Meritage Homes Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Meritage designs and builds single-family homes in the West, Central and East regions across seven states. It had 151 active communities at quarter-end.
Financial and operating results
Amounts below are in millions of dollars except per-share data, percentages, and home counts.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total closing revenue | $282.1 | $220.1 | $486.4 | $397.7 |
| Home closing revenue | $281.3 | $220.1 | $485.4 | $397.6 |
| Home closing gross profit / margin | $51.9 / 18.5% | $39.6 / 18.0% | $87.1 / 17.9% | $70.0 / 17.6% |
| Net income (loss) | $8.0 | $0.6 | $3.3 | $(6.1) |
| Diluted earnings (loss) per share | $0.24 | $0.02 | $0.10 | $(0.19) |
| Net cash used in operating activities | — | $(104.9) | $(32.7) |
- Demand and backlog: Q2 net home orders rose 48.7% to 1,353; order value rose 63.5% to $385.8 million, with average order price up 9.9% to $285,200. At June 30, backlog was 1,611 homes valued at $457.7 million, up 62.1% in units and 75.5% in value year over year. Q2 cancellations were 13% of gross orders, versus 15% a year earlier.
- Six-month activity: Home closings increased 17.4% to 1,801, and net orders increased 42.7% to 2,497. Average closing price rose 4.0% to $269,500.
- Margins and expenses: Q2 adjusted home gross margin, excluding impairments, was 18.5%, versus 18.3%; first-half adjusted margin was 18.0%, versus 17.9%. Commissions and sales costs were 8.2% of home revenue in Q2, down from 8.6%; G&A was 5.9% of total revenue, down from 6.8%, despite higher expense dollars.
- Cash and liquidity: Cash and equivalents were $81.8 million, investments and securities $103.8 million, and restricted cash $19.1 million, or $204.7 million combined. The combined amount fell $128.5 million from year-end, principally reflecting land purchases, development and inventory growth. Operating cash use increased to $104.9 million, including a $140.7 million increase in real estate inventory.
- Debt and capital: Notes totaled $596.1 million at June 30; stockholders’ equity was $496.7 million. Debt-to-capital was 54.5%, and net debt-to-capital was 44.1%, compared with 55.4% and 35.8% at year-end. The company issued $300 million of 7.00% notes due 2022 and retired all $285 million of 6.25% notes due 2015, as well as approximately $26.1 million of 2017 notes. The transactions incurred a $5.8 million extinguishment loss. Remaining note principal included $99.8 million due 2017 and $200 million due 2020.
Material changes and management outlook
- Management attributed improved results to higher closings and prices, stronger orders, improved sales pace and a shift toward newer or better-located communities. California and Florida showed notable growth; Texas closings declined year over year, although Texas remained the largest market.
- The $5.2 million Q2 tax benefit primarily reflected a partial reversal of the deferred-tax valuation allowance for Florida after sustained profitability. The company continued to maintain significant valuation allowances in other jurisdictions; the benefit is not presented as a recurring operating trend.
- Real estate inventory rose to $955.2 million from $815.4 million at year-end. First-half real-estate-related impairments were $1.2 million, including $669,000 on Nevada land held for sale. Management said it did not expect material future impairments in underperforming or mothballed communities, while cautioning that changing market conditions could alter that assessment.
- Meritage was winding down Nevada operations and expected to complete construction there within 12 to 18 months. It expanded in North Carolina and Tampa and planned to commence Charlotte homebuilding operations in late 2012.
- Management was cautiously optimistic and expected higher year-over-year closings and improved bottom-line results in the rest of 2012, citing backlog and order trends. It also noted that results depend on an uneven housing recovery, local employment and demand, mortgage availability, pricing and construction costs. No specific full-year numerical guidance was provided.
- After quarter-end, Meritage completed a 2.645-million-share offering at $34.75 per share, receiving approximately $87.1 million net, and entered a $125 million unsecured revolving facility maturing in July 2015, including $50 million available for letters of credit. Management reported strong liquidity after these transactions, but said additional capital might be sought and could dilute shareholders or increase interest costs.
Risks, contingencies and other notable items
- South Edge litigation: Meritage disputes claims arising from a Nevada joint venture and a repayment guarantee. The filing describes a lender claim of approximately $13.2 million, an arbitration demand for $13.5 million concerning the same alleged obligation, and a separate $9.8 million claim for alleged future infrastructure costs. Meritage says it has defenses, has recorded reserves below the claims’ aggregate amounts, and does not expect a material adverse effect. The outcome remains uncertain.
- Accrued liabilities included $9.0 million of legal reserves and $21.2 million of warranty reserves. Management believes reserves are adequate, but actual legal, warranty and construction-defect costs could differ from estimates.
- At June 30, the company reported $338,000 of limited repayment guarantees and a $13.2 million South Edge guarantee, whose enforceability it disputes. Outstanding surety bonds were $75.0 million and letters of credit $18.0 million; management considered significant draws unlikely. Many land options can be abandoned with loss limited to non-refundable deposits, but committed option contracts covered 2,943 lots with a stated purchase price of $150.9 million.
- Debt covenants were reported as compliant. The disclosed fixed-charge coverage ratio was 1.33 against a stated requirement above 2.00, while the leverage ratio was 1.29 against a limit below 3.00; the filing says both tests must fail for the specified consequence, which is a restriction on incurring additional debt rather than a default.
- Key risks include a renewed housing downturn, higher mortgage rates or tighter financing, buyer cancellations, construction-cost inflation, land availability, inventory write-downs, tax-benefit limitations, warranty claims, joint-venture partner performance, and the company’s leverage and ability to raise capital.
Important facts for investors to verify
- Whether the large backlog converts to closings and cash receipts, and whether cancellations remain low.
- Whether inventory and land-development investment continue to consume cash faster than operations generate it.
- Whether price increases and cost controls sustain gross margins, particularly as regional and product mix changes.
- Whether the Florida deferred-tax asset remains realizable and whether further valuation-allowance reversals are supported by results.
- Developments in the South Edge litigation, guarantee exposure and legal reserves.
- Liquidity and covenant headroom after the equity offering and revolving facility, including the effect of the disclosed fixed-charge coverage measure.