Meritage Homes Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Meritage builds single-family homes across the West, Central and East regions, operating in Arizona, Texas, California, Colorado, Florida and the Carolinas. Financial amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2013 | Q2 2012 | H1 2013 | H1 2012 |
|---|---|---|---|---|
| Total closing revenue | $450.0 | $282.1 | $786.4 | $486.4 |
| Home closing revenue | $436.0 | $281.3 | $766.8 | $485.4 |
| Home closing gross margin | 21.5% | 18.5% | 20.6% | 17.9% |
| Net earnings | $28.1 | $8.0 | $40.2 | $3.3 |
| Diluted EPS | $0.74 | $0.24 | $1.06 | $0.10 |
- Q2 home closings increased 26.8% to 1,321 homes; average selling price rose 22.3% to $330,100. H1 closings increased 31.8% to 2,373 homes, with average selling price up 19.9% to $323,100.
- Q2 net earnings included a $3.1 million loss on early debt extinguishment; H1 included $3.8 million. Q2 interest expense was $4.5 million versus $6.3 million a year earlier.
- H1 operating cash flow was negative $19.5 million, improving from negative $104.9 million. Real estate inventory increased to $1.23 billion from $1.11 billion at year-end, reflecting land acquisition, development and construction spending. Cash and cash equivalents ended at $218.0 million.
- Cash, investments and securities, and restricted cash totaled $353.3 million, up $57.8 million from year-end. Debt was $798.2 million, compared with $722.8 million at December 31, 2012. Debt-to-capital was 51.5%; net debt-to-capital was 37.2%.
- The $135 million revolving credit facility was undrawn. The company reported compliance with covenants, including an actual 32% leverage ratio against a maximum 60%, and $445.0 million of liquidity against a stated $49.3 million minimum liquidity requirement.
Material changes and operating trends
- Q2 net orders rose 21.0% to 1,637 homes; average order price increased 22.8% to $350,300. Backlog at June 30 was $806.3 million, up 76.2% year over year, comprising 2,283 homes, up 41.7%. The cancellation rate was 11%, versus 13%.
- Home closing gross margin improved 300 basis points year over year and 200 basis points sequentially. Management attributed gains to price appreciation, favorable community and home mix, higher volume and cost control; it noted construction costs were also rising.
- Financial services profit increased to $4.2 million for Q2 and $7.2 million for H1, primarily reflecting more closings processed through mortgage and title joint ventures. The company’s Carefree Title business remained in its start-up phase.
- In March, Meritage issued $175 million of 4.50% senior notes due 2018 and repurchased its 7.731% senior subordinated notes due 2017; all those notes were retired by June 30. The credit facility was amended in June, extending maturity to July 2016 and increasing current commitments to $135 million. Management said there were no debt maturities until 2018.
- Active communities totaled 165 at quarter-end, versus 151 a year earlier. The company purchased approximately 2,100 lots for $106.8 million during Q2, spent $49.0 million on land development and started 1,604 homes.
Outlook, commentary and risks
- Management described housing demand, affordability, consumer confidence and market conditions as improving, and said it expected a profitable year with improving revenue and profitability for the rest of 2013. It expected year-end active communities of 185 and anticipated home closing margins to remain stable or grow modestly. These are expectations, not quantified earnings guidance.
- Management cautioned that year-over-year comparisons would become more difficult as the recovery progressed. It also expected land acquisition and development cash outlays to exceed operating cash generation in the near term as the company expanded its lot supply and community count.
- Key risks include housing demand and mortgage-rate changes, home prices and cancellations, land availability and development delays, rising labor and material costs, inventory impairment, warranty and construction-defect claims, leverage and access to capital, and tax-asset utilization.
- Material litigation: In the South Edge/Inspirada matter, a court ruled in June that Meritage owed $15.1 million; a July 8 judgment, after additional prejudgment interest, was $15.75 million. Meritage appealed and posted a $16.05 million supersedeas bond to stay enforcement. Related arbitration claims were stayed pending appeal; a separate $9.8 million claim for future infrastructure costs was dismissed with prejudice. The company reported $16.7 million of legal reserves, including South Edge-related reserves, and disputed liability.
- Real-estate impairment charges were $0.15 million in Q2 and $0.19 million in H1, lower than the comparable 2012 periods. Management said it did not expect material future impairment charges in underperforming or mothballed communities, while warning that market changes could alter that assessment.
Important facts for investors to verify
- Track whether orders and backlog convert into closings at the reported prices and margins, particularly as year-over-year comparisons toughen.
- Assess cash use and funding needs as land, development and inventory investments rise; distinguish unrestricted cash from restricted cash and investments.
- Follow the South Edge appeal, related arbitration and recovery claims, including the eventual cash exposure relative to recorded reserves and the posted bond.
- Monitor debt, covenant headroom and the company’s ability to maintain liquidity while expanding community count and developing more land.
- Evaluate exposure to rising construction costs, mortgage rates, cancellations, warranty claims and potential inventory impairments.