Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ____________________________________________________________
FORM 10-Q
 ____________________________________________________________
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2013
Or 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 1-9977
 ____________________________________________________________
MERITAGE HOMES CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 ____________________________________________________________
Maryland
 
86-0611231
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)
 
 
 
17851 North 85th Street, Suite 300
 
 
Scottsdale, Arizona
 
85255
(Address of Principal Executive Offices)
 
(Zip Code)
(480) 515-8100
(Registrant’s Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 ___________________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by a checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Common shares outstanding as of July 31, 2013: 36,216,251


Table of Contents

MERITAGE HOMES CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2013
TABLE OF CONTENTS
 
 
 
 
Items 3-5. Not Applicable
 

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PART I — FINANCIAL INFORMATION
 
Item 1.
Financial Statements
MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
 
 
June 30,
2013
 
December 31,
2012
Assets:
 
 
 
Cash and cash equivalents
$
218,019

 
$
170,457

Investments and securities
91,988

 
86,074

Restricted cash
43,265

 
38,938

Other receivables
30,246

 
20,290

Real estate
1,227,229

 
1,113,187

Deposits on real estate under option or contract
21,712

 
14,351

Investments in unconsolidated entities
10,698

 
12,085

Property and equipment, net
17,013

 
15,718

Deferred tax asset
77,279

 
77,974

Prepaid expenses and other assets
30,028

 
26,488

Total assets
$
1,767,477

 
$
1,575,562

Liabilities:
 
 
 
Accounts payable
$
68,662

 
$
49,801

Accrued liabilities
124,353

 
96,377

Home sale deposits
25,566

 
12,377

Senior, senior subordinated, convertible senior notes and other borrowings
798,215

 
722,797

Total liabilities
1,016,796

 
881,352

Stockholders’ Equity:
 
 
 
Preferred stock, par value $0.01. Authorized 10,000,000 shares; none issued and outstanding at June 30, 2013 and December 31, 2012

 

Common stock, par value $0.01. Authorized 125,000,000 shares; issued 36,216,251 and 35,613,351 shares at June 30, 2013 and December 31, 2012, respectively
362

 
356

Additional paid-in capital
406,530

 
390,249

Retained earnings
343,789

 
303,605

Total stockholders’ equity
750,681

 
694,210

Total liabilities and stockholders’ equity
$
1,767,477

 
$
1,575,562

See accompanying notes to unaudited consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
 

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Homebuilding:
 
 
 
 
 
 
 
 
Home closing revenue
$
436,040

 
$
281,340

 
$
766,750

 
$
485,362

 
Land closing revenue
13,910

 
755

 
19,635

 
1,083

 
Total closing revenue
449,950

 
282,095

 
786,385

 
486,445

 
Cost of home closings
(342,435
)
 
(229,394
)
 
(608,785
)
 
(398,303
)
 
Cost of land closings
(12,463
)
 
(1,135
)
 
(18,013
)
 
(1,340
)
 
Total cost of closings
(354,898
)
 
(230,529
)
 
(626,798
)
 
(399,643
)
 
Home closing gross profit
93,605

 
51,946

 
157,965

 
87,059

 
Land closing gross profit/(loss)
1,447

 
(380
)
 
1,622

 
(257
)
 
Total closing gross profit
95,052

 
51,566

 
159,587

 
86,802

Financial Services:
 
 
 
 
 
 
 
 
Revenue
1,434

 

 
2,276

 

 
Expense
(755
)
 
(142
)
 
(1,328
)
 
(167
)
 
Earnings from financial services unconsolidated entities and other, net
3,486

 
2,319

 
6,273

 
3,925

 
Financial services profit
4,165

 
2,177

 
7,221

 
3,758

Commissions and other sales costs
(31,180
)
 
(23,118
)
 
(57,059
)
 
(42,095
)
General and administrative expenses
(22,451
)
 
(16,516
)
 
(42,175
)
 
(31,237
)
Loss from other unconsolidated entities, net
(120
)
 
(91
)
 
(275
)
 
(274
)
Interest expense
(4,523
)
 
(6,338
)
 
(9,651
)
 
(13,709
)
Other income, net
685

 
934

 
1,155

 
795

Loss on early extinguishment of debt
(3,096
)
 
(5,772
)
 
(3,796
)
 
(5,772
)
Earnings/(loss) before income taxes
38,532

 
2,842

 
55,007

 
(1,732
)
(Provision for)/benefit from income taxes
(10,389
)
 
5,163

 
(14,823
)
 
4,983

Net earnings
$
28,143

 
$
8,005

 
$
40,184

 
$
3,251

Earnings per common share:
 
 
 
 
 
 
 
 
Basic
$
0.78

 
$
0.24

 
$
1.12

 
$
0.10

 
Diluted
$
0.74

 
$
0.24

 
$
1.06

 
$
0.10

Weighted average number of shares:
 
 
 
 
 
 
 
 
Basic
36,151

 
32,755

 
35,976

 
32,694

 
Diluted
38,758

 
33,104

 
38,662

 
33,086




See accompanying notes to unaudited consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 

 
Six Months Ended June 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net earnings
$
40,184

 
$
3,251

Adjustments to reconcile net earnings to net cash used in operating activities:
 
 
 
Depreciation and amortization
4,658

 
3,614

Stock-based compensation
3,941

 
3,273

Loss on early extinguishment of debt
3,796

 
5,772

Excess income tax benefit from stock-based awards
(1,687
)
 

Equity in earnings from unconsolidated entities
(5,998
)
 
(3,651
)
Deferred tax asset valuation benefit
(3,057
)
 
(7,705
)
Distributions of earnings from unconsolidated entities
7,236

 
2,995

Other
4,022

 
1,202

Changes in assets and liabilities:
 
 
 
Increase in real estate
(113,992
)
 
(140,662
)
(Increase)/decrease in deposits on real estate under option or contract
(7,361
)
 
424

(Increase)/decrease in receivables and prepaid expenses and other assets
(13,167
)
 
1,758

Increase in accounts payable and accrued liabilities
48,715

 
20,934

Increase in home sale deposits
13,189

 
3,888

Net cash used in operating activities
(19,521
)
 
(104,907
)
Cash flows from investing activities:
 
 
 
Investments in unconsolidated entities
(116
)
 
(405
)
Distributions of capital from unconsolidated entities
74

 

Purchases of property and equipment
(5,787
)
 
(4,383
)
Proceeds from sales of property and equipment
32

 
364

Maturities of investments and securities
71,024

 
120,201

Payments to purchase investments and securities
(76,938
)
 
(76,502
)
Increase in restricted cash
(4,327
)
 
(6,962
)
Net cash (used in)/provided by investing activities
(16,038
)
 
32,313

Cash flows from financing activities:
 
 
 
Repayment of senior subordinated notes
(102,822
)
 
(315,080
)
Proceeds from issuance of senior notes
175,000

 
300,000

Debt issuance costs
(1,403
)
 
(5,334
)
Excess income tax benefit from stock-based awards
1,687

 

Non-controlling interest acquisition
(257
)
 

