Meritage Homes Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless otherwise noted. Meritage builds single-family homes across West, Central and East regions and operates title and other financial-services businesses. It was selling in 189 communities at quarter-end.
Financial and operating performance
- Homebuilding: Home-closing revenue was $405.8 million, up 22.7%; 1,109 homes closed, up 5.4%, and average closing price rose 16.4% to $365,900. Total closing revenue, including land sales, was $408.3 million.
- Margins and earnings: Home-closing gross margin increased to 22.8% from 19.5%. Earnings before tax were $39.8 million versus $16.5 million; net earnings were $25.4 million versus $12.0 million. Diluted EPS was $0.62 versus $0.32. The effective tax rate rose to 36.2% from 26.9%.
- Orders and backlog: Net orders were 1,525 homes, down 1.4% in units, while order value rose 6.7% to $555.0 million. Average orders pace declined to 8.1 per community per month from 9.5. Cancellation rate was 13% versus 11%. Quarter-end backlog increased 25.0% in value to $835.9 million and 15.4% in units to 2,269.
- Regional trends: Central and East were the principal growth drivers; Central orders increased 26% and East orders 21.8%. West orders fell 26%, and West backlog units declined 15.9%, despite higher average prices.
- Cash flow and liquidity: Operating cash used was $131.7 million versus $0.1 million used in Q1 2013, principally reflecting a $134.8 million increase in real estate inventory and lower payables/accruals. Cash and equivalents were $261.0 million; cash plus investments and securities totaled $338.7 million, down from $363.8 million at year-end. Investing cash provided $5.1 million and financing cash provided $113.4 million.
- Debt and capital: Notes and other borrowings totaled $904.9 million, broadly unchanged from year-end; no revolving-credit borrowings were outstanding. The $200 million facility had $164.4 million available after letters of credit. Debt-to-capital was 47.9% and net debt-to-capital 36.6%, compared with 51.8% and 39.1% at year-end. All debt was fixed-rate.
- Balance sheet and equity: Total assets were $2.13 billion and stockholders’ equity was $982.6 million. A January stock offering issued 2.53 million shares and generated $110.4 million net proceeds.
Changes, outlook and management commentary
- Management attributed improved earnings and margins mainly to higher selling prices, favorable community positioning and increased closings. Cost increases partly offset price gains. Financial-services profit was $3.0 million, essentially flat year over year.
- Management expected revenue and profitability to improve for the remainder of 2014, citing backlog value up 25% and units up 15.4%. It cautioned that margin growth was not expected to continue at the same pace and could moderate, particularly in softer markets.
- Management reported generally favorable housing conditions but noted slower sales pace, reduced affordability and buyer adjustment to higher mortgage rates and home prices. It expected community count to grow moderately and planned continued land acquisition and development; near-term land and inventory spending was expected to exceed operating cash generation.
- Meritage entered Nashville through its 2013 Phillips Builders acquisition and was no longer operating in Nevada, although it continued to market 174 Nevada lots. Nevada asset write-downs contributed to a $1.0 million land-sale gross loss in Q1.
Risks, contingencies and unusual items
- South Edge/Inspirada litigation: A court judgment and subsequent attorneys’ fee award totaled approximately $16.6 million, and the company posted an amended $16.9 million bond while appealing. Related arbitration is stayed pending the appeal. Meritage disputes liability, has recorded a reserve it considers appropriate, and said it did not expect a material adverse effect; the outcome remains uncertain.
- Real estate inventory rose to $1.54 billion from $1.41 billion. Results depend on estimates of future community costs and recoverability; changes in costs, demand or selling prices could require impairment charges.
- Other key risks include mortgage-rate increases, slower order absorption, construction-cost inflation, lot availability, cancellations, warranty/construction-defect claims, and the possibility of losses on land options, guarantees or legal matters. The company reported $17.2 million in legal reserves and $21.5 million in warranty reserves.
- There were no Q1 debt-extinguishment charges, compared with $0.7 million in Q1 2013. The higher 2014 tax rate reflects differences in tax credits and other tax benefits recognized in the prior-year period.
Important facts for investors to verify
- Track whether backlog converts to closings and earnings, particularly given weaker West orders and the 13% cancellation rate.
- Assess the sustainability of the 22.8% home-closing gross margin as demand and pricing moderate and construction costs rise.
- Monitor inventory investment, land-development spending and operating cash flow; Q1 operating cash use was substantial despite higher earnings.
- Review the South Edge appeal, the related reserve and potential cash exposure, along with warranty and other litigation claims.
- Confirm liquidity and covenant headroom, including facility availability, as land and inventory investment continues.