Meritage Homes Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Meritage builds single-family homes across the West, Central and East regions and operates a title business. Financial amounts below are in millions unless otherwise stated.
Business context and operating results
Management described housing markets as generally improving, but at a more moderate pace than in 2013, with rising home prices weighing on affordability. Meritage ended the quarter with 225 actively selling communities, including 32 added through its August acquisition of Legendary Communities, which expanded its presence in Atlanta and Greenville and increased its Charlotte operations.
- Q3 home closings revenue was $545.5, up 12.9% year over year; 1,522 homes closed, up 7.3%, and average selling price rose 5.2% to $358,400.
- Net orders were 1,500 homes, up 15.4%; order value increased 21.0% to $573.6. Backlog was 2,705 homes valued at $1,043.7, up 23.5% in units and 29.6% in value year over year.
- For the first nine months, home closings revenue was $1,454.1, up 16.3%; 3,999 homes closed, up 5.5%. Net orders increased 4.2% to 4,672.
- Regional performance was uneven: Texas Central and the East grew, aided by acquisitions; West revenue fell 11.4% in Q3, with weaker closings in Arizona and California. Management cited softening demand in Arizona.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total closing revenue | $556.8 | $492.1 | $1,470.7 | $1,278.5 |
| Home-closing gross margin | 20.4% | 22.8% | 21.6% | 21.5% |
| Pre-tax earnings | $47.0 | $56.8 | $142.0 | $111.8 |
| Net earnings | $32.6 | $38.2 | $93.0 | $78.4 |
| Diluted EPS | $0.79 | $0.99 | $2.27 | $2.05 |
- Q3 home-closing margin declined 240 basis points, which management attributed mainly to higher land costs and moderating prices in the West; Legendary purchase-accounting adjustments and Arizona community impairments also reduced margins. Year-to-date margin was slightly higher than the prior year.
- Q3 commissions and other sales costs were $40.2 (7.4% of home-closing revenue), versus $33.5 (6.9%) a year earlier. General and administrative expense was $29.2, up from $24.4. Management cited community openings, staffing, newer markets and acquisition-related costs.
- Cash and cash equivalents were $84.1 at September 30, down from $274.1 at December 31, 2013; investments and securities were $9.9, making combined cash and investments $94.0. Operating cash use was $236.2 for the first nine months, versus $39.5 in 2013, primarily reflecting a $350.9 increase in real estate inventory and land-development spending.
- Investing cash use was $67.2, including $130.7 for Legendary; financing cash provided $113.4, primarily from the January equity offering, which raised $110.4 net. Cash declined by $190.0 over the nine-month period.
- Total debt was $904.6, principally fixed-rate notes, with no revolver borrowings. The $400 credit facility had $375.7 available after letters of credit. Debt-to-capital was 46.1%; net debt-to-capital was 43.4%, up from 39.1% at year-end, as cash and investments fell.
- Total assets were $2,272.8, total liabilities $1,216.1 and stockholders’ equity $1,056.7 at quarter-end. Meritage reported compliance with credit-facility covenants.
Material changes, outlook and risks
- Legendary was acquired for approximately $130.7 in cash, with an estimated earn-out of about $10.0 over three years. It added approximately 4,800 lots under control and 185 homes to quarter-end backlog. Meritage recorded $22.7 of acquisition goodwill.
- Meritage issued 2.53 million common shares in January 2014 for net proceeds of $110.4. The increased share count contributed to diluted EPS growing less than net earnings year to date.
- Management expected continued order and revenue growth for the remainder of 2014, supported by community growth, acquisitions and demand, but gave no quantified earnings, revenue or margin guidance. It expected near-term cash outlays for land and development to exceed operating cash generation and intended to reinvest cash in strategic lots.
- Management anticipated Legendary purchase-accounting adjustments would pressure East-region margins in the near term, with the effect expected to fade over subsequent quarters. It also cited reduced affordability, market-specific demand changes, labor and material cost increases, mortgage rates, cancellations and competition as risks to results.
- South Edge/Inspirada litigation remains material: a court entered judgments totaling approximately $16.6, and Meritage appealed and posted an amended $16.9 bond. The company disputes liability, has recorded a reserve, and says the outcome should not materially adversely affect its financial condition; the appeal and related arbitration remained pending.
- Other items include $15.7 of reserves for non-warranty litigation and claims, $21.5 of warranty reserves, and $249.6 of outstanding surety bonds. Management said significant bond draws were unlikely. It did not expect to pay dividends in the foreseeable future.
Important facts for investors to verify
- Whether backlog converts to closings at expected prices and margins, particularly given weaker West-region demand and the rise in affordability concerns.
- How much margin pressure persists from land costs, Arizona impairments and Legendary acquisition accounting.
- Whether continued land investment, inventory growth and acquisition spending can be funded without materially reducing liquidity or increasing leverage.
- The integration and performance of Legendary, including its lot positions, earn-out and contribution to reported growth.
- The status and potential financial outcome of the South Edge/Inspirada appeal and arbitration, and whether reserves remain adequate.
- Any further share issuance or debt financing, which could dilute shareholders or increase financing costs.