Proceeds from stock option exercises
10,916

 
1,222

Net cash provided by/(used in) financing activities
83,121

 
(19,192
)
Net increase/(decrease) in cash and cash equivalents
47,562

 
(91,786
)
Cash and cash equivalents at beginning of period
170,457

 
173,612

Cash and cash equivalents at end of period
$
218,019

 
$
81,826

See supplemental disclosures of cash flow information at Note 11.
See accompanying notes to unaudited consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION
Organization. Meritage Homes is a leading designer and builder of single-family detached homes based on the number of home closings. We primarily build in the historically high-growth regions of the western and southern United States and offer a variety of homes that are designed to appeal to a wide range of homebuyers, including first-time, move-up, active adult and luxury. We have homebuilding operations in three regions: West, Central and East, which are comprised of six states: Arizona, Texas, California, Colorado, Florida and the Carolinas. Operations within the Carolinas include the Raleigh and Charlotte metropolitan areas, with some Charlotte communities located across the border into South Carolina. Through our predecessors, we commenced our homebuilding operations in 1985. In 2012, we commenced limited operations of our wholly-owned title company, Carefree Title Agency, Inc. ("Carefree Title"). Carefree Title's core business consists of title insurance and closing/settlement services we offer to our homebuyers and we expect to be fully operational in applicable markets by the end of 2013. Meritage Homes Corporation was incorporated in 1988 in the state of Maryland.
Our homebuilding and marketing activities are conducted under the name of Meritage Homes in each of our homebuilding markets, although we also operate as Monterey Homes in some markets in Arizona and Texas. At June 30, 2013, we were actively selling homes in 165 communities, with base prices ranging from approximately $117,000 to $799,000.
Basis of Presentation. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2012. The consolidated financial statements include the accounts of Meritage Homes Corporation and those of our consolidated subsidiaries, partnerships and other entities in which we have a controlling financial interest, and of variable interest entities (see Note 3) in which we are deemed the primary beneficiary (collectively, “us”, “we”, “our” and “the Company”). Intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the accompanying financial statements include all adjustments (consisting only of normal recurring entries), necessary for the fair presentation of our results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for the full year. Certain reclassifications have been made to the prior year income statement and footnotes to conform to current year presentation.
Cash and Cash Equivalents. Liquid investments with an initial maturity of three months or less are classified as cash equivalents. Amounts in transit from title companies for home closings of approximately $57.8 million and $30.4 million are included in cash and cash equivalents at June 30, 2013 and December 31, 2012, respectively. Included in our cash and cash equivalents balance as of June 30, 2013 and December 31, 2012 are $10.0 million and $0.3 million, respectively, of money market funds that are invested in short term (three months or less) U.S. government securities.
Restricted Cash. Restricted cash consists of amounts held in restricted accounts as collateral for our letter of credit arrangements. The aggregate capacity of these secured letter of credit arrangements was $60.0 million at June 30, 2013. Our restricted cash accounts invest in money market accounts and U.S. government securities and totaled $43.3 million and $38.9 million at June 30, 2013 and December 31, 2012, respectively.
Investments and Securities. Our investments and securities are comprised of both treasury securities and deposits with banks that are FDIC-insured and secured by U.S. government treasury-backed investments, and therefore we believe bear a limited risk of loss. All of our investments are classified as held-to-maturity and are recorded at amortized cost as we have both the ability and intent to hold them until their respective maturities. The contractual lives of these investments are greater than three months but do not exceed 18 months. Due to their short duration and low contractual interest rates, the amortized cost of the investments approximates fair value with no unrecognized gains and losses or other-than-temporary impairments.
Real Estate. Real estate is stated at cost unless the asset is determined to be impaired, at which point the inventory is written down to fair value as required by Accounting Standards Codification (“ASC”) Subtopic 360-10, Property, Plant and Equipment (“ASC 360-10”). Inventory includes the costs of land acquisition, land development, home construction, capitalized interest, real estate taxes, capitalized direct overhead costs incurred during development and home construction that benefit the entire community, less impairments, if any. Land and development costs are typically allocated and transferred to homes under construction when construction begins. Home construction costs are accumulated on a per-home basis, while most selling costs are expensed as incurred. Cost of home closings includes the specific construction costs of the home and all related allocated land acquisition, land development and other common costs (both incurred and estimated to be incurred) that are allocated based upon the total number of homes expected to be closed in each community or phase. Any changes to the estimated total

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development costs of a community or phase are allocated to the remaining homes in the community or phase. When a home closes, we may have incurred costs for goods and services that have not yet been paid. Therefore, an accrued liability to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.
We rely on certain estimates to determine our construction and land development costs. Construction and land costs are comprised of direct and allocated costs, including estimated future costs. In determining these costs, we compile project budgets that are based on a variety of assumptions, including future construction schedules and costs to be incurred. It is possible that actual results could differ from budgeted amounts for various reasons, including construction delays, labor or material shortages, increases in costs that have not yet been committed, changes in governmental requirements, or other unanticipated issues encountered during construction and development and other factors beyond our control. To address uncertainty in these budgets, we assess, update and revise project budgets on a regular basis, utilizing the most current information available to estimate construction and land costs.
Typically, a community’s life cycle ranges from three to five years, commencing with the acquisition of the land, continuing through the land development phase, if applicable, and concluding with the sale, construction and closing of the homes. Actual community lives will vary based on the size of the community, the sales absorption rate and whether the land purchased was raw, partially-developed or in finished status. Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving smaller finished lot purchases may be shorter.
All of our land inventory and related real estate assets are reviewed for recoverability quarterly, as our inventory is considered “long-lived” in accordance with GAAP. Impairment charges are recorded to write down an asset to its estimated fair value if the undiscounted cash flows expected to be generated by the asset are lower than its carrying amount. Our determination of fair value is based on projections and estimates. Changes in these expectations may lead to a change in the outcome of our impairment analysis, and actual results may also differ from our assumptions. Our analysis is completed on a quarterly basis with each community or land parcel evaluated individually. For those assets deemed to be impaired, the impairment recognized is measured as the amount by which the assets’ carrying amount exceeds their fair value. The impairment of a community is allocated to each lot on a straight-line basis.
Existing and continuing communities. When projections for the remaining income expected to be earned from existing communities are no longer positive, the underlying real estate assets are not deemed fully recoverable, and further analysis is performed to determine the required impairment. The fair value of the community’s assets is determined using either a discounted cash flow model for projects we intend to build out or a market-based approach for projects to be sold. Impairments are charged to cost of home closings in the period during which it is determined that the fair value is less than the assets’ carrying amount. If a market-based approach is used, we determine fair value based on recent comparable purchase and sale activity in the local market, adjusted for variances as determined by our knowledge of the region and general real estate expertise. If a discounted cash flow approach is used, we compute fair value based on a proprietary model. Our key estimates in deriving fair value under our cash flow model are (i) home selling prices in the community adjusted for current and expected sales discounts and incentives, (ii) costs related to the community — both land development and home construction — including costs spent to date and budgeted remaining costs to spend, (iii) projected sales absorption rates, reflecting any product mix change strategies and expected cancellation rates, (iv) alternative land uses including disposition of all or a portion of the land owned and (v) our discount rate, which is currently 14-16% and varies based on the perceived risk inherent in the community’s other cash flow assumptions. These assumptions vary widely across different communities and geographies and are largely dependent on local market conditions. Community-level factors that may impact our key estimates include:
The presence and significance of local competitors, including their offered product type and pricing, comparable lot size, and competitive actions;
Economic and related demographic conditions for the population of the surrounding community;
Desirability of the particular community, including unique amenities or other favorable or unfavorable attributes; and
Existing home inventory supplies, including foreclosures and short sales.
These local circumstances may significantly impact our assumptions and the resulting computation of fair value and are, therefore, closely evaluated by our division personnel in their generation of the discounted cash flow models. The models are also evaluated by regional and corporate personnel for consistency and integration, as decisions that affect pricing or absorption at one community may have resulting consequences for neighboring or nearby communities. We typically do not project market improvements in our discounted cash flow models, but may do so in limited circumstances in the latter years of a long-lived community.

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Mothball communities. In certain cases, we may elect to stop development (mothball) of an existing community if we believe the economic performance of the community would be maximized by deferring development for a period of time to allow market conditions to improve. When a community is initially placed into mothball status, it is management's belief that the community is affected by local market conditions that are expected to improve within the next 1-5 years. Therefore, a temporary postponement of construction and development work is expected to yield better overall future returns. The decision may be based on financial and/or operational metrics. If we decide to mothball a community, we will, if necessary, impair it to its fair value as discussed above and then cease future development activity until such time as management believes that market conditions have improved and economic performance will be maximized. No costs are capitalized related to communities that are designated as mothballed.

In addition to our quarterly impairment analysis, which is conducted to determine if any current impairments exist, we also conduct a thorough quarterly review of our underperforming and mothballed communities to determine if they are at risk of future impairment. The financial and operational status and expectations of these communities are analyzed as well as any unique attributes that could be viewed as indicators for future impairments. Adjustments are made accordingly and incremental impairments, if any, are recorded at each re-evaluation. Based on the facts and circumstances available as of June 30, 2013, we do not believe that any of our underperforming or mothballed communities will incur material impairments in the future. Changes in market and/or economic conditions could materially impact the conclusions of this analysis, and there can be no assurances that future impairments will not occur.
Inventory assessments on inactive assets. For our mothballed communities as well as our land held for future development, our inventory assessments typically include highly subjective estimates for future performance, including the timing of development, the product to be offered, sales rates and selling prices of the product when the community is anticipated to open for sales, and the projected costs to develop and construct the community. We evaluate various factors to develop our forecasts, including the availability of and demand for homes and finished lots within the marketplace, historical, current and future sales trends, and third-party data, if available. Based on these factors, we reach conclusions for future performance based on our judgment.
Deposits and pre-acquisition costs. We also evaluate assets associated with future communities for impairments on a quarterly basis. Using similar techniques described in the Existing and continuing communities section above, we determine if the income to be generated by our future communities is acceptable to us. If the projections indicate that a community is still meeting our internal investment guidelines and is generating a profit, those assets are determined to be fully recoverable and no impairments are required. In cases where we decide to abandon a project, we will fully impair all assets related to such project and will expense and accrue any additional costs that we are contractually obligated to incur. In certain circumstances, we may elect to continue with a project because it is expected to generate positive cash flows, even though it may not be generating an accounting profit. In such cases, we will impair our pre-acquisition costs and deposits, as necessary, and record an impairment to bring the carrying value to fair value.
Deposits. Deposits paid related to purchase contracts and land options are recorded and classified as Deposits on real estate under contract or option until the related land is purchased. Deposits are reclassified as a component of real estate inventory at the time the deposit is used to offset the acquisition price of the lots based on the terms of the underlying agreements. To the extent they are non-refundable, deposits are charged to expense if the land acquisition is terminated or no longer considered probable. Since the acquisition contracts typically do not require specific performance, we do not consider such contracts to be contractual obligations to purchase the land and our total exposure under such contracts is limited to the loss of the non-refundable deposits and any ancillary capitalized costs. The review of the likelihood of the acquisition of contracted lots is completed quarterly in conjunction with the real estate impairment analysis noted above and therefore, if impaired, the deposits are recorded at the lower of cost or fair value. Our deposits were $21.7 million and $14.4 million as of June 30, 2013 and December 31, 2012, respectively.
Off-Balance Sheet Arrangements Joint Ventures. In the past, we have participated in land development joint ventures as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base; however, in recent years, such ventures have not been a significant avenue for us to access lots. See Note 4 for additional discussion of our investments in unconsolidated entities.
Off-Balance Sheet Arrangements Other. We may acquire lots from various development and land bank entities pursuant to purchase and option agreements. The purchase price generally approximates the market price at the date the contract is executed (with possible future escalators). See Note 3 for further discussion.
We may provide letters of credit in support of our obligations relating to the development of our projects and other corporate purposes. We may also utilize surety bonds to guarantee our performance of certain development and construction activities. Surety bonds are generally posted in lieu of letters of credit or cash deposits. The amount of these obligations

