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Edited Transcript of MTH earnings conference call or presentation 24-Apr-19 2:00pm GMT

Q1 2019 Meritage Homes Corp Earnings Call

Scottsdale May 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Meritage Homes Corp earnings conference call or presentation Wednesday, April 24, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brent A. Anderson

Meritage Homes Corporation - VP of IR

* Hilla Sferruzza

Meritage Homes Corporation - CFO & Executive VP

* Phillippe Lord

Meritage Homes Corporation - COO & Executive VP

* Steven J. Hilton

Meritage Homes Corporation - Chairman & CEO

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* Carl Edwin Reichardt

BTIG, LLC, Research Division - MD

* Elad Elie Hillman

JP Morgan Chase & Co, Research Division - Analyst

* James C McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* John Lovallo

BofA Merrill Lynch, Research Division - VP

* Nishu Sood

Deutsche Bank AG, Research Division - Director

* Paul Allen Przybylski

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Ryan John Tomasello

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Scott Evan Schrier

Citigroup Inc, Research Division - Senior Associate

* Stephen Kim

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team

* Susan Marie Maklari

Crédit Suisse AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Meritage Homes First Quarter 2019 Analyst Conference Call. (Operator Instructions) Please note this event is being recorded. (Operator Instructions)

I would now like to turn the conference over to Brent Anderson, Vice President, Investor Relations. Please go ahead.

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Brent A. Anderson, Meritage Homes Corporation - VP of IR [2]

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Thank you, Andrew. Good morning, and welcome to our analyst call to discuss our first 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 today on our call on our website at investors.meritagehomes.com, or by selecting 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 and margins, as well as overhead and diluted earnings per share in addition to expectations about market trends. Those and any 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 Slide 2 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, which contains a more detailed discussion of those risks.

We've 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; Hilla Sferruzza, Executive Vice President and CFO; and Phillippe Lord, Executive Vice President and Chief Operating Officer of Meritage. We expect to conclude the call within 1 hour. And a replay will be available on our website within approximately 1 hour after we conclude the call. It will remain active through May 8.

Now I'd like to turn the call over to Mr. Hilton to review our first quarter results. Steve?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [3]

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Thank you, Brent, and welcome to everyone participating on our call today. We appreciate your interest, and I'll begin on Slide 4.

Considering the difficult market conditions we experienced in the fourth quarter of 2018, the first quarter of 2019 was a pleasant surprise. We announced on March 4 that our February year-to-date orders were flat year-over-year, which we considered a success, but March was the strongest month of the quarter, up 19% over last year. We put up 7% order growth over the first quarter of 2018 with a total of 2,530 orders in the first quarter of this year. It was our highest quarterly order number since the first quarter of 2006, and that says a lot.

Much of that was attributable to our strategic shift to more entry-level communities as our orders for the entry-level homes increased 26% over last year's first quarter. Aside from California, demand was strong in all of our markets, particularly in the entry-level space. The decline in mortgage interest rates since November certainly had a positive impact, but targeted incentives by us and other sellers also helped boost the confidence of those buyers who feared that they may be buying at the top of the market. As further evidence of their confidence, our cancellation rate was only 12% for the quarter, down from 21% last quarter.

Turning to Slide 5. In addition to getting the 2019 selling season off to a good start with that increase in orders, we also delivered a slight increase in first quarter closings despite entering the year with a backlog 15% or lower than it was at the beginning of 2018. We achieved that due to a higher backlog conversion rate as a result of closing more of our available spec inventory, consistent with our entry-level strategy. Our conversion rate was 73% for the first quarter versus 60% in the first quarter of last year. 67% of our closings in the first quarter were from spec inventory compared to 51% of closings from specs a year ago.

Our strategic shift towards more affordable entry-level and first move-up homes reduced our ASP 6% for the quarter, which resulted in a 4% decline of first quarter home closing revenue. When combined with targeted incentives we offered in the fourth quarter of 2018 and the first quarter of 2019, we used these incentives to hit the volume targets we were looking for while partially offsetting the discounts with improved overhead leverage from incremental closings.

The combination of sales and broker incentives were offered over the last -- last year -- 2 -- I'm sorry, the combination of sales and broker incentives were offered over the last 2 quarters reduced our home closing gross margin by 40 bps and increased selling expenses by 30 bps while helping to drive additional orders, but we expect to improve on those through the rest of this year.

Turning to Slide 6. We believe our strategic shift to focus on the entry-level and the first move-up market is clearly benefiting our orders and margins relative to where they would be with a primary move-up business like we had a couple of years ago. 36% of our communities and 45% of our orders in the first quarter of 2019 were entry-level compared with 32% of our communities and 38% of our orders a year ago. Our orders pace for the entry-level is approximately 1.5x our average for all non-entry-level communities. And our gross margins were also higher on average for entry-level and non-entry-level homes.

For those reasons, all the new lots we put under control in the first quarter were for entry-level communities since we already have a good supply of lots for first move-up communities. We're strategically exiting our second move-up business as that market is much thinner and more challenged than the entry-level and affordable first-time move-up communities -- first move-up communities. We expect that to impact our margins through 2019 but to have minimal impact next year.

In short, our strategy is proving to be the right strategy for us as it addresses the needs for millions of millennials and baby boomers who want affordable homes in highly desirable communities and a simplified and streamlined purchasing process.

Along those lines, one of our latest developments is to simplify and streamline the process -- the process that is our partnership with loanDepot, who is offering a fully automated, secured digital pre-approval process exclusively for Meritage Homes and available on our website. Using this technology, there is no need for a loan consultant to review and approve applications, so homebuyers can be preapproved for a new Meritage home anytime, anywhere in less than 15 minutes. It's another example of Meritage's commitment to innovation.

And I'll now turn it over to Phillippe to discuss some of the highlights of our sales trends. Phillippe?

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [4]

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Thank you, Steve. Our orders for the first quarter of 2019 were up over the first quarter of 2018 in the Central and East regions, with the West region down just 3% primarily due to the continuation of softer market conditions in California. I'll provide additional local color beginning with each region on Slide 8.

