After a full release of earnings data after the market closed on Monday, Jan. 28, Meritage Homes executives took analysts through a detailed journey of the positive news in Tuesday's fourth quarter and year-end earnings call, paying heed to how the company generated $153 million in cash flow, paid down debt, and anticipates minimal impairments going forward.
Meritage stock (NYSE:MTH) closed up 23.63% at $14.44 on Tuesday amid a continuing rally in builder stocks.
But despite the obvious effort made to shore up the balance sheet, primarily during the back half of the year, questions during the Q&A portion of the call continued to be focused on the company's joint ventures.
Meritage provided a fairly transparent view of its joint venture arrangements, a welcome effort in light of the industry's joint venture liability concerns of late. That transparency included the disclosure that four of its existing JVs are currently in default.
According to CEO Steve Hilton, the company only uses joint venture arrangements for two purposes: One is to provide mortgage and title services, and the other is to acquire and develop land. The exposure under the mortgage and title arrangements is very limited, but the equity in and liabilities to the remaining entities were under scrutiny.
In total, the company currently has 12 active joint ventures in the equity method and another two in cash method joint ventures.
The equity method JVs show total assets of $632 million and equity of $167 million, of which $22 million is showing as Meritage equity on its books. Of the total, the company has impaired its interest in four of the JVs, which makes up about 25% of the assets and debt. The largest single JV represents $361 million--more that half--of the assets; Meritage has a 20% interest in the venture and has impaired its investment by $15 million.
The cash method JVs show total assets of $1.4 billion and total equity of $462 million. Meritage however has limited ownership in these comprised of only 3% to 4% with only $2 million of equity after fully impairing one of these JVs and partially impairing the other.
According to CFO Larry Seay, the joint venture partners in the arrangements in default are "a combination of private and publics in [arrangements] that for one reason or another are not working out." Citing the ongoing negotiations with lenders, he wouldn't comment more on the specific companies involved.
Management took great care to underscore that the company is not at significant risk of assuming recourse debt related to the deals. "We think we are well protected legally," said Seay. And when an analyst suggested it was not yet clear how the ventures would ultimately work out, Hilton reaffirmed the sentiment. "What is clear is that the risk of us making a significant investment is minimal," he said.
In the equity arrangements, there is no action that could trigger a "bad-boy" event without the consent of the Meritage. Action to trigger the event in cash method JVs, however, is not within the control of the company. "Bad-boy" debt is a term used to describe a guarantee of principals of the borrowing entity that can, in some cases, trigger recourse back against the principals if a misapplication of funds or fraudulent type of activity takes place. In the case of joint ventures, it may have the potential to become an issue if certain parties are unable to meet their obligations under the arrangement.
Considering that two key components for survival in home building seem to be managing and protecting the cash, it's not surprising that Hilton took time to personally name and thank the two executives that he described as invaluable to the company during this recent business climate: Seay, who has a 12-year tenure with the company, and Tim White, who has been with the company since 1991 as general counsel.
In other strong news, executives said they believe that the bulk of impairments have already been recognized. "Although impairments may continue to occur due to changes in market conditions, based on the relatively stronger Texas market and the significant impairments and option terminations we have already taken in other markets, we believe the great majority of the impairments are behind us," said Hilton.