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outstanding at any time varies depending on the stage and level of our development activities. Bonds are generally not released until all development activities under the bond are complete. In the event a bond or letter of credit is drawn upon, we would be obligated to reimburse the issuer for any amounts advanced under the bond. We believe it is unlikely that any significant amounts of these bonds or letters of credit will be drawn upon. The table below outlines our surety bond and letter of credit obligations (in thousands):
 
 
At June 30, 2013
 
At December 31, 2012
 
Outstanding
 
Estimated work
remaining to
complete
 
Outstanding
 
Estimated work
remaining to
complete
Surety Bonds:
 
 
 
 
 
 
 
Surety bonds related to joint ventures
$
87

 
$
87

 
$
87

 
$
87

Surety bonds related to owned projects and lots under contract
135,755

 
62,116

 
87,305

 
38,936

Total surety bonds
$
135,842

 
$
62,203

 
$
87,392

 
$
39,023

Letters of Credit (“LOCs”):
 
 
 
 
 
 
 
LOCs in lieu of deposits for contracted lots
$
1,485

 
N/A

 
$

 
N/A

LOCs for land development
36,323

 
N/A

 
32,475

 
N/A

LOCs for general corporate operations
5,091

 
N/A

 
4,991

 
N/A

Total LOCs
$
42,899

 
N/A

 
$
37,466

 
N/A

Accrued Liabilities. Accrued liabilities consist of the following (in thousands):
 
At June 30, 2013
 
At December 31, 2012
Accruals related to real-estate development and construction activities
$
23,760

 
$
19,954

Payroll and other benefits
22,153

 
11,871

Accrued taxes
15,620

 
3,407

Warranty reserves
21,844

 
22,064

Legal reserves
16,703

 
16,067

Other accruals
24,273

 
23,014

Total
$
124,353

 
$
96,377

Warranty Reserves. We provide home purchasers with limited warranties against certain building defects and have certain obligations related to those post-construction warranties for closed homes. The specific terms and conditions of these limited warranties vary by state, but overall the nature of the warranties include a complete workmanship and materials warranty typically during the first year after the close of the home and a structural warranty that typically extends up to 10 years subsequent to the close of the home. With the assistance of an actuary, we have estimated these reserves for the structural related warranty based on the number of homes still under warranty and historical warranty data and trends for our communities. We also use industry data with respect to similar product types and geographic areas in markets where our experience may not be sufficient to draw a meaningful conclusion. We regularly review our warranty reserves and adjust them, as necessary, to reflect current claims and changes in trends as information becomes available. A summary of changes in our warranty reserves follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Balance, beginning of period
$
21,384

 
$
21,705

 
$
22,064

 
$
23,136

Additions to reserve from new home deliveries
3,166

 
2,074

 
5,237

 
3,605

Warranty claims
(2,706
)
 
(2,536
)
 
(5,457
)
 
(5,498
)
Adjustments to pre-existing reserves

 

 

 

Balance, end of period
$
21,844

 
$
21,243

 
$
21,844

 
$
21,243


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Warranty reserves are included in accrued liabilities on the accompanying consolidated balance sheets, and additions and adjustments to the reserves are included in cost of home closings within the accompanying consolidated income statements. These reserves are intended to cover costs associated with our contractual and statutory warranty obligations, which include, among other items, claims involving defective workmanship and materials. We believe that our total reserves, coupled with our contractual relationships and rights with our trades, are sufficient to cover our general warranty obligations. However, as unanticipated changes in legal, weather, environmental or other conditions could have an impact on our actual warranty costs, future costs could differ significantly from our estimates.
Recently Issued Accounting Pronouncements. In April 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-04, Liabilities ("ASU 2013-04"), which provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. ASU 2013-04 is effective for us beginning January 1, 2014. We do not anticipate the adoption of ASU 2013-04 to have an effect on our consolidated financial statements or disclosures.
NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST
Real estate consists of the following (in thousands):
 
 
At June 30, 2013
 
At December 31, 2012
Homes under contract under construction (1)
$
304,159

 
$
192,948

Unsold homes, completed and under construction (1)
96,076

 
107,466

Model homes (1)
70,596

 
62,411

Finished home sites and home sites under development
644,315

 
634,106

Land held for development (2)
57,650

 
56,118

Land held for sale
15,104

 
21,650

Communities in mothball status (3)
39,329

 
38,488

 
$
1,227,229

 
$
1,113,187

 
(1)    Includes the allocated land and land development costs associated with each lot for these homes.
(2)
Land held for development primarily reflects land and land development costs related to land where development activity is not currently underway but is expected to begin in the future. For these parcels, we may have chosen not to currently develop certain land holdings as they typically represent a portion of a larger land parcel that we plan to build out over several years.
(3)
Represents communities where we have decided to cease operations (mothball) as we have determined that their economic performance would be maximized by deferring development. In the future, some of these communities may be re-opened while others may be sold to third parties. If we deem our carrying value to not be fully recoverable, we adjust our carrying value for these assets to fair value at the time they are placed into mothball status. As of June 30, 2013, we had eight mothballed communities with a carrying value of $36.0 million in our West Region and two mothballed communities with a carrying value of $3.3 million in our Central Region. We do not capitalize interest for such mothballed assets, and all ongoing costs of land ownership are also expensed as incurred.
As previously noted, in accordance with ASC 360-10, each of our land inventory and related real estate assets is reviewed for recoverability when impairment indicators are present as our inventory is considered “long-lived” in accordance with GAAP. Due to the recent economic environment, we evaluate all of our real estate assets for impairment on a quarterly basis. ASC 360-10 requires impairment charges to be recorded if the asset is not deemed fully recoverable and the fair value of such assets is less than their carrying amounts. Our determination of fair value is based on projections and estimates. We also evaluate alternative product offerings in communities where impairment indicators are present and other strategies for the land exist, such as selling the land or holding the land for sale in the future. Based on these reviews of all our communities, we recorded real-estate impairment charges of $146,000 and $192,000 during the three and six months ended June 30, 2013, respectively, as compared to $863,000 and $1.2 million for the same periods in 2012. These charges are included in Cost of home closings in our income statements.
In the latter part of 2011, we announced our intent to wind-down operations in the Las Vegas, Nevada market. As of June 30, 2013, we had one lot remaining to close with no actively selling communities. The value of the remaining home in inventory was $0.2 million as of June 30, 2013. We expect to complete construction and close the remaining home in the third quarter of 2013. The remaining $12.2 million of Nevada assets relate to properties that we are not currently developing and are either actively marketing for sale or have mothballed.

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Subject to sufficient qualifying assets, we capitalize interest incurred in connection with the development and construction of real estate. Completed homes and land not actively under development do not qualify for interest capitalization. Capitalized interest is allocated to real estate when incurred and charged to cost of closings when the related property is delivered. To the extent our debt exceeds our qualified assets base, we expense a proportionate share of the interest incurred. A summary of our capitalized interest is as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
Capitalized interest, beginning of period
$
24,198

 
$
15,908

 
$
21,600

 
$
14,810

Interest incurred
12,642

 
11,318

 
25,368

 
22,165

Interest expensed
(4,523
)
 
(6,338
)
 
(9,651
)
 
(13,709
)
Interest amortized to cost of home and land closings
(6,023
)
 
(3,052
)
 
(11,023
)
 
(5,430
)
Capitalized interest, end of period (1)
$
26,294

 
$
17,836

 
$
26,294

 
$
17,836

 
(1)
Approximately $532,000 and $539,000 of the capitalized interest is related to our joint venture investments and is a component of “Investments in unconsolidated entities” on our consolidated balance sheets as of June 30, 2013 and December 31, 2012, respectively.
NOTE 3 — VARIABLE INTEREST ENTITIES AND CONSOLIDATED REAL ESTATE NOT OWNED
We enter into purchase and option agreements for land or lots as part of our normal course of business. These purchase and option agreements enable us to acquire properties at one or multiple future dates at pre-determined prices. We believe these acquisition structures reduce our financial risk associated with land acquisitions and holdings and allow us to better maximize our liquidity.
Based on the provisions of the relevant accounting guidance, we have concluded that when we enter into purchase or option agreements to acquire land or lots from an entity, a variable interest entity, or “VIE”, may be created. We evaluate all purchase and option agreements for land to determine whether they are a VIE. ASC 810, Consolidations, requires that for each VIE, we assess whether we are the primary beneficiary and, if we are, we consolidate the VIE in our financial statements and reflect such assets and liabilities as “Real estate not owned.” The liabilities related to consolidated VIEs are excluded from our debt covenant calculations.
In order to determine if we are the primary beneficiary, we must first assess whether we have the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with Meritage; and the ability to change or amend the existing option contract with the VIE. If we are not determined to control such activities, we are not considered the primary beneficiary of the VIE. If we do have the ability to control such activities, we will continue our analysis by determining if we are also expected to absorb a potentially significant amount of the VIE’s losses or, if no party absorbs the majority of such losses, if we will benefit from a potentially significant amount of the VIE’s expected gains.
In substantially all cases, creditors of the entities with which we have option agreements have no recourse against us and the maximum exposure to loss in our option agreements is limited to non-refundable option deposits and any capitalized pre-acquisition costs. Often, we are at risk for items over budget related to land development on property we have under option if we are the land developer. In these cases, we have contracted to complete development at a fixed cost on behalf of the land owner and any budget shortfalls are borne by us and any budget savings inure to us. Some of our option deposits may be refundable to us if certain contractual conditions are not performed by the party selling the lots.
    





