Meritage Homes Corp (MTH) 2003 Q2 法說會逐字稿

Good day and welcome to the Meritage second quarter, 2003 earnings results conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Chris Tofalli. Please go ahead, sir.

Good morning and welcome to the Meritage Corporation’s conference call to discuss operating results for the second quarter ended June 30, 2003. Participating on the call today, from the company’s management are Steve Hilton and John Landon, Co-Chairman and Co-Chief Executive Officers, and Larry Seay, Chief Financial Officer.

Before we start, I would like to remind everyone that during the course of this conference call, certain projections and other forward-looking statements may be made regarding future events or the future financial performance of the company. We refer you to the disclosures that the company files with the Securities and Exchange Commission, specifically those contained in the company’s most recently filed Form 10-K and 10-Q. The second quarter press release that contains disclosures about non-GAAP measures is available through a link to the SEC filings, on our website. These documents describe important factors that may cause actual results to differ materially from those contained in any projections or forward-looking statements made during this conference call. I would now like to turn the call over to Steve Hilton. Steve?

Good morning and thank you for joining us as we discuss Mertitage’s second quarter, 2003 results. First I will recap our performance for the second quarter and the first half of the year. Next John will discuss our new order results, market conditions, our outlook for the remainder of the year. Larry will then provide details about our balance sheet and other financial information. After that, we’ll be happy to answer any of your questions.

2002 was Mertitage’s 15th consecutive year in record revenues and net earnings and we believe we are well on our way to posting our 16th consecutive record year. This enviable record demonstrates that Meritage is a dynamic growth company that has established itself as a leading player in the consolidation of the home building industry that we believe will continue through the remaining decade. Meritage has achieved its success through a dual strategy of growing organically in its existing markets and successfully integrating end market and new market acquisitions. The successful execution of this strategy has placed Meritage among the top builders, not only in terms of growth and revenue, net earnings and EPS, but also for returns for returns on capital and equity. In fact, Meritage has grown to the 14th largest builder in the US in 2002, as ranked by Builder Magazine, a feat achieved in just six short years since going public at the beginning of 1997.

Net earnings reached a second quarter record of 21.3 million, or $1.55 per diluted share, a 30 percent earnings per share increase over the prior year’s quarter. This strong EPS gain reflects a 23 percent increase in home deliveries, a 7 percent increase in the average price of homes closed, and a 58 basis point improvement in SG and A leverage. These factors more than offset a 27 basis point decrease in housing gross margins and a 17 percent increase in the number of diluted shares relating to our June 2002 equity offering, done in anticipation of our Hammonds and Perma-Bilt acquisitions.

For the first half of 2003, net earnings totaled 37.1 million, or $2.70 per diluted share, up from 23.5 million, or $1.92 per diluted share for the first half of 2002. This was a 41 percent increase in EPS. Year-over-year, first half earnings were up a very impressive 58 percent. In addition, the company once again set a new quarterly record for revenue and all time records for home orders and backlogs of homes sold [bought] [phonetic] on closed homes. Our home building revenue in the second quarter of 2003 grew 326 million, an increase of 32 percent and a second quarter record.

Excluding our Hammonds and Perma-Bilt acquisitions that closed in the last half of 2002, home closing new revenues for the quarter were down 2 percent, mainly due to a decline of 24 percent in Arizona. As we have discussed in prior quarters, this decrease was caused by a sell off of communities in the Phoenix area earlier than anticipated and the delays in opening a replacement. The 37 percent increase of dollar value of new orders in Arizona during the second quarter of 2003 indicates that many of these replacement communities are now on line and actively selling.

Home closing revenue in Texas was up 102 percent in the second quarter of this year compared to the second quarter of last year. This includes $50 million in second quarter closing revenues generated from our July 2002 acquisition of Hammonds Homes. Without Hammonds Homes, home closing revenue in Texas would have still been up a robust 24 percent. Closing revenues in California advanced 7 percent on 3 percent fewer homes. What the latter also reflects is a reduced level of inventory availability.

