Business context and reporting period
Meritage Homes Corporation is a U.S. single-family homebuilder operating across the West, Central and East regions, plus a wholly owned title company. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the first quarter of 2016. At quarter-end, the company was selling homes in 256 communities across nine states.
Financial and operating performance
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Home-closing revenue | $660.6 million | $595.6 million; up 10.9% |
| Total closing revenue, including land | $672.8 million | $597.8 million |
| Net earnings | $23.6 million | $21.0 million |
| Diluted earnings per share | $0.56 | $0.50 |
| Home-closing gross profit / margin | $107.3 million / 16.2% | $103.3 million / 17.4% |
| Operating cash flow | $(84.8) million | $(81.8) million |
| Cash and cash equivalents at period-end | $85.7 million | $131.7 million at December 31, 2016 |
| Total debt, as presented in MD&A | $1,171.4 million | $1,127.3 million at December 31, 2016 |
| Debt-to-capital / net debt-to-capital | 44.7% / 42.8% | 44.2% / 41.2% at December 31, 2016 |
Home closings rose 6.3% to 1,581 units, while average selling price increased 4.4% to $417,800. Net earnings benefited from higher closing revenue and land profit and lower interest expense, partly offset by a higher tax provision. Home orders increased 7.4% to 2,135 units and order value rose 10.9% to $892.7 million. Ending backlog was 3,181 homes, down 10 homes year over year, with value up 1.6% to $1.368 billion. The cancellation rate was 12%, versus 11%.
Operating cash use primarily reflected a $89.2 million increase in real estate inventory as the company invested in land and development. The company purchased approximately 2,300 lots for $134.0 million, spent $73.0 million on land development and started approximately 1,900 homes. Financing activities provided $42.0 million, mainly from net Credit Facility proceeds; cash declined $46.0 million during the quarter.
Material changes versus the prior comparable period
- Home-closing revenue increased $65.0 million, driven by higher volume and average selling prices. The West led growth; East home orders fell 18.6% in units and its backlog declined 17.6% in units.
- Home-closing gross margin contracted 120 basis points to 16.2%, as higher land and construction-material costs outpaced pricing gains. Management also cited community-opening overhead and asset write-offs, including terminated land contracts, which reduced companywide margin by about 30 basis points in each period.
- Interest expense fell to $0.8 million from $3.3 million, primarily because more real estate under development qualified for interest capitalization.
- The effective tax rate rose to 35.9% from 27.4%. The prior-year rate benefited from federal energy tax credits; the enabling legislation expired and had not been renewed for 2017.
- Financial-services profit increased to $4.3 million from $4.0 million. General and administrative expense was essentially flat at $29.6 million, while commissions and other sales costs increased in dollars but declined as a share of home-closing revenue.
Outlook, management commentary, risks and unusual items
Management described housing fundamentals as favorable, citing low ownership costs and stronger first-time-buyer demand, while noting that rising land and construction-material costs are pressuring margins. The company plans to expand community count and lot supply, introduce its LiVE.NOW entry-level-plus product and new regional designs, and focus on cost control, sales pace and overhead leverage. No specific full-year financial guidance was provided.
Management expects cash outlays for land, development and construction to exceed operating cash generation in the near term as it grows the business, and intends to redeploy cash generated from inventory sales. It stated that liquidity was strong but noted that additional debt or equity financing could be sought; availability and terms are not assured. The $540 million unsecured revolving facility had $60.0 million drawn and $47.2 million of letters of credit outstanding, leaving $432.8 million available. The company reported compliance with its facility covenants.
Risks highlighted include higher mortgage or borrowing rates, reduced buyer financing access, land and labor availability and costs, slower sales absorption, cancellations, inventory impairment, construction defects and warranty claims, weather or natural disasters, regulation, competition, and the company’s geographic concentration. The company has $1.014 billion of land purchase and option contracts not recorded on its balance sheet; generally these do not require it to purchase the lots, and exposure is typically limited to nonrefundable deposits and related costs. At March 31, deposits on real estate under option or contract were $78.5 million.
Holders may require repurchase of the $126.5 million principal amount of 1.875% convertible notes on September 15, 2017, the fifth anniversary date, at principal plus accrued interest. Routine construction-defect and warranty matters are described as generally covered by reserves, insurance or indemnities; management did not identify pending matters expected to materially affect the company. The company paid the judgment in a long-running Nevada joint-venture dispute in 2016 and is pursuing arbitration against co-venturers to recover certain amounts. It reported no material warranty-reserve adjustment in Q1 2017.
Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The company has never declared cash dividends and does not expect to do so in the foreseeable future.
Most important facts for investors to verify
- Whether order growth and backlog convert into closings, particularly given East-region order and backlog declines and a higher companywide cancellation rate.
- Whether pricing and operating efficiencies can offset rising land, materials and labor costs and the reported gross-margin decline.
- Whether continued inventory investment sustains negative operating cash flow and increases reliance on borrowings; monitor cash, debt and available revolver capacity.
- The September 15, 2017 convertible-note holder repurchase right and the company’s liquidity plans around that date.
- Changes in land-option commitments, deposits at risk, warranty claims, litigation exposure and the outcome of the arbitration against Nevada joint-venture partners.
- Whether the expired federal energy-credit legislation is renewed and how tax rates compare with the prior-year period.