Business Context and Reporting Period
Company: Meritage Homes Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2010
Business Overview: Meritage is a designer and builder of single-family detached and attached homes in the western and southern United States. Operations are aggregated into three reporting segments: West (California, Nevada), Central (Texas, Arizona, Colorado), and East (Florida). As of June 30, 2010, the company was actively selling homes in 148 communities.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2010 |
Six Months Ended June 30, 2010 |
|---|---|---|
| Total Closing Revenue | $291,405 | $493,209 |
| Net Income | $4,166 | $6,826 |
| Net Income Per Share (Diluted) | $0.13 | $0.21 |
| Home Closing Gross Margin | 18.2% | 18.5% |
| Operating Cash Flow (6 months) | $58,845 | N/A |
| Cash and Cash Equivalents | $156,669 | $156,669 |
| Total Debt (Senior Notes) | $605,466 | $605,466 |
| Debt-to-Capital Ratio | 55.0% | 55.0% |
Material Changes vs. Prior Period
- Revenue Growth: Total closing revenue increased 32.2% for the quarter and 9.0% year-to-date compared to 2009, driven by a 35.6% increase in closing units. This surge was largely attributed to the expiration of the federal homebuyer tax credit, which accelerated closings to meet the June 30, 2010 deadline.
- Profitability Turnaround: The company reported net income of $4.2 million for the quarter, a significant improvement from a net loss of $73.6 million in the same period in 2009. Year-to-date net income was $6.8 million versus a loss of $92.0 million in 2009.
- Impairment Reduction: Real estate impairments dropped dramatically to $304,000 for the quarter (and $846,000 year-to-date) compared to $66.2 million (and $76.6 million) in the corresponding 2009 periods.
- Debt Restructuring: In Q2 2010, the company issued $200 million of 7.15% senior notes due 2020. Concurrently, it repurchased $130 million of 7.0% notes due 2014 and $65 million of 6.25% notes due 2015, resulting in a $3.5 million loss on extinguishment of debt.
- Backlog Decline: Order backlog decreased 23.4% year-over-year to $292.6 million, reflecting the post-tax credit sales slowdown in May and June.
Guidance, Outlook, and Risks
Management Commentary: Management anticipates continued volatility in 2010. While the tax credit expiration caused a sales decline in May and June, the company hopes for a recovery in sales absorption in the latter part of the year, similar to the auto industry's recovery after the "Cash for Clunkers" program. The company is focusing on cost reduction, product redesign for affordability, and tight cash flow control.
Risks and Contingencies:
- Chinese Drywall Litigation: The company has reserved $31.2 million for warranty claims, including $2.5 million specifically for Chinese drywall issues affecting approximately 80 homes in Florida. While 75% of affected homeowners have entered repair agreements, litigation remains pending, and total exposure is not definitively estimated.
- Joint Venture Guarantees: The company holds "Bad Boy" guarantees totaling approximately $61.2 million related to an inactive joint venture in default. While the debt is non-recourse, the guarantee could be triggered by specific actions (e.g., bankruptcy filing) by the venture.
- Market Conditions: High unemployment rates and uncertainty in the global economy remain barriers to home-buying decisions. The company expects cash outlays for land purchases to potentially exceed operating cash flow as it seeks to replenish lot inventory.
Investor Verification Checklist
- Backlog Sustainability: Verify the trend of order cancellations and new sales volume post-tax credit expiration to assess future revenue visibility.
- Impairment Trends: Monitor quarterly real estate impairment charges to ensure the significant reduction seen in 2010 is sustainable and not a one-time anomaly.
- Debt Covenant Compliance: Confirm continued compliance with fixed charge coverage and leverage ratios, particularly as the company incurs interest expense that cannot be capitalized.
- Chinese Drywall Exposure: Track the resolution of pending litigation and the adequacy of the $31.2 million warranty reserve against actual claim costs.
- Joint Venture Status: Review the status of the inactive Nevada joint venture and the potential trigger events for the $61.2 million "Bad Boy" guarantee.