Meritage Homes CORP quarterly report, Q3 FY2022

Meritage Homes Corporation — Q3 2022 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2022. Meritage designs and builds single-family homes in ten states across the West, Central and East regions, and provides mortgage, title, escrow and insurance services. It had 275 active communities at quarter-end.

Financial performance and position

Metric	Q3 2022	Q3 2021	Nine months 2022	Nine months 2021
Homebuilding closing revenue	$1.578 billion	$1.260 billion	$4.277 billion	$3.621 billion
Home closing gross margin	28.7%	29.7%	30.1%	27.4%
Earnings before income taxes	$329.5 million	$261.7 million	$947.1 million	$643.3 million
Net earnings	$262.5 million	$200.8 million	$729.8 million	$500.0 million
Diluted earnings per share	$7.10	$5.25	$19.65	$13.06

Q3 home closings rose 12.1% to 3,487 homes; average closing price increased 11.9% to $450,000. Nine-month closings rose 3.1% to 9,566, with average price up 13.9% to $441,500.
Q3 home closing gross profit was $450.6 million. Margin fell 100 basis points year over year as higher direct costs, buyer incentives and $8.8 million of terminated-land-contract charges offset pricing and volume. Excluding those charges, Q3 margin was 29.3%, versus 29.8% a year earlier.
Nine-month gross margin improved 270 basis points, reflecting earlier pricing strength and fixed-cost leverage. Q3 earnings also benefited from a lower effective tax rate, 20.3% versus 23.3%; the nine-month rates were 22.9% and 22.3%, respectively.
Financial services profit was $4.8 million in Q3, up from $4.2 million, but $12.3 million for nine months, down from $12.6 million.
Cash and equivalents were $299.4 million at September 30, down from $618.3 million at year-end 2021. Total assets were $5.571 billion and stockholders’ equity was $3.682 billion.
Operating cash flow was negative $169.8 million for the first nine months, compared with negative $248.7 million in 2021. Homebuilding investment increased real estate inventory by $990.1 million. Investing cash flow was negative $24.9 million; financing cash flow was negative $124.3 million, including $109.3 million of share repurchases.
Senior notes, net, and other borrowings totaled $1.156 billion. There were no borrowings under the $780 million revolving facility; $720.2 million remained available after letters of credit. The company reported compliance with its debt covenants. Debt-to-capital was 23.9%; net debt-to-capital was 18.9%, up from 15.1% at year-end, as cash declined.

Material changes and operating trends

Q3 net home orders fell 32.9% to 2,310; order value fell 34.6% to $974.3 million. The cancellation rate rose to 30% from 10%, and orders pace declined to 2.7 homes per community per month from 5.0.
Management attributed weaker demand and cancellations to higher mortgage rates, affordability concerns, economic uncertainty, buyer financial changes and extended construction timelines. Gross orders were down 14%, which management said indicated continuing demand for new homes.
Backlog at quarter-end was 6,064 homes valued at $2.827 billion, up 3.9% in units and 10.6% in value from a year earlier. Backlog reflects unclosed net sales; delayed construction and closings contributed to its level.
In response to weaker demand, Meritage terminated options for approximately 5,200 lots and recorded $8.8 million in related deposit and due-diligence write-offs. It purchased about 10,000 lots for $378.8 million and spent $794.5 million on land development during the nine-month period.
Q3 closings included delays affecting approximately 150 Florida homes following Hurricane Ian. The East region had the strongest year-to-date order growth; the West had the sharpest Q3 order decline and a 43% cancellation rate.
The 2021 comparison includes an $18.2 million loss on early extinguishment of debt; no similar charge occurred in 2022. The Inflation Reduction Act retroactively extended energy-efficient home tax credits, benefiting the 2022 tax provision. Management said the Act’s corporate minimum tax and stock-repurchase excise tax were not expected to materially affect the financial statements.

Outlook, risks and contingencies

Management described the housing market as deteriorating in Q3 and expects demand to be more normalized than in 2020–2021. It believes buyer demographics support long-term demand and is emphasizing affordable entry-level and first move-up homes, move-in-ready inventory, and incentives.
Management said supply-chain disruptions, labor constraints and longer cycle times continued to affect costs and production. It had been less able to offset cost increases through pricing and expected costs and cycle times to normalize over time, but provided no quantified earnings or revenue guidance.
The company expects to fund near-term needs primarily with cash and operating cash flow and considers available liquidity sufficient. It may seek additional financing; availability and acceptable terms are not assured. There are no debt maturities before 2025.
Key risks include further mortgage-rate increases or reduced mortgage availability, cancellations and slower absorption, home-price and incentive pressure, construction-cost inflation, labor and supply constraints, land impairments, and the company’s geographic concentration.
Surety bonds outstanding were $852.0 million, with estimated remaining work of $528.5 million; letters of credit totaled $59.8 million. The company considers significant draws unlikely. Purchase and option agreements covered 43,042 lots with a stated purchase price of $1.598 billion; most do not require purchase, and exposure is generally limited to nonrefundable deposits and related capitalized costs.
Routine litigation includes construction-defect claims. The company reported $31.7 million of warranty reserves, including case-specific reserves for alleged stucco defects in certain homes built primarily from 2006 to 2017, and believes reserves are sufficient. Actual warranty costs and legal outcomes could differ from estimates.

Investor facts to verify

Whether orders, cancellations and backlog conversion stabilize as mortgage rates and affordability change, particularly in the West and Central regions.
Whether incentives, construction costs and land-contract terminations continue to pressure gross margins; monitor the gap between Q3 margin and the margin excluding termination charges.
Whether inventory investment and negative operating cash flow moderate as homebuilding activity and community count adjust.
Cash availability, revolving-facility access and covenant compliance, alongside the increase in net debt-to-capital.
Whether warranty and stucco-related reserves, surety obligations and other land commitments remain adequate and manageable.