Our primary objective in East is to grow our business in order to gain leverage. And we have been accomplishing that by opening new entry-level communities that are selling well, much better than the move-up communities they are replacing. In fact, the first quarter orders in our entry-level communities were up 59% over last year in the east region.

East region orders were up 20% year-over-year in the first quarter with a 16% increase in average active communities and slightly higher absorptions. The region was led by order growth of 58% in Tennessee where we increased community count by 75% over last year's first quarter. Demand there was strong in order communities and improved throughout the quarter.

Orders were up 46% in North Carolina due to the combination of 35% expansion in average community count and an 8% increase in absorptions over last year. Those gains were primarily associated with our entry-level communities. Charlotte was especially strong after a surge in March orders.

Demand also improved in Florida during the first quarter with a 14% increase in orders mainly driven by more community openings and stronger demand than we experienced when interest rates rose in the third and fourth quarter of last year.

As a result of our shift to entry-level, our entry -- our average sales price on orders for the East region was 4% lower in the first quarter of 2019 compared to 2018, but total order value was 14% higher due to community count growth and stronger absorption.

Slide 9. Moving to the Central region. Texas produced an 8% order growth and a 10% increase in total order value as we not only grew our entry-level business but also had solid success selling through our higher-end move-up communities in Dallas, which had previously been a drag on our overall results in Texas. Those orders for higher-end homes increased our ASP for the quarter, which we expect to be only temporary as we sell through our remaining (inaudible) communities, while the longer-term trend for ASP should come down as the percentage of orders from entry-level communities increases. Absorptions in Texas were 13% higher in the first quarter of 2019 versus 2018 given the strong spring demand experienced across all 4 markets there.

Slide 10. Our orders in the West region were down just 3% from the first quarter of 2018, despite a 24% decline in California where demand is softer than other parts of the country and absorptions are much lower than the market has experienced there for several years. A 12% increase in average community count nearly offset the 14% decline in order pace for the region.

We have rebuilt our community count in Colorado over the past year after years of selling out of communities faster than we could replace them. Demand remains healthy there, though it has returned to historical levels after successive tightening of affordability over the last couple of years.

I will now turn it over to Hilla to provide some more additional information. Hilla?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [5]

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Thank you, Phillippe. I'll provide some more details on our P&L results as well as land and operating metrics beginning on Slide 11. As we noted when we reported last quarter, we expected our first quarter 2019 closings to be down year-over-year due to our 15% lower starting backlog. So we are pleasantly surprised that closings were actually up over 2018, and closing revenue was down much lower than we had anticipated.

Although we didn't provide earnings guidance for the quarter, we far exceeded our internally forecasted earnings with better-than-expected top line performance. The year-over-year decline in earnings was due to a combination of slightly lower home closing revenue on profit as well as an increase in interest expense and several onetime items impacting the year-over-year comparisons.

Our gross margin slipped to 16.7% from 17.1% in the first quarter of last year primarily due to the targeted incentives that Steve discussed and reduced leverage of our construction overhead expenses from lower home closing revenue despite the 2% growth in closing volume. Additionally, we had a benefit in the first quarter of 2018 of $1.4 million litigation recovery that increased our gross margin by 20 bps.

The lower revenue also had a negative impact on our SG&A leverage which increased to 12.3% of total home closing revenue, up from 11.5% in the first quarter of 2018. Compared to the first quarter of 2018, our 2019 SG&A expenses included higher brokerage commissions, severance costs of approximately $1.1 million and another $1.4 million for accelerated equity compensation pulled forward into Q1 from future periods. The combined impact of those 3 items on SG&A amounted to about 50 bps. We expect to improve our SG&A leverage throughout the year assuming market conditions remain steady.

Interest expense increased $3.9 million primarily due to less interest capitalized to assets under development, which is a result of faster construction times in turnover of inventory as part of our entry-level strategy. We expect that to continue to be the case throughout 2019.

The negative year-over-year earnings comparison was also due to first quarter 2018 net earnings benefiting from a favorable legal settlement of approximately $4.8 million, which accounted for most of the decline in net other income.

Finally, our effective tax rate was 21% in 2019 compared to just 10% in the first quarter of '18 when we benefited from a 1-year extension of energy tax credits for all qualifying homes closed in 2017. This benefit recorded in the first quarter of 2018 totaled $6.3 million. We expect our effective tax rate for the remainder of the year to be about 25%.

Slide 12. Turning to the balance sheet and cash flow items. We used $9 million to repurchase approximately 200,000 shares during the first quarter of 2019 and spent approximately $141 million on land and development in this year's first quarter, $62 million less than last year's first quarter total of $203 million, partially because the lots we purchased were for entry-level homes at a lower average cost.

We ended the first quarter of 2019 with total lots of approximately 33,800 compared to 34,000 at March 31, 2018. That translates to a lot supply of approximately 3.9 years this year compared to 4.3 years last year based on trailing 12 months closing. About 71% of total lot inventory was owned and 29% optioned at March 31, 2019.

Consistent with our strategy to increase our focus on the entry-level market, we are building more spec homes in those communities. We ended the first quarter of 2019 with about 2,200 spec homes or an average of 8.5 specs per community compared to an average of 7.9 per community a year ago. Approximately 36% of total specs were completed as of March 31, 2019.

Slide 13. We are encouraged by the outlook for interest rate stability and are optimistic that the spring selling season will continue as it has begun. We will remain cautious in projecting quarterly results. Based on our first quarter results and net outlook, we are currently projecting 2019 home closings and total home closing revenue of approximately 8,200 to 8,700 homes and $3.25 billion to $3.45 billion, respectively, for the full year.

We're anticipating home closing gross margin to be around 18% for the year, with slightly higher SG&A than 2018 due to increased commissions expense and approximately $4 million of start-up costs to open our Studio M showrooms in the remainder of our markets this year. Interest expense will trend down from Q1 but continue to be higher than 2018 due to lower land development spend and faster asset turns.

Operating margin should improve throughout the year. And we expect to generate $4.65 to $4.95 of diluted earnings per share for the full year.

