Business context and reporting period
Meritage Homes Corporation’s unaudited Form 10-Q covers the three months ended March 31, 2020, compared with the same period in 2019. The company builds single-family homes across the West, Central and East regions and also provides title, mortgage-related and insurance services. Results reflect strong growth before COVID-19 disruptions intensified late in March.
Key financial and operating metrics
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Q1 2020 | Q1 2019 / prior date |
|---|---|---|
| Total closing revenue | $901.0 | $708.1 |
| Home closing revenue; homes closed | $890.4; 2,316 | $698.7; 1,765 |
| Home closing gross profit / margin | $178.4 / 20.0% | $116.5 / 16.7% |
| Financial services profit | $2.8 | $4.7 |
| Income before taxes | $86.8 | $32.4 |
| Net earnings; diluted EPS | $71.2; $1.83 | $25.4; $0.65 |
| Effective tax rate | 18.1% | 21.5% |
| Operating cash flow | $43.9 | $32.3 |
| Cash and cash equivalents, at period end | $797.3 | $319.5 at Dec. 31, 2019 |
| Total debt, including senior notes and borrowings | $1,518.2 | $1,019.0 at Dec. 31, 2019 |
| Debt-to-capital / net debt-to-capital | 43.3% / 26.6% | 34.0% / 26.2% at Dec. 31, 2019 |
| Backlog at period end | 3,568 homes; $1,388.5 value | 3,198 homes; $1,295.3 value |
Material changes versus the prior comparable period
- Total closing revenue increased 27.2%; home closings rose 31.2%, while average home selling price fell 2.9% to $384,500, primarily reflecting a greater share of entry-level homes.
- Home closing gross margin expanded 330 basis points. Management attributed improvement to simpler, more efficient home designs, shorter construction cycles and better overhead absorption.
- Net earnings rose to $71.2 million from $25.4 million. Lower interest expense—following the prior-year period’s interest on notes redeemed in late 2019—and a lower tax rate contributed to the improvement.
- Net cash provided by financing activities was $438.2 million, versus $9.9 million used in Q1 2019. The company drew $500 million on its revolving facility and repurchased $60.8 million of shares.
- Orders rose 22.6% to 3,102 homes, but the average order price declined 1.5%. The overall cancellation rate was 13% versus 12%; March cancellations increased to 16% from 12% a year earlier.
- Financial services profit decreased to $2.8 million, partly because mortgage-joint-venture customer incentives were reflected in home revenue rather than financial services earnings following a change in presentation.
Outlook, risks and unusual items
- COVID-19 had caused significant declines in demand for new-home orders and increased cancellations by the filing date. Management said the duration and financial impact were difficult to estimate; the filing provides no quantified full-year earnings or revenue guidance.
- Construction continued in nearly all markets as an essential service, with virtual or appointment-based sales, remote buyer processes and enhanced health and safety measures. The company reported slower activity than before the pandemic.
- To preserve liquidity, Meritage drew $500 million under its credit facility, deferred or slowed some land acquisition and development, reduced discretionary spending, slowed speculative-home starts and suspended its share repurchase program. It reported $211.4 million of remaining facility availability after letters of credit.
- Management stated that cash and available facility capacity were sufficient to manage through the then-current environment, while noting it could seek additional debt or equity capital and could not assure availability on acceptable terms.
- COVID-related risks include weaker orders and closings, lower selling prices and margins, mortgage credit tightening, supply-chain and labor disruption, increased costs, restrictions on construction and potential real estate or goodwill impairment. Management reported no goodwill impairment indicators at March 31, 2020.
- Credit-facility and senior-note covenants were reported in compliance. Routine legal and construction-defect matters include Florida stucco and drainage claims; total warranty reserves were $22.1 million. Management believed reserves were sufficient but noted estimates could change as facts develop.
- There was no material change to previously disclosed risk factors apart from the added pandemic risk. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Subsequent quarterly order pace, cancellations, backlog conversion and average selling prices as pandemic effects developed.
- Whether liquidity, credit-facility availability and covenant headroom remained adequate, including the cost and availability of any further financing.
- Whether reduced land spending, construction starts and discretionary costs affected future community count, deliveries and margins.
- Developments in the Florida warranty matters and whether warranty reserves or real estate valuations required adjustment.
- The sustainability of Q1 margin expansion and earnings, given lower financial-services profit and the temporary tax benefits noted in the filing.