Meritage Homes Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Meritage designs and builds single-family homes, principally for first-time and first move-up buyers, across nine states in its West, Central and East regions. It also operates a title company. The filing is unaudited.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Home-closing revenue | $877.7 million | $805.0 million | $2,478.6 million | $2,263.4 million |
| Total closing revenue, including land | $884.6 million | $805.6 million | $2,504.6 million | $2,280.3 million |
| Home-closing gross profit | $158.6 million | $145.7 million | $442.4 million | $393.8 million |
| Home-closing gross margin | 18.1% | 18.1% | 17.8% | 17.4% |
| Net earnings | $54.1 million | $42.6 million | $151.8 million | $107.7 million |
| Diluted earnings per share | $1.33 | $1.02 | $3.69 | $2.55 |
| Effective tax rate | 24.2% | 32.9% | 20.7% | 34.1% |
- Q3 home closings rose 9.8% to 2,162 homes; average selling price was $406,000, down 0.7%. For the nine-month period, closings increased 10.4% to 6,026, while average price declined 0.8% to $411,300.
- Q3 orders fell 2.5% to 1,828 homes and order value declined 6.5% to $715.1 million. Nine-month orders increased 4.4% to 6,436 and order value rose 2.3% to $2.60 billion.
- At September 30, backlog was 3,285 homes valued at $1.37 billion, down 1.4% in units and 3.0% in value year over year. The company attributed the lower average price partly to a greater entry-level mix. Q3 cancellation rate increased to 17% from 13%.
- Financial-services profit was $6.3 million in Q3 and $16.2 million year to date, compared with $5.5 million and $15.4 million, respectively, in 2017.
Cash flow, debt and liquidity
- Nine-month operating cash flow was positive $73.7 million, versus negative $174.4 million in 2017. Real-estate inventory growth used $161.8 million, compared with $336.1 million a year earlier. Investing cash use was $23.6 million; financing cash use was $15.0 million.
- Cash and cash equivalents were $205.8 million at September 30, 2018, up from $170.7 million at year-end 2017. Real estate inventory was $2.89 billion, compared with $2.73 billion at year-end.
- Total debt, comprising senior notes and other borrowings, was $1.312 billion; senior notes, net, were $1.295 billion. Debt-to-capital was 43.4% and net debt-to-capital was 39.2%, down from 44.9% and 41.4% at year-end, respectively.
- The company had no Credit Facility borrowings and reported $703.8 million of availability after outstanding letters of credit. The facility commitment was increased to $780 million and maturity extended to July 2022. Meritage reported compliance with its covenants.
- In March, Meritage issued $200 million of additional 6.00% notes due 2025, using net proceeds to repay facility borrowings, including borrowings associated with repayment of $175 million of 4.50% notes due in March 2018. The company repurchased 686,000 shares for $29.4 million during the nine months; $70.6 million remained under its $100 million authorization.
Changes, outlook and management commentary
- Management cited solid economic and housing fundamentals but noted that rising mortgage rates and home prices were causing a near-term pause as buyers reassessed affordability. It expects demand to continue over the longer term, while warning that coming quarters may be uneven. No specific earnings or revenue guidance was provided.
- The strategy emphasizes affordable first-time and first move-up homes, margin improvement, cost control and maintaining community count. One-third of active communities targeted first-time buyers; those buyers represented more than 40% of Q3 orders. Active communities totaled 264, up 5.6% year over year.
- Regional results differed: Central and East drove much of closing growth, while West closings and orders declined. California community sell-outs and delayed openings affected West activity; hurricane preparations affected East Q3 orders. Meritage expected to open more than 20 West communities over the next two quarters, about half targeting first-time buyers.
- Q3 home-closing margin was flat year over year; management said it would have been 18.4% excluding a $2.6 million California land-contract termination charge. Nine-month margin improved 40 basis points. Year-to-date results also included a favorable $4.8 million settlement related to litigation involving a former Nevada joint venture.
- Lower effective tax rates reflected the Tax Cuts and Jobs Act; the nine-month rate also benefited from retroactively extended energy-efficient-home tax credits. Adoption of the new revenue standard did not materially affect 2018 results.
Risks, contingencies and unusual items
- Key risks include further mortgage-rate increases, affordability and slower absorption, higher labor and material costs, tariffs on building supplies, land availability and cost, cancellations, and potential real-estate impairments. Management specifically warned that tariffs could raise construction costs and pressure margins if price increases cannot offset them.
- Warranty reserves totaled $22.9 million. They include reserves for alleged Florida stucco defects and a foundation-design issue in one Texas community. Meritage considers reserves sufficient based on available information and potential recoveries, but estimates may change; its insurer initially denied coverage for the Texas matter, a denial the company disputes.
- The company is involved in routine legal and construction-defect proceedings. It stated that no unreserved pending matter was expected to materially harm its financial condition, results or cash flows. Surety bonds outstanding were $353.1 million, with estimated remaining work of $169.7 million; letters of credit totaled $76.2 million. Management considered significant draws unlikely.
- Meritage expects the 2019 lease-accounting standard to increase reported assets and liabilities for operating leases, primarily office leases, but does not expect a material income-statement impact.
Important facts for investors to verify
- Whether the Q3 decline in orders, lower backlog value and higher cancellation rate persist, particularly as mortgage rates and affordability affect buyers.
- Whether planned community openings occur on schedule and address the California supply gap, and whether entry-level growth sustains orders and margins.
- Whether construction-cost inflation, tariffs and the $2.6 million land-contract charge affect future gross margins.
- Whether warranty estimates and insurance or contractor recoveries adequately cover the Florida stucco and Texas foundation matters.
- Whether cash generation supports planned land investment and share repurchases while maintaining covenant compliance and liquidity.