We're going to continue to push that and as time goes on it will drive revenue growth and produce better margins.

Just one quick follow-up, Alan on the spec count, as we start to last prior year that where we started to see the community count growth in LiVE.NOW. we're not going to continue to have the spec count growth be quite as explicit if that was in '18 and '17 as we just started to build up our LiVE.NOW. communities, we still have more specs per store than we have ever held at 9.5 specs per community, but the shift is moving to being more LiVE.NOW. year-over-year, you're not going to see the same absolute value growth.

Got it. That's helpful guys. I appreciate that and second question just on the entry-level, we are hearing from some others that the single-family rental operators are very interested in either purchasing bulk sale of homes and close-out communities or even entire phases of projects. I'm just curious if you've gone down that road at all in some of your LiVE.NOW. projects or entertained the prospect of building for any of the single-family rental operators?

We've looked at it and we've entertained it but we feel like we can do better building them for our own account at a higher margin which will deliver better value to our shareholders, so if we had a lot of excess entry-level positions or positions that we didn't want maybe we would sell them to them, but that's not the case. We're really, really happy with all of our entry-level stores and we don't see a desire to need to discount those on to those rental operators.

So there is no contribution or no orders this quarter with any of those operators?

None.

Got it. Okay, thanks guys, good luck.

Thanks.

The next question is from Stephen Kim of Evercore ISI.

Yeah, thanks very much guys. Good job in the quarter. Wanted to ask you a few questions regarding absorptions. I think you indicated they were 1.5 times higher than the move-up. Did move-up absorption rates increase too and if so can you give us a sense for what the drivers to that might be? And then with respect to the expected life span of LiVE.NOW. communities given the strong absorptions, how has this changed relative to your initial expectation? How long you think it's going to take to sell out of these communities for example, and basically are you seeing absorptions faster than what you had initially envisioned and therefore the lifespan of these communities being shorter or not?

I'll let Hilla or Phillippe come to the number on the average size of our entry-level communities, but I can tell you they are much bigger -- we're buying much bigger positions for entry-level then we were for move-up, 150 plus lots in a lot of cases, but Hilla might haven't know, but I can tell you in absorptions our entry-level was up 19% year-over-year, first move-up was up 7% and our second move-up and are small active adult presence was up 19% because we're really incentivizing those stores to move out of those segments, so the opportunities for the buyers are pretty -- pretty compelling but certainly the absorption increases better for entry-level than it was for move-up. You know the average lot number count?

It is over a 100, there is a 110 and 112 actually, we average size...

…which is for both growth segments.

Which is combined for both segments, historically we are more 70, 75 or so, there's quite a bit of an increase.

I'm not concerned that we're going to move through these, we will run out of entry-level lots or have a supply issue because, we anticipated that the absorption will be will be stronger and that's why we bought bigger positions.

Yeah, our goal is to purchase land positions that have a three year to four year life, and that's based on the anticipated absorptions. So, obviously, we're going to take up or down bits on the product offering in that community.

Great. Yeah that makes sense now. So you anticipated a stronger absorptions when you originally moved into or bought these communities, a couple of years ago and that's great. You talked about your land spend and some of the dynamics there, one of the most interesting thing I heard you say was that, you're not really having trouble finding land to buy for entry-level that meets your underwriting thresholds and I'm curious about that, because, entry-level in general and obviously LiVE.NOW. for you specifically has been tremendously successful and this is something which would be kind of hard to miss, I would imagine for your competitors. So, I'm curious that you're not seeing more competition, let's say for the land parcels that would be suitable for an entry-level product. So I'm wondering why that is that you're able to find land to buy so readily? Is it that you're, let's say, moving into larger communities further out in your prospecting or are land sellers putting a lot more entry-level land on to the market? Or is there some other reasons that you are just simply not seeing other builders bidding on these kinds of parcels?

