Item 1. Business
Item 1. Business
The Company
Meritage Homes Corporation ("Meritage Homes") is a leading designer and builder of single-family attached and detached homes. We primarily build in historically high-growth regions of the United States and offer a variety of entry-level and first move-up homes. We have operations in three regions: West, Central and East, which are comprised of ten states: Arizona, California, Colorado, Texas, Florida, Georgia, North Carolina, South Carolina, Tennessee and Utah. These three regions are our principal homebuilding reporting segments. We also operate a financial services reporting segment. In this segment, we offer title and escrow, mortgage, and insurance services. Carefree Title Agency, Inc. ("Carefree Title"), our wholly-owned title company, provides title insurance and closing/settlement services to our homebuyers. Managing our own title operations allows us greater control over the entire escrow and closing cycles in addition to generating additional revenue. Meritage Homes Insurance Agency, Inc. (“Meritage Insurance”), our wholly-owned insurance broker, works in collaboration with insurance companies nationwide to offer homeowners insurance and other insurance products to our homebuyers. Our financial services operations also provide mortgage services to our homebuyers through an unconsolidated joint venture.
Our homebuilding activities are conducted under the name of Meritage Homes in each of our homebuilding markets. At December 31, 2022, we were actively selling homes in 271 communities, with base prices ranging from approximately $250,000 to $1,400,000. Our average sales price on home closings and orders was approximately $440,100 and $446,900, respectively, for the year ended December 31, 2022.
Available Information; Corporate Governance
We commenced our homebuilding operations in 1985 through our predecessor company, Monterey Homes. Meritage Homes Corporation was incorporated in the state of Maryland in 1988 under the name of Homeplex Mortgage Investments Corporation and merged with Monterey Homes in 1996, at which time our name was changed to Monterey Homes Corporation and later ultimately to Meritage Homes Corporation. Since that time, we have engaged in homebuilding and related activities. Meritage Homes Corporation operates as a holding company and has no independent assets or operations. Its homebuilding construction, development and sales activities are conducted through its subsidiaries.
Information about our Company and communities is provided on our Internet website at www.meritagehomes.com . The information contained on our website is not considered part of this Annual Report on Form 10-K. Our periodic and current reports, including any amendments, filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) are available, free of charge, on our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).
Meritage Homes operates within a comprehensive plan of corporate governance for the purpose of defining responsibilities and setting high standards for ethical conduct. Our Board of Directors has established an audit committee, executive compensation committee, nominating/governance committee, environmental, social and sustainability committee, and land committee. The charters for each of these committees are available on our website, along with our Lead Director Charter, Code of Ethics, Corporate Governance Principles and Practices, Conflict of Interest and Related Party Transaction Policy, Securities Trading Policy, Human Rights Policy, Vendor Code of Conduct, Environmental Responsibility Policy and Responsible Marketing Policy (collectively, the "charters and Published Policies"). All of our employees, officers and directors, are required to comply with our Code of Ethics and to immediately report through the appropriate channels, any known instances of non-compliance. Our charters and Published Policies are also available in print, free of charge, to any stockholder who requests any of them by calling us or by writing to us at our principal executive offices at the following address: Meritage Homes Corporation, 8800 East Raintree Drive, Suite 300, Scottsdale, Arizona 85260, Attention: Secretary. Our telephone number is (480) 515-8100.
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Strategy
All facets of Meritage's operations are governed by our core values that define our culture and operational parameters, ensuring that our actions are aligned around our brand promise of delivering to each of our customers a LIFE. BUILT. BETTER. ®
Our six core values include:
• Start With Heart
• Integrity Above All Else
• Develop to Empower
• Think Strategically
• Build Value, and
• Play to Win
These values combine our entrepreneurial spirit, cutting-edge innovation and organizational agility to strive for industry-leading results in all of our functional areas, including: land acquisition and development, finance, marketing, sales, purchasing, construction, customer care, and information technology. The main tenets of these core values are:
• Value, recognize and appreciate our employees, trade partners and customers;
• Always act with honesty, character and integrity by demonstrating openness and transparency with our internal and external customers;
• Provide the highest level of customer service by bringing passion and care to every customer interaction and make a difference by giving back to the communities we serve;
• Strive to have the best team available through investing in our people and fostering an environment that embraces continual growth and learning;
• Continuously and purposefully renew, rethink and innovate with the customer in mind by supporting and encouraging new ideas and recognizing efforts that grow shareholder value;
• Lead with action, be relentless in our pursuit of excellence and never settle; and
• Commitment to building an inclusive culture by fostering diversity and equity across our organization. We believe that cultivating a diverse team allows us to collectively be more successful and better address the needs of our customers. We champion a culture where team members are treated with respect, valued for their unique perspectives and experiences, and feel a sense of belonging.
These core values are evident in the operational decisions we make at our corporate offices and in each of our divisions and communities, all of which contribute to the successes we have achieved with our talent acquisition and employee development, customers, within the marketplace and within the homebuilding industry.
