Meritage Homes Corporation — Q1 2019 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2019, compared with Q1 2018. Meritage builds single-family homes across nine states in the West, Central and East regions, primarily targeting first-time and first-move-up buyers. It also operates a title company and has an investment in a mortgage joint venture.
Financial and operating performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Home closing revenue | $698.7 million | $728.5 million | Down 4.1% |
| Total closing revenue, including land | $708.1 million | $742.6 million | Down 4.6% |
| Home closings | 1,765 | 1,725 | Up 2.3% |
| Average home closing price | $395,800 | $422,300 | Down 6.3% |
| Home closing gross profit | $116.5 million | $124.3 million | Down $7.9 million |
| Home closing gross margin | 16.7% | 17.1% | Down 0.4 percentage points |
| Net earnings | $25.4 million | $43.9 million | Down 42.1% |
| Diluted earnings per share | $0.65 | $1.07 | Down $0.42 |
| Cash from operating activities | $32.3 million | Cash used of $17.3 million | Improved $49.6 million |
- Orders increased 7.3% to 2,530 homes, with order value up 1.5% to $977.0 million. The company ended the quarter with 260 active communities, up 2.8% year over year.
- Backlog was 3,198 homes valued at $1.295 billion, down 8.8% in units and 12.6% in value from March 31, 2018. Management attributed the decline, despite higher orders, to faster conversion of backlog, including closings of speculative inventory.
- Financial services profit rose to $4.7 million from $4.2 million. Land closing revenue was $9.5 million, with $0.4 million gross profit, compared with $14.0 million revenue and a $1.2 million gross loss.
- General and administrative expense increased to $33.6 million from $30.9 million; the 2019 quarter included $2.5 million of one-time severance and accelerated equity-compensation charges. Interest expense rose to $4.1 million from $0.1 million, primarily because less interest was capitalized to real estate inventory.
Balance sheet, debt and liquidity
- At March 31, 2019, cash and cash equivalents were $327.5 million; total assets were $3.396 billion; and stockholders’ equity was $1.743 billion.
- Senior notes, net, were $1.296 billion and loans payable and other borrowings were $13.8 million. The company had no borrowings under its $780 million revolving credit facility and reported $710.7 million available after letters of credit.
- Debt-to-capital was 42.9%, and net debt-to-capital was 36.0%. The company reported compliance with its credit-facility covenants.
- Operating cash flow was $32.3 million; investing cash outflow was $6.3 million and financing cash outflow was $9.9 million. Financing outflow included $9.0 million of share repurchases.
- Real estate inventory was $2.745 billion. The company purchased approximately 1,900 lots for $66.8 million, spent $74.4 million on land development and started 1,966 homes during the quarter.
Material changes and management outlook
- Management described improved homebuyer sentiment and activity, citing lower mortgage rates, improved affordability, low unemployment, wage growth and limited supply of new homes, particularly at entry-level price points.
- The company is shifting product and community focus toward first-time and first-move-up buyers. First-time-buyer communities represented 35.8% of active communities, and these buyers accounted for 44.7% of Q1 orders. Management expects this share to grow as planned community openings come online.
- Management expects simplified product offerings and improved backlog conversion to support better gross margins and overhead leverage as the year progresses. No quantified full-year earnings, revenue or margin guidance is provided in the filing.
- Management said ongoing cash needs and near-term growth are expected to be funded from operations, while noting it may seek additional debt or equity capital. It expects to redeploy much of cash generated into strategic land and lot positions.
- The board authorized a new $100 million share-repurchase program in February 2019. The company repurchased 208,840 shares for $9.0 million during Q1; $91.0 million remained available at quarter-end. Meritage does not expect to pay cash dividends in the foreseeable future.
Risks, contingencies and unusual items
- Key risks include mortgage-rate increases and mortgage availability, affordability and demand, labor and material costs, land availability, slower sales absorption, inventory impairments, cancellations, weather and natural disasters, and construction-defect or warranty claims.
- Total warranty reserves were $23.2 million. These include case-specific reserves for alleged stucco defects in Florida and a foundation design and performance matter affecting one Texas community. The insurer initially denied the company’s claim for the Texas matter; Meritage disputed the denial and said it believed reserves, including expected potential recoveries, were adequate. Outcomes and ultimate costs remain uncertain.
- Outstanding surety bonds were $369.8 million, with estimated remaining work of $163.4 million; letters of credit totaled $69.3 million. Management considered significant draws unlikely.
- Q1 2018 results included a $4.8 million legal settlement from prior litigation and a $6.3 million tax benefit related to retroactively extended energy credits. These items contributed to the lower year-over-year comparison. Q1 2019’s effective tax rate was 21.5%, versus 10.2% in Q1 2018.
- Adoption of the new lease standard on January 1, 2019 added $20.5 million of right-of-use assets and $28.7 million of lease liabilities to the balance sheet, with no income-statement impact upon adoption.
- After quarter-end, Meritage sold its interest in an Arizona land joint venture, reducing its investment in unconsolidated entities by $7.3 million.
Important facts for investors to verify
- Whether order growth and improving spring demand translate into sustained closings, backlog replenishment and pricing power, particularly given lower average selling prices.
- Whether the shift toward entry-level homes improves margins and operating leverage despite incentives, and whether gross margins recover as management expects.
- The composition and conversion of backlog, including regional trends: the West had a 30.8% decline in backlog value, while Central backlog value increased 3.7% year over year.
- The adequacy of warranty reserves and potential insurance or contractor recoveries for the Florida stucco and Texas foundation matters.
- Cash deployment, land commitments and repurchases relative to liquidity, leverage and the company’s stated growth plans.
- That reported interim results are unaudited and may not indicate full-year results; management also identifies seasonal working-capital needs, typically higher in the second and third quarters.