Well, there's a lot of competition, number one, we're competing with a lot of builders for these parcels, that's a given, but there's a lot of reasons why we're winning out in many cases. It's our local operators, relationships with land sellers, it's our land team, it's our reputation in the market, there is a whole variety of reasons why we're getting that particularly in a market like Phoenix, where we are a real big player and we've been here for almost 35 years. But in other markets we've carved out a really strong position in the entry-level space like in Austin and then in other places and we're just -- we're I think a little ahead of how we really know our costs, we've driven our costs down, allows us to underwrite deals quicker and maybe we're just more comfortable in the segment then some of the other mid-cap builders who are just may be differ in their tone, and right now are starting to get going. Clearly we have competition from a couple of the bigger, large cap builders on every corner, but we're still able to get the land that we need and to grow the business.

Got it. And then lastly from me on community count. Just want to make sure I got this right. What are you looking for your ending sub-count at the end of the year generally speaking and what do you think the mix of entry-level versus move up and second time move up will be at that time in terms of selling communities at the end of the year?

So our community count will dip in Q3. It will be a little lower than where it is today. But it should rebound in Q4 and we should end the year right about where we are right now. Unfortunately, that's a little bit less than we expected starting the year and that's because of the faster sell out of communities, it's also because when we ended last year, sales were pretty slow in the fourth quarter and we ended with more communities than we expected. And then we hope as we get into next year, we can start to resume some community count growth and we're working hard for that. So at the end of the year we'll probably end with one with less 2MU communities as we are working feverishly to finish those up and get out of those and we'll have more of course entry-level communities. But I don't, I'm afraid to give specific numbers right now for those segments, but I can tell you, as I said, we'll be less in Q3 and at the end of the year we'll be about flat with where we are now.

Great, thanks a lot guys.

The next question will be from John Lovallo with Bank of America. Please go ahead.

Hey, guys. Thank you for taking my question. The first one, Steve, you mentioned the entry level having higher average margins than your move-up homes. I'm just curious, is that a function of just a more efficient build process maybe less materials or is it more of a function of just having to put more incentives on the move-up homes at this point?

It's really both. I would say the incentives are a big part of it. I mean, the demand is stronger for entry-level than it is for move-ups, so we're not we're not incentivizing as much and by building 100% spec and for our LiVE.NOW. entry-level communities we're able to get better cost and build more efficiently and leverage our overhead better course and all of that leads to higher margins.

Okay, that's helpful and then Hilla, I think you talked about taking debt down in the early part of 2020. Should we expect non-capitalized interest expense to largely disappear by the second quarter? Is that the right way to think about that?

Yes. We should really not have interest breaking into the P&L after our maturity of our 2020 number.

Perfect, thank you very much guys.

Thank you.

The next question will be from Michael Rehaut with JPMorgan. Please go ahead.

Hi guys, congrats on the quarter. This is actually Elad on for Mike. I wanted to just ask a little bit more about the incentive levels in the overall pricing environment. You mentioned that incentive levels on entry-level are still lower than on your move-up, but just compared to last quarter you've been able to roll back on incentives through the quarter and maybe just some more commentary on the overall pricing environment?

I mean we had fewer incentives in the second quarter than we did in the first quarter or certainly in the fourth quarter last year, especially the entry-level homes. We elevated our incentives in our 2MU to close those out in California. The incentives have been sort of somewhat level, but demand has been softer.

There is actually some locations across the country where we've been able to start to increase pricing a little bit, definitely not in every market, but in some geographies and as Steve already mentioned the incentives on entry-level are already lower than everything else, so as in mix shift to more entry-level we are going to see the total incentive decrease for the company.

Okay, thank you.

The next question comes from Truman Patterson with Wells Fargo. Please go ahead.

Hi, good morning guys. Nice quarter. First just wanted to dig into the roll out of Studio M and if you guys could just give some metrics around that, the time line to completion, some of the costs on the back half of the year? And also -- so, could you just give an update and how it's been accepted by the customer in the market?

So, for those who don't know Studio M is our new design center strategy, that we are executing for our 1MU buyers. All of our LiVE.NOW. entry-level buyers are buying spec homes. They're already pre-plotted and pre-colorized with a variety of colorization schemes. Our 1MU buyers come to our new design centers they call Studio M and within those centers they'll go through an eight-step process of picking their selections and it's a much more streamlined version of what we were doing before. Less choices, but still a lot of choices. If you come to our Analyst Day that we're going to have in New York in November, you can see a lot more and learn a lot more about it, but this new Studio M will allow us to offer less SKUs which will allow us to negotiate better pricing with our vendors. At the same time take away a lot of the stress and anxiety that goes with going to a design center. Pricing will be more transparent. It will be easier and quicker. It's easier and quicker for our buyers to get through the design center process and get through two or three hours with one visit versus two or three visits before and they'll know when they leave exactly what things cost and what's their expense. So, we're really excited about it. We've opened eight studios up out of 16 that we planned. We'll be opening the balance of them up this quarter. We may have a couple of more flow into the fourth quarter, but their acceptance has been fantastic. We are getting a lot of positive feedback on them from our customers, very little negative. And our customers are actually spending more in these design centers and our margin in these from our customers for the upgrades is stronger than it was previously when we use the traditional design center method, so we're very, very excited about Studio M and we think it's going to the one more arrow in our quiver to improve our margins, streamline and simplify our business and make it a better experience for our customers and make it easier to operate for our employees.

Okay, thanks for that. Jumping over to your gross margin guide, you bumped it up by about 50 bps, I'm just hoping you guys can help us bridge the gap. What led to the increase? It seems like incentives are taking down for you, but you mentioned that land competition remains pretty high if you will. So if you can just bridge that gap for us, I'd appreciate it. And then also could you just give us what the gross margin delta is between you're LiVE.NOW. and your first move-up and kind of legacy if you move up plus segments?

Sure, so the majority of the lift in the full-year guidance on margin, it's really a function of two things as we accelerate the shift into entry level, those higher margins are improving the overall margins for the company and the second piece is leverage obviously we sold and closed more homes than we initially projected for the second quarter and you can see those projections are flowing through for the balance of the year. It wasn't a flow-through from Q3 into Q2. So as we talked about on other calls, there is a fixed component of overhead in gross margins that just gets leveraged at a much faster pace on higher volume virtually the combination of mix, continuing to find value engineering opportunities in our product, the roll out of additional Studio M's, as Steve has mentioned, with higher margins and the leveraging from the higher volumes. So, kind of combination of all of those is driving the higher guidance for the full year on gross margin. And then on the entry-level. I don't want to be the one to get into the specifics, they kind of shift quarter-to-quarter based on the mix even within the entry-levels and the first move-ups. We'll state that entry-level has notably higher margins than our non-first time move-ups, the second time move-up luxury stuff that we're exiting out of and highly discounting entry-levels, maybe just a hair better in our first time move-up right now although stay tuned because of the Studio M roll out, they're probably going to come pretty close in line with one another.

All right, thank you.

The next question will be from Jade Rahmani with KBW.

Hi, everyone. This is actually Ryan on for Jade. Just regarding M&A, do you think that the industry is really right for a significant consolidation at this point to drive things like scale, economics and also the ability for the industry to more significantly invest in technology and infrastructure and why do you think we haven't seen more consolidation at this point?

For the same reasons to go back, you know decades as well as social issues with founders that are still in control of some of the public companies in the large regional operators that are holding on to control these companies and family planning and state planning, it's a bit we're a very fragmented business and absolutely it looks like on paper that we should have more consolidation.

But realistically, it's probably not going to be a lot different than the past. Our eyes are certainly open to M&A opportunities. We're constantly looking at different things but our first and foremost priority right now is to grow organically and particularly in those markets where we're not a top 3, 4 or 5 builder and that's the strategy that we're in point.

And just a second question. In Arizona and in particular, Phoenix, are you seeing any impact in the market there from the growing share of I-buyers?

No, I mean the I-buyer presences is gotten larger here. We're using the some of the I-buyer companies to do trade-ins for some of our move-up communities, but it's still a relatively small piece of the overall resale market here, now in Phoenix.

Can you put any context around, any figures on the trade-ins that have occurred with you and I-buyers to date.

It's very, very limited. We're rolling it out across the country partnering with a couple of the big names that know, but it's not until...

We probably done a couple few hundred transactions with these companies over the last year plus, year to 18 months. So, out of more than 10,000 orders that we've taken, we've only done a couple of few hundred. Now, of course we haven't had it nationwide, but we had it in several markets and it's a nice tool. I think it's a nice thing for us to have with buyers coming in and out to sell, but it hasn't moved the needle yet.

