Meritage Homes Corporation — Q3 2012 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2012. Meritage designs and builds single-family homes across the West, Central and East regions, operating in seven states. It had 153 active selling communities at quarter-end. The filing is unaudited; interim results are not necessarily indicative of full-year results.
Financial and operating highlights
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total closing revenue | $342.6 million | $217.5 million | $829.1 million | $615.3 million |
| Net income (loss) | $6.8 million | ($3.2 million) | $10.0 million | ($9.3 million) |
| Diluted earnings (loss) per share | $0.19 | ($0.10) | $0.30 | ($0.29) |
| Home closing gross margin | 18.6% | 17.5% | 18.2% | 17.6% |
- Home closing revenue was $334.9 million in Q3 and $820.2 million for the first nine months, up 53.9% and 33.3%, respectively. Closings increased 42.5% in Q3 to 1,197 homes and 26.3% year to date to 2,998 homes. Average closing prices rose 8.0% in Q3 and 5.6% year to date.
- Orders rose 32.9% in Q3 to 1,204 and 39.3% year to date to 3,701. Quarter-end backlog was 1,618 homes valued at $489.5 million, up 52.6% in units and 69.7% in value year over year. Q3 cancellation rate was 13%, versus 17% a year earlier.
- Gross margin excluding impairments, a company-presented non-GAAP measure, was 18.7% for Q3 and 18.3% year to date, versus 17.9% in each prior-year period. Management attributed improvement principally to pricing and improved overhead leverage, partly offset by construction cost increases.
- Operating cash flow was negative $132.3 million for the first nine months, compared with negative $51.2 million a year earlier, largely reflecting a $190.5 million increase in real estate inventory. Cash and cash equivalents increased to $305.0 million from $173.6 million at year-end, with financing providing $192.9 million.
- At September 30, cash, investments and securities, and restricted cash totaled $386.9 million. Debt was $722.7 million, versus $606.4 million at December 31, 2011; stockholders’ equity was $596.1 million. Debt-to-capital was 54.8% and net debt-to-capital 36.0%.
Changes, financing and unusual items
- In April, Meritage issued $300 million of 7.00% senior notes due 2022 and repurchased all $285 million of 6.25% notes due 2015 and about $26.1 million of 7.731% notes due 2017. The transactions generated a $5.8 million debt-extinguishment loss in the first nine months.
- In July, it raised approximately $87.1 million net from issuing 2.645 million common shares and established a $125 million unsecured revolving credit facility; no advances or letters of credit were outstanding under the facility at quarter-end.
- In September, it issued $126.5 million of 1.875% convertible senior notes due 2032, generating about $122.3 million net proceeds. The notes are initially convertible at $58.14 per share; the stated conversion premium was 47.5% at issuance.
- Q3 and year-to-date results included an $8.7 million litigation reserve related to South Edge/Inspirada. The nine-month tax benefit was $4.8 million, primarily reflecting a partial reversal of the valuation allowance on Florida deferred tax assets. The filing says the effective tax rates are not meaningful because of valuation allowances and tax-loss carryforwards.
- Real estate inventory increased to $1.00 billion from $815.4 million at year-end, consistent with land acquisition, development and home construction activity.
Outlook, risks and contingencies
- Management described housing conditions as stabilizing and improving, while emphasizing that markets remain variable and the economic environment volatile. It expected improved results for the remainder of 2012, citing higher backlog, sales pace and average prices; it provided no quantified earnings or revenue guidance.
- Management said it was raising prices in many communities and expected pricing increases to more than offset construction cost increases. It planned to reinvest cash in strategic land and lot positions, expand community counts, and enter Charlotte, North Carolina; initial Tampa closings were expected in Q4 2012.
- Meritage was winding down Nevada operations and expected to complete construction there within 12–18 months, based on the current order pace. It noted that new-market start-up costs and faster community sell-outs could affect margins and community availability.
- In South Edge/Inspirada litigation, a court ruled in September that JP Morgan had standing to pursue the repayment-guarantee claim and that Meritage was liable, with damages still to be determined. Meritage disputes the ruling and is pursuing claims against former co-venturers. Related arbitration demands include $13.5 million and $9.8 million; the $13.5 million demand concerns the same alleged obligation as the guarantee litigation. The company reported a $16.2 million reserve for non-warranty litigation and asserted claims, including the Q3 reserve, and said it did not expect the ultimate outcome to materially adversely affect its financial condition.
- Other risks include housing demand and mortgage-rate changes, construction cost inflation, inventory and land valuation, warranty or construction-defect claims, joint-venture obligations and the ability to access additional capital. Management reported compliance with debt and credit-facility covenants at quarter-end. All outstanding debt was fixed-rate.
Important facts for investors to verify
- Whether order growth and the $489.5 million backlog convert into closings and sustained margins, particularly as active communities are replenished.
- The cash demands from inventory growth: nine-month operating cash flow was negative $132.3 million despite reported net income.
- Debt-service and covenant headroom, including the revolving facility’s stricter interest-coverage requirement beginning January 1, 2013, and the convertible notes’ holder redemption dates.
- Developments in the South Edge/Inspirada proceedings, damages, potential recovery from co-venturers, and whether the recorded reserve remains adequate.
- Real estate impairment assumptions, construction and warranty costs, and realization of deferred tax assets and net operating losses.