For the second quarter of 2019, we're projecting 1,900 to 2,100 closings for total home closing revenue of approximately $760 million to $825 million and a home closing gross margin percentage in the mid-17s for the quarter which reflects higher incentives offsetting cost savings over last year. We expect SG&A interest expense to be higher than 2018 for the reasons I stated earlier for the full year, translating to approximately $0.95 to $1.05 of diluted earnings per share for the quarter.

Upside to those estimates could occur if stronger demand persists throughout the selling season and beyond to the extent of at least traditional closing volume from spec inventories as our first quarter results demonstrated. That is the benefit of our strategy, but we don't have as much visibility into future closings due to our lower starting backlog and higher conversion rate and the current uncertainties in the housing market. We plan to update our outlook next quarter with the benefit of the spring selling season completed.

With that, I'll turn it back over to Steve.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [6]

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Thank you, Hilla. In summary, we are pleased with our first quarter results and the solid spring selling season we've experienced in the first 3 months of the year. Demand for new homes remains healthy. And we believe the demand we have seen so far in the spring selling season reflects sustained positive macroeconomic factors for the housing industry.

We're confident in our strategy and pleased with the results of our LiVE. NOW. communities and the early success of our streamlined Studio M offering for first move-up homes. There's still a shortage of entry-level products for buyers who are looking for more affordable homes that meet their needs and give them some extras to satisfy a few of their wants. We believe that is exactly what we provide with our new Meritage Homes.

Meritage offerings are industry-leading, energy efficiency, home automation, attractive and fresh designs in all of our homes, along with a stress-free experience for buyers purchasing their first home. It's clear that buyers appreciate those advantages as our customer satisfaction scores have increased to industry-leading levels as we've implemented those improvements.

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 Homes. And I'll now turn it over to the operator to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Alan Ratner of Zelman & Associates.

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Alan S. Ratner, Zelman & Associates LLC - MD [2]

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Congrats on the quarter and on the entry-level strategy. So I was hoping just to get a little bit more info on the -- kind of the pricing dynamics in March. The orders were obviously very strong. And I know and I think in January, you mentioned some of the incentives, and the market was very sensitive to those incentives where you kind of read a lot of contracts when you had the incentives out. And then when you tried to pull them back maybe the market softened a little bit.

So what were you doing in March on the incentive front when you experienced those strong sales? Would you say the incentives drove the sales? Or were they in spite of actually pulling back a bit on incentives?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [3]

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No. We didn't do anything unusual in March. We had a national promotion in January that we called flash sale, which was very successful, drove a much better January than we previously announced, so January was up 10%. I think that sale had a big impact on it. In February, we had an interest rate buydown program as rates continued to fall. It didn't really resonate with the buyers, and orders in February were a little bit less. But we didn't do anything on a national basis in March, and we just left it up to our local operators. And the incentives were pretty consistent with what we have been doing now for many months.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [4]

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Yes, this is Phillippe. I would just say that they were not higher in March than January and February. In fact, they were slightly lower. So March was just stronger without really tweaking incentives beyond what we had originally done in January and February, although it was slightly lower.

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Alan S. Ratner, Zelman & Associates LLC - MD [5]

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Thanks for that guidance. It's great to hear. And then second question, obviously the entry-level push seems to be paying some nice dividends here for you on the order side. At the same time, there has been some incremental tightening from FHA over the last month or so, targeting the high DTI, low FICO loans as well as some down payment assistance programs.

So was curious if you guys have kind of looked into your business, how much of that is reliant on those types of loans, and whether you've seen any impact thus far through April from the changes from FHA?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [6]

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We have not seen any real impact from that. We have very few buyers that fit into that category, and we don't expect to be impacted from that at all. Our average DTI is about 38%.

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Operator [7]

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The next question comes from John Lovallo of Bank of America.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [8]

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The first one, Hilla, I believe if I heard you correctly, you mentioned that interest expense should taper off in the second quarter and perhaps throughout the year. Can you just help us frame kind of the EPS impact for the full year at the expected level of interest expense versus -- is it the same percentage was capitalized as we experienced in the fourth quarter?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [9]

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So the percentage capitalized is going to be consistent. That's not changing. It's the piece that's breaking to the P&L that is going to be slightly elevated. It's more elevated in Q1 than any other quarter throughout the year. So you should definitely be modeling something slightly less in Q2, 3 and 4 than what we saw in Q1.

But it is going to tick slightly a bit higher than it has been last year just because we have slightly lowered land spend so the ability to capitalize interest to assets under production is lower. And then just our home construction cycle is turning much faster, so there's less months of inventory that get the interest component.

So overall, actual interest hasn't really changed. It's just -- is it coming through margin or is it coming through the P&L in the interest line?

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John Lovallo, BofA Merrill Lynch, Research Division - VP [10]

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So was there a margin benefit in the first quarter from this?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [11]

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The interest in margin is fairly consistent. It's not moving too much. We're just turning that inventory faster.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [12]

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Got it. And then finally, how should we think about the year-over-year impact from commissions and equity comp in 2Q through 4Q?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [13]

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So the equity comp is a onetime charge in Q1. It just pulls some costs forward with the change in the tax laws at the end of '17, we had a 1-year of tax shelters in '18. And then that changed for us rolling into 2019. So there were some tweaks that occurred with the equity compensation timing but not overall dollars. So you will see that first quarter expense spike up, but then there's no difference in modeling for the remainder of the year.

The commissions are running at a slightly elevated rate right now, but lower than what we saw in Q1. And we're kind of monitoring market conditions and seeing if we can pull back on those excessive commissions that we had to pay in Q4 and Q1.

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Operator [14]

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The next question comes from Stephen East of Wells Fargo.

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Paul Allen Przybylski, Wells Fargo Securities, LLC, Research Division - Associate Analyst [15]

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Yes, this is actually Paul Przybylski on for Stephen. I guess first off could you give us some color on how April is transpiring both from an orders prospective and also with respect to any incentives? And then if you're seeing any difference in incentive levels between LiVE. NOW. and the first move-up and move-up product lines?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [16]

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So we have modestly pulled back on our incentives in April, but I'd say very modestly, but April is feeling really good. We had 5 weekends in March which really helped those results. The weather was phenomenal in March. Interest rates continued to decline. The weather has been great in April. I'm very confident that we will have a plus over last year for our April numbers, and -- but we did have a -- we do have the Easter weekend and only 4 weekends in this month.

