Meritage Homes Corporation — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; filed February 12, 2018. Meritage builds single-family homes across nine states in West, Central and East regions, with a related title-services business. Its strategic emphasis is shifting toward entry-level and first move-up buyers.
Financial and operating results
| Metric | FY2017 | FY2016 |
|---|---|---|
| Home closing revenue | $3.187 billion | $3.003 billion |
| Total closing revenue, including land sales | $3.227 billion | $3.029 billion |
| Home closing gross profit / margin | $562.1 million / 17.6% | $528.8 million / 17.6% |
| Earnings before income taxes | $247.5 million | $218.1 million |
| Net earnings / diluted EPS | $143.3 million / $3.41 | $149.5 million / $3.55 |
| Net cash used in operating activities | $87.1 million | $103.4 million |
| Cash and cash equivalents at year-end | $170.7 million | $131.7 million |
| Debt, including notes and other borrowings | $1.284 billion | $1.127 billion |
| Debt-to-capital / net debt-to-capital | 44.9% / 41.4% | 44.2% / 41.2% |
- Closings rose 4.8% to 7,709 homes; average closing price increased 1.2% to approximately $413,400. Net orders rose 9.1% to 7,957 homes, and order value increased 9.8% to $3.297 billion.
- Year-end backlog grew 9.4% to 2,875 homes, valued at $1.246 billion. Active communities were nearly unchanged at 244. Controlled home sites increased 15.1% to 34,319.
- Gross margin was unchanged year over year: selling-price gains were offset by higher land, labor and construction costs and weather-related impacts. Regional results diverged: East margin declined to 14.8%, while West and Central improved to 17.6% and 20.4%, respectively.
- Net earnings fell 4.2% despite higher pretax earnings, principally because the effective tax rate rose to 42.1% from 31.4%. The 2017 rate included a $19.7 million noncash reduction in deferred tax assets following the Tax Act and fewer energy tax credits.
- Operating cash outflow improved from $103.4 million to $87.1 million, but remained negative, mainly reflecting a $301.5 million increase in real estate investment. Financing cash flow was positive $143.2 million, principally reflecting issuance of $300 million of notes, partly offset by repayment of convertible notes.
Debt, liquidity and capital
At year-end, Meritage had $170.7 million of cash, no borrowings outstanding under its $625 million unsecured revolving credit facility, and $550.3 million available to draw after letters of credit. The company issued $300 million of 5.125% senior notes due 2027 and used proceeds to retire all $126.5 million of its convertible notes. Total notes and other borrowings were approximately $1.284 billion. Management reported compliance with debt covenants. In January 2018, the full revolving facility commitment was extended to mature in July 2021.
Outlook, risks and notable items
- Management described housing demand as generally favorable, particularly for first-time buyers, and planned significant new community openings in the first half of 2018, with most aimed at first-time and first move-up buyers. It expects near-term cash spending on land, development and construction to exceed cash generated by operations.
- Management expects substantially all year-end backlog homes to be delivered in 2018, subject to cancellations and other conditions. This is an expectation, not guaranteed revenue.
- Weather affected construction and closings in 2017: Hurricane Harvey delayed activity in Texas, while Hurricane Irma delayed Florida closings into 2018. Management cited rising land, labor and material costs as constraints on margin expansion.
- Uncertain exposures include mortgage availability and interest rates, affordability, land and subcontractor availability, cost inflation, local-market concentration, regulatory and entitlement delays, inventory valuation, and warranty or construction-defect claims.
- The company disclosed two significant community/geographic warranty issues involving possible foundation design and alleged widespread stucco application defects; it also identified additional specific warranty matters. Warranty reserves were $23.3 million at year-end. The filing states that reserve and insurance adequacy cannot be assured.
- Routine legal proceedings include construction-defect claims. A Florida negligent-security case was scheduled for trial in Q1 2018; management did not expect an incremental reserve charge. In February 2018, Meritage received $4.8 million to settle claims relating to a Nevada joint venture. A retroactive 2017 energy-efficient-home tax credit was enacted after year-end and is expected to be recorded in 2018.
- Meritage paid no cash dividends in 2017 and said it did not intend to pay them in the foreseeable future. Auditors issued unqualified opinions on the financial statements and internal control over financial reporting.
Investor verification priorities
- Reconcile home closing revenue with total closing revenue, which includes land sales, and verify how the shifting entry-level product mix affects average prices and margins.
- Track operating cash flow, real estate investment and land-development spending; accounting earnings were positive while operating cash flow remained negative.
- Review debt maturities, interest costs, revolver availability and covenant headroom, including the $175 million notes due in 2018.
- Assess whether the higher unsold/spec inventory—2,086 homes, up from 1,692—and growing lot commitments can be absorbed without discounting or impairments.
- Monitor East Region performance, weather-related delays, construction and labor costs, and progress in opening planned communities.
- Check outcomes and reserve developments for the disclosed warranty matters and litigation, and the realized impact of the Tax Act and retroactive energy credit.