Meritage Homes Corporation — FY 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; filed February 17, 2016. The company designs and builds single-family homes across nine states in its West, Central and East regions, and operates a title-services business.
Financial and operating performance
- Revenue: Total closing revenue was $2.568 billion, up 18.2% from 2014. Home-closing revenue was $2.532 billion; land-closing revenue was $36.5 million.
- Profit and margins: Net earnings were $128.7 million, down from $142.2 million; diluted EPS was $3.09 versus $3.46. Home-closing gross profit was $481.9 million, with gross margin declining to 19.0% from 21.2%. Financial-services profit increased to $19.3 million from $16.2 million.
- Cash flow: Operating activities used $3.3 million, an improvement from $211.2 million used in 2014. Investing activities used $16.5 million; financing activities provided $178.7 million. Cash increased to $262.2 million from $103.3 million.
- Debt and liquidity: Debt and other borrowings totaled $1.128 billion; net debt was $865.6 million. Debt-to-capital was 47.3% and net debt-to-capital 40.7%. The $500 million unsecured revolving facility matures in 2019; $472.3 million remained available at year-end. The company reported compliance with its covenants.
- Orders and backlog: Net orders rose 19.4% to 7,100 homes, with order value up 26.1% to $2.823 billion. Year-end backlog increased 27.3% to 2,692 homes, valued at $1.138 billion. Closings rose 11.3% to 6,522 homes; average closing price increased 6.2% to $388,200. Active communities increased to 254 from 229.
- Fourth quarter: Total closing revenue was $781.6 million, net earnings were $52.9 million, and diluted EPS was $1.26.
Changes versus 2014
- Revenue and home-closing volume grew, and orders, backlog and cash balances increased. However, net earnings fell 9.5% as home-closing gross margin compressed by 220 basis points.
- Management attributed margin pressure mainly to higher land and labor costs, weather-related construction delays and a greater contribution from newer, lower-margin East Region operations. Impairments also weighed on margins.
- Interest expense increased to $16.0 million from $5.2 million, including costs associated with the 2015 debt issuance and higher intra-year credit-facility borrowings. A $4.1 million litigation charge also affected the comparison; 2014 included favorable legal settlements.
- Operating cash use improved substantially, but remained negative as the company invested in land, development and home inventory. Year-end controlled lots declined 8.3% to 27,785.
Outlook, risks and unusual items
- Management expects higher land spending in 2016 to replenish the pipeline and support growth. It expects land, development and construction cash outlays to exceed operating cash generation in the near term, while describing current liquidity as strong.
- Management expected to largely catch up on weather-related delays in Dallas and Denver in early 2016. It also expected weaker Houston demand until oil prices stabilized; lower oil prices had affected Houston orders and closings.
- Principal risks include mortgage availability and interest rates, land costs and availability, labor shortages, construction delays, housing-market downturns, inventory impairments, warranty claims and the company’s concentration in its existing geographic markets.
- The company recorded an additional $4.1 million reserve for South Edge joint-venture litigation after an appellate ruling affirmed a judgment. It paid the judgment in January 2016 and said it was fully reserved at year-end; it is pursuing recovery from former co-venturers.
- At year-end, committed land purchase and option contracts covered 8,577 lots with approximately $83.8 million in deposits; total contracts, including uncommitted refundable contracts, covered 12,908 lots with a stated purchase price of $927.3 million. Options and backlog do not ensure future closings or acquisitions.
- No cash dividend was declared, and management said it did not intend to declare one in the foreseeable future. The filing identifies one unresolved state tax examination; management did not anticipate a material adjustment.
Important facts for investors to verify
- Whether margin recovery can offset land, labor and other construction-cost inflation, particularly in the West and East regions.
- Whether backlog converts to closings as expected, including cancellation trends, buyer financing availability and average realized prices.
- Whether Houston demand and weather-delayed production improve as management anticipated, and whether newer markets achieve scale and stronger margins.
- Whether operating cash flow turns positive while the company increases land and development spending, and how debt, interest costs and covenant headroom evolve.
- The final cost and recovery prospects for the South Edge matter, and any changes in warranty reserves, land-option exposure or the pending state tax examination.