Great, thanks for that color.

Our next question comes from Carl Reichardt with BTIG. Please go ahead.

Thank you, guys. Hilla, to go back to Truman's question. So, the guide for this quarter was I think, mid '17's gross margin and you did '18 for so, is that component of differential really all related to leverage of fixed or there are some other things in there in terms of what you ended up with relative to where you guided three weeks into the quarter.

Yeah, so it's the same story for our actual results in Q2 versus our guidance that the combination of mix obviously higher, but now composition of the total, we were able to lift margins. Actually have had some numbers here, I know some of those on the call. How did the margin breakout by regions so West and Central were relatively steady year-over-year. It's really the East where we've had problems getting our margins up in the past. The margins in the East actually grew 100 bps, Q2 of last year to Q2 of this year the value engineering ability to close bigger portion of our backlog and value engineering that we had in that products in spec product really helped push our margins up. Of course, lumber always helps. I think all of those components with the higher closing volume than we had anticipated that helped us gain the leverage on the fixed component of gross margin, all of those together came to deliver a higher, higher margin than we had anticipated.

Okay, great, thank you for that. And then just on your lot options, I think it's 34% of your base now. Do you know roughly off hand what percentage of those are on paper lots or finished lots? And is that percentage within the option count changing?

I don't know the percentage on the actual option piece what paper versus not, but I believe we were right around 30% when we purchased it's about 30 - 70 split which we finished and needing some level of development.

Yeah. But we don't option paper lots. We buy finished lots through the option. So I guess you're asking is which ones haven't been developed yet and which ones are ready to go right now. I would say primarily most need to be developed and are not ready to go right now.

Okay, thanks. And then one last one, just sticking in Alan asked about institutional purchases of single family rentals. I'm interested in the sort of more of the [indiscernible] buyers. Do you know offhand what percentage of your orders have been tracking to what's just broadly called them non-owner occupants?

I can tell you it's pretty small. I go out in the field quite a bit to go to our new communities and I talk to our sales people and ask them how many of these are real investors and how many are actually living here. And I could tell you the investor community, unlike what we saw in the last cycle, is really, really small, say it's less than 5%.

Okay, thanks, Steve. Thanks, all.

[Operator Instructions] The next question will be from Alex Barron with Housing Research Center. Please go ahead.

Hey guys, great job. I was kind of wanted to ask two questions. One was on the LiVE.NOW. I guess what percentage of your communities are LiVE.NOW.? And where do you see that trending over the next year or two? And the second question is on the on the balance sheet. So you got the 2020 debt coming due. Is there any longer term to, kind of renew, issues on debt to replace that or to maintain a lower level of leverage and therefore a lower level of interest. If you are just generating enough cash to sustain the business at current growth rates?

So, 41% of our communities at quarter end were entry-level. 52% were orders for entry level. That 41% can go as high as 60%. I think that's our upper target, to be 60% entry-level. I don't have a time frame for that, but that's sort of where we're heading. As far as the debt, our plan right now at the moment is to pay that debt off in March with the cash that we are building up on our balance sheet and not to go out and replace that with additional debt, both plans certainly can change with the a variety of different things, potentially have opportunities potentially coming our way, but that's the point at the moment. We just feel like as we get longer into the cycle even though we believe there is tremendous opportunity long term for entry-level housing, it's prudent to deleverage the company a bit and not to refinance that issue that we're paying off and reduce our interest expense.

And one other point on that, I think some asked earlier if the interest expense that you're seeing breaking in the financial statements is going to go away and it did, but the total burden on this debt is closer to $22 million, not just the 10 that you're seeing breakthrough for the balance of that, well over time help margins as well because that interest won't get capitalized, there will be some margin improvement from that in the upcoming years of the loan.

Right. Yeah. That's why I was asking. Okay. Well, thanks a lot, and best of luck.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Steve Hilton for any closing remarks.

Thank you very much for your participation in our second quarter earnings call and we look forward to talking to you again next quarter. Have a great day.

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