Our operational strategy focuses on building affordable, quick move-in homes that are designed to meet the growing demand for entry-level and first move-up homes. Our LiVE.NOW ® communities are targeted to the entry-level price point combining nicely appointed affordable homes with simplified and streamlined construction and sales processes aimed to create a stress-free buying experience for our customers while also allowing our trade partners and suppliers to work more efficiently and cost effectively, which allows us to pass resulting savings on to our customers. We strive to achieve a 100% speculative ("spec") home building strategy for our entry-level product by pre-starting all of our homes and preselecting plans and features from our reduced SKU counts and plan libraries when we start the home. During 2022, supply chain disruptions and labor shortages coupled with high demand, particularly in the first half of the year, created a challenging environment to maintain strategic levels of spec inventory, although we still pre-started most of our homes. More recently, as the supply chain has started to loosen, we have an opportunity to replenish our spec inventory levels, increasing the number of homes at or near move-in ready. We believe this provides us a competitive advantage by allowing our customers to lock their mortgage rate and offer a quick delivery, as per the current desire in the marketplace. Our strategy also encompasses a simplification of the home buying process for the first move-up segment, a demographic we have historically had a significant presence in. For our first move-up product, our preselected option packages provide an experience that simplifies the sale and design processes, providing an efficient and less stressful way for homebuyers to personalize their new homes through preselected design collections versus the traditional a-la-carte design center offerings, although in 2022 most of these offerings were also pre-
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started prior to sales order to expedite the building cycle time. We believe our strategy addresses the need for well-appointed yet lower-priced homes, while allowing us to simplify and maximize the profitability of our business.
We continue to focus on innovation in every new home we build, employing industry-leading building techniques and technologies aimed at setting the standard for energy-efficient homebuilding. Accordingly, at a minimum, every new home we construct meets or exceeds ENERGY STAR ® standards and comes standard with the MERV-13 air filter, one of the most advanced air filtration systems offered today for residential construction, and a multispeed heating, ventilation and air conditioning ("HVAC") system that is designed to operate more efficiently than traditional HVAC, allowing owners to better manage the comfort of their home while reducing their environmental impact and operating costs. These standard offerings provide our customers with homes that utilize, on average, half of the energy of a typical U.S. home of the same size. As a result of our commitment to interior air quality, we carry the U.S. Environmental Protection Agency’s ("EPA") ENERGY STAR ® and Indoor airPLUS certifications. Our commitment to incorporate these energy and healthy living standards into all of our homes has resulted in our achievement of design, purchasing and production efficiencies that have allowed us to offer these as standard features to our home buyers for nominal additional cost while providing significant additional value to our customers. In addition, all homes we build include home automation features through our M.Connected Home™ Automation Suite which includes a central hub that allows users to monitor and control key components of their homes, such as Wi-Fi enabled thermostats, garage doors and smart door locks.
Year after year, we strive to improve the energy efficiency of our homes through better building processes and selection of construction materials and features inside the home. These efforts reduce the energy consumption and greenhouse gas emissions of our homes, which creates energy savings and lower utility bills for our homeowners. Our homes earn better Home Energy Rating System ("HERS") scores from the third-party energy rater, Residential Energy Services Network, as compared to their reference home. We have also received various national and regional awards in recognition of our efforts, including:
• 2022 EPA's ENERGY STAR ® Partner of the Year for Sustained Excellence for the ninth year;
• 2021 - 2022 EPA's Indoor airPLUS Leader Award;
• 2013 - 2022 EPA's ENERGY STAR ® Residential New Construction Market Leader Award;
• 2022 EPA's Market Leader Award for Certified Homes;
• 2020 Builder of the Year for Green Home Builder; and
• Various AVID Diamond, Gold and Benchmark customer service awards across multiple categories and divisions.
Environmental, Social and Governance
We believe responsible corporate governance and social responsibility is important for the long-term sustainability of the business and recognize the importance of environmental stewardship in our operations while serving our customers and growing our business. In 2022, we adopted an Environmental Responsibility Policy, a Vendor Code of Conduct, and a Responsible Marketing Policy. These policies are intended to define, promote and support continuous review and enhancements of sustainable practices throughout all phases of the homebuilding cycle, which we believe will help address climate change and biodiversity concerns. Also during 2022, we issued our inaugural Task Force on Climate-Related Financial Disclosures ("TCFD") report and joined approximately 3,900 other institutions to become an official TCFD supporter. We take pride in being an organization driven by ethics and living by our core values and our promise to deliver a Life.Built.Better. ® We promote the long-term interests of stakeholders and customers and focus on the transparency and accountability of Meritage’s Board of Directors, executive management, our employees and trade partners. More information regarding these topics can be found on our website and within publicly filed reports, including our environmental, social, and governance (“ESG”) report which is located within the Investor Relations area of our website. The ESG report and other information on our website is not incorporated by reference into this Annual Report on Form 10-K.
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Markets
We currently build and sell homes in the following markets:
Markets Year Entered
Phoenix, AZ 1985
Dallas/Ft. Worth, TX 1987
Austin, TX 1994
Tucson, AZ 1995
Houston, TX 1997
East Bay/Central Valley, CA 1998
Sacramento, CA 1998
San Antonio, TX 2003
Inland Empire, CA 2004
Denver, CO 2004
Orlando, FL 2004
Raleigh, NC 2011
Tampa, FL 2011
Charlotte, NC 2012
Nashville, TN 2013
Atlanta, GA 2014
Greenville, SC 2014
South Florida 2016
Myrtle Beach, SC 2021
Recent Industry and Company Developments
During the second half of 2020 and throughout all of 2021, the homebuilding industry experienced unprecedented growth. The expansion continued in the first quarter of 2022, but the market steadily weakened throughout the rest of 2022, as higher interest rates reduced the overall affordability of homes. Affordability constraints combined with uncertainty regarding future interest rates, inflation, and deterioration in the general economy, created homebuyer hesitancy and led to significant cancellations and drove down net orders in the back half of the year. Although these economic conditions are applying current downward pressure on the housing market, we believe favorable homebuyer demographics support long-term stable demand, although at a more normalized pace than what was experienced in the past two years. We believe our all-spec strategy targeting affordable homes offers our customers readily available inventory which, combined with our financing and other incentives, still provides an attractive opportunity for homeownership.
