Meritage Homes Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparative figures are for Q1 2015 unless otherwise stated. The financial statements are unaudited. Meritage builds single-family homes across nine states in the West, Central and East regions and operates a title company.
Financial results and position
- Revenue: Home-closing revenue rose 15.1% to $595.6 million. Total closing revenue, including land sales, was $597.8 million, up from $518.7 million. Home closings increased 11.5% to 1,488; average sales price increased 3.3% to $400,300.
- Orders and backlog: Net home orders were 1,987, up 0.4% in units and 2.8% in value to $804.6 million. Quarter-end backlog grew 15.7% to 3,191 homes, valued at $1.35 billion (+21.1%); average backlog sales price rose 4.7% to $422,000. Cancellation rate was 11%, unchanged.
- Profit: Net earnings increased 27.9% to $21.0 million; diluted EPS was $0.50 versus $0.40. Pretax earnings were $28.9 million versus $25.3 million. The effective tax rate fell to 27.4% from 35.2%, helped by federal energy tax credits applicable to prior years and the homebuilding manufacturing deduction.
- Margins and costs: Home-closing gross profit increased to $103.3 million, but gross margin declined to 17.4% from 18.5%. Management cited higher land and labor costs and targeted pricing concessions. G&A was nearly flat at $29.6 million and declined to 5.0% of total closing revenue from 5.7%.
- Cash flow and liquidity: Operating cash use was $81.8 million, versus $38.2 million, largely reflecting a $116.0 million increase in real estate inventory. Investing cash use was $4.0 million; financing cash use was $4.2 million. Cash declined $90.0 million from year-end to $172.2 million. The $500 million revolving facility had no borrowings; $471.9 million was available after letters of credit. Management said liquidity was strong.
- Debt and equity: Notes and other borrowings totaled $1.119 billion; senior and convertible notes, net, were $1.094 billion. Debt-to-capital was 46.6% and net debt-to-capital 42.4%, versus 47.0% and 40.4% at year-end. The company reported compliance with debt covenants and no debt maturities until 2018.
- Other: Real estate inventory was $2.219 billion, up from $2.098 billion at year-end. Stockholders’ equity was $1.284 billion. The company declared no cash dividends and did not expect to do so in the foreseeable future.
Material changes versus Q1 2015
- Revenue and closings grew, but home orders were nearly flat; management attributed subdued order growth partly to fast sellouts in California and Colorado and slower Houston demand amid oil-price uncertainty.
- Regional order performance diverged: West order units fell 11.3%, while Central rose 6.1% and East rose 9.9%. East backlog value increased 31.5%; total company backlog value grew 21.1%.
- Higher closings and sales prices supported earnings, while lower gross margin reflected cost inflation and selective discounts. Higher revenue improved overhead leverage.
- Operating cash use more than doubled, primarily as real estate investment increased. Cash was lower, though the company retained substantial cash and undrawn revolving capacity.
Outlook, risks and unusual items
- Management described housing conditions as supported by affordability, economic growth, wage and employment gains, and household formation, and expected a slow but steady industry recovery. It provided no specific numerical earnings or revenue guidance.
- Meritage planned to acquire and develop strategic lots, maintain or moderately grow community count, expand market share, target first-time buyers, and reinvest cash generated from inventory sales. It expected near-term cash outlays for land, development and construction to exceed operating cash generation.
- Key risks include mortgage-rate increases and weaker housing demand, land and labor availability and costs, slower absorption or higher cancellations, inventory impairments or option-deposit write-offs, construction and warranty claims, severe weather, and the company’s leverage and financing needs.
- Warranty reserves increased by $441,000 for updated estimates of claims on prior deliveries; the reserve totaled $22.3 million at quarter-end. Management cautioned actual warranty costs could differ from estimates.
- The company paid $16.6 million in January 2016 to resolve South Edge joint-venture lender judgments. Remaining litigation concerned attorneys’ fees, for which Meritage said it was fully reserved; it was also pursuing arbitration claims against former co-venturers to recover amounts paid or potentially payable.
- Management said it might seek additional debt or equity capital, with no assurance of acceptable terms; equity financing could dilute shareholders and debt could increase interest costs. It reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether order trends in West and Houston stabilize, and whether backlog converts to closings without elevated cancellations.
- Whether gross-margin pressure from land, labor and pricing concessions persists or worsens.
- Whether cash use and land-development spending remain within liquidity and covenant capacity; monitor cash, inventory, and net debt-to-capital.
- Progress and potential costs or recoveries from the South Edge litigation and arbitration, including the remaining attorneys’ fees matter.
- How much Q1 earnings benefited from prior-year energy tax credits and whether future tax rates are comparable.
- Warranty claims and reserve adequacy, as well as any changes in land-option commitments, impairment assumptions, or capital-raising plans.