Meritage Homes Corporation — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Meritage builds entry-level and first move-up single-family homes across the West, Central and East regions, and provides title, insurance and mortgage-related services. It was selling in 291 communities at quarter-end.
Financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Home closing revenue | $1.543 billion | $1.409 billion | $2.805 billion | $2.654 billion |
| Net earnings | $186.8 million | $250.1 million | $318.1 million | $467.3 million |
| Diluted EPS | $5.02 | $6.77 | $8.56 | $12.55 |
| Home closing gross margin | 24.4% | 31.6% | 23.5% | 31.0% |
- Q2 closings rose 8.4% to 3,490 homes; home closing revenue increased 9.5%, with average closing price up 1.1%. For the first half, closings increased 5.1% and home closing revenue rose 5.7%.
- Profitability declined as incentives, including mortgage rate locks and buy-downs, and elevated production costs compressed margins. Q2 margin improved 200 basis points sequentially as incentives were reduced.
- Financial services posted a $2.6 million Q2 loss, including $7.9 million of charges for unused prepaid interest-rate locks. Other income was $12.9 million in Q2, primarily reflecting interest earned on cash.
- Operating cash flow was $355.9 million for the first half, versus cash use of $206.8 million a year earlier. Cash and equivalents were $1.163 billion at June 30, up from $861.6 million at year-end.
- Total debt was $1.155 billion, primarily senior notes; there were no Credit Facility borrowings. Debt-to-capital was 21.4%, and net debt-to-capital was negative 0.2% (net cash position). The amended $835 million revolving facility had $794.9 million available after letters of credit; the company reported covenant compliance.
- Stockholders’ equity was $4.248 billion. The company paid $0.54 per share in dividends during the first half and repurchased $10 million of shares.
Demand, changes and outlook
- Q2 net orders fell 11.3% to 3,340 homes, and order value fell 18.5% to $1.475 billion. The average order price declined 8.1%, mainly because of affordability incentives. The cancellation rate was 12%, down from 13% a year earlier and 15% in Q1.
- Backlog at quarter-end was 3,772 homes worth $1.688 billion, down 47.9% by units and 50.9% by value year over year. Management attributed the decrease to lower orders and strong backlog conversion; Q2 conversion was 89.0%.
- Management said demand had improved from the latter half of 2022 and remained healthy, while acknowledging limited economic visibility and buyers’ need for mortgage-affordability assistance. It expects undersupply in the resale market and favorable demographics to support longer-term demand, particularly for affordable, quick move-in homes. No numerical earnings or revenue guidance was provided.
- Production costs remained elevated from inflation, though slightly lower than in Q2 2022. Construction cycle time for new starts shortened by more than three weeks versus Q1 2023 and was nearing historical averages.
- In June, the Credit Facility was increased to $835 million and extended to June 2028; its accordion feature permits a potential increase to $1.3 billion, subject to conditions. The amendment also eliminated the liquidity and interest coverage covenant and adjusted other terms.
Risks, contingencies and unusual items
- Key exposures include mortgage-rate changes and buyer access to financing, affordability, construction-cost inflation, labor and supply constraints, cancellations, land availability and pricing, weather and natural disasters, and potential real-estate impairments.
- The company reported $36.2 million of warranty reserves, including case-specific reserves for alleged stucco defects in certain older homes and HVAC condensation issues in limited areas. Management said reserves were sufficient, but estimates may change as information develops.
- Outstanding surety bonds totaled $968.7 million, with estimated remaining work of $689.2 million; letters of credit totaled $40.1 million. Management considered significant draws unlikely. Purchase and option agreements covered 35,578 lots with a stated purchase price of $1.494 billion; most agreements do not require purchase, and exposure is generally limited to non-refundable deposits and related costs.
- Management reported no pending legal or warranty matter expected to have a material adverse effect that was not sufficiently reserved. It also disclosed one pending state income-tax examination. The company said the IRA’s energy-efficient-home tax credits lowered its effective tax rate; the IRA’s alternative minimum tax and share-repurchase excise tax had no material reported impact for the period.
Important facts for investors to verify
- Whether margin improvement and reduced incentives can persist while protecting order pace and affordability.
- Whether lower orders and the sharply reduced backlog affect closings, revenue and cash generation in coming quarters.
- How interest rates, construction costs, labor availability and land commitments affect demand, costs and inventory valuations.
- Whether warranty reserves and surety-bond and letter-of-credit exposures remain adequate as claims and development work evolve.
- The sustainability of cash generation, dividends and repurchases, and the terms and availability of revolving-credit liquidity.