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The table below presents a summary of our lots under option or contract at June 30, 2013 (dollars in thousands): 
 
Number of
Lots
 
Purchase
Price
 
Option/Earnest
Money Deposits
Cash
 
Purchase and option contracts recorded on balance sheet as Real estate not owned

 
$

 
$

  
Purchase and option contracts not recorded on balance sheet — non-refundable deposits, committed (1)
4,842

 
210,769

 
18,131

  
Purchase and option contracts not recorded on balance sheet — refundable deposits, committed
610

 
30,785

 
555

  
Total committed (on and off balance sheet)
5,452

 
241,554

 
18,686

  
Total purchase and option contracts not recorded on balance sheet — refundable deposits, uncommitted (2)
4,722

 
158,589

 
3,026

  
Total lots under contract or option
10,174

 
$
400,143

 
$
21,712

  
Total option contracts not recorded on balance sheet
10,174

 
$
400,143

 
$
21,712

(3)
 
(1)
Deposits are generally non-refundable except if certain contractual conditions fail or certain contractual obligations are not performed by the selling party.
(2)
Deposits are refundable at our sole discretion. We have not completed our acquisition evaluation process and we have not internally committed to purchase these lots.
(3)
Amount is reflected in our consolidated balance sheet in the line item “Deposits on real estate under option or contract” as of June 30, 2013.
Generally, our option contracts to purchase lots remain effective so long as we purchase a pre-established minimum number of lots each month or quarter, as determined by the respective agreement. The pre-established number is typically structured to approximate our expected rate of home construction starts. Purchase contracts generally involved bulk purchase terms where we purchase all or a large portion of the lots at one time and are typically short-term in nature.
NOTE 4 — INVESTMENTS IN UNCONSOLIDATED ENTITIES

In the past, we have entered into land development joint ventures as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base. While purchasing land through a joint venture can be beneficial, currently we do not view them as critical to the success of our homebuilding operations and have not entered into any new land joint ventures since 2008. Based on the structure of these joint ventures, they may or may not be consolidated into our results. Our joint venture partners generally are other homebuilders, land sellers or other real estate investors. We generally do not have a controlling interest in these ventures, which means our joint venture partners could cause the venture to take actions we disagree with, or fail to take actions we believe should be undertaken, including the sale of the underlying property to repay debt or recoup all or part of the partners' investments. As of June 30, 2013, we had two active equity-method land development ventures.
For land development joint ventures, we, and in some cases our joint venture partners, usually receive an option or other similar arrangement to purchase portions of the land held by the joint venture. Option prices are generally negotiated prices that approximate market value when we enter into the option contract or similar arrangement. For these ventures, our share of the joint venture profit relating to lots we purchase from the joint ventures is deferred until homes are delivered by us and title passes to a homebuyer. Therefore, we allocate the portion of such joint venture profit to the land acquired by us as a reduction in the basis of the property.
In connection with our land development joint ventures, we may also provide certain types of guarantees to associated lenders. These guarantees can be classified into two categories: (i) Repayment Guarantees and (ii) Completion Guarantees, described in more detail below. Additionally, we have classified a guarantee related to our minority ownership in the South Edge joint venture separately, as there is pending litigation with the venture’s lender group and other venture partners regarding that guarantee.
    
 

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(In thousands)
At June 30, 2013
 
At December 31, 2012
Repayment guarantees
$
198

 
$
219

Completion guarantees (1)

 

South Edge guarantee (2)
13,243

 
13,243

Total guarantees
$
13,441

 
$
13,462

 
(1)
As our completion guarantees are typically backed by funding from a third party, we do not believe these guarantees represent a potential cash obligation for us, as they require only non-financial performance.
(2)
See Note 13 regarding outstanding litigation related to a joint venture project known as “South Edge” or "Inspirada" and the corresponding reserves and charges we have recorded relating thereto.
Repayment Guarantees. We and/or our land development joint venture partners occasionally provide limited repayment guarantees on a pro rata basis on the debt of land development joint ventures. If such a guarantee were ever to be called or triggered, the maximum exposure to Meritage would generally be only our pro-rata share of the amount of debt outstanding that was in excess of the fair value of the underlying land securing the debt. Our share of these limited pro rata repayment guarantees as of June 30, 2013 and December 31, 2012 is presented in the table above (excluding any potential recoveries from the joint venture’s land assets).
Completion Guarantees. If there is development work to be completed, we and our joint venture partners are also typically obligated to the project lender(s) to complete construction of the land development improvements if the joint venture does not perform the required development. Provided we and the other joint venture partners are in compliance with these completion obligations, the project lenders are generally obligated to fund these improvements through any financing commitments available under the applicable joint venture development and construction loans. In addition, we and our joint venture partners have from time to time provided unsecured indemnities to joint venture project lenders. These indemnities generally obligate us to reimburse the project lenders only for claims and losses related to matters for which such lenders are held responsible and our exposure under these indemnities is limited to specific matters such as environmental claims. A part of our project acquisition due diligence process is to determine potential environmental risks and generally we or the joint venture entity obtain an independent environmental review. Per the guidance of ASC 460-10, Guarantees, we believe these guarantees are either not applicable or not material to our financial results.
Surety Bonds. We and our joint venture partners also indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures. If a joint venture does not perform its obligations, the surety bond could be called. If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners may be obligated to make such payments. These surety indemnity arrangements are generally joint and several obligations with our joint venture partners. Although a majority of the required work may have been performed, these bonds are typically not released until all development specifications under the bond have been met. None of these bonds have been called to date and we believe it is unlikely that any of these bonds will be called or if called, that any such amounts would be material to us. See the table in Note 1 for more information on our surety bonds.
The joint venture obligations, guarantees and indemnities discussed above are generally provided by us or one of our subsidiaries. In joint ventures involving other homebuilders or developers, support for these obligations is generally provided by the parent companies of the joint venture partners. In connection with our periodic real estate impairment reviews, we may accrue for any such commitments where we believe our obligation to pay is probable and can be reasonably estimated. In such situations, our accrual represents the portion of the total joint venture obligation related to our relative ownership percentage. We continue to monitor these matters and reserve for these obligations if and when they become probable and can be reasonably estimated. Except as noted above and in Note 13 to these unaudited consolidated financial statements, as of June 30, 2013 and December 31, 2012, we did not have any such reserves.
We also participate in two mortgage and one title business joint ventures. The mortgage joint ventures are engaged in mortgage activities and they provide services to both our homebuyers ad well as other buyers. Although some of these ventures originate mortgage loans, we have limited recourse related to any mortgages originated by these ventures. Our investments in mortgage and title joint ventures as of June 30, 2013 and December 31, 2012 were $1.8 million and $2.0 million, respectively.
    
    


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The joint venture financial statements below represent the most recent information available to us.
Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method was as follows (in thousands):
 
At June 30, 2013
 
At December 31, 2012
Assets:
 
 
 
Cash
$
5,057

 
$
7,650

Real estate
36,012

 
36,626

Other assets
3,204

 
3,478

Total assets
$
44,273

 
$
47,754

Liabilities and equity:
 
 
 
Accounts payable and other liabilities
$
4,667

 
$
4,748

Notes and mortgages payable
13,940

 
14,001

Equity of:
 
 
 
Meritage (1)
8,486

 
9,631

Other
17,180

 
19,374

Total liabilities and equity
$
44,273

 
$
47,754

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
9,994

 
$
4,622

 
$
16,398

 
$
8,465

Costs and expenses
(3,833
)
 
(2,502
)
 
(6,210
)
 
(4,539
)
Net earnings of unconsolidated entities
$
6,161

 
$
2,120

 
$
10,188

 
$
3,926

Meritage’s share of pre-tax earnings (1)(2)
$
3,371

 
$
2,228

 
$
6,005

 
$
3,651

 
(1)
Balance represents Meritage’s interest, as reflected in the financial records of the respective joint ventures. This balance may differ from the balance reflected in our consolidated financial statements due to the following reconciling items: (i) timing differences for revenue and distributions recognition, (ii) step-up basis and corresponding amortization, (iii) income deferrals as discussed in Note (2) below and (iv) the cessation of allocation of losses from joint ventures in which we have previously impaired our investment balance to zero and where we have no commitment to fund additional losses.
(2)
Our share of pre-tax earnings is recorded in “Earnings from financial services unconsolidated entities and other, net” and “Loss from other unconsolidated entities, net” on our consolidated income statements and excludes joint venture profit related to lots we purchased from the joint ventures. Such profit is deferred until homes are delivered by us and title passes to a homebuyer.
Our investments in unconsolidated entities include $0.6 million and $0.8 million at June 30, 2013 and December 31, 2012, respectively, related to the difference between the amounts at which our investments are carried and the amount of our portion of the venture’s equity. These amounts are amortized as the assets of the respective joint ventures are sold. A de minimis amount of amortization was recorded for these assets in the three and six months ended June 30, 2013 with no amortization recorded for the same periods in 2012.
The joint venture assets and liabilities noted in the table above primarily represent two active land ventures, two mortgage ventures, one title venture and various inactive ventures in which we have a total investment of $10.7 million. As of June 30, 2013, we believe these ventures are in compliance with their respective debt agreements, if applicable, and except for $198,000 of our limited repayment guarantees as discussed above, the joint venture debt reflected above is non-recourse to us.

