Meritage Homes Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Meritage designs and builds single-family homes in the West, Central and East regions and provides title, mortgage-related and insurance services. It operated in nine states and had 204 actively selling communities at quarter-end.
Financial and operating results
| Metric | Q3 2020 | Q3 2019 | First nine months 2020 | First nine months 2019 |
|---|---|---|---|---|
| Total closing revenue | $1.138 billion | $940.9 million | $3.072 billion | $2.514 billion |
| Home closing revenue | $1.133 billion | $939.2 million | $3.055 billion | $2.501 billion |
| Home closing gross margin | 21.5% | 19.8% | 21.0% | 18.5% |
| Earnings before income taxes | $135.5 million | $92.4 million | $338.2 million | $192.4 million |
| Net earnings | $109.1 million | $69.8 million | $270.9 million | $146.0 million |
| Diluted EPS | $2.84 | $1.79 | $7.04 | $3.76 |
- Q3 closings increased 24.2% to 3,004 homes; nine-month closings rose 25.7% to 8,090. Average home closing prices declined 2.9% in Q3 and 2.8% year to date, which management attributed principally to a greater share of lower-priced entry-level homes.
- Q3 home orders rose 70.5% to 3,851 homes; nine-month orders increased 40.2% to 10,550. The cancellation rate was 13% in Q3, versus 17% a year earlier. Quarter-end backlog was 5,242 homes valued at $2.005 billion, up 49.0% in units and 43.5% in value year over year.
- Home closing gross profit increased to $243.6 million in Q3 and $642.6 million year to date. Management cited stronger pricing, simplified product designs, shorter construction cycles, purchasing efficiencies and greater overhead leverage. Pricing gains more than offset higher building-material costs, particularly lumber.
- Financial services profit decreased to $4.3 million in Q3 and $10.9 million year to date, from $5.6 million and $16.3 million, respectively. Management said a change in mortgage-joint-venture customer-incentive accounting shifted related amounts into home closing revenue from financial services earnings beginning in Q4 2019.
- Commissions and other sales costs were 6.5% of home closing revenue in Q3, down from 6.8%; general and administrative expense was 3.6%, down from 4.0%. The nine-month effective tax rate fell to 19.9% from 24.1%, reflecting energy-efficient-home tax credits and tax benefits from vested equity awards.
Cash flow, debt and liquidity
- Operating cash flow for the first nine months was $373.1 million, versus $167.4 million a year earlier. Net earnings and a $60.0 million increase in accounts payable and accrued liabilities contributed to 2020 operating cash flow.
- Cash and cash equivalents were $610.0 million at September 30, up from $319.5 million at year-end. Investing cash outflow was $13.2 million; financing cash outflow was $69.3 million, including $60.8 million of share repurchases.
- Total notes payable and other borrowings were approximately $1.020 billion, principally senior notes; the company had no revolving-credit-facility borrowings at quarter-end. Net debt was $409.8 million. Debt-to-capital was 31.7% and net debt-to-capital 15.7%, compared with 34.0% and 26.2% at year-end.
- The $780 million unsecured revolving credit facility had $705.4 million available after outstanding letters of credit. The company reported compliance with its covenants. It also reported $428.9 million of surety bonds outstanding and $74.6 million of letters of credit.
Management outlook, risks and unusual items
- Management described exceptionally strong demand and pricing power in Q2 and Q3, supported by low mortgage rates, limited existing-home supply and buyer interest in larger homes suited to working or schooling from home. It also said the pandemic makes future business and economic effects difficult to estimate.
- The company reported a pipeline of community openings over the next four to eight quarters, but expected community counts to remain uneven because of accelerated community close-outs and municipal delays. It had paused some land activity amid early pandemic uncertainty, then increased lot and community acquisitions and development.
- No specific earnings or revenue guidance was provided in the filing. Management said cash and credit-facility liquidity were sufficient for strategic growth and current uncertainty, while noting it could seek additional debt or equity capital. The company had $23.2 million remaining under its repurchase authorization and stated it had never paid cash dividends.
- Key risks include further COVID-19 disruption, weaker demand or prices, unemployment, tighter mortgage lending, cancellations, supply-chain or labor constraints, construction-cost inflation, interest-rate increases, land availability and potential real-estate impairments. The company noted that higher mortgage rates could reduce buyer demand and raise borrowing costs.
- Routine legal and construction-defect matters include alleged stucco defects in certain Florida communities and water-drainage issues in one Florida community. These matters are included in the $23.3 million warranty reserve; management considered reserves sufficient but said estimates could change as additional information becomes available.
Most important facts for investors to verify
- Whether elevated orders, backlog and pricing persist, and whether backlog converts to closings without higher cancellations or delays.
- Whether gross-margin improvement continues as product mix, lumber and other construction costs, and community availability change.
- How COVID-19, mortgage rates, labor and material availability, and municipal approvals affect demand, construction and community openings.
- Whether operating cash flow remains strong after considering working-capital timing, land acquisition and development spending, and share repurchases.
- Potential changes in Florida warranty and construction-defect exposures, land-option commitments, surety obligations and credit-facility availability.