Our full year financial results for 2022 were among the best in Company history, with record breaking home closing revenue of $6.2 billion, an expanded gross margin of 28.6% and greater leverage of overhead expenses, all of which resulted in a 34.5% increase in net earnings of $992.2 million. However, supply chain constraints, labor shortages and other economic-related disruptions impacted our production and the homebuilding industry as a whole during 2022. Through long cultivated relationships with our national and local partners, we were able to navigate the limitations and expect to continue to utilize our spec-focused, limited SKU operating model in 2023.
We have been successfully executing on our strategy to address the demand for more affordable homes by acquiring and developing communities and designing homes that can be delivered at a lower cost. We are achieving our goal by simplifying our product and construction processes, switching to an all spec home sales program for our entry-level communities, which allow buyers to move in quicker, and by enhancing and making the entire home buying experience faster, easier and less costly for our customers. We are confident in our strategy and continue to demonstrate our commitment to first-time and first move-up buyers through our land acquisitions, our streamlined option packages and upgrade offerings for our first move-up product, and our focus on delivering affordable homes through simplification of the design, development and construction processes. We also remain committed to our key financial goals such as higher home closing revenue, strong home closing gross margin, controlling selling, and general and administrative costs, and maintaining sufficient liquidity. Our products and simplification strategy have enabled us to deliver on these goals and we believe will continue to provide improved profitability while also preserving liquidity. Our near-term objectives in today's uncertain environment are expanding our market share and maintaining
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liquidity. Nearly our entire portfolio of active communities are targeted to first-time and first move-up buyers and who collectively represented approximately 99% of our orders and 98% of our closings in 2022.
Home closing revenue grew 21.8% for the year ended December 31, 2022, the result of a 10.2% increase in home closing volume and a 10.6% increase in Average Sales Price ("ASP") on closing providing $6.2 billion in home closing revenue. We had a 6.5% increase in ASP on orders due entirely to pricing power resulting from strong demand with limited housing supply in the first half of the year. Growing homebuyer concerns over affordability and general economic trends in second half of 2022 led to elevated cancellations and a 14.8% reduction in order volume, ending 2022 with a 9.3% decrease in home order value compared to 2021. Home closing gross margin improved by 80 basis points to our highest full-year home closing margin in Company history of 28.6% in 2022, compared to 27.8% in 2021. Our 2022 net earnings increased by 34.5% with a 38.6% increase in diluted EPS compared to prior year.
We carefully manage our liquidity and balance sheet, particularly during times of limited economic visibility. Our improved earnings are generating cash that is allowing us to reinvest in our business through acquiring and developing land, increasing the number of homes under construction as our community count grows and returning shareholder value by repurchasing our common stock. Throughout 2022, we repurchased 1,166,040 shares of our common stock for $109.3 million and we ended the year with cash and cash equivalents totaling $861.6 million as compared to $618.3 million at December 31, 2021, while growing our inventory 16.7% to $4.4 billion. Our debt-to-capital ratio was 22.6% and our net debt-to-capital ratio was 6.8% at December 31, 2022, compared to 27.6% and 15.1%, respectively, at December 31, 2021.
Land Acquisition and Development
Our current land pipeline goal is to maintain an approximate four-to-five year supply of lots, which we believe provides an appropriate planning horizon to address regulatory matters, perform land development and manage to our business plan for future closings. With the slowing market, we are limiting new land acquisitions to exceptional and unique opportunities or to develop our pipeline in newer markets, as we currently have enough land in our portfolio to meet our longer term community count goals. During the year ended December 31, 2022, we invested approximately $1.5 billion in land acquisition and development and secured approximately 2,000 net new lots, down from 34,000 net new lots in 2021. We ended the year with 63,182 lots under control at December 31, 2022 versus 75,049 in 2021. As of December 31, 2022 we have a 4.5 year supply of lots, based on 2022 closings, in line with our goal to maintain four to five years supply. In response to slowing demand, we evaluated our land positions during the year and terminated underperforming land deals totaling approximately 10,100 lots. All of the lots placed under control in 2022 are designated for entry-level communities. We are currently focused on growing our market share in our existing markets. We continually evaluate our markets, monitoring and adjusting our lot supply through lot and land acquisitions or to ensure we have a sufficient pipeline that is in sync with local market dynamics as well as our goals for growth in those markets. During 2022, we closed 14,106 homes, purchased approximately 12,600 lots for $457.0 million, spent $1.1 billion on land development, and started construction on 13,847 homes. At December 31, 2022 and 2021, respectively, 73% and 65% of our controlled lots were owned.
We are currently purchasing primarily undeveloped land as the opportunity to purchase partially developed or substantially finished lots in desired locations is limited. Finished lots are those on which the development has been completed by a third party and are ready for immediate home construction. The entitlement and development of raw and undeveloped land and partially developed lots require a longer lead time to allow for development activities before our new communities are able to open for sales. Typically, undeveloped and partially developed lots will have a lower all-in cost than finished lots as we are responsible for improvements on the land, rather than paying a mark-up on improvements by a prior developer. When evaluating any land acquisition opportunity, our selection is based upon a variety of factors, including:
• financial feasibility of the proposed project, including projected profit margins, return on capital invested, and the capital payback period;
• suitability of the land for our product offering of entry-level and first move-up homes;
• management’s judgment as to the local real estate market and economic trends, and our experience in particular markets;
• environmental impact and sustainability considerations;
• existing concentration of lots owned and controlled by other builders and developers in surrounding markets, including nearby Meritage communities;
• development timeline, generally a three to five-year period from the purchase of the underlying property to the delivery of the last home;
• demographic data from the surrounding area based on extensive market studies, including surveys of both new and resale homebuyers;
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• the ability to secure governmental approvals and entitlements, if required, and any associated risks;
• results of technical, environmental and legal due diligence;
• proximity to schools, local traffic and employment corridors, goods and services, and amenities;
• assessment of development risks, complexities and timelines; and
• availability and financial impact of seller-provided purchase options or agreements that allow us to defer lot purchases until needed for production, if applicable.