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NOTE 5 — SENIOR, SENIOR SUBORDINATED, CONVERTIBLE SENIOR NOTES AND OTHER BORROWINGS
    
Senior, senior subordinated, convertible senior notes and other borrowings consist of the following (in thousands):
 
 
At June 30, 2013
 
At December 31, 2012
7.731% senior subordinated notes due 2017
$

 
$
99,825

4.50% senior notes due 2018
175,000

 

7.15% senior notes due 2020. At June 30, 2013 and December 31, 2012, there was approximately $3,285 and $3,528 in unamortized discount, respectively
196,715

 
196,472

7.00% senior notes due 2022
300,000

 
300,000

1.875% convertible senior notes due 2032
126,500

 
126,500

$135 million unsecured revolving credit facility

 

 
$
798,215


$
722,797

The indentures for our 4.50%, 7.15% and 7.00% senior notes (collectively, "the senior notes") contain covenants including, among others, limitations on the amount of secured debt we may incur, and limitations on sale and leaseback transactions and mergers. Our convertible senior notes do not have any financial covenants.

Borrowings under our unsecured revolving credit facility ("the Credit Facility") are subject to, among other things, a borrowing base. The Credit Facility also contains certain financial covenants, including (a) a minimum tangible net worth requirement of $360.0 million (which amount is subject to increase over time based on subsequent earnings and proceeds from equity offerings), and (b) a maximum leverage covenant that prohibits the leverage ratio (as defined therein) from exceeding 60%. In addition, we are required to maintain either (i) an interest coverage ratio (EBITDA to interest expense, as defined therein) of at least 1.50 to 1.00 or (ii) liquidity (as defined therein) of an amount not less than our consolidated interest incurred during the trailing 12 months. No amounts were drawn under the Credit Facility as of June 30, 2013 and December 31, 2012.
In March 2013, we completed an offering of $175 million aggregate principal amount of 4.50% Senior Notes due 2018. Concurrent with this offering, we announced a tender offer to repurchase any or all of our 7.731% Senior Subordinated Notes due 2017 ("2017 Notes") and subsequently issued a call offer to repurchase any and all remaining notes not tendered. As a result of the tender offer, as of June 30, 2013, we had repurchased all of the $99.8 million outstanding 2017 Notes. The debt redemption transactions resulted in $3.1 million of expense in the second quarter of 2013 and $3.8 million for the six months ended June 30, 2013 reflected as Loss on early extinguishment of debt in our consolidated income statements.    
In June 2013, we amended our existing $125 million Credit Facility, to among other things, extend the facility maturity date by two years from July 24, 2014 to July 24, 2016, amend the formula for calculating the borrowing base and to increase the accordion feature to $75 million. In addition, two additional lenders joined the Credit Facility lending syndicate, thereby increasing the total commitment currently available under the Credit Facility to $135 million.
Obligations to pay principal and interest on our notes listed in the table above are guaranteed by all of our wholly-owned subsidiaries (each a “Guarantor” and, collectively, the “Guarantor Subsidiaries”), each of which is directly or indirectly 100% owned by Meritage Homes Corporation. Such guarantees are full and unconditional, and joint and several. In the event of a sale or other disposition of all of the assets of any Guarantor, by way of merger, consolidation or otherwise, or a sale or other disposition of all of the equity interests of any Guarantor then held by Meritage and its subsidiaries, then that Guarantor will be released and relieved of any obligations under its note guarantee. There are no significant restrictions on our ability or the ability of any Guarantor to obtain funds from their respective subsidiaries, as applicable, by dividend or loan. We do not provide separate financial statements of the Guarantor Subsidiaries because Meritage (the parent company) has no independent assets or operations and the guarantees are full and unconditional and joint and several. Subsidiaries of Meritage Homes Corporation that are nonguarantor subsidiaries, if any, are, individually and in the aggregate, inconsequential.



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NOTE 6 — FAIR VALUE DISCLOSURES
We account for the non-recurring fair value measurements of our non-financial assets and liabilities in accordance with ASC 820-10, Fair Value Measurement and Disclosure. This guidance defines fair value, establishes a framework for measuring fair value and addresses required disclosures about fair value measurements. This standard establishes a three-level hierarchy for fair value measurements based upon the significant inputs used to determine fair value. Observable inputs are those which are obtained from market participants external to the company while unobservable inputs are generally developed internally, utilizing management’s estimates, assumptions and specific knowledge of the assets/liabilities and related markets. The three levels are defined as follows:
Level 1 — Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 — Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active, or by model-based techniques in which all significant inputs are observable in the market.
Level 3 — Valuation is derived from model-based techniques in which at least one significant input is unobservable and based on the company’s own estimates about the assumptions that market participants would use to value the asset or liability.
If the only observable inputs are from inactive markets or for transactions which the company evaluates as “distressed”, the use of Level 1 inputs should be modified by the company to properly address these factors, or the reliance of such inputs may be limited, with a greater weight attributed to Level 3 inputs. Refer to Notes 1 and 2 for additional information regarding the valuation of our non-financial assets.
Due to our quarterly review of our long-lived real-estate assets as described in Note 2, we consider the carrying amounts of real-estate assets subject to current period impairments to approximate fair value, although all such adjustments for the three and six months ended June 30, 2013 and June, 2012 were considered immaterial.
     Financial Instruments. The fair value of our fixed-rate debt is derived from quoted market prices by independent
dealers and is as follows (in thousands):
 
 
 
 
June 30, 2013
 
December 31, 2012
 
Hierarchy
Aggregate
Principal
 
Estimated
Fair Value
 
Aggregate
Principal
 
Estimated
Fair Value
7.731% senior subordinated notes
Level 2
 
N/A

 
N/A

 
$
99,825

 
$
102,950

4.50% senior notes
Level 2
 
$
175,000

 
$
173,250

 
N/A

 
N/A

7.15% senior notes
Level 2
 
$
200,000

 
$
220,000

 
$
200,000

 
$
220,760

7.00% senior notes
Level 2
 
$
300,000

 
$
329,250

 
$
300,000

 
$
328,500

1.875% convertible senior notes
Level 2
 
$
126,500

 
$
137,885

 
$
126,500

 
$
127,449

Due to the short-term nature of other financial assets and liabilities, we consider the carrying amounts of our other short-term financial instruments to approximate fair value.








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NOTE 7 — EARNINGS PER SHARE
Basic and diluted earnings per common share were calculated as follows (in thousands, except per share amounts):  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Basic weighted average number of shares outstanding
36,151

 
32,755

 
35,976

 
32,694

Effect of dilutive securities:
 
 
 
 
 
 
 
Convertible debt (1)
2,176

 

 
2,176

 

Stock options and unvested restricted stock
431

 
349

 
510

 
392

Diluted weighted average shares outstanding
38,758

 
33,104

 
38,662

 
33,086

 
 
 
 
 
 
 
 
Net earnings as reported
$
28,143

 
$
8,005

 
$
40,184

 
$
3,251

Interest attributable to convertible senior notes, net of income taxes
393

 

 
782

 

Net earnings for earnings per share
$
28,536

 
$
8,005

 
$
40,966

 
$
3,251

Basic earnings per share
$
0.78

 
$
0.24

 
$
1.12

 
$
0.10

Diluted earnings per share (1)
$
0.74

 
$
0.24

 
$
1.06

 
$
0.10

Antidilutive stock options not included in the calculation of diluted income per share
5

 
260

 
3

 
255

 
(1)
In the third quarter of 2012, we issued $126.5 million of 1.875% convertible senior notes convertible into shares of our common stock at a rate of 17.1985 shares per $1,000 principle amount. In accordance with ASC Subtopic 260-10, Earnings Per Share, ("ASC 260-10") we calculate the dilutive effect of convertible securities using the "if-converted" method.

