Meritage Homes Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Meritage designs and builds single-family homes across nine states in its West, Central and East regions, and operates a title company. It had 257 active communities at quarter-end.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Home-closing revenue | $797.8m | $795.8m | $1,458.4m | $1,391.5m |
| Total closing revenue, including land | $802.0m | $797.9m | $1,474.8m | $1,395.7m |
| Home-closing gross margin | 17.7% | 17.3% | 17.0% | 17.3% |
| Net earnings | $41.6m | $39.9m | $65.2m | $60.8m |
| Diluted EPS | $0.98 | $0.95 | $1.54 | $1.45 |
- Q2 closings were 1,906 homes, down 2.3%; average selling price rose 2.6% to $418,600. First-half closings increased 1.4% to 3,487 homes, with average price up 3.3% to $418,200.
- Net cash used in operating activities was $130.7m in the first half, compared with $110.6m used in 2016, primarily reflecting increased real estate investment. Investing cash use was $7.4m. Financing provided $223.2m, including proceeds from the new senior notes. Cash ended at $216.7m, up from $131.7m at year-end.
- Total debt was approximately $1.358bn; debt-to-capital was 47.6% and net debt-to-capital 43.3%, versus 44.2% and 41.2% at year-end. There were no Credit Facility borrowings at June 30; $566.4m remained available after letters of credit. The company reported compliance with its covenants.
Changes and operating trends
- Q2 net earnings increased 4.3%; first-half earnings rose 7.1%. First-half home-closing revenue increased 4.8%, while gross margin declined 30 basis points, attributed largely to first-quarter cost and volume leverage.
- Q2 orders grew 3.9% in units and value; first-half orders grew 5.6% in units and 7.4% in value. Backlog at June 30 was 3,428 homes worth $1.449bn, up 3.4% in units and 3.8% in value year over year. Cancellation rates were 13%, versus 11% in both comparison periods.
- Regional performance diverged: West and Central improved in Q2 closings and operating results, while East closings fell 26.1% and East home-closing margin declined to 14.4% from 15.4%. East order units also weakened. Management attributed East softness partly to lower beginning backlog, delayed community openings and transition to updated product plans.
- Q2 home-closing gross profit included about $1.2m of asset write-offs, mainly price reductions at a slow-moving Southern California community; management said these reduced margin by about 20 basis points companywide.
Outlook, financing and risks
- Management described housing demand as strong, supported by first-time buyers and limited resale-home supply, while noting rising land, labor and material costs constrain margin expansion. It plans to grow communities and lot supply, expand entry-level offerings, and roll out updated East-region products. No numerical earnings or revenue guidance was provided.
- The company issued $300m of 5.125% senior notes due 2027 and repurchased $51.9m principal of convertible notes for $52.1m cash. It intended to redeem the remaining $74.6m convertible notes on September 20, 2017. The Credit Facility was expanded to $625m and extended, with maturities in July 2019 and July 2021.
- Management expects land, development and construction cash outlays to exceed operating cash generation in the near term as it invests in growth. It said liquidity was strong but may seek additional debt or equity financing; financing availability and terms are not assured.
- Key risks include mortgage-rate increases and reduced buyer affordability, land availability and cost, labor and materials inflation, slower sales or higher cancellations, inventory impairment, weather and natural disasters, construction-defect and warranty claims, and the company’s leverage. The 2017 effective tax rate was higher than 2016 because federal energy-credit legislation expired without renewal; rates were 34.2% for Q2 and 34.8% for the first half.
- Routine legal and construction-defect matters were disclosed; management did not believe unreserved matters would materially harm financial condition, results or cash flows. Surety bonds outstanding were $262.7m, with estimated remaining work of $107.2m; letters of credit totaled $58.6m. Management considered significant draws unlikely.
Important facts for investors to verify
- Whether East-region community openings and new products improve orders, closings and margins, and whether cancellation rates remain elevated.
- Whether pricing and operating efficiencies offset land, labor and construction-cost inflation; monitor the East margin and inventory write-offs.
- How land investment affects operating cash flow, debt levels and liquidity as the company redeploys cash into lot acquisition and development.
- Completion and funding of the planned September 2017 convertible-note redemption, and ongoing compliance with debt covenants.
- Potential effects of mortgage-rate changes, expiring tax benefits, warranty claims and other contingencies.