MTH

Meritage Homes Corp. 10-Q Summary (Q1 2011)

Business Context and Reporting Period

This filing covers the quarterly period ended March 31, 2011. Meritage Homes Corporation 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 announced an expansion into the Raleigh-Durham, North Carolina market in April 2011. The reporting period reflects a challenging sales environment following the expiration of the federal home-buyer tax credit in April 2010.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total closing revenue decreased 11.5% year-over-year, driven by a 16.1% reduction in homes closed (678 units vs. 808 units). This was partially offset by a 5.5% increase in average sales price to $261,800.
• Net Loss: The company reported a net loss of $6.7 million compared to net income of $2.7 million in Q1 2010. The prior year's income included a $2.4 million gain from a legal settlement not present in the current period.
• Backlog Reduction: Order backlog decreased 31.1% to $244.9 million (940 homes) due to lower sales volume and higher closings relative to new orders.
• Regional Performance:
  • West: Revenue dropped 41.7% primarily due to weak performance in California.
  • Central: Revenue declined 8.0%, though Colorado saw an 81.3% revenue increase.
  • East: Revenue increased 37.3% with higher average sales prices and unit closings.
• Cash Flow: Net cash used in operating activities was $24.6 million, compared to $43.9 million provided in the prior year. Investing activities provided $22.6 million due to maturities of investments exceeding purchases.

Guidance, Outlook, and Risks

• Outlook: Management notes that the spring selling season was weaker than anticipated. While some markets show signs of bottoming, the company does not know when the national recovery will gain momentum. They expect cash outlays for land purchases to exceed cash generated by operations as they expand their business.
• Strategic Initiatives: The company is focusing on redesigning product offerings to reduce costs, expanding into new markets (Raleigh-Durham), and maintaining strict cash flow controls. They aim to reach at least 150 active communities by June 30, 2011.
• Contingencies and Risks:
  • Chinese Drywall: The company has identified 97 homes with defective Chinese drywall (90 in Florida, 7 in Texas). Warranty reserves of $27.2 million are deemed sufficient to cover repairs, though investigations continue.
  • Joint Venture Litigation: Meritage is involved in litigation regarding a Nevada-based joint venture. While the company believes its exposure is limited and covered by reserves, potential maximum pro-rata exposure on springing repayment guarantees is estimated at $11.6 million.
  • Market Conditions: Risks include high unemployment, inventory oversupply, foreclosure rates, and interest rate sensitivity.
• Covenants: The company is in compliance with all debt covenants, including the Fixed Charge Coverage Ratio (1.437 vs. 2.00 required) and Leverage Ratio (1.282 vs. 3.00 required).

Investor Verification Checklist

• Verify the sufficiency of the $27.2 million warranty reserve against potential future claims related to defective Chinese drywall.
• Monitor the outcome of the Nevada joint venture litigation and the potential enforcement of springing repayment guarantees.
• Assess the impact of the 31% decline in backlog on future revenue visibility and the ability to meet growth targets.
• Review the Fixed Charge Coverage Ratio (1.437) which is below the 2.00 covenant requirement, noting that while not a default, it restricts the incurrence of additional indebtedness.
• Track the expansion into North Carolina and the associated capital deployment versus expected returns in a new market.