When purchasing undeveloped or partially developed land, we strive to defer the closing for the land until after entitlements have been obtained to eliminate or significantly minimize risk and so that development or construction may begin as market conditions dictate. The term “entitlements” refers to appropriate zoning, unit density and total lot yield, development agreements and preliminary or tentative maps or plats, depending on the jurisdiction within which the land is located. Entitlements generally give the developer the right to obtain building permits upon compliance with conditions that are ordinarily within the developer’s control. Although entitlements are almost always obtained before land is purchased, we are typically still required to secure a variety of other governmental approvals and permits prior to and during development, and the process of obtaining such approvals and permits can be lengthy. In unique circumstances, we may consider the purchase of unentitled land when we can do so in a manner consistent with our business strategy. We generally purchase and develop parcels that provide us with communities that range on average from 100 to 200 lots.
Once we secure undeveloped land, we generally supervise and control the development of the land through contractual agreements with subcontractors. These activities may include site planning and engineering, as well as constructing road, sewer, water, utilities, drainage, landscaping improvements, recreation amenities and other improvements and refinements. We may build homes in master-planned communities with home sites that are adjacent to or near major amenities, such as golf courses or recreation facilities.
The factors used to evaluate finished lot purchases are similar to those for land we intend to develop ourselves, although the development risks associated with the undeveloped land—financial, entitlement, environmental, legal and governmental—have largely been borne by others. Therefore, these finished lots may be more attractive to us, despite their higher price, as we can immediately bring the community to market and begin home construction as well as mitigate potential cost and time risks that can occur during the land entitlement and development process. We develop a design and marketing plan tailored to each community, which includes the determination of type, size, style and price range of homes. We may also determine the overall community design for each project we develop including street and community layout, individual lot size and layout, and common areas and amenities to be included within the community. The homes offered depend upon many factors, including the guidelines, if any, of the existing community, housing available in the area, the needs and desired housing product for a particular market, and our lot sizes, though we almost exclusively use our standardized home design plans in our communities.
As a means of accessing parcels of land with minimal cash outlay, we may use rolling option contracts. Acquiring our land through option contracts, when available, allows us to leverage our balance sheet by controlling the timing and volume of lot and land purchases from third parties. These contracts provide us the right, but generally not the obligation, to buy lots at predetermined future intervals and are usually structured to approximate our projected home sales absorption rate at the time the contract is negotiated. Lot option contracts are generally non-recourse and typically require the payment of non-refundable deposits of 5% to 20% of the total land purchase price. The use of option contracts limits the market risks associated with land ownership by allowing us to re-negotiate option terms or terminate options in the event of market downturns but also include a financial return to the counterparty. In the event we elect to cancel an option contract, our losses are typically limited to the forfeiture of our option deposits and any associated capitalized pre-acquisition costs. The cost of obtaining land through such option contracts is generally higher than if we were to purchase land in bulk, although the financial leverage benefits they can provide can outweigh the financing costs associated with them. During periods of gross margin contraction, it is more difficult to achieve financial feasibility through option contracts and we will generally only contract for lots in this manner if we are still able to achieve desired margins. Land purchases are generally financed through our working capital, including corporate borrowings.
At December 31, 2022, in addition to our 46,317 owned lots, we also had 16,865 lots under committed purchase or option contracts with a total purchase price of approximately $738.5 million secured by $67.0 million in cash deposits. We purchase and develop land primarily to support our homebuilding operations, although we may sell land and lots to other developers and homebuilders from time to time where we have excess land positions or for other strategic reasons. Information related to lots and land under option contracts is presented in Note 3 in the accompanying consolidated financial statements.
All land and lot acquisitions are reviewed by our corporate land acquisition committee, which is comprised of certain members of our executive management team and key operational leaders. All land acquisitions exceeding a specified dollar
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amount must also be approved by our Executive Chairman, with a secondary threshold requiring approval by our Board of Directors' Land Committee.
Investments in Unconsolidated Entities — Joint Ventures
We may enter into joint ventures as a means of accessing larger parcels of land, expanding our market opportunities, managing our risk profile and leveraging our capital. While purchasing land through a joint venture can be beneficial, we do not view joint ventures as critical to the success of our homebuilding operations. We currently have two active land development ventures. In addition to the land development joint ventures, we also participate in one mortgage business joint venture. The mortgage joint venture is engaged in mortgage activities and primarily provides services to our homebuyers.
In connection with our land development joint ventures, we may also provide certain types of limited guarantees to associated lenders and municipalities.
Construction Operations
We typically act as the general contractor for our projects and hire experienced subcontractors on a geographic basis to complete construction at fixed prices. We usually enter into agreements with subcontractors and materials suppliers after receiving competitive bids. In certain markets at high risk for construction or development cost increases, we enter into fixed-fee bids when it makes economic sense to do so. We also enter into longer-term and national or regional contracts with subcontractors and suppliers, where possible, to obtain more favorable terms, minimize construction costs and to control product consistency and availability. In addition to contractually requiring that our subcontractors comply with all laws and labor practices pertaining to their work, subcontractors must also adhere to our Code of Ethics, Vendor Code of Conduct, follow local building codes and permits, and meet performance, warranty and insurance requirements. Our purchasing and construction managers coordinate and monitor the activities of subcontractors and suppliers, and monitor compliance with zoning, building and safety codes. At December 31, 2022, we employed approximately 995 full-time construction and warranty employees.
We specify that quality durable materials be used in the construction of our homes and we do not maintain significant inventories of construction materials, except for work in process materials for homes under construction. When possible, we negotiate price and volume discounts and rebates with manufacturers and suppliers on behalf of our subcontractors so we can take advantage of production volume. Our raw materials consist primarily of lumber, concrete, drywall, roofing materials and similar construction materials and are frequently purchased on a national or regional level. Such materials have historically been available from multiple suppliers and therefore we do not believe there is a supplier risk concentration. However, because such materials are substantially comprised of natural resource commodities, their cost and availability are subject to national and worldwide price fluctuations and inflation, each of which could be impacted by legislation or regulation relating to energy, climate change and tariffs. We typically do not enter into any derivative contracts to hedge against weather or materials fluctuations as we do not believe they are particularly advantageous to our operations, although we do periodically lock in short and mid-term pricing with our vendors for certain key construction commodities. Beginning in 2021 and continuing throughout 2022, we experienced building material cost pressures and production capacity issues with some of our main product suppliers, including supply chain constraints largely associated with world-wide labor, material, and transportation shortages. We continue to carefully navigate this constrained operating environment by expanding our trade base and strengthening critical relationships and expect that over time, with lower, normalized volume in the homebuilding market, costs will begin to decline and cycle times will shorten.
We generally build and sell homes in phases within our larger projects, which we believe creates efficiencies in land development, home construction operations and cash management. We also believe it improves customer satisfaction by reducing the number of vacant lots and construction activity surrounding completed homes. Our homes are typically completed within three to five months from the start of construction, depending upon the geographic location and the size and complexity of the home, although we are currently experiencing longer cycle times due to the supply chain constraints previously discussed. Construction schedules may vary depending on the size of the home, availability of labor, materials and supplies, product type, location, municipal requirements and weather. Our homes are usually designed to promote efficient use of space and materials, and to minimize construction costs and time.
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Marketing and Sales
We believe that we have an established reputation for building attractive, high quality energy-efficient and affordable homes, which helps generate demand in our communities. Our communication and marketing plans are tailored to target and reach our different customer segments. Part of these plans involve reaching new customers through a combination of advertising and other promotional activities targeting key consumer segments through online advertising, online listings, social media, email, articles and posts to drive consumers to our website at www.meritagehomes.com . We leverage a suite of digital offerings to provide our customers with a simple and streamlined experience, including:
• Online scheduling to allow customers to schedule in-person, self-guided model home tours after hours in select locations;
• Virtual tours in all of our communities for realtors, customers, and prospective buyers;
• Extensive online tools such as 3-D tours and dynamic floor plans to mimic the live experience of walking through a model home;
• Our chat bot, Virtual Assistant Liaison ("VAL"), provides customers and owners with around-the-clock information and support on our website;
• Pre-qualifying buyers for mortgages through digital solutions on our website;
• Collecting earnest money payments remotely through third-party hosted money-transfer solutions;
• Providing a warranty portal for our homeowners to submit and track warranty-related matters and a comprehensive online suite of financial services such as on-demand homeowners’ insurance quotes; and
• Digital signing of sales contracts and drive-through and partial or fully virtual closings in states where such services are permitted.
In addition, our local marketing efforts are focused on opening new communities with strong interest lists and driving consumer traffic to communities through digital media campaigns, virtual events for both consumers and real estate agents, grass roots marketing, and strategically placed signs in the surrounding areas of our communities. Our marketing strategy is aimed at differentiating Meritage Homes by highlighting our simplification throughout the buying, building and closing processes, our transparency in setting clear expectations and by building a better home leveraging industry leading energy-efficient features, cutting edge design, upgrades and finishes. All of this is part of our LIFE. BUILT. BETTER. ® brand promise to our customers, which means having a home that is quieter, cleaner, healthier and smarter.
We sell our homes using furnished model homes as a marketing tool to demonstrate to prospective homebuyers the advantages of the designs and features of our homes. At December 31, 2022, we owned 247 completed model homes, had 59 models under construction and leased back 19 model homes previously sold to buyers. We generally employ or contract with interior and landscape designers who enhance the appeal of our model homes, which highlight the features and options available for the homes within a project. We typically build between one and three model homes for each actively selling community, depending upon the products to be offered and the number of homes to be built in the project. We strive to implement marketing strategies that will educate our buyers on how our unique building techniques and the energy efficient and home automation features in our homes differentiate them from other homes. We integrate interactive in-home displays in order to inform our buyers about our many energy-efficient and home automation features and help them understand how, and to what extent, a Meritage home can help them realize savings through reduced energy bills, and experience and enjoy healthier living, improved comfort and peace of mind.
For our first move-up buyers, we offer option packages which we refer to as our "Design Collections". These Design Collections offer pre-selected combinations of flooring, cabinetry, countertops, lighting and fixtures that are all professionally designed to work together to meet each buyer's preference, and our homebuyers benefit from bulk-purchase savings that we pass through from our national vendor relationships. Our concept for Design Collections is a direct result of feedback from our homebuyers and based on our core values of innovating with the customer in mind. We took action to completely rethink how the home buying and design process should work to meet the needs of today’s buyer.
Our homes generally are sold by our commissioned sales associate employees who work from a sales office typically located in a converted garage of one of the model homes for each community. We also employ a team of online sales associates who offer assistance to potential buyers viewing our communities and products online through digital offerings such as virtual tours and 3-D tours and dynamic floor plans. At December 31, 2022, we had approximately 475 full-time sales and marketing personnel. Our goal is to ensure that our sales force has extensive knowledge of our homes and their energy efficient and innovative features, our sales strategies, mortgage options, and community dynamics, in order to fully execute our marketing message. To achieve this goal, we train our sales associates and conduct regular meetings to update them on our product, communities, sales techniques, competition in the area, financing availability, construction schedules, marketing and
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advertising plans, available product lines, pricing, and options offered, as well as the numerous benefits and savings our energy efficient product provides. Our sales associates are licensed real estate agents where required by law.
Third-party brokers may also sell our homes and are usually paid a sales commission based on the price of the home. Frequently, third-party brokers bring prospective buyers to our communities. We have a robust loyalty program for these brokers and we aim to regularly educate them on the benefits of owning a Meritage home and our community offerings, which we believe help enhance the impact of our marketing message. We may offer various sales incentives, including mortgage-related incentives such as interest rate locks or buy-downs, price concessions, assistance with closing costs, and landscaping or interior upgrades, to attract buyers. The use, type and amount of incentives depends largely on economic and local competitive market conditions.
Backlog
Our sales contracts require cash deposits and may be subject to certain contingencies such as the buyer’s ability to qualify for financing. Homes covered by sales contracts but which are not yet closed are considered “backlog” and are representative of potential future home closing revenue. Started homes are excluded from backlog until a sales contract is signed and are referred to as unsold speculative or “spec” inventory. A contract contingent upon the sale of a customer’s existing home or a mortgage pre-approval is not considered a sale and not included in backlog until the contingency is removed. We strive to achieve a 100% spec home building strategy for our entry-level product, whereas our first move-up homes may be started as a spec home or after a sales contract is signed. In first move-up communities, we may also start construction on spec homes to accelerate or facilitate the close out of a community. Our spec inventory per active community as of December 31, 2022 was 18.0 or 4,891 units as compared to 12.3 or 3,180 units as of December 31, 2021. At December 31, 2022, approximately 90% of our 3,332 homes in backlog were under construction.
We do not recognize any revenue from a home sale until a finished home is delivered to the homebuyer, payment is collected and other criteria for sale and profit recognition are met. At December 31, 2022, of our total unsold homes in inventory, excluding completed model homes, 85% were under construction and 15% were completed. A portion of the unsold inventory resulted from homes that began construction with valid sales contracts that were subsequently canceled. We believe that during 2023 we will deliver to customers substantially all homes in backlog at December 31, 2022 under existing contracts, or, in the case of cancellations, replacement sales contracts.
The number of units in backlog decreased 41.3% to 3,332 units at December 31, 2022 from 5,679 units at December 31, 2021 with a 39.4% decrease in the value of backlog to $1.5 billion from $2.5 billion, largely due to an increased closing volume in the back half of 2022 coupled with a slower orders pace.
Customer Financing
Most of our homebuyers require financing to purchase their home. Accordingly, we refer them to mortgage lenders that offer a variety of financing options. While our homebuyers may obtain financing from any mortgage provider of their choice, we have a joint venture arrangement with an established mortgage broker that acts as a preferred mortgage broker to our buyers to help facilitate the financing process as well as generate additional revenue for us through our interest in the joint venture (see Note 5 in the accompanying consolidated financial statements for additional information on joint venture financial results). We also have referral relationships with unaffiliated preferred mortgage lenders. We may pay a portion of the closing costs or obtain interest rate locks or buy-downs to assist homebuyers who obtain financing from our preferred lenders.
Customer Relations, Quality Control and Warranty Programs
We believe that positive customer relations and an adherence to stringent quality control standards are fundamental to our continued success, and that our commitment to buyer satisfaction and quality control has significantly contributed to our reputation as a high-quality builder.
In accordance with our company-wide standards, one or more Meritage project managers or superintendents generally monitors compliance with quality control standards for each community throughout the building phase of our homes. These employees perform the following tasks:
• oversee home construction;
• monitor subcontractor and supplier performance;
• manage scheduling and construction completion deadlines; and
• conduct formal inspections as specific stages of construction are completed.
At the time a home is completed and delivered to a buyer, the continuing relationship is transitioned to a customer relations employee who manages our warranty and customer care efforts.
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We generally provide a complete workmanship and materials warranty for the first year after the close of the home, a major mechanical warranty for two years after the close of the home and a structural warranty that typically extends up to 10 years after the close of the home. We require our subcontractors to provide evidence of insurance before beginning work and to provide a warranty to us and to indemnify us from defects in their work and the materials they provide and therefore any claims relating to workmanship and materials are generally the subcontractors’ responsibility. In certain markets and for certain attached product, we offer a Company-controlled insurance program to our subcontractors underwritten on behalf of Meritage which, if accepted, is the insurance for damage resulting from construction defects in lieu of the standard insurance we require from subcontractors. Although our subcontractors are generally required to repair and replace any product or labor defects (and for those operating in markets with our Company-controlled insurance program, pay a deductible as a condition to such coverage), we are, during applicable warranty periods, ultimately responsible to the homeowner for making such repairs. Accordingly, with the assistance of an actuary, we have estimated and established reserves for future structural warranty costs based on the number of home closings and historical data trends for warranty work within our communities. Warranty reserves generally range between 0.1% to 0.5% of a home’s sale price. Those projections are subject to variability due to uncertainties regarding structural warranty claims relating to the construction of our homes, the markets in which we build, claim settlement history, and insurance and legal interpretations and developments, among other factors and we are, therefore, constantly monitoring such reserves. Historically, these reserves, as adjusted, have been sufficient to cover net out-of-pocket warranty costs.
