Business Context and Reporting Period
Company: Meritage Homes Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2010
Business Overview: Meritage is a leading designer and builder of single-family homes in the southern and western United States, operating in three regions (West, Central, East) across six states. The company focuses on first-time, move-up, luxury, and active adult buyers. In 2010, the company returned to profitability, closed 3,700 homes, and actively sold in 151 communities.
Key Financial Metrics
| Metric | 2010 | 2009 |
|---|---|---|
| Total Closing Revenue | $941.7 million | $970.3 million |
| Net Income (Loss) | $7.2 million | ($66.5 million) |
| Gross Profit | $167.7 million | $4.1 million |
| Adjusted Gross Margin (excl. impairments) | 18.5% | 13.5% |
| Operating Cash Flow | $32.6 million | $184.1 million |
| Total Debt | $605.8 million | $605.0 million |
| Cash, Equivalents & Investments | $412.6 million | $391.4 million |
| Net Debt-to-Capital Ratio | 27.9% | 30.6% |
| Backlog (Units) | 778 | 1,095 |
| Backlog (Value) | $201.8 million | $287.5 million |
Material Changes vs. Prior Period
- Revenue: Total closing revenue decreased 2.3% to $941.7 million, driven by a 8.4% reduction in homes closed (3,700 vs. 4,039), partially offset by a 6.6% increase in average sales price ($254,200 vs. $238,400).
- Profitability: The company returned to net income of $7.2 million in 2010, compared to a net loss of $66.5 million in 2009. This improvement was aided by a significant reduction in real estate impairments ($6.5 million in 2010 vs. $126.2 million in 2009) and improved gross margins.
- Backlog: Ending backlog decreased 29.8% in value and 28.9% in units due to lower sales volume and faster construction/delivery cycles.
- Debt Restructuring: The company issued $200 million of 7.15% senior notes due 2020 and used proceeds to repurchase $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.
- Regional Performance: The East Region (Florida) saw revenue increase 61.4%, while the Central Region (dominated by Texas) saw revenue decrease 9.7% due to a reduction in active communities.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management anticipates a "difficult but profitable year" in 2011. While signs of stabilization exist in some markets, the company expects continued volatility due to economic uncertainty, high unemployment, and limited mortgage financing. The company plans to redeploy cash to acquire well-positioned lots to increase active communities as demand stabilizes.
Key Risks & Contingencies:
- Market Conditions: Continued weakness in the homebuilding industry, high foreclosure rates, and restrictive mortgage underwriting standards pose significant risks to sales volume and pricing.
- Chinese Drywall Litigation: The company is a defendant in lawsuits regarding defective Chinese drywall in homes built in 2005-2006. As of year-end, $2.0 million in warranty reserves were accrued for repairs and defense costs. Management believes existing reserves are sufficient but acknowledges potential for additional costs if the scope expands.
- Joint Venture Litigation: Meritage is involved in litigation regarding a Nevada-based joint venture where lenders are seeking damages on completion guarantees. The company believes its potential share of any award will not be material and that existing legal reserves are sufficient.
- Impairments: Further declines in the homebuilding market could require additional write-downs of real estate inventory and option deposits.
Investor Verification Checklist
- Backlog Conversion: Verify the company's ability to convert the reduced backlog of 778 units into revenue in 2011 given the competitive market environment.
- Impairment Trends: Monitor quarterly reports for any resurgence in real estate impairments, which significantly impacted earnings in prior years.
- Debt Covenants: Confirm continued compliance with debt covenants, specifically the Fixed Charge Coverage Ratio (actual 1.691 vs. required 2.0) and Leverage Ratio (actual 1.275 vs. required 3.0).
- Chinese Drywall Exposure: Track updates on the Chinese drywall litigation to ensure the $2.0 million reserve remains adequate and no new claims emerge.
- Lot Acquisition Strategy: Assess the success of the strategy to acquire finished lots in strategic submarkets to drive future margin expansion.