Meritage Homes Corporation — Q3 2019 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Meritage builds single-family homes in nine states across the West, Central and East regions, primarily targeting first-time and first move-up buyers. It also operates a title company and has an interest in a mortgage joint venture. The company reported 250 actively selling communities at quarter-end.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Home closing revenue | $939.2 million | $877.7 million | $2,500.9 million | $2,478.6 million |
| Total closing revenue, including land sales | $940.9 million | $884.6 million | $2,513.6 million | $2,504.6 million |
| Home closing gross margin | 19.8% | 18.1% | 18.5% | 17.8% |
| Net earnings | $69.8 million | $54.1 million | $146.0 million | $151.8 million |
| Diluted earnings per share | $1.79 | $1.33 | $3.76 | $3.69 |
| Operating cash flow | Not separately presented for quarter | Not separately presented for quarter | $167.4 million | $73.7 million |
- Q3 homes closed increased 11.9% to 2,419; average selling price declined 4.4% to $388,300, reflecting a higher share of more affordable homes.
- Q3 home closing gross profit rose $27.5 million to $186.1 million. For the nine-month period, it increased $19.3 million to $461.7 million.
- Financial services profit was $5.6 million in Q3, down from $6.3 million; nine-month profit was $16.3 million, slightly above $16.2 million.
- Q3 interest expense was $1.1 million versus $0.1 million; nine-month interest expense was $8.4 million versus $0.2 million. Management attributed the increase primarily to less interest being capitalized as inventory turned over more quickly.
Balance sheet, debt and liquidity
- At September 30, 2019, cash and cash equivalents were $454.8 million, up from $311.5 million at year-end 2018. Total assets were $3.64 billion and stockholders’ equity was $1.87 billion.
- Senior notes, net, were $1.296 billion; loans payable and other borrowings were $14.0 million. Debt-to-capital was 41.1% and net debt-to-capital was 31.3%, compared with 43.2% and 36.7%, respectively, at December 31, 2018.
- The $780 million unsecured revolving credit facility had no borrowings outstanding; $727.3 million remained available after letters of credit. The facility maturity was extended to July 2023. The company reported compliance with its financial covenants.
- Nine-month operating cash flow was $167.4 million; investing cash use was $12.0 million and financing cash use was $12.0 million. Operating cash flow benefited from higher accrued liabilities and accounts payable, as well as lower real-estate investment outflow than in the prior year.
Material changes versus prior comparable periods
- Q3 net earnings increased 29.0%, supported by higher closings and a 170-basis-point improvement in home closing gross margin.
- Nine-month net earnings declined to $146.0 million from $151.8 million despite higher home closing gross profit. The prior-year period included a $4.8 million legal settlement; 2019 also had higher interest and tax expense.
- Orders rose 23.5% in Q3 to 2,258 homes and 16.9% year to date to 7,523 homes. At quarter-end, backlog was 3,519 homes valued at $1.397 billion, up 7.1% in units and 2.2% in value year over year; backlog average selling price was lower.
- Active communities declined to 250 from 264 a year earlier. The Central region’s community count fell as homes sold faster than replacement communities opened.
- The company repurchased 208,840 shares for $9.0 million during the first nine months. $91.0 million remained under the $100 million repurchase authorization at September 30.
Outlook, management commentary and risks
- Management described the Q3 homebuying environment as favorable, citing low mortgage rates, employment and wage trends, and demand for affordable homes. It said the company would continue focusing on first-time and first move-up buyers, simplifying product offerings and construction, improving margins, controlling overhead and growing community count. Approximately 86% of active communities targeted those buyers, who accounted for about 92% of Q3 orders.
- The filing provides no specific numerical earnings or revenue guidance. Management expects near-term cash needs and growth to be funded from ongoing operations, while redeploying much of the cash generated into strategic land and lot positions. It also said additional debt or equity capital could be considered, with no assurance of availability on acceptable terms.
- On October 28, 2019, the company notified holders of its $300 million 7.15% senior notes due 2020 of its intent to redeem them early. The anticipated Q4 redemption was to be funded with cash on hand and includes prepayment of interest through original maturity, discounted to the redemption date.
- Key risks include sensitivity of housing demand and buyer financing to mortgage rates; land, labor and material availability and costs; slower sales absorption and inventory impairment; competition; weather and natural disasters; and construction-defect and warranty claims.
- Total warranty reserves were $21.3 million. Specific reserves include alleged stucco defects in Florida and a foundation design and performance matter in one Texas community. Repairs and related claims remain ongoing; the company said reserves were sufficient, while noting that estimates may change as information develops. Its insurance claim for the Texas matter was initially denied and was disputed.
- Land purchase and option arrangements covered 22,307 lots with a stated purchase price of $956.7 million; most were not recorded as obligations to purchase, and exposure was generally limited to deposits and certain capitalized costs. Surety bonds and letters of credit were also outstanding; management considered significant drawdowns unlikely.
Important facts for investors to verify
- Whether strong order growth and backlog convert into closings without further pressure on average selling prices, incentives or cancellation rates.
- Whether margin gains from simplified products and construction efficiencies persist as the buyer and regional mix changes.
- The eventual costs, insurance or contractor recoveries, and reserve adequacy for the Florida stucco and Texas foundation matters.
- The terms, timing and cash impact of the planned $300 million senior-note redemption, including the discounted prepayment of interest.
- Whether operating cash generation remains sufficient to fund land investment, construction and liquidity needs while maintaining leverage and covenant compliance.