In addition, Nevada based, Perma-Bilt Homes acquired in October of 2002, generated 34.3 million in home closing revenues in the second quarter, or approximately 11 percent of the total. The average price of a home closure in the quarter increased by 7 percent over the prior year’s quarterly average. This was due mainly to a mix of higher priced homes closing, particularly in Arizona and California, offset somewhat by the addition of Hammonds and Perma-Bilt Homes, which sell somewhat lower priced homes than the company average.

Meritage has continued to achieve good profitability levels in the somewhat more competitive current market environment. Pre-tax margins advanced 34 basis points to 10.2 percent for the second quarter, and 44 basis points, to 9.7 percent for the first half, as compared to the same periods in 2002. These increases are the primary result of leveraging G and A expenses.

Our second quarter gross margin from home building was 20.1 percent of housing revenue, a slight decrease in margin of 27 basis points from the prior year’s second quarter. However, the gross margins from home building for the first six months of 2003 is 20 percent, or 32 basis points higher than the first six months of 2002. We anticipate gross margins in the latter half of 2003 to be relatively consistent with those in the second quarter. G and A expenses as a percent of revenue were 3.6 percent for the quarter, an 89 basis point reduction from the same quarter a year ago, reflecting the end of the earn-out payments relating to Northern California, cost savings from successful integration of our recent acquisitions and other scale efficiencies.

Salary expenses during the quarter were 6.4 percent of revenue, an increase of 31 basis points from last year’s quarter, reflecting slightly higher marketing costs and advertising costs. John Landon will now cover our new order results, marketing conditions, and our expectations for the remainder of 2003. John?

Thank you, Steve, and good morning everyone. We are excited about our record orders for the second quarter, which provides good backlog visibility for the balance of the year. The dollar value of new orders in the second quarter of 2003 reached an all-time high of 463 million, a very strong 56 percent increase over 2002’s second quarter, leaving the dollar value of order backlog of 46 percent, to 805 million, another all-time high.

New unit orders advanced 64 percent in the quarter overall and rose 13 percent excluding acquisitions, as compared to the prior year’s quarter. Our average selling price of new orders were down 5 percent in this year’s second quarter from the same period a year ago. This reflects a larger number of closings from our lower price Texas, Arizona and Nevada markets this quarter, offset somewhat by general price level increases allowed by the current strong demand for homes. Average sales prices for new orders during the quarter were up 11 percent in Texas and 7 percent in California and flat in Arizona, compared to last year’s quarter. The average home price in Nevada is 2 percent under the overall company average.

Our sales prospects for the balance of the year are excellent, with 137 actively selling communities as of June 30, 2003, up 78 percent over the prior year’s quarter. This includes approximately 40 communities from Hammonds and five communities from Perma-Bilt. Organically, our community count at June 30, 2002 was up approximately 19 percent over the prior year’s quarter. We anticipate the number of actively selling communities will increase to roughly 145-150 by the end of the year, approximately 13-17 percent above the levels at the end of 2002.

The housing market continues to be strong, providing a platform for sustained, superior operating results for the public home builders, relative to most other sectors. Mortgage rates continue at or near historic lows and we feel they are unlikely to rise significantly any time soon. In addition, demographic trends are projected to remain favorable to the industry in the next several years as are the competitive dynamics of accessing land and capital that also favors the public builders.

Based on our year-to-date results, we are pleased to again increase our earnings guidance for 2003, with first half revenue of 617 million and our backlog at June 30, 2003 at 805 million, we currently anticipate closings in 2003 to be in the neighborhood of 5,400-5,700 homes and revenue to be in the 1.3-1.4 billion range, and increase of about 20-25 percent over 2002. Based on our expectations for relatively steady margins, we also anticipate the diluted earnings per share should approximate $6.20-$6.40 this year, up from our prior quarter’s guidance of $5.90-$6.10. This would represent a 17-20 percent increase over prior year’s EPS of $5.31. For the third quarter we anticipated diluted earnings per share to range from $1.55-$1.60.

As Steve pointed out, the first half of 2003 has been very strong, due both to organic growth and from our latter half 2002 acquisitions. While we expect the second half will be strong as well, we anticipate the rate of growth the slow as we reach the anniversaries of the Hammonds and Perma-Bilt acquisitions. In addition, the benefit of the new communities coming on line, which we’re now beginning to see in our recent acquisition order rates and are anticipated to occur later in the year in California, will not be fully reflected in deliveries until next year.

Our guidance does not assume any additional acquisitions and though we continue to explore acquisition opportunities, none are eminent at this time. Areas of particular interest are Southern California, Colorado, New Mexico, Georgia and Florida. We are very pleased with our record setting performance during the second quarter and first half of 2003. With our home sales revenue up 46 percent, dollar value of home orders up 48 percent during the first half of the year, and all-time high backlog of 804.7 million at June 30, 2003 and our quality [lot] [phonetic] position, we are poised for another record year. I will now turn the call over to Larry Seay to discuss our balance sheet in more detail. Larry?

Thanks, John, and good morning everyone. Our company’s balance sheet remains strong, which is a high priority for Meritage and we feel, one of the keys to our future success. Our ratio of net debt to capital at quarter end was on target at 50 percent and excluding any acquisitions, we expect a ratio at the end of 2003 to be in the low to mid-40 percent range. The year earlier leverage ratio of 33 percent benefited from the June 2002 closing of our 85 million follow-on stock offering that we issued in anticipation of a Hammonds and Perma-Bilt acquisition. They did not close until the second half of that year.

At quarter end, the company had approximately 372 million in notes payable, consisting mainly of 206 million in senior notes and 165 million in our bank credit facility. With 26.6 million of cash on the balance sheet and approximately 61 million of additional, immediately available funds under our credit facility, our liquidity at quarter end is strong. After considering our most restrictive covenant, this entire amount is available to borrow. At quarter end, our inventory investment is up 53 percent from last year, consistent with our growth in revenues. We now own or control approximately 28,500 lots, up 59 percent from last year, roughly a 4.5 year supply. The number of completed and unsold homes stands at approximately 90, less than one per community, in comparison to 36 homes at the end of prior year’s second quarter.

Much of this increase came from our Hammonds acquisition. We did not purchase any shares of the company’s stock during the quarter and the current stock price will probably limits our stock repurchases in the near term. EBITDA for the quarter was 40.9 million, compared to 31 million for the prior year’s quarter, an increase of 32 percent. For the quarter, interest incurred was 6.5 [inaudible] and interest expense and cost of sales was 4.8 million. On a trailing four quarter basis, this results in an interest coverage ratio of about 7.3 times and a debt to equity ratio of about 2.3 times.

We continue to work with our auditors, KPMG, to apply actual accounting standard board interpretation number 46, [inaudible] consolidation of variable interest entities – 1046. At this time we have determined and we believe that most other home builders have determined that 1046 will apply to certain land and lots purchased in option contracts that are customarily entered into by builders to obtain land and lots on which to build homes. If these agreements are determined to create variable interests, as defined by 1046, it is determined that the builder is contractually required to absorb the majority of the expected losses of the variable interests. 1046 requires that those purchase and option agreements be consolidated on the builder’s balance sheet.

Unfortunately, the language of 1046 pronouncement is broadly written, of conceptual nature and does not provide a high level of specific guidance regarding its application to specific industries. In fact, there’s no specific guidance in the pronouncement regarding how 1046 should be applied to land and lot purchase and option agreements. We have developed that framework to implement 1046 as it relates to our option agreements. Within this framework we are analyzing our option agreements and we are in the process of obtaining KPMG’s concurrence with that work. 1046 requires immediately application agreements entered into since February 1st, 2003. A 1046 is not required to be applied to agreements entered into prior to February, 2003, until our third quarter of this year.

However, based on preliminary analysis, we do not believe that a significant amount of our option agreements will require to be consolidated. Our option agreements are structured so that that seller retains much of the market risk of owning land. A 1046 does not alter the economic substance of these agreements. We do not believe there will be a reassessment of our risk profile by debt rating agencies. Expect to include a complete discussion and disclosure of 1046 in the company’s June 30, 2003 report on Form 10-Q.

