Business Context and Reporting Period
Company: Meritage Homes Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2009
Business Overview: Meritage is a leading designer and builder of single-family homes in the southern and western United States, operating in three regions: West (California, Nevada), Central (Arizona, Texas, Colorado), and East (Florida). The company focuses on first-time and first-time move-up buyers, utilizing the "Meritage Forward" strategy to streamline operations, reduce costs, and improve affordability.
Key Financial Metrics
| Metric | 2009 | 2008 |
|---|---|---|
| Total Closing Revenue | $970.3 million | $1,523.1 million |
| Net Loss | $(66.5) million | $(291.9) million |
| Loss Per Share (Basic/Diluted) | $(2.12) | $(9.95) |
| Operating Cash Flow | $184.1 million | $199.8 million |
| Cash, Cash Equivalents & Restricted Cash | $391.4 million | $205.9 million |
| Total Debt (Notes & Borrowings) | $605.0 million | $629.0 million |
| Net Debt-to-Capital Ratio | 30.6% | 44.5% |
| Home Closings | 4,039 units | 5,627 units |
| Average Closing Price | $238,400 | $267,500 |
| Backlog (Units) | 1,095 | 1,281 |
| Backlog Value | $287.5 million | $338.0 million |
Margins: Home closing gross margin was 1.9% in 2009 (including impairments) compared to 0.4% in 2008. Excluding impairments, the adjusted gross margin was 13.5% in 2009 versus 13.3% in 2008.
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 36.0% year-over-year, driven by a 28.2% reduction in home closings and a 10.9% decrease in average closing prices.
- Improved Profitability: Net loss narrowed significantly from $(291.9) million in 2008 to $(66.5) million in 2009. This improvement was aided by a $9.4 million gain on the extinguishment of debt and a $88.3 million income tax benefit resulting from the Worker, Homeownership, and Business Assistance Act of 2009, which allowed for a five-year net operating loss (NOL) carryback.
- Impairments: The company recorded $129.0 million in pre-tax real estate-related impairments in 2009, down from $263.4 million in 2008. Additionally, $71.0 million in option deposits and pre-acquisition costs were written off in 2009.
- Liquidity Strengthening: Cash and cash equivalents increased by approximately $185.5 million to $391.4 million, bolstered by operating cash flows and the collection of $108.4 million in income tax refunds.
- Debt Reduction: Total debt decreased by $24.0 million. The company retired $24.1 million of senior subordinated notes by issuing common stock at a 41% discount.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management believes the housing market is bottoming out, citing stabilization in average home prices and declining inventory months' supply. The company plans to continue focusing on lower price points (Simply Smart Series) to target first-time buyers. They expect to deliver substantially all homes in the current backlog during 2010. While sales orders increased 24% in Q4 2009, the company anticipates continued volatility in 2010 and expects cash expenditures for land purchases to potentially exceed cash generated by operations as they rebuild lot positions.
Key Risks and Contingencies:
- Market Conditions: Continued economic recession, high unemployment, and limited mortgage availability remain significant headwinds.
- Chinese Drywall: The company identified 76 homes in Florida containing defective Chinese drywall and accrued $6.0 million for repairs. While they believe current reserves are sufficient, there is uncertainty regarding potential health effects and the scope of the issue.
- Joint Ventures: Two large Nevada-based joint ventures are in default of debt agreements. Lenders have filed lawsuits seeking damages under completion guarantees. Meritage's exposure is limited but subject to litigation outcomes.
- Valuation Allowance: The company maintains a full valuation allowance against deferred tax assets ($92.6 million) due to uncertainty in future profitability, though they expect to realize tax refunds in early 2010.
Investor Verification Checklist
- Tax Refund Realization: Verify the receipt of the expected $92.5 million in federal tax refunds in early 2010, which is critical to the 2009 net loss reduction.
- Backlog Conversion: Monitor the conversion rate of the $287.5 million backlog into revenue in 2010, given the risk of cancellations in a volatile market.
- Chinese Drywall Exposure: Track any new litigation or claims related to defective drywall to ensure the $6.0 million accrual remains adequate.
- Joint Venture Litigation: Review updates on the Nevada joint venture lawsuits to assess potential liability beyond the impaired investment value.
- Land Acquisition Strategy: Evaluate the success of the strategy to acquire bargain-priced finished lots and the impact on future gross margins.