NOTE 8 — STOCKHOLDERS’ EQUITY    
A summary of changes in shareholders’ equity is presented below: 
 
Six Months Ended June 30, 2013
 
(In thousands)
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Total
Balance at December 31, 2012
35,613

 
$
356

 
$
390,249

 
$
303,605

 
$
694,210

Net earnings

 

 

 
40,184

 
40,184

Exercise of stock options
322

 
3

 
10,913

 

 
10,916

Excess income tax benefit from stock-based awards

 

 
1,687

 

 
1,687

Equity award compensation expense

 

 
3,941

 

 
3,941

Issuance of restricted stock
281

 
3

 
(3
)
 

 

Non-controlling interest acquisition

 

 
(257
)
 

 
(257
)
Balance at June 30, 2013
36,216

 
$
362

 
$
406,530

 
$
343,789

 
$
750,681


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Six Months Ended June 30, 2012
 
(In thousands)
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Total
Balance at December 31, 2011
40,377

 
$
404

 
$
478,839

 
$
198,442

 
$
(188,773
)
 
$
488,912

Net earnings

 

 

 
3,251

 

 
3,251

Exercise of stock options
79

 
1

 
1,221

 

 

 
1,222

Equity award compensation expense

 

 
3,273

 

 

 
3,273

Issuance of restricted stock
197

 
2

 
(2
)
 

 

 

Balance at June 30, 2012
40,653

 
$
407

 
$
483,331

 
$
201,693

 
$
(188,773
)
 
$
496,658


NOTE 9 — STOCK-BASED COMPENSATION
We have a stock compensation plan, the 2006 Stock Option Plan (the “Plan”), that was adopted in 2006, and superceded a prior stock compensation plan. The Plan has been amended from time to time. The Plan was approved by our stockholders and is administered by our Board of Directors. The provisions of the Plan allow for the grant of stock appreciation rights, restricted stock awards, performance share awards and performance-based awards in addition to non-qualified and incentive stock options. The Plan authorizes awards to officers, key employees, non-employee directors and consultants for up to 8,950,000 shares of common stock, of which 935,556 shares remain available for grant at June 30, 2013. We believe that such awards provide a means of performance-based compensation to attract and retain qualified employees and better align the interests of our employees with those of our stockholders. Non-vested stock awards and stock options granted in previous years are typically granted with a five-year ratable vesting period. Non-vested stock awards and performance-based awards granted to our executive management team and our Board of Directors are typically granted with a three-year cliff vesting.
Compensation cost related to time-based restricted stock awards are measured as of the closing price on the date of grant and are expensed on a straight-line basis over the vesting period of the award. Compensation cost related to performance-based restricted stock awards are also measured as of the closing price on the date of grant but are expensed in accordance with ASC 718-10-25-20, Compensation – Stock Compensation, which requires an assessment of probability of attainment of the performance target. As our performance targets are annual in nature, once we determine that the performance target outcome is probable, the year-to-date expense is recorded and the remaining expense is recorded on a straight-line basis through the end of the award’s vesting period.
Below is a summary of compensation expense and stock award activity (dollars in thousands): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Stock-based compensation expense
$
2,097

 
$
1,620

 
$
3,941

 
$
3,273

Non-vested shares granted
10,000

 
20,500

 
342,100

 
369,750

Performance-based non-vested shares granted

 

 
62,500

 
56,250

Stock options exercised
199,827

 
10,600

 
322,100

 
79,300

Restricted stock awards vested (includes performance-based awards)
6,200

 
3,400

 
280,800

 
197,016

We did not grant any stock option awards during the six months ended June 30, 2013 or June 30, 2012. The following table includes additional information regarding the Plan (dollars in thousands):
 
As of
 
June 30, 2013
 
December 31, 2012
Unrecognized stock-based compensation cost
$
21,513

 
$
13,072

Weighted average years remaining vesting period
2.66

 
2.17

Total equity awards outstanding (1)
1,367,985

 
1,615,235

 
(1)    Includes vested and unvested options outstanding and unvested restricted stock awards.

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NOTE 10INCOME TAXES    
Components of the income tax (provision)/benefit are as follows (in thousands): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Federal
$
(11,919
)
 
$

 
$
(15,694
)
 
$

State
1,530

 
5,163

 
871

 
4,983

Total
$
(10,389
)
 
$
5,163

 
$
(14,823
)
 
$
4,983

The effective tax rate for the three months ended June 30, 2013 is 27.0% and reflects the benefit of energy tax credits from the IRC §45L homebuilder manufacturing deduction, and partial reversal of the state valuation allowance on our deferred tax assets. Due to the effects of the deferred tax asset valuation allowance and federal and state tax net operating losses (“NOLs”), the effective tax rate in 2012 is not meaningful as there is no correlation between the effective tax rate and the amount of pre-tax income or loss for that period.
At June 30, 2013 and December 31, 2012, we have no unrecognized tax benefits due to the lapse of the statute of limitations and completion of audits for prior years. We believe that our current income tax filing positions and deductions would be sustained on audit and do not anticipate any adjustments that would result in a material change. Our policy is to accrue interest and penalties on unrecognized tax benefits and include them in federal income tax expense.
In accordance with ASC 740-10, Income Taxes, we determine our net deferred tax assets by taxing jurisdiction. We evaluate our net deferred tax assets, including the benefit from NOLs, by jurisdiction to determine if a valuation allowance is required. Companies must assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified. This assessment considers, among other matters, the nature, frequency and severity of cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and experiences of utilizing tax credit carryforwards and tax planning alternatives.
We recorded a full valuation allowance against all of our net deferred tax assets during 2008 due to economic conditions and the weight of negative evidence at that time. During the second quarter of 2012, we determined that the positive evidence exceeded the negative evidence in the tax jurisdiction of Florida and that it was more likely than not that most of the deferred tax assets and NOL carryovers for the Florida jurisdiction would be realized. In the fourth quarter of 2012, we reversed the valuation allowance against our federal deferred tax assets and those in most of our state jurisdictions because the weight of the positive evidence in those jurisdictions exceeded that of the negative evidence. However, we retained a valuation allowance for certain states which have shorter carryforward periods for utilization of NOL carryovers or lower current earnings relative to their NOL carryforward balance. A portion of this remaining allowance relating to state tax assets was released in the second quarter of 2013.
We continue to evaluate the remaining state valuation allowance to determine if sufficient positive evidence indicates that it is more likely than not that an additional portion of the underlying state NOL carryforwards should be able to be realized.
At June 30, 2013 and December 31, 2012, we had a valuation allowance against deferred tax assets as follows (in thousands):
 
June 30, 2013
 
December 31, 2012
State
5,609

 
8,666

Total valuation allowance
$
5,609

 
$
8,666

Our future NOL and deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws. Federal NOL carryforwards may be used to offset future taxable income for 20 years. State NOL carryforwards may be used to offset future taxable income for a period of time ranging from 5 to 20 years, depending on the state jurisdiction. At June 30, 2013, we had a federal NOL carryforward benefit of $9.1 million that expires in 2031 and federal tax credit carryforwards of $5.7 million which begin to expire in 2030. At June 30, 2013, we also had tax benefits for state NOL carryforwards of $17.9 million that expire at various times from 2013 to 2031 depending on the state jurisdiction.

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At June 30, 2013, we have income taxes payable of $12.2 million, which primarily consists of current state tax accruals as well as tax and interest amounts that we expect to pay within one year for having amended prior-year tax returns. This amount is recorded in accrued liabilities in the accompanying balance sheet as of June 30, 2013.
We conduct business and are subject to tax in the U.S. and several states. With few exceptions, we are no longer subject to U.S. federal, state, or local income tax examinations by taxing authorities for years prior to 2008. We are not subject to any federal or state income tax examination at this time.
The tax benefits from our NOLs, built-in losses, and tax credits would be materially reduced or potentially eliminated if we experience an “ownership change” as defined under Internal Revenue Code (“IRC”) §382. Based on our analysis performed as of June 30, 2013, we do not believe that we have experienced an ownership change. As a protective measure, our stockholders held a Special Meeting of Stockholders on February 16, 2009 and approved an amendment to our Articles of Incorporation that restricts certain transfers of our common stock. The amendment is intended to help us avoid an unintended ownership change and thereby preserve the value of our tax benefits for future utilization.
On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (the “Act”), which the President signed into law on January 2, 2013. The Act extended certain tax provisions which have a retroactive effect on 2012. Among other things, the Act extended for two years the availability of a business tax credit under IRC §45L for building new energy efficient homes which originally was set to expire at the end of 2011. Under ASC 740, the effects of new legislation are recognized in the period that includes the date of enactment, regardless of the retroactive benefit. In accordance with this guidance, we recorded a tax effected benefit of approximately $2.6 million in the first half of 2013 related to the extension of the IRC §45L tax credit for the qualifying new energy efficient homes that we sold in 2012 and the first half of 2013. Additional IRC §45L credits for homes sold in 2012 and 2013 will be recognized in future periods if we determine that we quality for them after completing a more in-depth analysis.
NOTE 11 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The following presents certain supplemental cash flow information (in thousands):
 
 
Six Months Ended June 30,
 
2013
 
2012
Cash paid during the period for:
 
 
 
Interest, net of interest capitalized
$
7,061

 
$
13,726

Income taxes
$
992

 
$
909

Non-cash operating activities:
 
 
 
Real estate not owned
$

 
$
233

NOTE 12 — OPERATING AND REPORTING SEGMENTS
We operate with two principal business segments: homebuilding and financial services. As defined in ASC 280-10, Segment Reporting, we have six homebuilding operating segments (the six states in which we operate) within our homebuilding business. These segments are engaged in the business of acquiring and developing land, constructing homes, marketing and selling those homes, and providing warranty and customer service. We aggregate our homebuilding operating segments into reporting segments based on similar long-term economic characteristics and geographical proximity. In the latter part of 2012, management's evaluation of segment reporting led to a re-grouping of our homebuilding segments to more closely align them into long-term expected profitability trends and, accordingly, all prior year segment financial information has been updated to reflect our new aggregation. Our current reportable homebuilding segments are as follows:
West:       Arizona, California and Colorado (1)
Central:  Texas
East:       Florida and the Carolinas

