Meritage Homes Corporation — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Financial statements are unaudited. Meritage builds single-family homes across the West, Central and East regions of the United States.
Financial performance and operating metrics
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total closing revenue | $492.1 million | $342.6 million | $1,278.5 million | $829.1 million |
| Net earnings | $38.2 million | $6.8 million | $78.4 million | $10.0 million |
| Diluted earnings per share | $0.99 | $0.19 | $2.05 | $0.30 |
| Home closings | 1,418 | 1,197 | 3,791 | 2,998 |
| Home closing gross margin | 22.8% | 18.6% | 21.5% | 18.2% |
Q3 home closing revenue rose 44.3% to $483.1 million; closings increased 18.5% and average closing price increased 21.8% to $340,700. Q3 home orders rose 8.0% to 1,300 units, with average order price up 19.7% to $364,600. Backlog at quarter-end was $805.6 million, up 64.6% year over year, representing 2,190 homes versus 1,618.
For the first nine months, home closing revenue rose 52.4% to $1,249.9 million; closings increased 26.5% and average closing price rose 20.5% to $329,700. Home orders increased 21.2% to 4,484 units.
Cash flow, balance sheet and debt
- Cash and cash equivalents were $177.6 million at September 30; investments and securities were $92.8 million and restricted cash was $40.9 million, totaling $311.3 million of cash, investments and restricted cash.
- Operating cash flow was negative $39.5 million for the nine months, compared with negative $132.3 million in 2012. Real estate inventory increased $221.7 million, reflecting land acquisition, development and home construction.
- Debt and other borrowings totaled $798.3 million, versus $722.8 million at year-end 2012. Net debt was $487.0 million; debt-to-capital was 50.2% and net debt-to-capital 38.1%.
- No revolver borrowings were outstanding. The amended unsecured credit facility has $135 million of commitments and matures in July 2016; the company reported compliance with its covenants.
- In March, Meritage issued $175 million of 4.50% senior notes due 2018 and repurchased its remaining $99.8 million of 7.731% notes due 2017. The transactions generated $3.8 million of debt-extinguishment charges. The company reported no debt maturities before 2018.
Material changes and management commentary
- Management attributed stronger results to improving housing demand, price increases, favorable community locations, higher closing volume and operating leverage. Price increases more than offset construction cost increases during the period.
- Management said Q3 order pace moderated somewhat amid higher mortgage rates, higher home prices and seasonal summer softness; the company emphasized maximizing pricing and profitability over sales pace in some markets.
- Management expected improving revenue and profitability for the remainder of 2013 and moderate housing-market growth in upcoming quarters. It expected year-end active communities of approximately 185, versus 179 at September 30. Management anticipated home closing margins could remain stable or rise modestly in the near term, but normalize at a somewhat lower level over time.
- The company opened 27 communities and closed out 13 during Q3. It entered Nashville through the August acquisition of Phillips Builders, acquiring approximately 500 lots; the acquisition contributed 30 homes to backlog at quarter-end. Meritage reported six Q3 closings and 11 orders in Tennessee.
- The Q3 cancellation rate was 14%, compared with 13% a year earlier. Management noted this remained somewhat below historical averages.
- Real estate inventory increased to $1.35 billion from $1.11 billion at year-end. The company recorded $0.6 million of real estate impairments in Q3 and $0.8 million year to date, and stated it did not expect material future impairments in its underperforming or mothballed communities based on conditions then known.
Risks, contingencies and unusual items
- Housing demand is sensitive to mortgage rates and buyer access to financing. Management also cited risks from slower sales absorption, price changes, land availability, labor and material costs, development delays, cancellations, and construction-defect and warranty claims.
- South Edge/Inspirada litigation remains significant. A court entered a $15.75 million judgment against Meritage related to a repayment guarantee; the company appealed and posted a $16.05 million bond that stayed enforcement. Related arbitration is stayed pending the appeal. Meritage disputes liability and has claims against former joint-venture partners. A separate $9.8 million claim for future infrastructure costs was dismissed. The company had $16.8 million in reserves for non-warranty litigation and asserted claims, including this matter.
- Surety bonds outstanding were $165.9 million and letters of credit were $40.5 million. The company said it believed significant draws were unlikely. Certain non-refundable land-option and purchase deposits, totaling $32.9 million for committed lots, could be at risk if transactions do not proceed.
- Management noted that additional debt or equity financing may be pursued, but availability and terms are uncertain; equity issuance could dilute shareholders and debt could increase interest expense. The company did not declare cash dividends and did not expect to do so in the foreseeable future.
- Q3 earnings comparisons benefited from the absence of the $8.7 million litigation reserve charge recorded in other expense in Q3 2012. The 2013 nine-month tax provision was $33.4 million; reported effective tax rates were 32.7% for Q3 and 29.9% year to date, while 2012 rates were not considered meaningful due to tax attributes and valuation allowances.
Important facts for investors to verify
- Whether the South Edge appeal changes the judgment, related reserve needs, or potential recovery from co-venturers.
- Whether backlog converts to closings at expected prices and margins, particularly given higher mortgage rates and the 14% Q3 cancellation rate.
- Whether continued land and development spending can be supported by operating cash generation and available liquidity.
- Whether price increases continue to offset higher construction costs and whether margins move toward management’s longer-term expectations.
- How successfully Meritage integrates the Nashville acquisition and expands its active community count toward the stated year-end target.
- Whether warranty, land-option, surety-bond and letter-of-credit exposures remain consistent with reported reserves and management’s assessments.