Competition and Market Factors
The construction and sale of homes is a highly-competitive industry. We compete for sales in each of our markets with national, regional and local developers and homebuilders, as well as existing resale homes, condominiums, townhomes and rental housing. Some of our competitors have greater financial resources and may have lower costs than we do. Competition among residential homebuilders of all sizes is based on a number of interrelated factors, including location, reputation, product type, amenities, design, innovation, quality and price. We believe that we compare favorably to other homebuilders in the markets in which we operate due to our:
• streamlined construction processes that allow us to save on materials, labor and time and pass those savings to our customers in the form of lower prices while still offering a well-appointed home;
• simplified and less stressful home buying experience through LiVE.NOW ® and Design Collections;
• experience within our geographic markets which allows us to develop and offer products that provide superior design and quality in line with the needs and desires of the targeted demographic;
• ENERGY STAR ® standards in all of our communities and incremental energy-efficient features that create a variety of benefits to our customers which we believe differentiate our product from competing new and existing home inventories by providing cleaner, and healthier homes;
• inclusion of home automation through our M.Connected Home Automation Suite ® ;
• ability to recognize and adapt to changing market conditions, from both a capital and human resource perspective;
• ability to capitalize on opportunities to acquire land in desirable locations and on favorable terms;
• digital offerings in all stages of the homebuying process, as previously discussed; and
• reputation for outstanding service and quality products and our exceptional customer and warranty service.
Our product offerings and strategic locations are successfully competing with both existing homes inventory and surrounding new-home communities as evidenced by our relative orders volume and market share in most of our markets. We expect that the strengths noted above will continue to provide us with long-term competitive advantages.
We have an extensive market research department that assists us in each of our markets to better compete with other homebuilders and the inventory of re-sale homes in surrounding neighborhoods. Our strategic operations team conducts in-depth community-level reviews in each of our markets, including a detailed analysis of existing inventory, pricing, buyer demographics and the identification of each location’s key buyer metrics. This analysis and resulting analytical tools assist in decision-making regarding product designs, positioning, and pricing and underwriting standards for land purchases and land development. Additionally, our market research department supports the Company strategy by researching new market opportunities, new market entries, product library development and evolving consumer trends and preferences in housing.
Government Regulation and Environmental Matters
To the extent that we acquire undeveloped land, we prefer to close the acquisition of such land after all governmental approvals and permits have been obtained. Construction may begin almost immediately on such entitled land upon compliance with and receipt of specified permits, approvals and other conditions, which generally are within our control. The time needed
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to obtain such approvals and permits affects the carrying costs of unimproved property acquired for development and construction. The continued effectiveness of permits already granted is subject to factors such as changes in government policies, rules and regulations, and their interpretation and application. Government approval processes occasionally cause timing delays but have not had a material adverse effect on our operations, although there is no assurance that these and other restrictions will not adversely affect future operations as, among other things, sunset clauses may exist on some of our entitlements and they could lapse.
Local and state governments have broad discretion regarding the imposition of development fees for projects under their jurisdictions. These fees are normally established when maps or plats are recorded and building permits obtained. Governing agencies may also require concessions or may require the builder to construct certain improvements to public areas such as parks and streets. In addition, governing agencies may impose construction moratoriums and therefore we could become subject to delays or may be precluded entirely from developing communities due to building moratoriums, “no growth” or “slow growth” initiatives or building permit allocation ordinances, which could be implemented in the future. However, because most of our land is entitled, construction moratoriums typically would not affect us in the near term unless they arise from health, safety or welfare issues, such as insufficient water, electric or sewage facilities.
In addition, there is constantly a variety of new regulations being adopted and legislation being enacted, or considered for enactment, at the federal, state and local levels relating to energy and climate change. Some of this legislation relates to items such as carbon dioxide emissions control and building codes that impose energy efficiency standards. New building code requirements that impose stricter energy efficiency standards could significantly increase the cost to construct homes, although our energy-efficiency technologies and offerings meet, and in many instances exceed, current and expected energy efficiency thresholds. As climate change concerns continue to grow, legislation and regulations of this nature are expected to continue and may result in increased costs and longer approval and development timelines. Similarly, energy and environment-related initiatives affect a wide variety of companies throughout the United States and the world, and because our operations are heavily dependent on significant amounts of raw materials, such as lumber, steel, and concrete, such initiatives could have an indirect adverse impact on our operations and profitability to the extent the manufacturers and suppliers of our materials are burdened with expensive carbon dioxide emissions control and other environmental and energy-related regulations.
We are also subject to a variety of local, state, and federal statutes, ordinances, rules and regulations concerning the protection of health and the environment. In some markets, we are subject to environmentally-sensitive land ordinances that mandate open space areas with public elements in housing developments, and prevent development on hillsides, wetlands and other protected areas. We must also comply with open space restrictions, flood plain restrictions, desert wash area restrictions, native plant regulations, endangered species acts and view restrictions. These and similar laws and regulations may result in delays, cause substantial compliance and other costs, and prohibit or severely restrict development in certain environmentally sensitive regions or areas. In addition, our failure to comply with such restrictions could result in penalties or fines. To date, compliance with such laws and regulations has not materially affected our operations, although it may do so in the future.
We condition our obligation to acquire property on, among other things, an environmental review of the land. To date, we have not incurred material unanticipated liabilities relating to the removal or remediation of toxic wastes or other environmental conditions. However, there is no assurance that we will not incur material liabilities in the future relating to toxic waste removal or other environmental conditions affecting land currently or previously owned.
Some of our homebuyers elect to purchase their homes with mortgages that are insured or guaranteed by certain government entities. In order for our homebuyers to finance their home purchases with Federal Housing Administration ("FHA")-insured or Veterans Administration ("VA")-guaranteed or United States Department of Agriculture ("USDA")-guaranteed mortgages, we are required to build such homes in accordance with the regulatory requirements of those agencies.
