Meritage Homes Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited results compared with Q1 2017. Meritage builds single-family homes across nine states in the West, Central and East regions, primarily serving first-time and first move-up buyers, and operates a title company.
Financial and operating results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Home closing revenue | $728.5 million | $660.6 million | +10.3% |
| Total closing revenue, including land | $742.6 million | $672.8 million | +10.4% |
| Home closings | 1,725 | 1,581 | +9.1% |
| Home closing gross profit / margin | $124.3 million / 17.1% | $107.3 million / 16.2% | Margin +0.9 percentage points |
| Net earnings | $43.9 million | $23.6 million | +86.1% |
| Diluted EPS | $1.07 | $0.56 | +91.1% |
| Operating cash flow | $(17.3) million | $(84.8) million | Cash use narrowed |
- Home orders rose 10.4% to 2,358 units; order value increased 7.9% to $962.8 million. Backlog at quarter-end was 3,508 homes valued at $1.482 billion, up 10.3% in units and 8.4% in value year over year. Average backlog price declined 1.7% to $422,500.
- Financial services profit was $4.2 million, little changed from $4.3 million. Total closing gross profit, including land, was $123.1 million; land closings produced a $1.2 million loss versus $2.5 million profit in Q1 2017.
- Effective tax rate fell to 10.2% from 35.9%, reflecting lower federal corporate tax rates and retroactive energy-efficient home tax credits. The tax rate was a major contributor to earnings growth.
- Cash and cash equivalents were $172.6 million at March 31, up $1.8 million from year-end. Real estate inventory was $2.803 billion, up from $2.731 billion at year-end; operating cash use primarily reflected inventory investment.
- Debt, including senior notes and other borrowings, was $1.311 billion; debt-to-capital was 44.7% and net debt-to-capital 41.2%. The $625 million unsecured revolving facility had no borrowings outstanding and $529.6 million available after letters of credit. The company reported compliance with its financial covenants.
Material changes and management commentary
- East was the strongest region by growth: home closings increased 29.0% and home closing revenue 24.8%. Central closings rose 9.5%; West closings declined 5.4%, although West home closing revenue edged higher on price and mix.
- Management cited solid demand, job and wage growth, and limited existing-home supply. Strategy centers on expanding communities aimed at first-time buyers, growing community count, improving margins and controlling overhead. The company ended the quarter with 253 active communities, slightly fewer than a year earlier.
- Home closing gross margin improved 90 basis points, with higher volume and cost leverage cited as drivers. East margin also benefited from a 60-basis-point one-time recovery of prior Chinese drywall costs; Q1 2017 had included land-contract asset write-offs not repeated in Q1 2018.
- Orders pace improved to 9.5 homes per average community from 8.6; companywide cancellations increased to 14% from 12%. Management said it planned more than 20 West-region community openings in the following two quarters, with over 60% targeting first-time buyers.
- In March, Meritage issued $200 million of additional 6.00% senior notes due 2025 at a premium, bringing those notes to $400 million outstanding. Proceeds helped repay borrowings used to retire $175 million of 4.50% notes due March 2018. The credit facility’s full $625 million commitment now matures in July 2021.
Outlook, risks and unusual items
- No specific full-year revenue or earnings guidance is provided. Management expects demand to remain positive, especially among first-time buyers, and expects cash needs to moderate as ongoing operations support growth; it intends to reinvest cash in land and lot development.
- Q1 net earnings included a favorable $4.8 million settlement of long-standing litigation tied to a former Nevada joint venture. This is a non-recurring item. The company also recorded retroactive energy tax credits in Q1.
- Key risks include mortgage-rate increases affecting buyer affordability and demand, rising land, labor and material costs, lot availability, cancellations and slower absorption, inventory impairments, construction-defect and warranty claims, severe weather, and reliance on financing and surety bonds. The company notes that land options and development arrangements create commitments and exposures, although most option agreements do not require purchase.
- Warranty reserves were $23.8 million. The filing describes specific reserves related to alleged Florida stucco defects, a solar component issue and a possible Texas foundation-design matter. Management stated it did not believe pending legal or warranty matters were expected to have a material adverse effect.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The company has not declared cash dividends and does not expect to do so in the foreseeable future.
Investor verification priorities
- Assess how much earnings growth is sustainable after the lower tax rate and the $4.8 million settlement; compare future tax expense with the Q1 effective rate.
- Track order growth, cancellations, backlog conversion and average selling prices, especially as the product mix shifts toward lower-priced homes.
- Monitor inventory and land spending against operating cash flow, along with the company’s expectation that cash needs will moderate.
- Review debt maturities, interest costs and facility availability, including covenant headroom and the effects of the 6.00% note issuance.
- Follow gross margins, construction and land costs, warranty claims, land-option exposure and the resolution of disclosed legal matters.