Meritage Homes Corporation — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 19, 2019. The filing also reports fourth-quarter results. Meritage builds single-family homes across nine states in the West, Central and East regions, with a focus on first-time and first move-up buyers, and operates a title company.
Financial and operating results
| Metric | FY 2018 | FY 2017 | Change or context |
|---|---|---|---|
| Total closing revenue | $3.513 billion | $3.227 billion | Up 8.9%; home-closing revenue was $3.475 billion, up 9.0%. |
| Home closings | 8,531 | 7,709 | Up 10.7%; average closing price declined 1.5% to about $407,300. |
| Home-closing gross profit / margin | $632.0 million / 18.2% | $562.1 million / 17.6% | Margin improved 60 basis points. |
| Pre-tax earnings | $283.3 million | $247.5 million | Up 14.4%. |
| Net earnings / diluted EPS | $227.3 million / $5.58 | $143.3 million / $3.41 | Net earnings up 58.7%; diluted EPS up 63.6%. |
| Operating cash flow | $262.2 million provided | $87.1 million used | 2018 benefited from earnings and much lower real-estate investment. |
| Cash and cash equivalents | $311.5 million | $170.7 million | Up $140.7 million. |
| Debt and leverage | $1.310 billion debt; 43.2% debt-to-capital; 36.7% net debt-to-capital | $1.284 billion; 44.9%; 41.4% | No Credit Facility borrowings at year-end; $706 million remained available. |
Fourth-quarter 2018 total closing revenue was $1.009 billion, closing gross profit was $188.7 million, net earnings were $75.5 million and diluted EPS was $1.91. The filing’s quarterly table does not separately provide fourth-quarter home-closing margin.
Material changes and business trends
- Orders rose 1.7% to 8,089 units, but order value fell 1.7% to $3.240 billion as average order price declined 3.3% to about $400,600, reflecting the shift toward lower-priced homes.
- Year-end backlog fell 15.4% to 2,433 homes and 18.5% in value to $1.016 billion. Management attributed the decline to slower late-year orders, higher cancellations and strong fourth-quarter closings. The cancellation rate increased to 15.7% from 13.4%.
- Results varied by region: East closing revenue rose 21.8%, Central rose 11.3%, while West was essentially flat. West orders declined 7.0%, with a marked slowdown in California.
- Active communities increased to 272 from 244. About one-third of year-end communities and over 40% of 2018 orders were entry-level product.
- The effective tax rate decreased to 19.7% from 42.1%, reflecting the lower federal corporate tax rate and energy tax credits, among other items. The 2017 rate included a $19.7 million deferred-tax revaluation charge; 2018 included a favorable $2.7 million tax adjustment.
Liquidity, debt and capital allocation
Meritage issued $200 million of additional 6.00% senior notes due 2025, bringing that issue to $400 million, and used proceeds to repay borrowings associated in part with redeeming $175 million of 4.50% notes due in 2018. It also extended and increased its unsecured revolving credit facility to $780 million, maturing in July 2022. At year-end, $74 million of letters of credit reduced drawable capacity to $706 million. The company reported compliance with debt covenants.
Land and development spending was $209.2 million lower than in 2017. The company controlled 34,553 lots, including 24,009 owned lots, and reported a 4.1-year lot supply based on 2018 closings. It repurchased $100 million of stock during 2018, retiring 2.6 million shares; a new $100 million authorization was approved in February 2019. The company said it did not expect to pay cash dividends in the foreseeable future.
Outlook, risks and unusual items
- Management expects demand for affordable new homes to remain supported over the longer term, but described the next several quarters as uncertain or potentially “choppy” as buyers adjust to higher home prices and interest rates. It expects to deliver substantially all year-end backlog homes during 2019 and planned additional community openings, particularly for first-time and first move-up buyers.
- Key risks include mortgage-rate increases or tighter financing, reduced affordability, weaker orders or higher cancellations, home-price declines, and the success of the strategic shift toward entry-level homes. Rising labor, land and materials costs—including tariff-related costs—could pressure margins.
- Other risks include subcontractor labor availability, weather and natural disasters, land entitlement and development delays, regulatory changes, and possible real-estate inventory impairments. The company’s geographic concentration in nine states may amplify regional downturns.
- Warranty and construction-defect matters include a foundation-design issue in one Texas community and alleged stucco defects in Florida communities. The $24.6 million warranty reserve includes case-specific amounts for both matters. The insurer initially denied the company’s claim for the Texas matter; Meritage disputed the denial and stated that it believed reserves and potential recoveries were sufficient.
- Unusual items included a $4.8 million settlement from long-standing Nevada joint-venture litigation, a $2.8 million loss on land closings (versus a $4.4 million gain in 2017), and $6.7 million of home and land impairments. Management reported no pending legal or warranty matter expected to have a material adverse effect beyond amounts sufficiently reserved.
Important facts for investors to verify
- Whether orders, cancellations and backlog stabilize after the second-half 2018 slowdown, particularly in California and other pressured markets.
- Whether the 18.2% home-closing gross margin can be sustained amid cost inflation, incentives and the lower-price product mix.
- The composition and realization of 2018 tax benefits and whether future earnings are comparable absent similar credits or adjustments.
- Developments, insurance recoveries and reserve adequacy for the Texas foundation and Florida stucco matters.
- Liquidity and refinancing plans for the $300 million of 7.15% notes due in 2020, alongside planned land investment and the remaining debt maturities.
- Whether management’s expectation to convert substantially all year-end backlog to closings in 2019 is achieved.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting.