U.S. markets close in 1 hour 50 minutes
  • S&P 500

    +10.34 (+0.26%)
  • Dow 30

    +205.83 (+0.64%)
  • Nasdaq

    -50.16 (-0.42%)
  • Russell 2000

    +21.71 (+1.25%)
  • Crude Oil

    +3.51 (+5.07%)
  • Gold

    -29.50 (-1.49%)
  • Silver

    -0.23 (-0.98%)

    +0.0030 (+0.28%)
  • 10-Yr Bond

    +0.1330 (+3.93%)

    +0.0047 (+0.38%)

    +0.9720 (+0.74%)
  • Bitcoin USD

    -873.54 (-3.14%)
  • CMC Crypto 200

    -20.18 (-3.32%)
  • FTSE 100

    +66.32 (+0.90%)
  • Nikkei 225

    +91.62 (+0.33%)

Meritage Homes Corporation (NYSE:MTH) Q4 2022 Earnings Call Transcript

Meritage Homes Corporation (NYSE:MTH) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Greetings and welcome to the Meritage Homes Fourth Quarter 2022 Analyst Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Emily Tadano, Vice President of Investor Relations and ESG. Thank you. Please go ahead.

Emily Tadano: Thank you, operator. Good morning and welcome to our analyst call to discuss our fourth quarter and full year 2022 results. We issued the press release yesterday after the market closed. You can find it along with the slides we'll refer to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of our home page. Please refer to Slide 2, cautioning you that our statements during this call as well as in the earnings release and accompanying slides contain forward-looking statements. Those and any other projections represent the current opinions of management which are subject to change at any time and we assume no obligation to update them. Any forward-looking statements are inherently uncertain.

Our actual results may be materially different than our expectations due to a wide variety of risk factors which we have identified and listed on this slide as well as in our earnings release and most recent filings with the Securities and Exchange Commission, specifically our 2021 annual report on Form 10-K and subsequent quarterly reports on Form 10-Q which contain a more detailed discussion of those risks. We've also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Executive Chairman; Phillippe Lord, CEO; and Hilla Sferruzza, Executive Vice President and CFO of Meritage Homes. We expect today's call to last about an hour.

A replay will be available on our website within approximately 2 hours after we conclude the call and will remain active until February 16. I'll now turn it over to Mr. Hilton. Steve?

Steve Hilton: Thank you, Emily. Good morning and welcome to everyone participating in our call this morning. I'll start with a brief discussion about what we are seeing in the market and provide an overview of our recent company milestones. Philippe will cover our strategy and quarterly performance. Hilla will provide a financial overview of the fourth quarter and forward-looking guidance. Q4 marked a strong finish to a year of exceptional execution and dedication from the Meritage team. We delivered 29% more homes this quarter and generated $2 billion in home closing revenue in the fourth quarter which was 32% higher than the fourth quarter of '21. Our home closing gross margin of 25.2% and quarterly SG&A leverage of 8.4% led to our quarterly diluted EPS of $7.09.

Although favorable demographics and the low supply of housing inventory should drive long-term demand, we believe they were overshadowed in the back half of the year by ongoing economic uncertainty and buyer psychology, increasing mortgage interest rates and inflation. With homebuyers on a about when to get back into the market, our fourth quarter sales orders declined 46% year-over-year driven by a cancellation rate of 39%. Today's higher mortgage interest rates continue to pressure housing prices as monthly payments still remain above 2020 and 2021 levels despite price cuts and rate locks. We believe that until rates stabilize, home sales activity will remain choppy. We see some potential buyers who could qualify but are waiting for further price declines as they anticipate additional builder incentives are coming.

Other current buyers with rate locks in place or below current market mortgage rates were cancelling due to the buyer hesitancy as they may have been nervous of the general economy or their own financial positions. However, given our available inventory, we are seeing some buyers -- the market and respond favorably to our quick movement selection as well as our incentives and company-wide sales initiatives. Now, on to Slide 4. As the team that embodies our start with heart core value, Meritage employees donated countless hours to deliver 3 mortgage-free homes to deserving military veterans and their families on Veterans Day in Houston, Nashville and Tucson. This is one of the most impactful annual initiatives that the entire organization looks forward to and we were excited and humbled to continue that tradition in 2022.

We also expanded our long-term history of contributing to local non-profit organizations to further our diversity, equity and inclusion mission as well as voluntary time and donated financial support to organizations, combating food and security across the country and providing shelter to those in need. This quarter, Meritage was recognized by the Phoenix business shareholder, both as one of the best places to work and one of the healthiest employers. And as a result of our overall commitment to ESG, Meritage was named one of the 2023 America's Most Responsible Companies by News League Magazine. Overall, we are proud of what our team members accomplished this quarter on top of the quarter of solid operational execution. I'll now turn it over to Philippe.

Phillippe Lord: Thank you, Steve. During the quarter and looking into 2023, we are analyzing the business through the lens of market events and actions that are within our control. We could not influence the macroeconomic factors impacting Q4 sales that Steve described. However, we can control how we react to them and how agile our business can be are focused around our core strategies that we have honed for many years now. To reiterate our strategies and the actions we have taken, we remain committed to prestarting 100% of our entry-level homes. This readily available home inventory puts us in a favorable position since buyers in the current market want homes are ready to close within 45 to 60 days. Eliminating uncertainty and reducing stress are a premium in today's murky economic environment.

Further, line building allows us to complete homes on a shorter cycle time than a build-to-order model despite supply chain issues. Prestarting homes with a limited SKU library means we can also offer more affordable products as we pass on our savings to our customers. As an added benefit, when we have cancelled inventory, the lack of customization of our homes, stemming from our streamlined and -- specifications, results in limited discounting for the future resell of that home. Since we mainly build entry-level products, we expect a higher average absorption pace and prioritize pace over price. Like all homebuilders, we benefited from the runup in home prices for the first 2 years at COVID. And despite higher costs, we experienced industry-leading gross margin levels.

More importantly, we increased our market share. Consistent with our strategy, we continue to target 3 to 4 net sales per month. As we had a net order absorption pace of 2.2 per month in Q4, we have taken additional actions to get back on our target, including lowering prices and utilizing a full range of incentives such as mortgage rate locks, rate buydowns until we find the market clearing point to move our inventory and get back to our target sales pace. The timing of these actions align with the production time line of our spec inventory which is now completed or near completed and ready for quick moving sale ahead spring selling season. Further, during Q4, our operations team worked hard to close a large portion of our backlog despite supply chain issues impacting cycle times.

We also aggressively validated every home that remain in our backlog as of year-end. Most confirmed their commitment to their homes. Some use incremental pricing or rate adjustments that we were able to offer. In other cases, though, we had to cancel the sales, it was clear the buyer is not going to purchase home with a reasonable incentive structure. By proactively showing our backlog, we likely identified some cancellations earlier in the cycle than normal but this gave us more confidence in our backlog at the end of 2022 and added available inventory for sales into January. While we certainly don't have a crystal ball regarding what cancellations rates will do in 2023, we are comfortable that the buyers who purchased homes in earlier March 2022 under a different market and economic environment represent a smaller portion of today's backlog compared to a greater portion coming from buyers that have a more fulsome understanding of the current market conditions, their monthly payment expectations and the relative advantage of their rates and pricing incentives.

In addition to our sales initiatives, our purchasing team is actively rebidding our vertical costs to capture cost savings as incremental capacity is growing within our supply chain. Hilla will touch on more details but suffice to say, we are pursuing cost savings across all cost categories in all of our markets this year. These intentional actions enable us to adjust pricing and can structure community by community so that we can take advantage of our supply of available inventory as we kick off 2023. We believe we have the right level of completed and near-completed hotel which combined with a different mix of pricing actions, financing solutions and incentives allows us to offer a total package that is aligned with each local market environment.

Now, turning to Slide 5 to share our operational statistics. The 29% year-over-year increase in our Q4 closings to 4,540 homes was attributed to our team successfully managing the persistent labor and supply chain challenges. Entry-level loans made up 85% of closings, up from 81% in the prior year. Our fourth quarter 2022 sales orders of 1,808 homes were comprised of 89% entry-level homes, up from 82% in the fourth quarter last year. The 46% decline in sales orders year-over-year was primarily due to elevated cancellations and weaker overall demand despite a 10% year-over-year increase in average communities. Our cancellation rate in Q4 of 39% increased from 12% in Q4 2021 and 30% in Q3 2022. Quarterly gross sales orders declined a more modest 22% year-over-year.

Our fourth 2022 average absorption pace was 2.2 per month which was down from 4.5 per month in the fourth quarter of 2021 but gross sales pace was 3.6 per month at our 3 to 4 monthly target, affirming the underlying consumer demand is indeed present. In finding the right pace to price relationship, we expect our average absorption pace will get fast towards a target of 3 to 4 net sales per month during 2023. Moving to the regional level trends on Slide 6. The highest regional absorption pace of 2.6 per month in the fourth quarter occurred in our Central region which is comprised of our Texas markets. Orders were down 46% year-over-year in Texas overall. With all 4 Texas markets holding a growth sales pace greater than 3.0 per month, we believe we are starting to find stability in Houston, Austin and San Antonio, while in Dallas, we are experiencing a steadier environment and are gaining market share.

The fourth quarter regional absorption pace for the East region was 2.5 per month. We still have work to do here but all of our Eastern markets actually had a gross sales pace in line with our 3 to 4 per month per target. And we are confident that we are well positioned in this part of the country. The East had the lowest region of decline in orders up 41% year-over-year and the lowest cancellation rate in the fourth quarter. In Florida, ASPs on orders were up 11% due to product mix shift even after our price adjustments, while orders were down to 25% reduction in average communities. Consumer pullback was most evident in the West region, where the absorption pace was 1.6 per month for the fourth quarter. California was the only place to have an increase in orders year-over-year which is primarily the result of more convenience.

California also had a gross sales pace over 3 per month, given the quality of our locations and our entry-level positioning in the market. Colorado and Arizona continue to experience be hesitate to transact as they adjust to the higher lovely payments in these markets that experienced a higher runoff in ASPs over the past 2 years. Further, cycle times in these 2 markets are still so are the longest and least predictable. Although the new incremental capacity showing up in the supply chain now is providing a run rate for improvement here. We wanted to provide some color into January sales. As we know, that's top of mind for everybody on today's call. Compared to the average absorption pace of 2.2 per month in Q4, we saw a notable improvement in January, achieving a net absorption pace greater than 4.0 per month per community as well as a more normalized cancellation rate in the mid-teens.

We sold over 1,200 houses in January, up approximately 4% over last January. We have some initial confidence that we found the right combination of pricing incentives to sell at our targeted 3 to 4 net sales per month. Now, turning to Slide 7. To align starts with lower demand we further moderated construction this quarter, starting approximately 2,100 homes in the fourth quarter compared to approximately 2,700 in Q3 2022 and more than 3,700 in the fourth quarter of 2021. We ended the period with nearly 4,900 spec homes in inventory or an average of 18 per community as compared to approximately 3,200 specs or an average of 12.3% in the fourth quarter of 2021. Market demand dictates our target amount of available inventory in each of our communities.

Our goal is to keep 4 to 6 months' supply of specs on the ground by managing our starts to match our sales pace and production capabilities, although excess cancellations increased our specs slightly above our target rate in the quarter. To align with the additional supply of inventory on hand, we will flex and slow down our starts until we reach our optimal equal liver. But as noted, we have already worked through about 25% of these stacks in January. Similar to last year, 79% of our home holding this quarter came from previously started inventory. At December 31, 2022, we added over 750 complete homes to sell. Our 15% completed homes is higher than the last couple of quarters and, coupled with our homes that can close by the end of Q1, represent about 1/3 of our spec inventory.

We ended the fourth quarter with a backlog of 3,300 units as we closed out a significant portion of our backlog and improved our conversion rate from 60% last year to 75% this year. Q4 cycle times continue to be similar to the earliest 3 quarters of 2022 which were still approximately 6 to 8 weeks longer than our pre-COVID . However, we are targeting aggressive reductions in construction time for 2023 and are already starting to see some improvements from our front-end trades. We are hopeful that with the industry backlog clearing over the next few quarters and the capacity of back-end trades like appliances, flooring, countertops in cabinets loosening, our cycle plan and backlog conversion rates will improve in the back half of this year. I'm now going to turn it over to Hilla to provide additional analysis on our financial results.


Hilla Sferruzza: Thank you, Philippe. Like last quarter, we'll start by providing a bit of color on our BFR business before reviewing the financials in detail. Sales through our built-for-rent partners in the fourth quarter only represented a low single-digit percentage of our net orders volume as the rental operators, much like the rest of the sector, are pausing to analyze their financial hurdles and adjust underwriting targets. We're encouraged to see some incremental interest in January and continue to believe in the viability of this channel due to the historical countercyclical strength of rental market and higher interest rate environment. Now let's turn to Slide 8 and cover our Q4 financial results in more detail. Home closing revenue grew 32% year-over-year to $2.0 billion in the fourth quarter of 2022 combining 29% greater home closing volume and 3% higher ASPs when compared to prior year as we overcame supply chain challenges to close a substantial portion of our backlog.

Our fourth quarter 2022 home closing gross margin was 25.2%. The 380 bps deterioration grew 29.8% a year ago was the result of greater incentives and higher direct costs as well as several nonrecurring items, including $10.9 million and warranty adjustment related to 2 specific cases and $4.2 million in write-offs for option deposits and due diligence costs for terminated land yields which were partially offset by $5.4 million in retroactive vendor rebates. In the fourth quarter of 2021, we had $2.5 million in write-offs for terminated land deals and no warranty or rebate adjustments. Excluding these nonrecurring items, adjusted fourth quarter 2022 home closing margin was 25.7% compared to 29.2% in Q4 of 2021. We expect that price concessions elevated discounts and a continuation of financing incentives for rate locks and buydown will negatively impact gross margins in 2023.

We However, with our sales ASP down 10% to $389,000 this quarter when compared to last year, we've already taken material pricing action, demonstrating our commitment to elevating our sales pace. And although we're not projecting broad-based cost savings to offset the challenging market conditions today, we are starting to make some headway to reduce direct costs and improve cycle time. There are full company initiatives to drive substantial cost reductions with success stories of $15,000 per home in savings just since already emerging in some divisions, particularly in our slower markets where trades have excess capacity. However, we likely won't benefit from the full impact of these savings until the tail end of 2023 and into 2024 as they will be captured in our home starts until mid to late this year.

We still believe that long term, our normalized gross margin will benefit from better operating leverage from our increased volume and our streamlined operations and will end up at or above 200 bps from our historical average of 20%, although the next several quarters are likely to be bumpy. SG&A as a percentage of home closing revenue was 8.4% for the current quarter which was a slight improvement over 8.5% in the prior year. Our higher revenue allowed us to better leverage our SG&A. This was partially offset by higher commissions and advertising costs that reflects our response to the current sales environment. We believe marketing costs and broker commissions will remain above historical averages in the near future which, combined with lower expected closing volume in 2023, will drive lower SG&A leverage.

Photo by Breno Assis on Unsplash

The fourth quarter 2022 effective income tax rate was 23.3% compared to 23.8% in the prior year. Tax credits were earned on qualifying energy-efficient homes under both the 2022 Inflation Reduction Act for the current quarter and the 2019 Taxpayer Certainty and Disaster Tax Relief Act for the prior year. Overall, higher claim closing volume, combined with the lower outstanding share count in the current quarter, led to a 13% year-over-year increase in fourth quarter 2022 diluted EPS to $7.09. To highlight a few full year 2020 results on a year-over-year basis, order units declined 15%. Closings were up 10%. We had an 80 bps expansion of our home closing gross margin to 28.6% in fiscal 2022 and SG&A as a percentage of home closing revenue improved 90 bps to 8.3%.

