Meritage Homes Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Meritage designs and builds single-family homes, primarily for first-time and first move-up buyers, across nine states in the West, Central and East regions. It also operates a title agency. Results are unaudited.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Home closing revenue | $863.1 million | $872.4 million | $1,561.7 million | $1,600.9 million |
| Total closing gross profit | $157.4 million | $158.8 million | $274.2 million | $281.9 million |
| Home closing gross margin | 18.4% | 18.3% | 17.6% | 17.7% |
| Net earnings | $50.8 million | $53.8 million | $76.2 million | $97.7 million |
| Diluted EPS | $1.31 | $1.31 | $1.97 | $2.37 |
| Operating cash flow | — | $113.3 million | $(10.5) million |
- Q2 home closings rose 5.3% to 2,253, while average selling price fell 6.1% to $383,100; management attributed the price decline primarily to the shift toward more affordable homes. First-half closings rose 4.0%, while average price fell 6.2%.
- Q2 orders increased 21.6% to 2,735 homes; first-half orders increased 14.3% to 5,265. At June 30, backlog was 3,680 homes valued at $1.477 billion, up 1.7% in units but down 3.4% in value year over year.
- Financial-services profit was $6.0 million in Q2 and $10.7 million for the first half, both above the prior-year periods. Q2 selling costs were 7.0% of home closing revenue; general and administrative expense was 4.0%.
- Cash and cash equivalents were $407.4 million, versus $311.5 million at year-end 2018. Real estate inventory was $2.736 billion. Cash flow from operations improved principally because real estate levels remained relatively flat, versus a $155.8 million inventory increase in the first half of 2018.
- Total debt, including senior notes and other borrowings, was approximately $1.308 billion. Debt-to-capital was 42.1% and net debt-to-capital was 33.4%. No revolving-credit-facility borrowings were outstanding; $724.4 million was available after letters of credit. The $780 million facility was extended to July 2023, and the company reported covenant compliance.
Changes versus prior year
- Q2 net earnings declined 5.6%, despite slightly higher home-closing gross margin, largely reflecting $3.2 million of interest expense versus $44,000 a year earlier. Management attributed the increase in expensed interest to less interest capitalized as inventory turned more efficiently.
- First-half net earnings declined to $76.2 million from $97.7 million. Lower closing gross profit, higher interest expense and a $3.7 million decrease in other income contributed; first-half 2018 other income included a $4.8 million litigation settlement.
- The effective tax rate was 23.8% for the first half of 2019 versus 18.6% in 2018. The prior period benefited from a $6.3 million tax provision reduction related to retroactively extended energy-efficient home credits. The 2019 rate included benefits from additional energy credits and equity compensation.
- Share repurchases reduced the weighted-average share count. The company repurchased and retired 208,840 shares for $9.0 million in the first half; $91.0 million remained under its $100 million authorization.
Outlook, commentary and risks
- Management cited positive buyer sentiment, low mortgage rates, low unemployment and wage growth, and expects demand for affordable new homes to remain favorable. Approximately 85% of active communities targeted first-time or first move-up buyers, who represented about 90% of Q2 orders.
- Management expects improved backlog conversion and simplified product offerings to support margin improvement and overhead leverage in the second half of 2019. It gave no specific full-year numerical guidance in the provided filing text.
- The company plans to reinvest much of operating cash in strategic land and lot positions, and said near-term needs and growth are expected to be funded from ongoing operations. It may seek additional debt or equity capital, but availability and terms are not assured. It does not expect to pay cash dividends in the foreseeable future.
- Key risks include mortgage-rate increases and reduced mortgage availability, land, labor and material costs, slower sales absorption, cancellations, inventory impairments, severe weather, geographic concentration, and construction-defect and warranty claims.
- Total warranty reserves were $20.9 million. Reserves include claims involving alleged Florida stucco defects and a Texas community foundation matter. The insurer initially denied the claim for the Texas matter; the company disputes the denial and believes reserves are sufficient, taking potential recoveries into account. Future repair costs and recoveries remain uncertain.
- A $1.7 million Q2 charge related to selling a community that no longer fit the company’s strategy affected land-closing gross loss. First-half G&A included $3.1 million of one-time severance and accelerated equity-compensation costs.
Important facts for investors to verify
- Whether higher order volume converts into closings and revenue, particularly as average selling prices and backlog value have declined.
- Whether the affordable-home strategy can sustain or improve gross margins while managing incentives, construction costs and overhead.
- The timing and cost of land purchases and development, and the resulting effects on operating cash flow and inventory levels.
- Debt maturities, refinancing conditions, interest expense and continued compliance with credit-facility covenants.
- Developments in the Texas foundation and Florida stucco matters, including insurance and contractor recoveries and any required changes to warranty reserves.