Meritage Homes Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Meritage designs and builds single-family homes across the West, Central and East regions, with financial-services operations. The August 2014 Legendary Communities acquisition expanded the East region into Georgia and South Carolina and affects year-over-year comparisons.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Home-closing revenue | $591.0 million | $502.8 million | $1,108.3 million | $908.6 million |
| Total closing revenue, including land | $597.8 million | $505.6 million | $1,116.5 million | $913.9 million |
| Net earnings | $29.1 million | $35.1 million | $45.5 million | $60.5 million |
| Diluted earnings per share | $0.70 | $0.85 | $1.10 | $1.48 |
| Home-closing gross margin | 19.3% | 21.9% | 18.9% | 22.3% |
- Q2 home closings increased 13.7% to 1,556 homes, while average selling price rose 3.3% to $379,800. First-half closings rose 16.7% to 2,891 homes and average selling price increased 4.5% to $383,400.
- Gross margin pressure reflected higher land costs, lower-margin newer East-region operations, Legendary acquisition accounting adjustments and West-region impairments. Management reported an 80-basis-point sequential margin improvement from Q1 2015.
- Q2 financial-services profit was $4.1 million, up from $3.6 million. Q2 interest expense rose to $4.6 million from $1.4 million, primarily reflecting credit-facility borrowings during the quarter and the new notes. The effective tax rate declined to 29.7% from 36.5%, helped by tax credits and a Texas tax-rate change.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $217.0 million, versus $103.3 million at year-end 2014. Total assets were $2.587 billion; stockholders’ equity was $1.168 billion.
- First-half operating cash use was $76.9 million, compared with $170.6 million in the prior-year period, primarily reflecting investment in real estate inventory. Investing activities used $8.0 million; financing activities provided $198.7 million.
- Debt and other borrowings totaled $1.139 billion, including $1.104 billion of senior and convertible notes. In June, the company issued $200 million of 6.00% senior notes due 2025. Debt-to-capital was 49.4%, compared with 45.7% at December 31, 2014; net debt-to-capital was 44.1%, compared with 42.9%.
- The $500 million revolving credit facility had no borrowings at quarter-end; $17.6 million of letters of credit left $482.4 million available. The company reported compliance with its covenants. In July 2015, after quarter-end, the facility maturity was extended to July 2019 and its accordion capacity increased to $600 million.
Operating trends, outlook and risks
- Q2 net orders increased 20.6% to 1,986 homes; order value rose 25.4% to $775.8 million. Backlog at June 30 increased 25.1% to 3,188 homes, valued at $1.297 billion; average backlog price rose 8.9% to $406,800. The cancellation rate improved to 11% from 13%.
- Active communities rose to 240 from 175 a year earlier. The East region drove much of the growth, including acquired Georgia and South Carolina operations. Texas orders declined year over year, while West-region orders increased.
- Management cited job growth, consumer confidence and low interest rates as supportive market conditions. It expected continued growth in new communities during 2015 and planned to reinvest cash in strategic land and lot positions. No specific earnings or revenue guidance was provided. Management expected near-term land, development and construction outlays to exceed operating cash generation.
- Key business sensitivities include mortgage and borrowing rates, homebuyer access to financing, lot availability and costs, labor and materials inflation, sales absorption and cancellations, weather-related delays, warranty/construction-defect claims, and the ability to integrate acquisitions and scale newer divisions.
- A long-running South Edge joint-venture dispute remained on appeal. A court judgment and related attorneys’ fee award totaled approximately $16.6 million; enforcement was stayed by a $16.9 million bond. The company disputes liability and has recorded legal reserves, but the ultimate outcome is uncertain. Total non-warranty litigation reserves were approximately $15.5 million.
- The company had $92.1 million of deposits on land under option or contract and 15,705 lots under contract or option, with an indicated purchase price of $976.7 million. Most option agreements do not require the company to purchase the lots; non-refundable deposits and related costs may nevertheless be at risk.
Most important facts for investors to verify
- Whether order, backlog and community growth convert into closings and cash generation, particularly in newer East-region markets and Texas.
- Whether gross margins recover as land and construction costs, West-region pricing and acquisition-related accounting adjustments evolve.
- Debt-service capacity and covenant headroom as leverage increased and interest expense rose; also confirm the terms and availability of the amended credit facility.
- The outcome and potential cash exposure from the South Edge litigation, warranty claims and other contingencies.
- Land commitments, deposit exposure and the pace of cash investment in real estate relative to operating cash flow.