Meritage Homes Corporation (NYSE: MTH) — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports unaudited quarterly results, including fourth-quarter 2019. Meritage builds single-family homes across nine states in the West, Central and East regions and operates title, insurance and mortgage-related financial services businesses.
Financial and operating performance
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Home-closing revenue | $3.605 billion | $3.475 billion | +3.7% |
| Total closing revenue, including land sales | $3.650 billion | $3.513 billion | +3.9% |
| Home closings | 9,267 | 8,531 | +8.6% |
| Average closing price | $389,000 | $407,300 | -4.5% |
| Home-closing gross margin | 18.9% | 18.2% | +70 bps |
| Net earnings | $249.7 million | $227.3 million | +9.8% |
| Diluted EPS | $6.42 | $5.58 | +15.1% |
| Operating cash flow | $346.8 million | $262.2 million | +32.3% |
| Cash and cash equivalents at year-end | $319.5 million | $311.5 million | +$8.0 million |
| Debt-to-capital / net debt-to-capital | 34.0% / 26.2% | 43.2% / 36.7% | Lower leverage |
Fourth-quarter 2019 total closing revenue was $1.137 billion and net earnings were $103.6 million, versus $1.009 billion and $75.5 million, respectively, in fourth-quarter 2018. Quarterly diluted EPS was $2.65 versus $1.91.
FY2019 home orders rose 18.9% to 9,616 units; order value increased 13.7% to $3.684 billion. Year-end backlog increased 14.3% to 2,782 homes and 8.1% in value to $1.098 billion. The cancellation rate declined to 14.2% from 15.7%. Financial services profit fell to $20.6 million from $24.0 million, partly because mortgage-joint-venture customer incentives were reflected in home-closing revenue rather than financial-services earnings in the fourth quarter.
Material changes and balance-sheet position
- Growth in closings and orders was accompanied by lower average selling prices, consistent with a shift toward entry-level and first move-up homes. About 87% of active communities targeted these buyers, who accounted for approximately 90% of orders.
- Home-closing gross margin improved with construction efficiencies, cost controls and higher volume. Selling commissions and other sales costs declined to 6.8% of home-closing revenue from 7.0%; general and administrative costs increased to 4.1% from 4.0%.
- Meritage redeemed its $300 million, 7.15% senior notes due 2020 in the fourth quarter, recording a $5.6 million early-extinguishment loss. Year-end senior notes, net, were $996.1 million; loans and other borrowings were $22.9 million. No credit-facility borrowings were outstanding.
- Cash from operations was $346.8 million; investing activities used $13.5 million and financing activities used $325.3 million, primarily reflecting repayment of the 2020 notes and $16.0 million of share repurchases.
- The $780 million revolving credit facility was extended to July 2023. After $60.9 million of letters of credit, $719.1 million was available to draw. The company reported compliance with its debt covenants.
- Lots under control rose to 41,399 from 34,553, representing a 4.5-year supply based on 2019 closings. Approximately 85% of lots placed under control in 2019 were designated for entry-level communities.
Outlook, risks and unusual items
- Management cited healthy 2019 housing demand, supported by low mortgage rates, wage growth, low unemployment and demand for affordable homes. It expects the longer-term homebuilding cycle to continue but noted that market outcomes will vary.
- Management is pursuing improved gross margins, cost control and community growth, with a target of 300 actively selling communities by the end of 2021. The filing does not provide quantified earnings or revenue guidance for 2020.
- Management intends to increase land and development spending to replenish lots and support growth. Land purchases and options carry execution, entitlement, development and deposit-forfeiture risks; committed option and purchase contracts totaled about $709.7 million, supported by $47.8 million of cash deposits.
- Key exposures include housing affordability and mortgage rates or credit availability; construction labor and material costs, including tariff-related costs; land and inventory impairments; weather and natural disasters; regulation and development delays; and geographic concentration.
- The company disclosed alleged widespread stucco issues in certain Florida communities and a foundation design/performance matter in one Texas community. Warranty reserves were $22.0 million. The Texas matter included a disputed initial denial of an insurance claim; management said reserves were adequate based on information available, but estimates may change.
- A malware incident affected some systems in the first quarter of fiscal 2020. Meritage said core operations continued and systems had been restored by the report date; cost and insurance analyses were not final, though management did not expect a material adverse effect.
- Other notable items: the effective tax rate fell to 17.6% from 19.7%, including a $19.9 million estimated tax benefit from extension of the energy-efficient homes credit; land sales generated a $1.0 million loss; and the independent auditor issued unqualified opinions on the financial statements and internal controls. Real-estate valuation was identified as a critical audit matter.
Important facts for investors to verify
- Whether order growth and backlog convert into closings while preserving margins as the lower-priced product mix expands.
- How average selling prices, cancellation rates and absorption trends develop by region, especially given fewer active communities at year-end.
- Whether land spending and the 4.5-year lot pipeline support the stated community-growth target without weakening liquidity or returns.
- Actual costs and recoveries associated with the Florida stucco claims and Texas foundation matter, including insurance coverage and adequacy of warranty reserves.
- Debt maturities, credit-facility availability and covenant headroom, alongside cash needs for land development and any further repurchases.
- Final costs, insurance recovery and any continuing operational or data-security effects from the early-2020 malware incident.