Meritage Homes Corporation — FY2014 Form 10-K
Business context and reporting period. This audited annual report covers the fiscal year ended December 31, 2014, with comparisons to 2013. Meritage designs and builds single-family homes in nine states across its West, Central and East regions, and operates a title business. Its financial statements received an unqualified audit opinion.
Key financial and operating metrics
- Revenue: Total closing revenue was $2.170 billion, up 19.6% from $1.815 billion. Home-closing revenue was $2.142 billion, up 20.1%; 5,862 homes closed, up 11.5%, and average closing price rose 7.8% to $365,500.
- Profit: Net earnings were $142.2 million, versus $124.5 million; diluted EPS was $3.46, versus $3.25. Earnings before tax were $208.4 million. Financial-services profit was $16.2 million.
- Margins: Home-closing gross profit was $453.7 million, or 21.2% of home-closing revenue, compared with $391.9 million, or 22.0%, in 2013. Total closing gross profit, including land sales, was $452.6 million. Management cited weaker West-region conditions, higher land costs and acquisition-accounting adjustments as margin pressures.
- Cash flow: Operating activities used $211.2 million, compared with $77.9 million used in 2013. The main use was a $338.6 million increase in real estate inventory, reflecting land acquisition, development and home construction. Investing activities used $62.9 million; financing activities provided $103.3 million. Cash declined by $170.8 million to $103.3 million.
- Debt and liquidity: Notes, loans and other borrowings totaled $935.2 million at year-end, versus $921.0 million. Net debt was $831.9 million. Debt-to-capital was 45.7% (52.3% in 2013); net debt-to-capital was 42.9% (39.8%). The amended unsecured revolver provides $400 million of commitments; $19.5 million of letters of credit left $380.5 million available, with no revolver borrowing outstanding at year-end. The company reported compliance with covenants.
- Orders and backlog: Net orders increased 5.9% to 5,944 homes, with order value up 12.9% to $2.238 billion. Year-end backlog grew 14.1% to 2,114 homes, valued at $846.5 million, with an average price of $400,400. The cancellation rate rose to 14.0% from 12.8%.
- Q4 snapshot: Fourth-quarter total closing revenue was $698.9 million, gross profit $140.3 million and net earnings $49.2 million; diluted EPS was $1.19. In Q4 2013, the respective figures were $536.2 million, $123.6 million, $46.1 million and $1.19.
Material changes versus 2013
- Revenue, closings, average closing prices and backlog increased, but order growth was more moderate than the prior year and cancellations increased.
- Regional results diverged: Texas home-closing revenue rose 38.7%, while West-region revenue declined 1.8%, with fewer closings partly offset by higher average prices. East-region revenue rose 50.5%, substantially reflecting expanded communities and acquisitions.
- Active selling communities increased from 188 to 229; controlled home sites rose 18.1% to 30,295.
- In August 2014 Meritage acquired Legendary Communities for approximately $130.7 million, entering Atlanta and Greenville and expanding in Charlotte. The acquisition added $22.7 million of goodwill; purchase-accounting adjustments reduced reported margins, and management expected some pressure to continue into 2015.
- The company raised $110.4 million net through an equity offering and increased its revolving credit facility from $200 million to $400 million. Cash nevertheless fell as capital was deployed into land, development, inventory and the acquisition.
- Land-sale gross results shifted to a $1.1 million loss from $4.5 million profit, largely due to sales of remaining Las Vegas assets.
Outlook, commentary and risks
- Management described housing conditions as improving but at a more moderate pace, with significant variation by market. It expects cash outlays for land, development and construction to exceed cash generated from operations in the near term as the business expands. It intends to reinvest proceeds from home closings in strategic lots.
- Management expected to deliver substantially all year-end backlog during 2015, subject to existing contracts and replacement sales following cancellations. It provided no numerical earnings or revenue guidance.
- Management is migrating the acquired Legendary Communities operating model toward its traditional community structure, with the aim of improving order pace and operating leverage. The acquisition’s accounting adjustments were expected to continue weighing on year-over-year margins in 2015.
- Important sensitivities include mortgage availability and rates, home affordability, sales pace and cancellations, land and construction costs, labor and materials availability, and the ability to acquire and develop suitable lots. Management noted potential exposure to lower oil prices in Houston and Colorado and the company’s limited geographic diversification.
- At December 31, the company controlled 30,295 home sites, including 10,622 under option or contract; committed option and purchase contracts had an aggregate purchase price of about $754.7 million and $92.1 million of cash deposits. Options may be terminated, but deposits and related costs could be forfeited.
- Contingency: In the South Edge/Inspirada joint-venture dispute, a court entered judgments against Meritage totaling approximately $16.6 million, including a subsequent attorneys’ fee award. Meritage disputed liability and appealed; a $16.9 million supersedeas bond stayed enforcement. Related arbitration claims were stayed pending appeal. The company had $16.5 million in reserves for non-warranty litigation and asserted claims; the ultimate outcome remains uncertain.
- Other risks include real-estate impairments, construction-defect and warranty claims, regulatory or environmental delays, natural disasters, and the ability to integrate acquisitions. The $22.1 million warranty reserve is based partly on estimates. Management reported effective internal controls, but the control assessment excluded Legendary Communities, acquired in 2014.
Most important facts for investors to verify
- Whether operating cash use moderates and liquidity remains adequate as land and construction spending continues.
- Whether backlog converts to closings and whether order trends, cancellation rates and regional demand improve or weaken.
- Whether acquired-market integration improves order pace and margins, and how long purchase-accounting effects persist.
- The status and potential financial impact of the South Edge/Inspirada appeal, related arbitration and recorded reserves.
- Whether land commitments, option deposits, development costs and inventory values remain supportable under changing market conditions.
- Exposure to mortgage-market changes, construction-cost inflation and economic weakness in concentrated markets, including Houston and Colorado.