We generated a 35% increase in net earnings and diluted EPS was a record $26.74 for the year, a 39% increase from 2021. Turning to Page 9. Given slower market conditions, we are also focused on exercising balance sheet discipline. We reduced spend on land, development and phone inventory, ending the year with over $860 million in cash and generating $562 million of free cash flow just this quarter. At December 31, 2022, nothing was drawn on our credit facility and our net debt to cap was just 6.8% which is well below our maximum internal threshold of high 20s. With no shares repurchased during the quarter, we ended 2022 with $244 million available under our authorized share repurchase program. Ahead of the spring selling season, we felt it was prudent to grow our cash position to maintain maximum flexibility in an uncertain environment.

In the coming months, we will look to strike a balance between cash preservation for operations and returning dollars to shareholders and we expect to provide additional updates on our next quarterly call. Shifting gears, I want to remind everyone about how impairments are calculated. When we estimate that the cash to be generated from the sale of homes in a community is not expected to cover the cost we will incur in that community and impairment is present. We review all of our assets every quarter and determined that there were no impaired communities in Q4 despite the reduced ASPs and higher direct costs. Looking at our expected home prices in 2023, we do not expect broad-based impairments across our assets. On to Slide 10. Even with the increased liquidity this year, we grew our community count 5% in 2022 to 271 communities at year end.

In Q4, we opened 21 new communities compared to 11 in Q3 this year. The ongoing supply chain issues transformers continue to extend the time line for our new community openings. Additionally, we have strategically slowed and at times halted some of our openings to take advantage of the opportunity to rebid and lower our vertical costs so that these communities can open in a more competitive position when they come online. We expect to continue to open new stores throughout the year and return to our 300-community targets over the next several quarters. This quarter, we continue to rightsize our land portfolio, walking away from underperforming land deals or recently sourced deals where we could not secure closing extensions. Even with slightly more than 10,000 terminated loss this year, we still ended 2022 with 4.5-year supply of lots within our target of 4 to 5 years.

So we're comfortable that we have all the land we need right now. In Q4, we did not add any new lots under control while we terminated roughly 3,700 lots with a corresponding write-off of $4.2 million. These terminated loss relate to approximately $280 million of future land and development spend that we will not be incurring. For full year 2022, after considering $15.8 million of walkaway charges from terminated land yields, we only have $92.5 million of incremental exposure related to deposits, due diligence for future lots under control which includes next phases of our existing communities. All in, this makes up less than 2% of our total assets. During the fourth quarter, we spent only $351 million on land acquisition and development, bringing our full year total spend to $1.5 billion.

With reduced land acquisitions, about 2/3 of the spend was on land development costs. We expect our 2023 land acquisition and development spend to be at or below the $1.5 billion extended in 2022 despite the anticipated community count growth. At December 31, 2022, we had approximately 63,000 total lots under control compared to approximately 75,000 total lots at December 31, 2021. About 73% of our total lot inventory at December 31, 2022 was owned and 27% was auctioned as the terminations of auctioned lots understandably drove the mix of controlled but not one lot lower. In the prior year, we had a 65% owned inventory and a 35% auctioned lot position. With just under 50% of our current portfolio sourced from land secured in 2022 or earlier, we are comfortable with the basis of the land control as well as the balance of owned and auctioned lots.

Finally, turning to Slide 11. Looking to Q1, we expect closings to be between 22 and 2,600 units with corresponding revenue of $940 million to $1.1 billion. We expect margins to trend down to 21% to 22% and our tax rate to be around 22% to 23%. With limited visibility and market conditions, we're holding off on providing full year guidance at this time. With that, I'll turn it back over to Philippe.

Phillippe Lord: Thank you, Hilla. To summarize on Slide 12. January is off to a great start but too early to quantify the strength in spring selling season. We are prepared to find the right combination of product pricing incentives for all of our communities to achieve a pace of 3 to 4 net sales per month. Our commitment to prestarting 100% of -- homes, streamline operations and prioritizing takeover price positions us to capture market share, gain leverage and maximize profitability as market conditions evolve. In conclusion, I would like to thank all Meritage employees for their hard work and the job well done in 2022. Their dedication drove our success. And with that, I will now turn the call over to the operator for instructions on the Q&A. Operator?

See also 25 Least Developed Countries in Europe and Top 20 Financial Cities in the World.

To continue reading the Q&A session, please click here.