So -- but it feels really good right now. Certainly, some markets are exceptionally strong. Like Phoenix is one of those right now. In the entry-level space it's really, really strong. Other markets are good as well, but some are certainly better than others.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [17]

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And to answer the question on the incentives between entry-level, first move-up and other, I mean, the incentives on entry-level they're a little bit higher from last year just to compete with what the other competitors are doing but not much. First move-up, a little bit more than that.

And then clearly, we've articulated that we're aggressively getting out of the second move-up business. So the incentives on the second move-up business are meaningfully higher than they were last year as we try to strategically get ourselves out of those type of communities and reinvest that capital into entry-level and first move-up communities.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [18]

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You'll see those incentives slightly elevated from the 2 MU business in our margins in the first half of the year and then kind of start to taper off as we get to the end of the year and be really negligible into next year.

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Paul Allen Przybylski, Wells Fargo Securities, LLC, Research Division - Associate Analyst [19]

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Okay. And diving into California with the order decline and the strong community count growth, did you see any improvement in that market as we moved through the quarter as rates trended down? Or is that market really just set for a bigger pricing reset just to get it [flat]?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [20]

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I think that we saw -- certainly, we saw the seasonal improvement and we certainly saw more action in some of our lower-priced communities that we've newly opened. So I would say it's very local in California. And some of our communities performed well, and then some of our higher-priced communities didn't perform as well and -- but our biggest challenge in California has really been our community count. And we're starting to make some inroads there getting more communities open.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [21]

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Yes, we're going to see improvement in California just because of the community count ramp-up. But locally, it's definitely a market where we're seeing buyers' expectations around incentives being the highest. They want to make a deal. They're coming in with expectations that they're going to get a deal. And then as you look at the competitive landscape, other builders are aggressively delivering those deals. So it's a very competitive environment from an incentive standpoint right now.

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Operator [22]

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The next question comes from Nishu Sood of Deutsche Bank.

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Nishu Sood, Deutsche Bank AG, Research Division - Director [23]

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I wanted to ask about the incentive environment. I think there's been some debate about how the fluctuations in interest rates and rising home prices, the kind of pressures on affordability have driven the need for incentives and obviously across the different kind of product segments, entry-level versus move-up. The conventional wisdom says that the entry-level gets hit more by affordability concerns. But Steve, your experience over the last couple of quarters shows that you've had more success through this difficult period with the entry-level.

So I just wanted to get your thoughts on it. What can we take from that? Is it really company by company? Is it just specific? Or what are you seeing in the market generally? Like what part of the market has been more affected by the volatility here in rates and affordability? And where -- how has that driven the use of incentives differently in each of those end markets?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [24]

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Well, I think 2 things are happening. Number one, the entire entry-level market has been underserved, okay. So there has not been enough supplier capacity or product put on the market to serve the entry-level market as the entry-level segment is getting bigger because the millennials are becoming more into their home buying years. So that is way offsetting the negative impact from rising rates that we saw last year.

In addition, housing prices have climbed quite a bit over the last 15 years. You go back to what the prices were in the mid-2000s versus what they are today, they've risen a lot for a lot of reasons. So a lot of people skipped the entry-level market and went to the first move-up market or beyond, they're now coming back to the entry-level market. So -- and then we have these baby boomers that are moving down and buying entry-level homes as well because housing is expensive, but they still want a new home.

So I think those factors are mitigating the rising interest rates. And that's why ourselves and others that are in this entry-level space are doing well.

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Nishu Sood, Deutsche Bank AG, Research Division - Director [25]

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Got it. Got it, makes sense. On SG&A. So in the quarter, we had some SG&A deleveraging even if you take out those one-off factors that you mentioned, Hilla. So the deleveraging driven by the fact that revenues were down because of ASPs even though volumes went up. Your ASPs will probably continue to fall obviously based on the success of your entry-level strategy.

So how should we think about SG&A leverage going forward? You mentioned you expect it to happen throughout the rest of '19. So what will that require? And what's driving that dynamic where even with the ASP declines are driving the deleveraging?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [26]

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So I think we already touched on this, but I'll just cover it again. There's 50 bps in that 12.3% number that are either commission related which we expect to kind of taper off towards the end of the year or onetime item which we don't expect to be recurring. Because of that elevated starting point, we are going to be slightly elevated in our expectation in our guidance with slightly elevated SG&A for '19 over '18.

Although there are a lot of efficiencies that are going to be coming through once we exit our second move-up communities, they're highly inefficient surrounding the absorptions pace. It doesn't sync up with the rest of our community strategy. So once those fall off and we're able to redeploy those resources back into more effective and efficient communities and the move-up, first time move-up and entry-level space, we'll be able to get back to the target number that we have for SG&A leveraging.

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Operator [27]

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The next question comes from Scott Schrier of Citi.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [28]

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I wanted to know if you could talk a little bit about your gross margin bridge, what you might have seen from lumber deflation versus some of the other cost buckets where you're seeing in inflation as well as some of the impacts from less overhead from your faster turn asset strategies? So maybe in the quarter and how you're thinking about some of those things going forward for the year.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [29]

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I'll take the cost piece of that, and then maybe Hilla can piggyback on that. We were able to really get some great savings over the last 3 quarters, starting back in the second or the third quarter of last year. As you guys know, lumber was really structurally impacted in the first half of 2018. We were able to claw those costs back successfully. And our costs are -- our lumber costs are pretty much back to what they were before the ramp-up. And those were all captured in our go-forward business. We captured most of that in Q1. We saw that in our margins. So it helped us offset the additional incentives and commissions that we were offering in the market.

As it relates to our forward-looking kind of vision into the costs, the costs are pretty stable right now. Labor is pretty stable. Our key commodities are pretty stable. We're not tracking any spikes in lumber or concrete, et cetera, et cetera. So we feel pretty good about the stable cost environment going forward.

