Meritage Homes Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance sheet comparisons are to December 31, 2011. Meritage designs and builds single-family homes in the West, Central and East regions across seven states. It had 150 active selling communities at quarter-end. Unless stated otherwise, dollar amounts below are in millions.
Financial results and key metrics
- Revenue: Total closing revenue was $204.4 million, up 15.1% year over year; home-closing revenue was $204.0 million, up 14.9%. The company closed 759 homes, up 11.9%, while average selling price rose 2.7% to $268,800.
- Profitability: Net loss was $4.8 million, or $0.15 per diluted share, compared with a $6.7 million loss, or $0.21 per share, in Q1 2011. Loss before tax was $4.6 million. Management said closings and gross profit remained insufficient to cover overhead.
- Margins and expenses: Home-closing gross profit was $35.1 million, a 17.2% margin versus 17.1%. Excluding impairments, the non-GAAP gross margin was 17.4% versus 17.5%. Commissions and other sales costs rose to $19.0 million (9.3% of home-closing revenue, versus 8.6%); general and administrative expenses fell to $14.7 million (7.2% of total revenue, versus 8.5%). Interest expense declined to $7.4 million from $8.0 million.
- Cash flow and liquidity: Operating cash use was $55.4 million, versus $24.6 million in Q1 2011, largely reflecting a $52.7 million increase in real estate inventory. Cash and cash equivalents ended at $90.6 million, compared with $173.6 million at year-end 2011. Cash, investments and securities, and restricted cash totaled $276.8 million, down from $333.2 million.
- Debt and leverage: Notes totaled $606.6 million at carrying value. Debt-to-capital was 55.5% and net debt-to-capital was 40.4%, compared with 55.4% and 35.8% at year-end. All debt was fixed-rate at quarter-end. Management reported covenant compliance; disclosed fixed-charge coverage was 1.19 against a stated requirement above 2.00, and leverage ratio was 1.31 against a limit below 3.00. The filing says both ratios must fail to trigger the specified restriction on additional debt incurrence.
- Other metrics: Home orders rose 36.2% to 1,144 units, with order value up 39.8% to $308.3 million. Backlog increased 44.2% year over year to 1,300 homes valued at $353.2 million. The cancellation rate was 15%, versus 17%. Real estate inventory was $868.0 million, up from $815.4 million at year-end.
Material changes versus Q1 2011
- Sales, closings and backlog improved substantially, led by stronger West and East region activity. Central region revenue was broadly flat; Texas closings and average selling price declined.
- Net loss narrowed by $1.9 million. Gross margin was nearly unchanged, while lower G&A and interest expense were partly offset by higher sales costs and lower other income.
- Real estate impairments declined to $0.3 million from $0.7 million. No community-level impairments were recorded in either period; 2012 charges related to individual homes and terminated option costs.
- Operating cash use increased, and the combined cash, investment and restricted-cash balance fell, as the company invested in land acquisition, development and inventory.
Outlook, risks and unusual items
- Management was cautiously optimistic, expecting continued year-over-year improvement in sales and backlog and, if economic recovery continued, higher closings and profits during 2012. It cited affordability, improving consumer sentiment and reduced existing-home inventory, while noting resale competition and a volatile economy. No quantified earnings or revenue guidance was provided.
- The company said modest price increases had begun in many communities, but land and construction cost increases and sales mix could constrain margins. It expected cash outlays for land purchases and development to exceed operating cash generation as it expanded.
- Subsequent refinancing: On April 10, 2012, Meritage issued $300 million of 7.00% senior notes due 2022 and repurchased approximately $259 million of 6.25% notes due 2015 and $26.1 million of 7.731% notes due 2017. It planned to redeem the remaining approximately $26 million of 2015 notes in May. The transactions were expected to extend the earliest maturities to 2017 and produce about $5.5 million of second-quarter early-extinguishment expense.
- Legal matters: The South Edge/Inspirada joint-venture dispute includes lender and successor-builder claims, including a $13.2 million guarantee demand and a new arbitration demand for $13.5 million plus $9.8 million of alleged future infrastructure costs. Meritage disputes the claims; the filing says reserves have been established but does not provide a clear amount specific to this dispute. Total reserves for probable and estimable litigation and asserted claims were approximately $9.0 million.
- Warranty exposure: Warranty reserves were $21.7 million. Meritage had confirmed approximately 100 homes with defective Chinese drywall; 83 repairs were complete and about 10 were in progress. The company said reserves included expected repair costs and that it had received reimbursement for a significant portion, while continuing to seek additional reimbursement.
- Other risks: The company maintained a full valuation allowance against deferred tax assets ($95.2 million). It identified housing demand, mortgage rates and availability, cancellations, home prices, construction costs, land availability, warranty claims, litigation, liquidity and debt leverage among risks. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether order growth and the $353.2 million backlog convert into closings and improved profitability, particularly given seasonality and cancellation risk.
- How margins develop as selling prices, land and construction costs, sales mix, and commissions change.
- Post-refinancing debt balances, interest costs, the planned 2015-note redemption and the effect of the approximately $5.5 million charge; also clarify covenant headroom given the disclosed coverage ratio.
- The outcome and potential exposure from South Edge/Inspirada litigation, and whether warranty and Chinese-drywall reserves and recoveries prove adequate.
- Cash consumption and liquidity as land and development spending rises, and the recoverability of real estate inventory and deferred tax assets.