Meritage Homes Corporation — Q2 2014 Form 10-Q
Business context and reporting period
For the three and six months ended June 30, 2014, Meritage designed and built single-family homes across the West, Central and East regions in eight states. It also operated a title company and had financial-services joint-venture interests. At quarter-end, it was selling in 175 communities, with base prices of approximately $130,000 to $875,000.
Financial and operating performance
- Q2 revenue and earnings: Home-closing revenue was $502.8 million, up 15.3% year over year, supported by 1,368 closings (+3.6%) and an average sales price of $367,500 (+11.3%). Total closing revenue, including land sales, was $505.6 million. Net earnings were $35.1 million versus $28.1 million; diluted EPS was $0.85 versus $0.74.
- Six-month results: Home-closing revenue was $908.6 million (+18.5%); total closing revenue was $913.9 million. Net earnings were $60.5 million versus $40.2 million, and diluted EPS was $1.48 versus $1.06.
- Margins: Home-closing gross margin was 21.9% in Q2 versus 21.5% a year earlier, but down from 22.8% in Q1 2014. Six-month margin was 22.3% versus 20.6%. Management cited pricing and product mix, with rising land and construction costs and softer markets tempering improvement.
- Orders and backlog: Q2 net orders were 1,647, nearly flat year over year; average order pace declined to 9.0 from 9.8 per average active community. June-end backlog was 2,548 homes valued at $951.6 million, up 11.6% in units and 18.0% in value. Q2 cancellations were 13% of gross orders versus 11% a year earlier.
- Cash flow and liquidity: Cash from operations was negative $174.7 million for the six months, versus negative $19.5 million in 2013, largely reflecting a $234.9 million increase in real estate inventory amid land development and home construction. Cash and investments totaled $290.6 million at June 30, down $73.2 million from year-end. Cash and cash equivalents alone were $230.6 million.
- Debt and capital: Debt was $904.8 million, consisting primarily of fixed-rate notes; no revolving-facility borrowings were outstanding. The new unsecured revolver provides $400 million of commitments, with $373.3 million available after letters of credit. Debt-to-capital was 47.0% and net debt-to-capital 37.6%. The company raised $110.4 million net in a January common-stock offering.
- Other metrics: Financial-services profit was $3.6 million in Q2 versus $4.2 million and $6.6 million for the six months versus $7.2 million. The effective tax rate rose to 36.5% for Q2 and 36.4% for the six months, from 27.0% and 26.9%, respectively.
Material changes versus prior comparable periods
- Higher average selling prices drove revenue and earnings growth, while Q2 unit closings increased only modestly and orders were essentially flat.
- Regional performance diverged: Texas led growth, with Q2 closing revenue up 36.4% and backlog value up 67.4%. East-region closing revenue rose 53.6%, aided by newer markets. West-region closing revenue fell 6.0%; West orders declined 17.4%, reflecting weaker demand in Arizona and normalization in California.
- Operating cash use increased substantially as the company expanded land, development and home inventory investment. Equity issuance and increased cash use occurred alongside a lower net debt-to-capital ratio than at year-end.
- Prior-year results included debt-extinguishment charges and tax benefits that did not recur in 2014, affecting year-over-year comparisons.
Outlook, management commentary, risks and unusual items
Management expected revenue and profitability to improve year over year for the rest of 2014, citing backlog dollars up 18.0% and units up 11.6%. It expected margin growth to moderate, with comparisons becoming more difficult and some markets slowing. No specific full-year numerical guidance was provided. Management planned to grow active communities and lot supply, prioritize profitability over sales pace in many markets, and redeploy cash into strategic land positions. Community openings had been delayed by governmental plan approvals; management expected delayed openings to come online in the third quarter.
- In July 2014, the company agreed to acquire Legendary Communities for approximately $130 million, with an expected third-quarter close. Legendary reported about 500 closings and $156 million revenue in 2013 and controlled approximately 4,000 home sites. Closing and integration remained subject to execution.
- Material operating risks include mortgage-rate increases and affordability, slower orders or higher cancellations, labor and material cost inflation, land availability and valuation, and the company’s substantial inventory and associated cash requirements.
- The South Edge/Inspirada dispute remained under appeal. A court judgment and subsequent attorneys’ fee award totaled approximately $16.6 million; the company had posted an amended $16.9 million bond staying enforcement. The company disputed liability and stated it did not expect ultimate resolution to materially adversely affect its financial condition. The matter was reserved, but its outcome was uncertain.
- Surety bonds totaled $237.4 million, with estimated remaining work of $96.0 million; letters of credit totaled $26.7 million. Management considered significant draws unlikely. Warranty reserves were $20.9 million; actual claims may differ from estimates.
- Management reported compliance with credit-facility covenants at quarter-end. Fixed-rate debt limits direct exposure to rate changes, but higher mortgage rates could weaken homebuyer demand. The company did not intend to pay cash dividends in the foreseeable future.
Important facts for investors to verify
- Whether backlog converts to closings at expected prices, particularly given flat orders, lower sales pace and the higher cancellation rate.
- Whether West-region demand stabilizes and whether pricing, costs and land mix support margins in subsequent quarters.
- How continued land and inventory investment affects operating cash flow, liquidity and leverage.
- The outcome and potential cash exposure of the South Edge litigation and related arbitration.
- Completion, purchase price and integration results for the Legendary acquisition, and the pace of delayed community openings.