Lastly, and I'll let Hilla piggyback, we've just been really dialing in the cost of our product as we've rolled out our entry-level strategy. And we've been able to really refine our product offering which has allowed us to build homes in a more efficient manner, in a more cost-effective manner, repeating what we're doing there. And we know to drive a lot of efficiencies in our cost structure through the pivot entry-level which has also benefited our costs as we go forward. So we continue to capture those opportunities to help us manage the market.

I don't know if you have anything to add?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [30]

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Sure. So I think we mentioned on prior calls that we expect the benefit from lumber to be about 100 bps in the margin. So most of that is now fully baked into our Q1 numbers. We've had a couple of successive quarters of home construction with those lower rates locked in.

Now the offset there, of course, are higher incentives and slightly lower revenue that's offsetting the fixed component of our overhead. So there's some fixed components in the margins, that the lower overhead -- that the lower revenue is not offsetting all of the overhead.

Now just a reminder on the lumber, the improvements are there from Q3 and Q4. First quarter of last year did not have elevated lumber. So when you're comparing apples to apples, the lumber is actually fairly consistent with what it was last year's first quarter. So there's not a benefit on a year-over-year basis even though there is a benefit on a successive quarter basis. So that's kind of how it all shakes out. With the 40 bps change, it's really just a higher incentive. We were able to recapture some of that with incremental volume and savings from our entry-level strategy.

And then just as a reminder, we mentioned this in the script, there's about 20 bps that used up last year's first quarter margin -- gross margin that was related to a successful settlement from a legal case that was actually running through our margin. So kind of apples to apples, it was 16.9% to 16.7%. So the incremental decline on a year-over-year basis is really nominal.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [31]

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I would also add that we had a reduction in headcount event in January, where we reduced our headcount 6% or 7%, and that's why we took the $1.1 million charge. But we're really trying to be mindful this year of our hiring and trying to be more efficient with our overhead, freezing our overhead levels to last year or below.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [32]

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Great. I appreciate all that color. For my second question, I wanted to ask about Colorado. Your absorptions still declined there significantly, but you were -- or I should say, despite the fact that you were able to get your ASP down 7%. So I'm curious if you still have to burn through the product that you have there to get lower price product on the ground and also more incentives. Or is there something different there, maybe an overall slowdown in the market that you're seeing?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [33]

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No, I wouldn't read too much into that. It's the timing. We have some new communities open that weren't open for the full quarter. Business in Colorado is very good. Clearly, if you're at the lower end, you're going to do better. But I would not lump Colorado in with California. We're feeling pretty bullish about our business and our positioning up there and where it's at.

I don't know if you want to add some more to that, Phillippe?

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [34]

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Yes. No, I wouldn't add too much. I mean it's definitely a market that's been impacted by affordability. We saw that coming 2 years ago and started buying more entry-level stuff. So that pivot has offset some of the softening that has occurred in the higher end. But we have some really strong move-up and second move-up communities in Colorado. It's a very strong market. So although absorptions are off a little bit in that space, they're still pretty good from a company perspective. And then we continue to open up the entry-level business, which is offsetting some of that softening in the higher end.

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Operator [35]

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The next question comes from Stephen Kim of Evercore ISI.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [36]

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Good job in the quarter and navigating the market. I wanted to ask about the incentive. It sounds like you're moving a little bit more away from the national-type incentives to maybe more regional ones, leaving it up to the local guys. I assume that's going to continue going forward. So should we assume from that, that we are not going to see the national Flash Sale that you did in January be a repeating event? Or is that actually incorporated -- another one, incorporated in your full year guide?

And then specifically to California, I know in the Inland Empire, you were bringing on a number of communities over the course of this year. Was wondering how the -- how your attitude has changed, if at all, with respect to that and if your absorption pace is okay enough, sufficient at present. Or do you think you're going to need to increase your incentives there more than you already have?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [37]

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Stephen, I would disagree with the first part. I would say a good fisherman is always changing his bait, and we're not going to tell the fish when we're going to change the bait and what bait we're going to use, but we're going to be really nimble and creative. And 1 month, it may be a national promotion and the next month, that may be local. But we have some definite plans and ideas for what we're going to do the rest of the year, and we're learning what's working and what's not.

You can't -- the Flash Sale worked great in January, but you can't do that every month because then it's not going to have the -- be as effective, of course. What was the second part of the question?

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [38]

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Inland Empire.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [39]

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Inland Empire.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [40]

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Inland Empire. Yes, we have -- we're not a good barometer for the Inland Empire. I think we have 2 stores open out there. So I would encourage you to seek out others to really get a beat on that market.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [41]

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Okay. My sense was that you were going to be bringing on a number of them over the course of the next 12 to 18 months. I guess that's not really the case then going forward.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [42]

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No, we are bringing on some more stores out there. But again, until we're open, you're not really going to get a beat on what's happening there.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [43]

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As we sit here today, we have 2 communities open in the Inland Empire. One has been open for a bit here, and another one that just opened. They're doing okay, right? But like Steve said, there's a lot of diversity to the Inland Empire, and we're only in 2 submarkets, and so we're just not a good data point on how that market is doing.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [44]

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I'm hearing some other builders that we're talking to that it's kind of a mixed bag. Some people are doing well in certain locations, and some are not. But...

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [45]

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Yes, that's fine. Okay. And then regarding margins, just as a -- from a longer-term perspective, I look back, and Meritage generated double-digit operating margins in the previous cycle, and that was even when you were not really doing much in the way of land development. Today, you're willing to do a little more land development.

And so I was curious, just longer term, is a double-digit operating margin simply not in the cards over the next couple of years? Or do you think it is? And if it isn't, what would be the reason for that?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [46]

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Well, it's not in the cards this year, but certainly, we hope it could be in the future. But we're really targeting more of a 10% -- I mean a 20% gross margin and getting our SG&A closer to 10% to get to that double-digit operating margin. And we got to clear out the 2 MU. We got to get our entry-level position higher, and we got to get more efficient.