Thank you, Larry. I think all of you can see that we are on track to achieve another record year in 2003. That ends our formal comments and we’ll now open the floor to questions. The conference call operator will provide you with instructions on how to register your questions.

Thank you. Today’s question and answer session will be conducted electronically. To ask a question, press the star key, followed by the digit 1 on your touch-tone phone. Please make sure your mute function is turned off so your question will register on our equipment. And again, that’s star 1 if you’d like to ask a question. Our first question, Margaret [Weiland] [phonetic], UBS.

Good morning. It’s actually William Lam. Just two questions. One is, in terms of your land position, I noticed you have not given out the percentage of optioned or owned land.

Yes, it remains around where it was last quarter. I think we’re at about 83 percent of optioned land this quarter.

Okay. And our other question is – I understand you’re probably still going through a bunch of processes and may not have a forecast for ’04, but I was wondering if you can provide some sort of preliminary comments on ’04?

This is Larry talking. At this point in time I don’t think we’re providing 2004 guidance. We’ll probably provide that guidance as we approach the end of the year.

Okay. And in terms of your ’03 guidance, I guess again, it seemed a little conservative to us and we’re wondering if you can provide a little more color as to perhaps the deliveries that are expected in the third and fourth quarter, and just some comments on the margins that are expected in the two different quarters?

Yes. Currently, I think the third quarter comparisons to last year are a little bit more difficult, because the third quarter was a very good quarter. I think if you look at the full year guidance, we have increased full year guidance significantly. And I know the guidance we provided on the third quarter is a little bit lower than that Street estimates out there today. But, we think that that accurately reflects where the second half closings are going to fall. I don't think it’s a negative. It’s just a little bit of fine tuning on where we think the two quarters are going to show up. Overall, we’re very pleased with the full year and we think that the full year is going to be in the range we currently provided.

We also have a lot of new subdivisions, as we mentioned, opening in Arizona and California in the second half of the year. And we won’t see the results of those – the deliveries from those subdivisions until ’04. So we won’t get the boost that we got from the acquisitions, the first half of the year, the second half of the year from those new communities until next year.

Okay, thank you, guys.

And as a reminder, star 1 on your touch-tone phone for questions. Our next question, Alex Barronne, Franklin Templeton.

Yes, good morning and congratulations. I have a few questions here. One of them, I guess related to your comments on California and related to your closing. Are you expected to deliver, roughly, the same number of homes for the next couple of quarters as you did last year, or should we expect things to be slightly even lower given that you sort of sold out a little bit sooner than expected?

I was going to say, is your question related strictly to California or to the whole company?

No, just to California.

Well, you know, total closings for the full year for California – we’re looking at around 700 homes. So, that is an increase over last year. I don’t have last year’s number right in front of me. But California is doing very well. In fact, they’re doing so well, that’s why we are having a little bit of early sell-out of communities. But as we’ve previously discussed, I think we’re about at nine or ten actively selling communities now, but by the end of the year we expect to be back up to about 15 or 16. So, you’re just seeing the impact of the great business we’ve had there over the last few quarters – impact the number of currently available communities selling today.

Right. No, I understand. But I just wanted to get a better feel for how to model these closings, relative to next year.

Without giving you a specific number, Alex, I can say that we’re not going to see huge increases in California as far as number of homes delivered, but our profits and our margins there are way up. So, a lot more profit dollars are coming out of there for us and aren’t going to help us in the second half, but I think we’ll meet or beat last year’s.

Alex, last year’s closing number was 594, so being in the 700 range is up quite a bit. I think in ’04, giving the economy staying strong there, you’ll definitely see a big increase in deliveries in ’04 in California.

Okay. Now, if you could talk a little bit more on margins. I mean, last year you had the two acquisitions in the second half. So, should we expect a pick up in margins as you sort of get it back from purchase accounting at this time?

Yes. You know, last year the margins tended to range in kind of the 19 percent range. I even think the fourth quarter was a bit lower than that. And we anticipate the rest of the year being in that 20 percent range, which is where we’ve been over the last couple of quarters.

Okay. If I could ask one more. Can you talk about the tax rate? I guess it was just a little bit lower this quarter. What was the reason for that and is that something we should expect going forward or more like the historical rates?

Yes, again, the tax rate – I think we talked about this on other calls as being positively impacted by the percentage of business that we’re doing in non-state income tax states like Texas and Nevada. So, I think you’ll see that we’re about in the 37.5 percent effective tax rate. And I think you’ll probably see that percentage go forward.

Okay. I’ll let some other people ask now.

And as a reminder, star 1 for questions. Our next question, Charles Mooken, with Norman Checker Company.

Hi. Another wonderful quarter. Thank you. I just had a question about the G and A, which took a sudden drop, which is delightful, as a percentage of revenues. And your explanation suggests that maybe this was kind of a new ratio here and this is more or less permanent. Is that correct?

Yes, I think you’ll see that the scale advantages that we’ve picked up over the last few quarters and also losing the last bit of the Northern California earn-out that was paid to the division President at that time and the owner of that company, before we bought the Northern California division, are going to continue to impact G and A and you’ll see it kind of drop down to the lower percentages we’re achieving today.

Isn’t that great. Are earnings – buyouts a significant part of the current G and A on newer acquisitions?

No, because that transactions were structured differently. We don’t have an earn-out in the current acquisitions or they’re being accounted for differently.

Okay. Sounds wonderful.

And again, that’s star 1 if you’d like to ask a question. And we have a follow-up, Alex Barronne, Franklin Templeton.

Can you give us a rough idea of the dollar value that I guess you’re saving now from that California earn-out?

It’s in – for the first – let me think here. For last quarter I think it was in the $2 million range. Let me just check that here real quick. I do have a paper with that. I’m pretty sure it was in that dollar range, Alex.

Okay. And is that in the [indecipherable] I guess as G and A?

Correct. It was in the $2 million range for the second quarter and the $3 million range for the six-months ended.

Okay. And do you expect that you’ll be perhaps looking to get lower rates on debts at some point?

Well, our current bank facilities are certainly benefiting from the low interest rates today. And as we continue to grow and build the company, we hope that we’ll lower our pricing on the bank debt and when we go out and issue new senior note offerings, that the rates on those will be corresponding or lower as the market recognizes our size and in concert with the balance sheet.

Okay, great. Thanks again.

Our next question, Dan Cillie, Sidoti and Company.

Hey, good morning guys. Great quarter. I’m just wondering, do you anticipate any additional land sales through the end of the year?

No, not really. I mean, anything we’d sell would be pretty minor. I don’t think we have anything significantly scheduled.

Thanks.

As a reminder, star 1 for questions. Our next question, Marcus Ortega, JP Turner and Company.

Good morning. First time I’ve been on a call. Great quarter, fantastic first half. I respect the sensitivity on margins and you’ve done a great job managing them. But I follow the futures markets pretty aggressively in my modeling, and one of the things that has me concerned is lumber futures. Lumber futures in the first quarter and probably for the latter part of 2002 were about $230 or $240 per thousand board foot and recently they’ve been as high as $280 to $290 per thousand board foot. How are you guys managing to sidestep that commodity inflation in terms of protecting your margins?

You know, that’s something that we’ve managed – you know, as long as we’ve been in the business – and remember, the lumber is only a relatively, maybe 5-10 percent of the total cost of building a home, which is only around 50 percent of the sales price of a home. So even though it fluctuates up and down, it can have an impact. But at the rates that you’re talking about, it impacts the homes very nominally. I’m talking $300-$400 a house. We do lock-in our pricing on our lumber. So, everything that we sell, we’ve got locked-in. So we are able to, if we do see significant increases of lumber or any other type of material, we can take it into account, when we price our product for future sales.

Thank you very much.

Having no further questions, Mr. Landon, I’d like to turn the conference back over to you for any additional or closing comments.

Thank you for joining us today. We look forward to reviewing our third quarter results for you in October.

This does conclude today’s conference. Thank you for your participation. You may now disconnect.