MTH

Meritage Homes Corp. 10-Q Summary (Period Ended June 30, 2009)

Business Context and Reporting Period

This is a Quarterly Report on Form 10-Q for Meritage Homes Corporation, a leading designer and builder of single-family detached homes in the western and southern United States. The report covers the three and six months ended June 30, 2009. The company operates in three reporting segments: West (California, Nevada), Central (Texas, Arizona, Colorado), and East (Florida). As of June 30, 2009, the company was actively selling homes in 178 communities.

Key Financial Metrics

Margins: Home closing gross margin was negative 4.8% for the six months ended June 30, 2009, compared to 3.3% in the prior year period. Excluding impairments, the gross margin was 12.2%.

Material Changes vs. Prior Period

• Revenue Decline: Total closing revenue decreased 39.5% year-over-year, driven by a 32.5% reduction in homes closed (1,822 vs. 2,716) and lower average sales prices ($247.7k vs. $274.5k).
• Increased Net Loss: Net loss widened by $23.2 million compared to the prior year, primarily due to the absence of a $36.2 million tax benefit recorded in 2008 and increased impairment charges.
• Impairments: The company recorded $76.6 million in real estate-related impairments for the six months ended June 30, 2009. This includes a significant $55.4 million write-off related to the abandonment of a 1,200-lot optioned project in North Phoenix.
• Liquidity Improvement: Cash and cash equivalents increased to a record $385.3 million, up from $205.9 million at year-end 2008. This was driven by positive operating cash flows and the collection of $107.7 million in income tax refunds.
• Debt Reduction: Total debt decreased by approximately $24 million due to the retirement of senior subordinated notes via a stock-for-debt exchange.

Guidance, Outlook, and Risks

• Market Outlook: Management notes signs of stabilization in certain markets and improved sales pace during the spring season, though the industry remains impacted by the economic recession, foreclosures, and restrictive mortgage financing.
• Strategic Actions: The company is reducing active community counts, repositioning product to lower price points to compete with foreclosures, and increasing "spec" starts to meet demand for immediate move-in homes.
• Chinese Drywall Contingency: The company identified 44 homes in the Ft. Myers, Florida area with suspected defective Chinese drywall, with up to 50 additional homes potentially affected. Management believes existing warranty reserves ($28.6 million) and insurance are sufficient to cover costs but cannot currently estimate total exposure.
• Joint Venture Risks: Several joint ventures are in default of debt agreements. While debt is generally non-recourse, the company holds "bad boy" guarantees totaling $72.5 million. Management believes exposure is limited but monitors these situations closely.
• Capital Structure: The company plans to terminate its $150 million Credit Facility in the third quarter of 2009 and intends to enter into new credit commitments for letters of credit.

Investor Verification Checklist

• Impairment Sustainability: Verify if the $55.4 million write-off of the North Phoenix project represents the final significant impairment charge or if further option terminations are likely.
• Chinese Drywall Exposure: Monitor updates on the number of affected homes in Florida and the sufficiency of insurance recoveries versus warranty reserves.
• Joint Venture Defaults: Review the status of the four joint ventures in default and the likelihood of "bad boy" guarantees being triggered.
• Backlog Quality: Assess the cancellation rate (23% in Q2 2009) and the ability to convert the current $382 million backlog into revenue given market conditions.
• Debt Covenant Compliance: Confirm continued compliance with the Fixed Charge Coverage and Leverage Ratio covenants on senior notes, especially as the company transitions off its Credit Facility.