In the last cycle, we had 40% entry-level. So we're just getting back to that point to where we were in the last cycle. And there's a whole variety of other factors why we're not double digit today. But clearly, that's our aspirational goal we want to be.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [47]

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And then, Stephen, just one more comment on that. We've been telegraphing our intent to the pivot on entry-level and first-time move-up. So there's a little bit of inefficiency as we make a pivot because you're carrying some of the old product and the old processes as you're converting to the new product and the new processes. As we bleed through the higher-level, higher-priced point communities that require a different operating structure and we're fully implemented in just the entry-level and first-time move-up, you'll see the full benefit of the efficiency that we're putting in place right now.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [48]

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But we 100% believe that the clearest path for our business to get to a 10% double-digit operating is all about volume. And our entire strategy is built around driving a higher volume per store, being able to build those houses faster and more efficiently. And our goal is to get there through that strategy.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [49]

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Yes, you guys have been really clear about that and definitely making progress, so that's been good to see.

My last question is related to volume. In the past, Meritage has been among the builders that has been the most -- has grown -- had the most success with integrating acquisitions. You stubbed your toe on a recent slate several years back, but that's been kind of a while ago.

I'm curious with your pivot here that you've made more towards the entry-level, whether you feel confident enough in the degree to which you have worked through that transition to now once again be open to doing M&A. And we have observed that the M&A in the industry seems like it's been pretty strong over the past year or so. And curious if you could speak to the pipeline you're seeing out there, your general interest level and your preparedness to do something in that regard.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [50]

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We are ready to do M&A. We are -- our eyes are open to M&A opportunities. We're regularly looking at them. But we're going to be very disciplined about doing one that fits with our strategy. So buying a move-up builder is really not going to fit for us. And we -- our preference is to find somebody who's in a market that we're already in so we can leverage our overhead. And we just have not seen those opportunities that fit with our strategy at prices that make sense.

That's not to say there's not going to be any in the future, but many of the deals that we've seen over the last couple of years just really haven't fit for us.

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Operator [51]

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The next question comes from Alex Barrón of Housing Research Center.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [52]

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Congratulations on the move. I think it's working nicely. So my questions were precisely around the -- I guess the benefits of being more in this new kind of spec entry-level-driven model.

So I'm just curious if you can speak to what do you think are, from your experience so far, have been the more interesting changes. Has it been in the sales space you're able to see or in the cycle time to build these homes or in the ability to change or improve your margins based on how much you're able to, I guess, buy things in bulk? Can you just kind of talk about your experience and benefits you've seen so far?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [53]

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I mean it's both. I mean we -- turn your volume down just a touch, Alex? We're getting a little feedback from it. But it's both. We're seeing from our surveys, from talking to our customers that more than half of our entry-level customers are renters, and they don't want to wait 6 months for a home. They want to move in sooner than later. They don't want to go to the design center and get overwhelmed by all the different choices and selections. But they do want a premium finish. They want nicer carpet, nicer flooring, nicer cabinets.

So we're able to meet those needs and demands of those customers with the way we're selling our LiVE. NOW. product. They come into our office. They come to our sales kiosks. They can see all of the product that's available. When it will be ready, we can immediately text it to them on their phone or e-mail it to them. They love that. And that's really, really helping.

And then on the other side, the production side, our contractors that work for us really love having a consistent pace. They really prefer building spec houses over a build-to-order. It's easier for them. They keep their people on our job site. We're getting better pricing. We've value-engineered a lot of our product now across the country. We've been able to reduce our construction costs significantly as we pivoted to entry-level.

And so it's working for both sides of the equation. When we get our costs down we're able to deliver better value to the customer, which allows us to sell more homes and be more competitive with those other high-volume, entry-level builders. So we learn a lot every day, not only in entry-level space but also in the move-up space.

I would encourage you to come out and see one of our new Studio Ms. I think they're -- it's revolutionary the way that we're approaching colorization and design for the move-up buyer by moving away from the à la carte model to a model that offers 7 or 8 or 9 professionally-curated choices for those customers that include the cabinets, the countertops, the paint colors, the flooring, all-in-one module, one designated package, and all the packages are the same price.

And the feedback we're getting from our customers is they really love it, and it really makes the whole design center experience better, allows us to sell more options at a higher margin and move the people through the process in a quicker, more efficient timeframe.

So we're excited about what we're doing on the entry-level side and what we're doing on the move-up space. It's -- both of those things combined are going to make us much more efficient over the long term.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [54]

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Yes. And Alex, since we've -- I just can't emphasize enough what building homes faster does for our business. And in the entry-level stage, we have been able to shave off anywhere from 2 to 3 weeks in our build times on average company-wide as we've rolled into these entry-level communities. And that has just allowed us to drive a much more efficient cost structure.

As Steve articulated, the trades want to work for builders that build homes faster in a more predictable manner. So the speed in which we are building our homes is having a significant impact on our business.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [55]

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Okay. Great. And can you just talk a little bit how low of a price point have you guys been able to achieve at this point? Like are there some markets where you're in the mid-100s? Or like how low how have you been able to bid? And which market would you say right now you're kind of the furthest along in this kind of transformation revolution?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [56]

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Yes. No, we're not going to be the lowest cost producer of entry-level homes. I mean there are guys, without mentioning their names, that are hitting a lower price point than we are. But we're -- in Phoenix, we have 1 or 2 communities slightly below $200,000. In Texas, we have a few communities that are slightly below $200,000. But we're definitely not going to be in the mid-100s.

The sweet spot for us, for the entry-level, is the $200,000 to $250,000 price range in the -- in those lower-priced regions in Arizona and Texas and in the South. We are building quite a few more townhouse communities, particularly in the South and in Florida. They're allowing us to drive down our ASPs and be more affordable. But again, we're not going to be the $150,000 or $175,000 builder anywhere.

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Operator [57]

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The next question comes from Michael Rehaut of JPMorgan.

