Meritage Homes Corporation — FY 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. Meritage designs and builds single-family homes across the West, Central and East regions, with operations in eight states. It ended the year selling in 188 communities and entered the Nashville market through an acquisition.
Financial and operating performance
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Total closing revenue | $1.815 billion | $1.194 billion |
| Home closing revenue | $1.783 billion | $1.184 billion |
| Net earnings | $124.5 million | $105.2 million |
| Diluted earnings per share | $3.25 | $3.00 |
| Home closing gross margin | 22.0% | 18.4% |
| Cash used in operating activities | $86.3 million | $220.5 million |
| Cash, investments, securities and restricted cash | $363.8 million | $295.5 million |
| Notes and other borrowings | $905.1 million | $722.8 million |
- Closings rose 24.1% to 5,259 homes; average closing price increased 21.3% to $339,100. Home orders rose 17.1% to 5,615 units, and year-end backlog grew 25.9% to 1,853 homes valued at $686.7 million.
- Cancellation rate improved to 12.8% from 13.2%. Active communities increased to 188 from 158, and controlled home sites increased 23.3% to 25,662.
- Q4 2013 total closing revenue was $536.2 million, closing gross profit was $123.6 million, and net earnings were $46.1 million.
- Debt-to-capital was 51.8%; net debt-to-capital was 39.1%. The $200 million unsecured revolver had no borrowings and $157.9 million available after letters of credit at year-end.
Material changes and unusual items
- Revenue and earnings benefited from higher closings, higher average prices, improved demand and expanded community count. Gross margin improvement reflected pricing power, a shift toward more desirable locations and larger homes, and construction cost leverage.
- Operating cash flow remained negative as the company invested in land, development and home construction. Management said these cash outlays were expected to exceed cash generated from operations in the near term as the business expanded.
- In 2013, Meritage issued $175 million of 4.50% notes due 2018 and added $100 million to its 7.15% notes due 2020; it redeemed the remaining $99.8 million of 7.731% subordinated notes due 2017. Debt extinguishment expense was $3.8 million. The revolver capacity was increased to $200 million.
- In January 2014, after year-end, the company raised approximately $110.5 million net from a public equity offering.
- Income tax expense was $53.2 million in 2013. Comparisons with 2012 are affected by the substantial 2012 tax benefit from reversal of deferred-tax valuation allowances; the remaining allowance was reversed in 2013.
- The company recorded $1.0 million of real-estate impairments in 2013, versus $2.0 million in 2012. It reported a $22.0 million warranty reserve and $16.5 million in reserves for non-warranty litigation and asserted claims.
Outlook, commentary and risks
- Management expected improving housing-market conditions to continue into at least 2014 and said it expected to deliver substantially all year-end backlog during 2014, subject to cancellations and replacement contracts. The filing provides no specific earnings or revenue guidance.
- Management described a slower second half of 2013, citing successive price increases and higher mortgage rates; in some strong markets it prioritized price increases over sales pace.
- Key risks include higher mortgage rates or tighter credit, weaker housing demand, cancellations, falling home prices, rising land, labor and material costs, labor shortages, construction delays, regulatory and environmental constraints, and potential real-estate impairments.
- South Edge/Inspirada litigation: A court entered a $15.75 million judgment against Meritage in 2013 on a disputed repayment guarantee. Meritage appealed and posted a $16.05 million supersedeas bond. Related arbitration claims were stayed pending the appeal; a separate $9.8 million infrastructure-cost claim was dismissed. The ultimate outcome remains uncertain.
- Management reported compliance with credit-facility covenants at year-end. The independent auditor issued an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether backlog converts to closings at expected prices and margins, and whether cancellation rates remain controlled.
- How much operating cash flow is consumed by land purchases, development and inventory growth, and the company’s liquidity after the 2014 equity offering.
- Debt maturities, interest costs, revolver availability and continued covenant compliance.
- The outcome and potential financial effect of the South Edge/Inspirada appeal and related arbitration.
- Whether warranty reserves and real-estate carrying values remain adequate if housing demand, prices or absorption weaken.