(1)    Activity for our wind-down Nevada operations is reflected in the West Region's results.
Management's evaluation of homebuilding segment performance is based on segment operating income, which we define as homebuilding and land revenues less cost of home construction, commissions and other sales costs, land development and other land sales costs and other costs incurred by or allocated to each segment, including impairments. Each reportable segment follows the same accounting policies described in our 2012 Form 10-K in Note 1, “Business and Summary of Significant

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Accounting Policies.” Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity for the periods presented. The following segment information is in thousands:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Homebuilding revenue (1):
 
 
 
 
 
 
 
West
$
246,741

 
$
134,263

 
$
435,946

 
$
228,964

Central
127,310

 
102,499

 
218,099

 
174,478

East
75,899

 
45,333

 
132,340

 
83,003

Consolidated total
$
449,950

 
$
282,095

 
$
786,385

 
$
486,445

Homebuilding segment operating income:
 
 
 
 
 
 
 
West
$
34,895

 
$
8,410

 
$
54,058

 
$
11,651

Central
7,263

 
5,336

 
9,643

 
5,652

East
6,765

 
3,271

 
10,001

 
6,077

Total homebuilding segment operating income
48,923

 
17,017

 
73,702

 
23,380

Financial services profit
4,165

 
2,177

 
7,221

 
3,758

Corporate and unallocated (2)
(7,502
)
 
(5,085
)
 
(13,349
)
 
(9,910
)
Loss from other unconsolidated entities, net
(120
)
 
(91
)
 
(275
)
 
(274
)
Interest expense
(4,523
)
 
(6,338
)
 
(9,651
)
 
(13,709
)
Other income, net
685

 
934

 
1,155

 
795

Loss on early extinguishment of debt
(3,096
)
 
(5,772
)
 
(3,796
)
 
(5,772
)
Earnings/(loss) before income taxes
$
38,532

 
$
2,842

 
$
55,007

 
$
(1,732
)
 
(1)
Homebuilding revenue includes the following land closing revenue, by segment:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Land closing revenue:
 
 
 
 
 
 
 
West
100

 
$

 
$
5,741

 
$

Central
10,340

 
755

 
10,424

 
1,083

East
3,470

 

 
3,470

 

Consolidated total
$
13,910

 
$
755

 
$
19,635

 
$
1,083


(2)
Balance consists primarily of corporate costs and numerous shared service functions such as finance and treasury that are not allocated to the homebuilding or financial services reporting segments.


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At June 30, 2013
 
West
 
Central
 
East
 
Financial Services
 
Corporate and
Unallocated (1)
 
Total
Deposits on real estate under option or contract
$
5,601

 
$
7,570

 
$
8,541

 
$

 
$

 
$
21,712

Real estate
691,423

 
328,895

 
206,911

 

 

 
1,227,229

Investments in unconsolidated entities
206

 
9,427

 
40

 

 
1,025

 
10,698

Other assets (2)
44,661

 
161,252

 
26,230

 
506

 
275,189

 
507,838

Total assets
$
741,891

 
$
507,144

 
$
241,722

 
$
506

 
$
276,214

 
$
1,767,477

 
 
At December 31, 2012
 
West
 
Central
 
East
 
Financial Services
 
Corporate and
Unallocated (3)
 
Total
Deposits on real estate under option or contract
$
4,419

 
$
7,168

 
$
2,764

 
$

 
$

 
$
14,351

Real estate
647,316

 
305,100

 
160,771

 

 

 
1,113,187

Investments in unconsolidated entities
365

 
10,645

 
16

 

 
1,059

 
12,085

Other assets (4)
24,935

 
132,546

 
25,914

 
297

 
252,247

 
435,939

Total assets
$
677,035

 
$
455,459

 
$
189,465

 
$
297

 
$
253,306

 
$
1,575,562

 
(1)(3)    Balance consists primarily of corporate assets not allocated to the reporting segments.
(2)(4)    Balance consists primarily of cash and securities.

NOTE 13COMMITMENTS AND CONTINGENCIES     
We are involved in various routine legal proceedings incidental to our business, some of which are covered by insurance. With respect to most pending litigation matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and our actual future expenditure to resolve those matters could prove to be different from the amount that we accrued or reserved. On a quarterly basis, our senior management and legal team conduct an in-depth review of all active legal claims and litigation matters and we record a legal or warranty accrual representing the estimated total expense required to resolve each such matter. We have reserved approximately $16.7 million related to non-warranty related litigation and asserted claims, which includes reserves for the Joint Venture Litigation discussed below. In addition, our $21.8 million warranty reserve includes accruals for all construction defect claims that are similarly recorded in an amount we believe will be necessary to resolve those construction defect claims. Except as may be specifically disclosed herein, we currently believe that any reasonably possible additional losses from existing claims and litigation in excess of our existing reserves and accruals would be immaterial, individually and in the aggregate, to our financial results.
Joint Venture Litigation
We are a defendant in a lawsuit filed by the lenders related to a project known as “South Edge” or “Inspirada”. We are also a party to a demand for arbitration made by an entity controlled by certain co-venturers, which demand was made by that entity as Estate Representative of bankrupt South Edge, LLC. The project involves a large master-planned community located in Henderson, Nevada, which was acquired by an unconsolidated joint venture with capital supplied by us and our co-venturers, and a syndicated loan for the project. In connection with the loan obtained by the venture, we provided a narrowly crafted repayment guarantee that could only be triggered upon a “bankruptcy event”. That guarantee covers our 3.53% pro rata share of the project financing.
On December 9, 2010, three of the lenders filed a petition seeking to place the venture into an involuntary bankruptcy. On June 6, 2011, we received a demand letter from the lenders, requesting full payment of $13.2 million the lenders claimed to be owed under the springing repayment guarantee, including past-due interest and penalties. The lenders claim that the involuntary bankruptcy filed by three of the lenders triggered the “springing” repayment guarantee. We do not believe the lenders have an enforceable position associated with their $13.2 million claim and do not believe we should be required to pay such amount because, among other reasons, the lenders breached their contract with us by refusing to accept the April 2008 full tender of our performance and by refusing to release their lien in connection with our second and final takedown in this project and we do not believe the repayment guarantee was triggered by the lenders’ filing of the involuntary bankruptcy. As a result,

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on August 19, 2011, we filed a lawsuit against JP Morgan Chase Bank, NA (“JP Morgan”) in the Court of Common Pleas in Franklin County, Ohio (Case No. 11CVH0810353) regarding the repayment guarantee. In reaction to that lawsuit, on August 25, 2011, JP Morgan filed a lawsuit against us in the US District Court of Nevada, which is currently being prosecuted in the name of JP Morgan's agent, ISG Insolvency Group, Inc. regarding the same issues addressed in the Ohio litigation. The Ohio action and the Nevada action have been consolidated. On October 26, 2011, the Bankruptcy Court approved a Plan pursuant to which (i) the lenders have received all payments to which they are entitled, (ii) the project has been conveyed to Inspirada Builders, LLC, which is an entity owned by four of the co-venturers in the South Edge entity (KB Home, Toll Brothers, Pardee Homes and Beazer Homes), and (iii) the four co-venturer builders claim to have succeeded to the lenders' repayment guarantee claim against Meritage.
On September 4, 2012, the Court ruled on a motion for summary judgment that JP Morgan has standing to pursue its repayment guarantee claims against Meritage, that Meritage was liable thereunder to JP Morgan and that the parties should be permitted to conduct discovery with respect to the amount of damages to which JP Morgan is entitled under the repayment guarantee. Following limited discovery, JP Morgan filed a motion for summary judgment with respect to damages, and on June 17, 2013 the Court granted the motion, ruling that Meritage owes JP Morgan $15,053,857. Later, on July 8, 2013, the Court entered Judgment in favor of JP Morgan in the amount of $15,753,344, which included an additional $699,487 for pre-judgment interest that accrued between December 6, 2012 and the date of the Judgment. We immediately appealed the Court's rulings, and on July 17, 2013 posted a supersedeas bond in the amount of $16,050,604 staying enforcement of the Judgment, which was approved by the Court on July 17, 2013. Pursuant to a stipulation between the parties, the bond amount included the amount of the Judgment and additional sums for a potential award of post-judgment interest and attorneys' fees on appeal. We disagree with many of the conclusions and findings contained in the Court's order, and have challenged and will continue to challenge the rulings. In addition, we believe that the four above-named builders are liable to Meritage for any amounts that Meritage may ultimately be required to pay under the repayment guarantee, and we have filed claims against those builders to, among other things, recover from them any amounts Meritage is required to pay under the repayment guarantee.
In March 2012, Inspirada Builders, LLC, as Estate Representative of South Edge, LLC (the original joint venture) filed demand for arbitration in the United States Bankruptcy Court in the District of Nevada against Meritage Homes of Nevada, Inc. seeking: (1) $13.5 million, relating to alleged breaches of the Operating Agreement of South Edge, LLC, for an alleged failure to pay the amounts Meritage Homes of Nevada fully tendered but South Edge rejected in April 2008; and (2) $9.8 million relating to our supposed pro rata share of alleged future infrastructure improvement costs to be incurred by Inspirada Builders, LLC (the new owner of the project and which is owned by the four builders identified above). The $13.5 million component of this claim represents the same alleged obligation and amount that is the subject of the above described pending repayment guarantee litigation between us and JP Morgan. Meritage has filed a response to Inspirada Builders' arbitration claims denying liability, together with cross-claims against each of the four above-named co-venture builders for breach of contract, breach of the implied covenant of good faith and fair dealing, and indemnity. On June 27, 2013, Inspirada Builders agreed to dismiss with prejudice its $9.8 million claim for future infrastructure costs. Although the balance of the parties' claims are currently pending and were set to be resolved at a hearing in late 2013, per the parties' stipulation the Arbitration has now been stayed pending resolution of our appeal of the Court's rulings in favor of JP Morgan in the federal court action. In connection with the on-going legal proceedings, we have established reserves for amounts that we believe are appropriate for these matters. Our 3.53% investment in the venture has previously been fully impaired. We do not believe that the ultimate disposition of these matters will have a material adverse effect on our financial condition.