Some states have statutory disclosure requirements governing the marketing and sale of new homes. These requirements vary widely from state to state.
Some states require us to be registered as a licensed contractor, a licensed real estate broker and in some markets our sales agents are required to be registered as licensed real estate agents.
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Human Capital
Human capital is one of our most critical assets. At December 31, 2022, we had 1,921 full-time employees, including 384 in management and administration, 67 in our title and insurance companies, 475 in sales and marketing, and 995 in construction and warranty operations. We are committed to creating and cultivating a diverse team, fostering an inclusive culture and creating a workplace environment where our team members can reach their full potential in support of organizational goals. We have a robust talent recognition and succession planning model designed to help identify and develop talent and provide a roadmap for promotion of identified employees. Developing our employees enhances each individual’s opportunity to progress their career at Meritage and enrich their work experience. We work to retain talent by offering competitive and comprehensive compensation and benefits that include health insurance, 401(k) savings plan with a competitive company match, paid time off, paid parental benefits, employee discounts, tuition reimbursement, and a wellness program, among many others. Of our entire employee population at December 31, 2022, 40% were female and 26% were minorities. We are proud of the diversity in our team and are committed to the ongoing and intentional work to achieve inclusive excellence, including the long-term goals of attracting diverse talent and forming strategic relationships. The Company is dedicated to learning, improving its practices and challenging its leaders and employees to recognize and leverage our differences for the greater good of the team and the organization and we promote an open-door policy where individuals are encouraged to voice concerns which are promptly addressed. In order to uphold our core values, we intend to continue to expand our commitment to diversity, equity & inclusion ("DE&I").
Our operations are carried out through both local and centralized management. Our corporate management team sets our strategy and leads decisions related to the Company's land acquisition, risk management, finance, cash management, capital allocation and information systems. Local operations are made up of our division employees, led by management with significant homebuilding experience and who possess a great depth of knowledge in their particular markets. Our employees are not unionized, and we have a highly engaged workforce. We act solely as a general contractor, and all construction operations are coordinated by our project managers and field superintendents who schedule and monitor third-party independent subcontractors. We may use independent consultants and contractors for certain architectural, engineering, advertising, technology and legal services, and we strive to maintain good relationships with our subcontractors and independent consultants and contractors. Our Vendor Code of Conduct applies to all contractors and subcontractors.
Seasonality
Historically, we have experienced seasonal variations in our quarterly operating results and capital requirements. We typically sell more homes in the first half of the fiscal year than in the second half, which creates additional working capital requirements in the second and third quarters to build our inventories to satisfy the deliveries in the second half of the year. We typically benefit from the cash generated from home closings more in the third and fourth quarters than in the first and second quarters. During 2020, historical cycles were impacted by COVID-19 and since then were further impacted by elevated demand and supply chain and labor constraints. Historical seasonality returned in 2022 and we expect it to continue over the long term, although it may, from time to time, be affected by short-term volatility in the homebuilding industry and in the overall economy.
Information about our Executive Officers
The names, ages, positions and business experience of our executive officers as of the date of this report are listed below (all ages are as of December 31, 2022):
Name Age Position
Steven J. Hilton 61 Executive Chairman
Phillippe Lord 49 Chief Executive Officer, Executive Vice President
Hilla Sferruzza 47 Chief Financial Officer, Executive Vice President
Clinton Szubinski 46 Chief Operating Officer, Executive Vice President
Malissia Clinton 54 General Counsel, Executive Vice President and Secretary
Javier Feliciano 49 Chief People Officer, Executive Vice President
Steven J. Hilton co-founded Monterey Homes in 1985, which merged with Homeplex in December 1996 and later became known as Meritage Homes. Mr. Hilton served as Co-Chairman and Co-Chief Executive Officer from July 1997 to May 2006, served as Chairman and Chief Executive Officer from May 2006 to December 2020, and became the Executive Chairman effective January 1, 2021.
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Phillippe Lord was appointed Chief Executive Officer on January 1, 2021. Prior to his appointment as Chief Executive Officer, Mr. Lord was Chief Operating Officer, Executive Vice President from April 2015 to December 2020, Western Region President from 2012 through March 2015 and Vice President of Strategic Operations from 2008 through 2012.
Hilla Sferruzza was appointed Chief Financial Officer and Executive Vice President in April 2016. Prior to her appointment as Chief Financial Officer and Executive Vice President, Ms. Sferruzza was our Chief Accounting Officer and Corporate Controller since 2010 and has worked in other management roles at the Company since 2006.
Clinton Szubinski was appointed Chief Operating Officer, Executive Vice President on January 1, 2021. Prior to his appointment as Chief Operating Officer, Mr. Szubinski served as South Region President of Meritage Homes from 2018 to December 2020. Previously, Mr. Szubinski served in senior management roles at K. Hovnanian and CalAtlantic, both public U.S. homebuilders, from 2014 to 2018 and from 2011-2014, was the Florida Region President at Meritage Homes.
Malissia Clinton joined Meritage on April 18, 2022 as General Counsel, Executive Vice President and Secretary. Prior to joining Meritage, Ms. Clinton was employed by The Aerospace Corporation from July 2009 through April 2022, where she served as Senior Vice President, General Counsel and Secretary.
Javier Feliciano joined Meritage in November 2015 as Chief Human Resources Officer (now "Chief People Officer"), Executive Vice President. From January 2013 through November 2015, Mr. Feliciano was employed by Apollo Education Group as Vice President, Human Resources and as HR Director from June 2010 through January 2013.
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