Meritage Homes Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Meritage designs and builds homes in the West, Central and East regions across seven states. At quarter-end it was selling in 149 communities. Unless noted otherwise, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Home closing revenue | $217.5 | $233.8 | $615.2 | $725.8 |
| Home closing gross profit | $38.1 | $42.6 | $108.0 | $133.5 |
| Home closing gross margin | 17.5% | 18.2% | 17.6% | 18.4% |
| Net income (loss) | $(3.2) | $1.2 | $(9.3) | $8.0 |
| Basic and diluted EPS | $(0.10) | $0.04 | $(0.29) | $0.25 |
- Q3 closings were 840 homes, down 0.9%; average selling price fell 6.1% to $259,000. For the nine months, closings declined 17.1% to 2,374, while average selling price rose 2.2% to $259,100.
- Gross margin excluding impairments, a company-presented non-GAAP measure, was 17.9% in both Q3 and the nine-month period, versus 18.5% and 18.6%, respectively, in 2010. Management attributed pressure to price concessions, market softness, lower closing volumes and mix.
- Commissions and other sales costs were 9.1% of home closing revenue in Q3 and 8.8% year to date, up from 8.4% and 8.1%. G&A was $16.5 million in Q3 and $46.6 million year to date; as a share of total revenue it rose to 7.6% in both periods.
- Real-estate-related impairments were $1.0 million in Q3 and $2.3 million year to date, compared with $0.8 million and $1.6 million in 2010. Nine-month results in 2010 also included a $3.5 million debt-extinguishment loss.
Cash, liquidity and debt
- Cash and cash equivalents were $157.1 million at September 30, 2011; investments and securities were $189.0 million and restricted cash was $11.1 million. Together these totaled $357.2 million, down from $412.6 million at December 31, 2010.
- Nine-month operating cash flow was a use of $51.2 million, versus $38.2 million provided in 2010. Investing activities provided $102.5 million, largely reflecting net investment maturities; financing activities provided $1.8 million. Ending cash was $157.1 million.
- Real estate inventory was $798.1 million, up from $738.9 million at year-end 2010. Stockholders’ equity was $497.7 million.
- Notes totaled $606.3 million: $285.0 million of 6.25% senior notes due 2015, $125.9 million of 7.731% senior subordinated notes due 2017 and $200.0 million of 7.15% senior notes due 2020. Debt was essentially unchanged from year-end. Debt-to-capital was 54.9%; net debt-to-capital increased to 33.4% from 27.9%.
- The company reported compliance with note covenants. Its disclosed fixed-charge coverage ratio was 1.13 against a stated threshold above 2.00, and leverage ratio was 1.29 against a threshold below 3.00. The filing says both tests must fail for specified restrictions on incurring additional debt to apply.
Operating trends, outlook and risks
- Q3 net orders rose 28.3% to 906 homes, with order value up 33.6% to $245.2 million and average order price up 4.1% to $270,700. Cancellation rate fell to 17% from 24%. Backlog grew 19.0% year over year to 1,060 homes valued at $288.5 million.
- Management expected positive year-over-year sales and backlog comparisons to continue in Q4 2011 and anticipated higher comparative Q4 closings. It described early signs of market improvement but emphasized that sales remained well below historical levels and the timing and pace of a broader recovery were uncertain. No specific earnings or revenue guidance was provided.
- Management said it was controlling overhead and cash use, acquiring and developing strategic lots, and pursuing expansion. It bought about 1,300 lots for $49.3 million and spent $12.2 million on land development in Q3. Raleigh-Durham sales operations began in Q4 2011.
- Management anticipated land-purchase and development outlays could exceed operating cash generation as the business expands. It described liquidity as strong, while noting it might seek additional debt or equity capital; availability and terms were not assured. No debt maturities were due before 2015.
- South Edge joint-venture litigation is a material uncertainty. Lenders demanded $13.2 million under a disputed guarantee; Meritage contests enforceability and reported maximum pro rata exposure of $13.2 million. The company had recorded litigation reserves but did not disclose their specific amount for this matter. A bankruptcy plan approved October 26, 2011, after quarter-end, provided for assignment of the lenders’ claim to four builder partners. Meritage said the ultimate resolution was uncertain and did not expect a material adverse effect.
- Other exposures include approximately $10.2 million of reserves for probable, estimable litigation and $26.1 million of warranty reserves. About 100 homes were confirmed to contain defective Chinese drywall; approximately 80 had been repaired and four were being repaired. Further discoveries or warranty claims could increase costs.
- Key risks cited include weak housing demand, mortgage availability and rates, home prices and cancellations, construction costs, inventory impairments, joint-venture obligations, litigation and warranty claims, leverage and access to capital, and realization of tax assets. The company maintained a full valuation allowance against $92.4 million of deferred tax assets.
Most important facts for investors to verify
- Whether order and backlog growth converts into closings, revenue and improved margins, particularly given the lower average Q3 closing price.
- Cash use, lot acquisition and development spending, and the sustainability of the $357.2 million reported liquidity total.
- The South Edge guarantee and arbitration outcomes, reserve adequacy, and any changes following the post-quarter bankruptcy plan.
- Warranty exposure, including Chinese drywall investigations, repair costs and expected reimbursements.
- Debt-covenant calculations and restrictions, and whether any additional capital is raised and on what terms.