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Elad Elie Hillman, JP Morgan Chase & Co, Research Division - Analyst [58]

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This is Elad on for Mike. Congrats on the quarter and on the guidance. I was just wondering how we should be thinking about community count growth for 2Q and the full year, given the strong sales pace this quarter and the closeout of some of the slower communities and the openings of the new communities.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [59]

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The community count growth is going to be flattish to slightly down for the quarter and for the year. We'll probably be able to give you a better read on that next quarter, but we're moving through a lot of our second move-up communities faster than we originally anticipated, which is muting our community count growth.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [60]

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Although you'll see the entry-level become a more meaningful percentage of our total composition of communities.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [61]

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Right, right.

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Operator [62]

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The next question comes from Carl Reichardt of BTIG.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD [63]

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And just following up on that. Steve, last -- at the end of last quarter, you talked about 15% of your store base being the second move-up. And Hilla, I think today, you said by the third and fourth quarter, you're expecting effectively a minimal margin drag. So what's your composition of 2 MU at the end of the first quarter? What will it be at the end of the year? And what is the margin differential as you see it of 2 MU backlog versus LiVE. NOW. or entry-level backlog?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [64]

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We were -- we've done some stats today, and we put 2 MU into the bucket. We call it 2 MU and other. So we have luxury in there, and we have some active adults in there. And that -- we have 109 communities that were in that bucket a year ago, and now we are down -- I'm sorry, no. I gave you the wrong number. We had -- what am I looking at here? It's down 23%. I don't know. What was the ending community count? Oh, we had 63 communities, and now we've got 40.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [65]

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It's going to continue to decline. The sales pace in the communities is much slower. So you can hang on to what we consider an active community when you're selling 1 or 2 a month for quite a while, but there's going to be a noticeable decline in our community count for sure. But more importantly, the volume of the homes coming from those communities are going to become less and less meaningful to our total.

And then as far as the margin, it can be a couple of hundred basis points difference in the margin between our first-time move-up and entry-level community versus the stuff that we're exiting.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [66]

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Carl, are we going to make a believer out of you today?

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD [67]

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It's not a matter of belief. It's a function of just what that drag is and how fast you have to get out of it that impacts how we think about things. You know what we think about the entry-level.

But I wanted to go back though and, Steve, and ask you a little more about Studio M, too. And I'm just curious, in terms of the rollout, how far along are you with it? And what's your anticipation of what it can do in terms of improving the speed at which you build? Or is it a function of being able to better more efficiently price options that would help your margin?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [68]

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It's all of the above. We're -- by the end of this quarter, we'll be halfway there. And by the end of the year, we'll be 100% of the way there. So every division will have its Studio M by the end of the year, and we'll really have it dialed in really tight. What it allows us to do is single source a lot of the products.

For example, all of the flooring, all the carpet materials and some of the EVP, we're buying it exclusively from Shaw. Shaw gives us better pricing. We reduced the number of SKUs, and that makes it more efficient for them. We're buying carpet by the roll as opposed to by the house. And then the same thing with the cabinets and ceramic tile and wood flooring and the other components that go into -- that you sell at the design studio. We're able to get much better pricing on that. We're able to pass some of that pricing onto the customer, which gives them better value, but it also allows us to increase our margin at the point of sale on those goods.

So sometimes, you're waiting for a product, it's slowing down the construction cycle. We're not going to be having to wait for certain products because we're buying less products, more products that are in stock that we can get quicker, that we have in our vendor's warehouse locally.

So there's just a whole plethora of advantages, and we're not -- all these studios, for the most part, are being run by Meritage people. They're in-house studios. We do have some contractual relationships with outside vendors that run a few of them, but we're also able to reduce the cost by running them ourselves versus contracting it out. So I think long term, it's going to be a great, great strategy for 1 MU.

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [69]

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I think the last thing I would add to that is if you go to other builders that offer a traditional design studio experience, you will find that it typically takes 2 to 3 appointments for a customer to make all of their selections. We're able to navigate our customers through our Studio M in one appointment, usually not taking more than 2 hours. So you can imagine that allows us to permit the house and start building the house much faster than a traditional design experience.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [70]

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And then just one last point, I don't know if you were alluding to this in your question or not, the reason why there's a drag on the financials and the SG&A is as you're building these, you're incurring the costs. But the benefit that's coming from the margin, those homes aren't closing yet. So since we're doing the roll-offs throughout the country, this is going to be the year of transition. And then starting in 2020, all the divisions will be closing homes under the new Studio M option structure, which you'll see the benefit of the revenue versus just the expense running through this year.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [71]

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We're open today in Florida. We're open in Houston. We're open in Denver. We're open in Tucson. We're going to be open in Phoenix really soon. And then we have many other markets, particularly in the south, coming right on the heels of that. And of course, by the end of the year, we'll have them all opened.

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Operator [72]

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The next question comes from Jade Rahmani of KBW.

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Ryan John Tomasello, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [73]

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This is Ryan on Jade. In terms of gross margins, can you quantify the approximate differential between entry-level and first-time move-up product versus your other products, and similarly, the difference between your spec build and non-spec homes?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [74]

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So I think we just mentioned that there's a couple of 100-basis-point benefit to our strategic product, which is entry-level and first-time move-up versus what we're currently exiting out of, which is anything higher level, luxury, second-time move-up. There's a slight benefit on the entry-level versus first-time move-up, but they're fairly similar. It depends on the community and its geography. So those are fairly consistent. And then I'm sorry, what was your second question?

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Ryan John Tomasello, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [75]

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Just the difference between spec build versus non-spec?

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [76]

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Oh, so entry-level is 100% spec-build, so there is no comparison to to-be-built. That's all we offer, and that's almost half of our business. So there's not really a differential for us between spec and non-spec.

I'll caveat that by saying there is a differential on the second-time move-up between spec and non-spec because we're trying to upload through that inventory a little bit quicker and exit that segment of the market. But for the most part, it's fairly limited between spec and non-spec for us.

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Ryan John Tomasello, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [77]

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And then just in terms of the land market, any noticeable change in competition or prices there or underwriting in response to the choppiness that the market has seen overall?

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [78]

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No, I mean we have seen people -- builders pull away from some things over the last 2 quarters just to fill out the market, but that hasn't resulted in land prices coming down. They're pretty sticky, and they're the last things to move. And now that sales are picking up, we don't really expect them to move that much. So I'd say generally, we haven't seen really any impact to the land market.

