Business Context and Reporting Period
Company: Meritage Homes Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: Meritage is a designer and builder of single-family homes operating in the West (California, Nevada), Central (Texas, Arizona, Colorado), and East (Florida) regions. The company operates 207 active communities as of the reporting date.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 |
|---|---|---|
| Total Closing Revenue | $374,766 | $1,123,493 |
| Net Loss | $(144,013) | $(212,786) |
| Loss Per Share (Basic & Diluted) | $(4.69) | $(7.37) |
| Operating Cash Flow | N/A | $106,152 |
| Cash and Cash Equivalents | $119,027 | $119,027 |
| Total Debt (Notes + Loans) | $629,718 | $629,718 |
| Home Closing Gross Margin | 1.8% | 2.8% |
Note: Total Debt includes $628,926 in Senior/Senior Subordinated Notes and $792 in other borrowings. The revolving credit facility was fully paid down.
Material Changes vs. Prior Period
- Revenue Decline: Total closing revenue decreased 35% in the quarter and 35% year-to-date compared to 2007, driven by a 25% drop in homes closed and a 14% decrease in average sales prices.
- Increased Net Loss: Net loss for the quarter increased to $144.0 million from $118.6 million in the prior year. The year-to-date loss increased to $212.8 million from $160.0 million.
- Impairments: Real estate-related impairments totaled $55.1 million for the quarter and $154.3 million for the nine months, a significant reduction from $216.8 million and $341.7 million in the comparable 2007 periods.
- Backlog Reduction: Order backlog decreased 40% to $612.9 million (2,269 homes) from $1.01 billion (3,379 homes) a year ago.
- Cancellation Rates: The cancellation rate for the quarter was 40%, rising to 45% in September due to the financial crisis.
Outlook, Risks, and Management Commentary
Management Commentary
Management attributes the financial results to the financial crisis, slowing economy, and limited mortgage financing. The company recorded a $106.2 million valuation allowance against deferred tax assets due to uncertainty regarding future taxable income. Strategic initiatives include winding down under-performing operations, reducing lot supply, re-engineering product offerings to lower price points, and aggressively managing cash flow.
Liquidity and Capital Resources
The company generated $106.2 million in operating cash flow for the nine months ended September 30, 2008. Cash balances increased to $119.0 million. The company fully repaid its $82.0 million balance on its Credit Facility. As of September 30, 2008, the company had $337.7 million in additional borrowing availability under the Credit Facility and was in compliance with all debt covenants.
Risks and Contingencies
- Market Conditions: Continued declines in home sales, asset values, and buyer confidence due to the economic downturn.
- Joint Venture Exposure: The company has approximately $29.4 million in limited repayment guarantees and $72.5 million in "bad boy" guarantees related to joint ventures. Two joint ventures are in default of debt agreements, though the company believes exposure is limited.
- Legal Proceedings: A $111 million jury verdict against a former executive is stayed due to the executive's Chapter 11 bankruptcy filing. The company is also a defendant in a lawsuit regarding a completion guarantee for a Las Vegas joint venture, which it intends to vigorously defend.
Investor Verification Checklist
- Deferred Tax Assets: Verify the sustainability of the $106.2 million valuation allowance and the remaining $31.3 million net deferred tax assets.
- Joint Venture Guarantees: Assess the risk of the $29.4 million repayment guarantees and $72.5 million "bad boy" guarantees, particularly regarding the two ventures currently in default.
- Backlog Quality: Monitor the 40% cancellation rate and the ability to convert the remaining $612.9 million backlog into revenue given current financing constraints.
- Covenant Compliance: Confirm continued compliance with the amended Credit Facility covenants, specifically the Minimum Interest Coverage Ratio and Leverage Ratio.
- Inventory Levels: Track the reduction of unsold home inventory and the impact of price concessions on future gross margins.