Business context and reporting period
Meritage Homes Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. The company builds single-family homes across West, Central and East regions in the western and southern United States. It had 145 active communities at quarter-end and announced entry into Raleigh-Durham, North Carolina, with sales expected to begin in the second half of 2011.
Financial and operating results
Unless otherwise indicated, amounts are in millions; financial statement amounts are unaudited.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Closing revenue | $220.1 | $291.4 | $397.7 | $493.2 |
| Net income (loss) | $0.6 | $4.2 | ($6.1) | $6.8 |
| Basic and diluted EPS | $0.02 | $0.13 | ($0.19) | $0.21 |
| Home closing gross margin | 18.0% | 18.2% | 17.6% | 18.5% |
| Gross margin excluding impairments | 18.3% | 18.3% | 17.9% | 18.6% |
| Operating cash flow | Not separately presented by quarter | ($32.7) | $58.8 |
- Q2 home closings fell 29.1% to 856; average closing price rose 6.5% to $257,200. First-half closings declined 23.9% to 1,534, while average price increased 6.1% to $259,200.
- Q2 net orders increased 1.1% to 910 homes, with order value up 3.2% to $236.0 million. The cancellation rate improved to 15% from 20%.
- Quarter-end backlog was 994 homes valued at $260.8 million, down 4.8% in units and 10.9% in value year over year, but up 54 units sequentially from March 31.
- Gross margin excluding impairments was flat year over year in Q2, but declined 70 basis points for the first half. Management attributed the first-half erosion chiefly to price concessions on older communities and soft market conditions, with some material and labor cost increases.
- Cash and cash equivalents were $167.6 million, investments and securities $199.2 million, and restricted cash $10.3 million at June 30. Together these totaled $377.1 million, down $35.6 million from December 31, 2010.
- Notes payable totaled $606.1 million, nearly unchanged from year-end. Debt-to-capital was 54.9%; net debt was $229.0 million and net debt-to-capital was 31.5%, versus 27.9% at year-end.
- Cash from investing activities was $94.6 million, principally reflecting net maturities of investments and securities. Financing cash flow was $1.8 million; cash increased $63.6 million to $167.6 million during the half.
Changes versus the prior comparable period
Revenue and earnings weakened against the first half of 2010, when the federal homebuyer tax credit supported sales and closings. Q2 revenue declined 24.5% and first-half revenue declined 19.2%; the company moved from first-half net income to a net loss. The first-half operating cash outflow of $32.7 million compared with $58.8 million of operating cash inflow a year earlier. Management said the weaker spring selling season and low beginning backlog contributed to lower closings. Q2 orders improved year over year and sequentially, but backlog remained below the prior-year level.
Outlook, risks and unusual items
- Management expected positive year-over-year comparisons in closings, sales and backlog for the remainder of 2011 and believed second-half profitability was achievable if market conditions did not worsen. These expectations were conditional; management said the timing and pace of a housing recovery remained uncertain.
- The company planned to invest in strategic lots and communities. It warned that land purchases and development could cause cash outlays to exceed cash generated from operations as the business expands. It may seek additional debt or equity capital, with no assurance it could obtain acceptable terms.
- All reported debt was fixed-rate: $285 million of 6.25% senior notes due 2015, $125.9 million of 7.731% senior subordinated notes due 2017, and $200 million of 7.15% senior notes due 2020. Management reported covenant compliance. The actual fixed-charge coverage ratio was 1.248 against a stated threshold above 2.00; management said restrictions on additional indebtedness arise only if both specified financial tests are failed.
- South Edge joint-venture lenders demanded $13.2 million under a disputed repayment guarantee. Meritage said it disputed enforceability and did not expect to pay the full demand; the matter remained subject to litigation and/or settlement. The venture’s loan principal was reported at $328 million, and Meritage’s 3.53% investment had previously been fully impaired.
- Warranty reserves were $25.9 million, including estimated costs for confirmed defective Chinese drywall in approximately 100 homes. About 70 homes had been repaired and about 10 were being repaired; investigations and claims for reimbursement continued. Additional findings could require higher reserves.
- The company had accrued approximately $10.1 million for probable, estimable litigation and asserted claims. It also maintained a full valuation allowance against $91.4 million of deferred tax assets, citing uncertainty about future taxable income.
- Real estate impairments were $1.3 million in the first half of 2011 versus $0.8 million in the first half of 2010. No debt-extinguishment loss was recorded in 2011; the 2010 comparison included a $3.5 million loss on debt refinancing.
Important facts for investors to verify
- Whether order growth converts into closings and backlog recovery, particularly given the 10.9% year-over-year decline in backlog value.
- Whether management’s conditional second-half profitability expectation is achieved and how pricing, incentives and costs affect gross margins.
- Cash requirements for land acquisition and development, operating cash flow trends, and whether additional financing is pursued.
- Compliance with debt covenants and the implications of the reported fixed-charge coverage ratio, including any limits on additional borrowing.
- Developments in the South Edge litigation and the ultimate exposure under the disputed guarantee and related claims.
- Whether Chinese drywall investigations or other warranty claims require reserve increases, and whether anticipated insurance or third-party reimbursements are realized.