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Operator [79]

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The next question comes from Susan Maklari of Crédit Suisse.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [80]

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My first question is just around -- you talked to the improvement that you've been able to see in build times as you've made this transition with your strategy. Can you talk to how much more you think you can realize there? And maybe what are -- how do we think about the constraints that are in place today and what they'll mean for build times even as you fully transition to a more entry-level model?

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [81]

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I mean we're building entry-level homes today in less than 100 days, so we think that's pretty good. We might be able to get that down a little bit more as we continue to drive some efficiency here. There's the constraints of labor, and all the other builders are building homes too, and so we don't think there's a big opportunity to drive that down. We think that's our target is can we build a house in 3 months, that's a pretty good number. So I don't see a lot of opportunities to drive that down any further. But as we continue to make our product more efficient and focus on how we build those houses, again, Steve mentioned a number of times how do we really drive a repeatable cost structure, there'll continue to be some benefits there. But I mean wringing out 2 to 3 weeks in the last year is really we thought -- we think pretty good, and that's why we're going to be sitting.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [82]

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The big impact is going to be as we move $400 million to $500 million of our balance sheet out of these segments, which is entry-level -- I mean which is second move-up from luxury and some active adult that we're not going to continue to pursue and move that money, which is not making much profit for us right now back into the entry-level and the first move-up, it should have a meaningful impact on our ROA, ROE and then our margins over the long term. So that's really what we're focused on. And then I also think that the new Studio M is going to allow us to build our first move-up homes faster, and we'll have some better cycle times there as well. So everything that we're doing today is in the pursuit of our long-term strategy to improve all of our financial metrics.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [83]

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Okay. And then just as a follow-up, you mentioned in your opening remarks some relative strength that you saw in Dallas. Can you just talk to, generally, what you've been seeing in the Texas market and maybe how it compares to your expectations?

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Phillippe Lord, Meritage Homes Corporation - COO & Executive VP [84]

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Yes, I mean I'll go around the horn. San Antonio feels really good to us. I know other builders have suggested it's a more difficult market. We're doing really well there. We have great operations there. We know our markets. We know our product. So we're doing really well there. We feel like that market is strong. We have a strong entry-level business there.

Austin continues to be extremely strong, especially below 300,000. All of our new communities that we have and the new communities that are coming on are generally positioned there. We see tremendous strength below 300,000.

Houston is kind of cats and dogs. The entry-level is strong. Certain move-up places are strong. Second move-up is slow. But overall, pretty healthy market.

And then Dallas is just -- it's highly competitive. It's gotten very unaffordable. It's very sensitive to interest rates. The move-up is much slower than the entry-level. We need a lot more entry-level. We haven't pivoted as hard there. It's coming. But Dallas is probably the choppiest market of the 4, and we see sort of buyer resistance, buyers wanting big incentives, especially in the move-up. Overall, it's a strong market, especially if you're in the entry-level business like some of our competitors, but it's a very choppy market.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [85]

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Yes. I'd say, also in Dallas, we had the best month in March in Dallas since the last cycle, since 2006 by a long distance. I mean we really killed it in March. And we're not really exactly sure why the stars, the sun, the moon all lined up in March in Dallas. It's not as good this month. But I'd also say we have 14 entry-level communities in the pipeline that are all going to be open in the next 12 months or so in the Dallas metro area that are going to dramatically reposition our product to much more entry-level focus in that market.

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Operator [86]

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And the last questioner today will be Jay McCanless of Wedbush.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [87]

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So I guess on the 2 MU and other, what is you all's internal timeline for getting those sold through and out of the way? Because I think at this point, it seems like there's still potentially some earnings and revenue volatility as you guys try to move through this in fits and starts?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [88]

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Well, it's still like 15% of our business. I don't think it's going to be all gone this year. But within the next 4 to 6 quarters, it'll drop down below 10%, being closer to 5% and it'll become less relevant. So -- but as we continue to make that pivot, it'll continue to be a drag. But we won't be down to 0 for quite a while.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [89]

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We're not wholesale discounting this to get it off the books at large charges. We're selling it at low margin, and we're getting it off the books as quickly as possible. But this is still a viable product. We're not wholesale discounting.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [90]

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Yes.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [91]

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And then just a request, if you guys could start breaking that out, the 2 MU versus the entry-level, breaking that out in the orders in closing, I think that would give us a better sense of where organic growth is in your core strategy.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [92]

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Yes, it's too small of a number for us to start breaking it at that level of detail...

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [93]

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I don't think people do that necessarily.

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Hilla Sferruzza, Meritage Homes Corporation - CFO & Executive VP [94]

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Yes, that's going to create some other headaches for us. So I mean it's going to -- I think we've been pretty clear it's going to taper off. There's going to be some continuing volatility from those incentives through the rest of '19. And then by 2020, it stops being a meaningful impact in the financials.

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [95]

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We'll try to continue to give you color on every call, but I just don't know that we can get that detailed.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [96]

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And just one other quick question. What are you hearing from investors from the single-family rental guys? Is there an opportunity maybe for you guys to move some of this 2 MU and even the land associated with it, move it off to some of those folks and help you get through that quicker?

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [97]

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They don't want 2 MU. What they want is entry-level. And we've talked to them and the prices that they're offering, really we can't make money. So we haven't had really any success selling to them our product. I mean we have more of a premium entry-level product. They generally buy more of a stripped-down entry-level product. And we've been asked about why don't we just build communities for the single-family rental market, and the answer to that is why would we build for them and sell it at wholesale when we can build it for ourselves and sell them at retail and make money on it? So again, we're not tone deaf to the whole segment. We've certainly examined it and explored it but can't seem to figure out a way where it really makes sense for us.

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Operator [98]

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

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Steven J. Hilton, Meritage Homes Corporation - Chairman & CEO [99]

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Thank you very much for your participation in our first quarter earnings call, and we look forward to speaking with you again here over the summer when we conclude our second quarter. Thank you very much. Have a great day.

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Operator [100]

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