Meritage Homes Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with Q1 2012 unless otherwise noted. Meritage builds single-family homes across the West, Central and East regions, and operates a developing title-services business. It had 168 active selling communities at quarter-end.
Financial and operating performance
- Revenue and earnings: Home and land closing revenue was $336.4 million, up 64.6% from $204.4 million. Home closing revenue alone rose 62.1% to $330.7 million. Net earnings were $12.0 million, versus a $4.8 million loss; diluted EPS was $0.32 versus a $0.15 loss.
- Margins and expenses: Home closing gross margin improved to 19.5% from 17.2%. Commissions and other sales costs fell to 7.8% of home closing revenue from 9.3%; G&A fell to 5.9% of total closing revenue from 7.2%. Financial services profit increased to $3.1 million from $1.6 million. Interest expense declined to $5.1 million from $7.4 million.
- Demand and backlog: Orders rose 35.2% to 1,547 homes, and closings increased 38.6% to 1,052. Average closing price rose 17.0% to $314,400. Quarter-end backlog was 1,967 homes valued at $669.0 million, up 51.3% in units and 89.4% in value year over year. Cancellations were 11% of gross orders, compared with 15%.
- Cash flow and liquidity: Operating cash flow was a use of $0.1 million, compared with a $55.4 million use in Q1 2012. Cash and cash equivalents were $325.0 million; investments and securities were $88.9 million and restricted cash was $38.9 million, totaling $452.9 million. Cash increased $154.6 million during the quarter, mainly reflecting debt issuance.
- Debt and capital: Debt was $881.2 million at March 31, up from $722.8 million at year-end. Debt-to-capital was 55.3%; net debt-to-capital was 37.6%. The company issued $175 million of 4.50% senior notes due 2018 and repurchased $16.7 million of its 7.731% notes due 2017. It redeemed the remaining 2017 notes after quarter-end; management said this would leave no debt maturities until 2018. The revolver was undrawn, and the company reported compliance with its covenants.
- Balance sheet: Total assets were $1.77 billion and stockholders’ equity was $711.6 million at March 31, 2013. Real estate inventory was $1.15 billion.
Changes, outlook and management commentary
Management attributed stronger results to improving housing demand, higher order volume and prices, well-located communities, product mix and operating leverage. It said price increases had more than offset construction cost increases in most markets. Regional home gross margins were 21.0% in West (16.1% prior year), 16.7% in Central (unchanged), and 18.8% in East (20.8% prior year).
Management expected active selling communities to reach approximately 185 by year-end, compared with 168 at quarter-end, and anticipated improved bottom-line results for the rest of 2013 based on backlog, orders and pricing trends. These are outlook statements, not quantified earnings guidance. The company expected land acquisition and development cash outlays to exceed operating cash generation in the near term as it replenished lot supply. It reported buying about 700 lots for $36.9 million, spending $38.3 million on land development and starting 1,308 homes in Q1. Nevada operations were winding down, with remaining construction expected to be completed in 2013.
Risks, contingencies and unusual items
- Debt extinguishment and taxes: Q1 earnings included a $0.7 million loss on early debt extinguishment; the April 2013 redemption was expected to generate approximately $3.0 million of additional charges. The Q1 tax provision was $4.4 million, including an approximately $2.1 million tax-effected benefit from the retroactive extension of the energy-efficient home tax credit.
- South Edge/Inspirada litigation: Meritage disputes claims tied to a Nevada joint venture. A court had ruled that JP Morgan could pursue a repayment-guarantee claim and that Meritage was liable, a ruling the company challenged. Related claims include approximately $13.2 million under the guarantee, a $13.5 million arbitration demand concerning the same alleged obligation, and a separate $9.8 million demand for alleged infrastructure costs. The company reported a $16.2 million reserve for non-warranty litigation and asserted claims, including this matter, and said it did not expect the ultimate outcome to materially harm its financial condition. Outcomes remain uncertain.
- Other exposures: Real-estate valuations and impairment tests depend on estimates of selling prices, costs, absorption and discount rates. Management reported $46,000 of real-estate impairment charges in Q1 2013, versus $293,000 in Q1 2012, but cautioned that changing market conditions could cause future impairments. Warranty reserves were $21.4 million; actual claims could differ from estimates. Surety bonds and letters of credit were also outstanding, and management said significant draws were unlikely.
- Market risks: Higher mortgage rates could reduce homebuyer demand and adversely affect revenue, margins and earnings. Other cited risks include land and labor availability and costs, cancellations, construction defects, development delays, competition, and the company’s leverage and ability to access capital. Results are seasonal and interim results may not indicate full-year performance.
Important facts for investors to verify
- Whether order growth, backlog conversion, pricing and gross-margin improvement continued after March 31, 2013, and whether the year-end community-count outlook was achieved.
- How much operating cash flow funded land purchases and development, and whether liquidity remained adequate as investment spending increased.
- The post-quarter repayment accounting and total costs of retiring the 2017 notes, including the additional extinguishment charge.
- Developments and potential exposure in the South Edge/Inspirada litigation and whether reserves remained adequate.
- Whether real-estate valuations, warranty claims and construction-cost trends changed materially after quarter-end.