It's beginning to sound like a broken record. Scottsdale, Ariz.-based Meritage Homes joined other home builders this week in announcing an end to its streak of profitable earnings. Citing deteriorating market conditions, Meritage reported a net loss for the second quarter 2007 of $57 million (-$2.16 per share), compared to net earnings of $77 million, or $2.82 per diluted share in the second quarter 2006.
Yet, unlike many of his peers, Meritage CEO Steven J. Hilton speculates a recovery for the company is in sight. "I've got to believe we are on the bottom, or near the bottom," said Hilton when asked during a conference call with analysts to project when the company would see improving comps for sales and the top-line performance. "I can't fathom it will get much worse. It might not be first quarter, but I think in '08, we'll start to see some positives."
The company has historically touted its strategy to option a high majority of its land, justifying the missed potential for incremental developing revenues by a claiming to employ a safer and less capital-intensive model, should market conditions soften. However, as is evidenced in this quarter's results, the strategy is still less than fail proof.
The results included pre-tax real estate-related and joint venture impairments of $80 million and goodwill-related impairments of $28 million in the second quarter of 2007. Charges stemmed from reduced market valuations of properties in California ($45 million), Florida ($15 million), Nevada ($12 million) and Arizona ($8 million). In addition, all goodwill and other intangible assets relating to the February 2005 acquisition of Colonial Homes in Ft. Myers/Naples, Fla. were impaired and written off. These charges, after tax effects, combined to reduce net earnings from home-building operations by $70 million.
Excluding these charges, adjusted net earnings for the second quarter 2007 were $13 million, compared to $82 million in 2006.
"Southwest Florida has been experiencing some of the most difficult housing market conditions in the country," said Hilton in a statement to investors earlier this month. "While our 2006 home closings there represented only approximately 2% of our company-wide closings, our year-to-date 2007 home closings in Fort Myers/Naples are down more than 70% from the level a year ago."
The company stopped short of announcing plans to permanently exit the market, but did confirm that it has terminated all future options -- more than 2,500 -- to purchase additional lots in southwest Florida. "We are suspending operations," said Hilton. "Whether we pull out completely is a decision we'll make down the road."
In total, Meritage impaired 22 communities this quarter and terminated 8 option contracts. Since the beginning of '07, the company has terminated options on 9,525 lots. "We look at the margin we are achieving, looking at our investment, what's our cash-on-cash return and what does the future hold based on what the competition is doing," said Hilton. "We look at all those factors when we decide whether or not to terminate a contract."
The company continues to believe in its option strategy going forward, noting that terms and pricing from land bankers have become more flexible over the last 90 days. As a result, the company is seeing some success as it grapples with aligning takedowns to slowing absorption rates. "Although it hasn't shielded us from conditions completely, by controlling most of our land through options, we have been protected," said Brent Anderson, director of investor relations. "[Financials] could have been much worse, had we owned more land."
On the land front, the company has decreased its total lot position by nearly 30% from its peak in September of '05, but the balance of owned-versus-optioned has shifted sharply with owned lots increasing 49% during the quarter. Currently, the company's overall lot inventory is 38,925, of which 75% is optioned. In all, 43% of the company's position is based in Texas where every market continues to be profitable.
The company ended the quarter with 222 active communities, up from 213 at the beginning of the year and 204 from the same period last year. "We expect that to be the high water mark and it will gradually come down as we work through lots in '08," said CFO Larry Seay.
In addition, the company is selling some of its owned land, "to the degree that we can," said Hilton. "Although it'll be better for the balance sheet in the short-term, it'll be better for the income statement if we can work through it. We are evaluating every market and every community. Those that make sense to dispose of, we'll take action."
The company's cancellation rate rose to 37% from 32% during the same time last year.
"We are working hard as a management team to reduce specs and we are focused on balance sheet management and keeping our debt-to-cap under 50%," said Hilton.
The company's earnings release follows:
Meritage Homes today reported a net loss for the second quarter 2007 of $57 million, (-$2.16) per share, compared to net earnings of $77 million, or$2.82 per diluted share in the second quarter 2006.
The results included pre-tax real estate-related and joint venture impairments of $80 million and goodwill-related impairments of $28 million in the second quarter 2007. The 2007 real estate-related charges stemmed from reduced market valuations of properties in California ($45 million), Florida ($15 million), Nevada ($12 million) and Arizona ($8 million). Due to persistent and severe weakness in southwest Florida, all goodwill and other intangible assets relating to a February 2005 acquisition in Ft.Myers/Naples were impaired and written off. These charges, after tax effects, combined to reduce net earnings from homebuilding operations by $70 million. Excluding these charges, adjusted net earnings for the second quarter 2007 were $13 million, compared to $82 million in 2006.
Second-quarter home closing revenue was $568 million in 2007, compared to$903 million in 2006. This 37% revenue decline reflects an 8% reduction in ASP on 32% fewer home closings. The largest year-over-year declines in closing revenue were experienced in Nevada (-69%), Arizona (-58%) and California (-52%), while quarterly revenue from Texas home closings increased 8% in 2007 over 2006.
Gross margin was 1.7%, or 15.6% before real estate-related impairments in the second quarter 2007, compared to 24.1% and 24.9%, respectively, one year earlier. These adjusted gross margins exclude second quarter real estate-related impairments of $79 million in 2007 and $7 million in 2006.
"Weakened demand and increased price incentives have resulted in lower margins on homes sold and more write-offs on remaining inventories," said Steven J. Hilton, CEO of Meritage. "Based on lower market values, we adjusted our inventory valuations and abandoned certain lot purchase options where previously-negotiated prices won't allow us to generate a reasonable return at today's lower home selling prices."
Softer demand coupled with higher cancellation rates reduced net orders to1,734 homes with a total value of $501 million in 2007, compared to 2,116 orders valued at $694 million in 2006. This 18% decline in net home orders, combined with a 12% lower ASP, resulted in a 28% year-over-year reduction in order value, with the largest declines in Arizona (-37%) and California (-35%). The second quarter 2007 cancellation rate rose to approximately 37% of gross orders, compared to 32% in the second quarter 2006.
For the first half of 2007, Meritage reported a net loss of $41 million, or($1.58) per share, compared to net earnings of $157 million, or $5.68 per diluted share for the first six months of 2006. The 2007 results included pre-tax real estate-related and joint venture impairments of $97 million and goodwill-related impairments of $28 million, which combined to reduce net earnings from homebuilding operations by $81 million after tax.
Year-to-date home closing revenue for 2007 was $1.1 billion, generated from3,654 homes closed at an ASP of approximately $313,000. First half 2006 home closing revenue was $1.7 billion, generated from 5,250 homes closed at an ASP of approximately $333,000. The largest declines were in Nevada (-74%) and California (-56%), while Florida and Arizona closing revenues also decreased 42% and 41%, respectively. Texas closing revenue increased 5% year-to-date 2007 compared to 2006.
Net orders for the first six months declined 19%, with an 8% lower ASP, resulting in total order value 25% less than the same period a year ago.Average sales per community ran slightly less than 3 per month, compared to4 per month last year. Slower absorption rates resulted in a 9% increase in communities open for sale as of June 30, 2007 compared to the same date in 2006, as communities have not sold out as quickly as originally projected, and a few communities in the development pipeline have opened and started selling.
Order backlog stood at 3,838 homes valued at $1.2 billion on June 30, 2007, compared to 5,849 homes valued at $2.0 billion on June 30, 2006. A 7% year-over-year decline in the ASP of homes in backlog, combined with the 34% lower volume, reduced backlog value by 39% from a year ago. Arizona and Florida represented the largest declines in backlog from the previous year at -60% and -71%, respectively, with Texas backlog 9% lower than a year ago.
"Based on weaker demand today and our expectation of difficult selling conditions persisting for at least the remainder of the year, we reduced our lot supply by 7% this quarter -- and by 29% from its September 2005 peak -- abandoning options to purchase another 2,000 lots, which would have cost about $110 million," said Hilton. "Since the first quarter 2006, we have terminated options to purchase more than 9,000 lots representing about 20% of our total lots under option, which will avoid over $690 million of purchases. Our total lot supply today stands at 38,925 -- roughly a four-and-a-half-year supply of lots based on trailing twelve months'deliveries -- with only one year's supply owned. We have $175 million of deposits controlling $1.7 billion of land, which represents 75% of our total supply, and we will continually evaluate market conditions going forward before deciding whether or not to exercise these options."
Inventories of unsold homes increased slightly during the quarter, ending at1,387 spec homes, compared to 1,365 specs at the beginning of the year.Total real estate inventories at June 30, 2007 were $1.6 billion, compared to $1.5 billion at year-end 2006, due to the slight increase in specs from cancellations, and closings slowing faster than lot purchases.
Meritage's net debt-to-capital ratio was 47% as of June 30, 2007, compared to 42% at June 30, 2006, reflecting increases in inventory levels, but still within the Company's target range of 40-50%. Total funds available under Meritage's existing bank credit facility stood at $516 million at June 30, 2007, after considering the facility's borrowing base availability and most restrictive covenants.
"Market conditions have become more challenging in the last few months, as interest rates have increased, mortgage credit has tightened, and buyers continue to wait for signs that we're near the bottom, especially in markets where affordability was a relevant concern," commented Hilton. "Many believe we're approaching the bottom in terms of housing demand and buyer confidence, and we at Meritage are working to help buyers get more comfortable with their purchase decision. We've increased our sales training and marketing, and improved our customer satisfaction ratings, while reducing costs and future commitments in under-performing markets.
"We expect the remainder of 2007 will be difficult, but take confidence in our sound strategy, strong organization, proven record of success, and solid franchise that includes some of the historically best homebuilding markets in the country. We are emphasizing value, quality and customer satisfaction, and are determined to maintain a strong balance sheet that will allow us to emerge a stronger competitor when the market improves."
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