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview and Outlook

Throughout the first six months of 2013, the positive housing market momentum continued, largely driven by excellent housing affordability, decreasing levels of home inventory in many markets, increasing consumer confidence levels and an improving economy. Increased customer interest and traffic in our communities translated to positive order trends in all of our active divisions.

We remain focused on strategically positioning ourselves in well-located and highly-desired communities in many of the top real-estate markets in the United States. We continue to differentiate ourselves from our competition in this recovering market by offering a new line-up of plans that highlight the benefits of our industry-leading energy efficient homes. We also offer our buyers the ability to personalize their homes and we provide a home warranty, further setting us apart from the competition we face with resale homes. Our strong operating and financial results during the first half of 2013 are reflected in both our strengthened balance sheet and our improved profitability.

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Company Actions and Positioning
As the homebuilding market recovery continues, we remain focused on increasing community count and securing land to support future growth in our orders volume, revenue, costs, margins and profitability while maintaining a strong balance sheet. To help meet these goals we continue to execute on the following initiatives:

Acquiring and developing lots in high-performing markets we deem key to our success in order to maintain and grow our lot supply and active community count;
Utilizing our enhanced market research to capitalize on the knowledge of our buyers' demands in each community, tailoring our pricing, product and amenities offered;
Continuing to innovate and promote the Meritage Green energy efficiency program, where every new home we construct, at a minimum, meets ENERGY STAR® standards, certified by the U.S. Environmental Protection Agency, for indoor air quality, water conservation and overall energy efficiency;
Adapting sales and marketing efforts to generate additional traffic and successfully compete with resale homes;
Focusing our purchasing efforts to manage costs as homebuilding recovers and demand rises;
Growing our inventory balance while ensuring sufficient liquidity through exercising tight control over cash flows;
Striving for excellence in construction; and monitoring our customers' satisfaction as measured by survey scores and working toward improving them based on the results of the surveys.
We also continue to opportunistically access the capital markets through various debt and equity transactions, providing additional liquidity, extending our debt maturities and strengthening our balance sheet.
In addition to the initiatives listed above, we are also evaluating opportunities for expansion into new markets that indicate positive long-term growth trends. We are looking to redeploy our capital into projects both within our geographic footprint and through entry into new markets. In connection with these efforts, over the last several years we announced our entry into the Raleigh-Durham and Charlotte, North Carolina and Tampa, Florida markets and our wind-down of operations in the Las Vegas, Nevada market. We are now effectively closed out of the Las Vegas market, only providing on-going warranty support for our homeowners.
    
In the second quarter of 2013, we opened 27 new communities while closing out 30 communities, ending the quarter with 165 active communities. We expect active community growth at a tempered pace as we are closing out older, shorter lived communities while our replacement communities require a longer lead time to allow for development activities as more of our acquisitions are from a higher percentage of undeveloped land. We expect to end the year with 185 actively-selling communities.
Over the past 18 months, we have taken steps to strengthen our balance sheet and extend debt maturities through debt transactions. Most recently, in March 2013, we concurrently issued $175.0 million of 4.50% senior notes due 2018 and redeemed $16.7 million of our $99.8 million senior subordinated notes due 2017. We redeemed the remaining balance of these notes in April 2013. In June 2013, we amended our Credit Facility to extend the facility maturity date by two years to July 2016 and increased the total commitment currently available under the Credit Facility by $10.0 million to $135.0 million. (See Note 5 to the accompanying unaudited consolidated financial statements for further discussion.)    
Summary Company Results    
Along with most of the homebuilding industry, we continued to experience strong operating and financial performance in the second quarter of 2013. We believe our overall improving trends are attributable to our focus on community placement, seeking investments in new communities located in highly desirable submarkets, coupled with our Meritage Green energy efficiency product offerings as well as overall improvement in home demand. Demand in most of our markets continues to outpace supply, allowing us to benefit from price appreciation in a majority of our communities, offsetting construction cost increases, and thereby improving our margins. We continue to focus on growing our land positions and strategically increasing our active community count in preferred locations to meet the additional demand we are experiencing.
In the second quarter of 2013, we benefited from gains in all key operating and financial metrics. We recorded 1,637 orders and 1,321 closings, increases of 21.0% and 26.8%, respectively over the second quarter of 2012. An increase in orders per average active community of 8.9% versus the same period in 2012 to 9.8 orders per average active community generated the positive volume trends we are experiencing. Most notably, we recorded a significant increase year-over year in home closing gross margin during the three months ended June 30, 2013, increasing 300 basis points from the same period in 2012 to 21.5%. We believe these results are indicative of our successful execution of business initiatives, increased housing demand, as well as consumer confidence, all of which should translate into higher revenues and profitability moving forward. Comparative

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positive trends are and will continue to be increasingly more difficult as we began experiencing notable and sustained improvement in the second quarter of 2012. Accordingly, moving forward; while we expect improvements in nearly all metrics, we anticipate the comparative gains to be more tempered as we experience successive quarters of the improved homebuilding environment. We believe our current operating results indicate solid housing market conditions, and we believe we are well positioned for another profitable year.
Total home closing revenue was $436.0 million for the three months ended June 30, 2013, increasing 55.0% from the same period last year. The $154.7 million increase is mainly driven by the 279 additional closing units for the quarter ended June 30, 2013 as compared to the same period last year, further aided by a 22.3% increase in average sales prices to $330,100. The increased sales prices were partially due to a shift in order mix to communities and states that have a greater demand for larger homes with higher average home prices and partially due to price appreciation. We reported net earnings of $28.1 million for the three months ended June 30, 2013, as compared to $8.0 million for the same period in 2012. We expect improving revenue and profitability for the remainder of the year, as indicated by our higher ending backlog, average sales prices and improved margins.
Total home closing revenue for the six months ended June 30, 2013 was $766.8 million as compared to $485.4 million for the 2012 period. The 58.0% increase in year-to-date closing revenue is due to a 572-unit increase as well as a $53,600 increase in average sales prices. Net earnings for the year-to-date period increased $36.9 million from $3.3 million in 2012 to $40.2 million in 2013. The same contributing factors for second quarter results mentioned above impacted the year-to-date results.
At June 30, 2013, our backlog of $806.3 million reflects an increase of 76.2% or $348.7 million, when compared to backlog at June 30, 2012. The improvement reflects a 21.0% increase in unit orders, as well as higher average sales prices on home orders of 22.8% for the three months ended June 30, 2013, as compared to the same period a year ago. In the second quarter of 2013, we were also able to maintain a low cancellation rate on home orders at 11% of gross orders as compared to 13% in the same period a year ago.
Land Closing Revenue and Gross Profit
From time to time, we sell certain land parcels to other homebuilders, developers or investors if we believe the sale will provide a greater economic benefit to us than continuing home construction or where we are looking to diversify or divest our land positions in the specific geography. As a result of such sales, we recognized land closing revenue of $13.9 million and $19.6 million for the three and six months ending June 30, 2013, respectively, as compared to $755,000 and $1.1 million for the three and six months ending June 30, 2012, respectively.  The majority of the 2013 land sales are from the sale of certain parcels in communities where we continue to hold extended lot positions as well as the sale of certain Nevada assets as part of our wind-down efforts.
Critical Accounting Policies
The accounting policies we deem most critical to us and that involve the most difficult, subjective or complex judgments include revenue recognition, valuation of real estate, warranty reserves, off-balance sheet arrangements, and share-based payments. There have been no significant changes to our critical accounting policies during the three months ended June 30, 2013 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2012 Annual Report on Form 10-K.


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The composition of our closings, home orders and backlog is constantly changing and is based on a dissimilar mix of communities between periods as new projects open and existing projects wind down. Further, individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality of lots (e.g. cul-de-sac, view lots, greenbelt lots). These variations result in a lack of meaningful comparability between our home orders, closings and backlog due to the changing mix between periods. The tables below present operating and financial data that we consider most critical to managing our operations (dollars in thousands):
Home Closing Revenue
 
Three Months Ended June 30,
 
Quarter over Quarter
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
436,040

 
$
281,340

 
$
154,700

 
55.0
%
Homes closed
1,321

 
1,042

 
279

 
26.8
%
Avg sales price
$
330.1

 
$
270.0

 
$
60.1

 
22.3
%
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
79,736

 
$
54,772

 
$
24,964

 
45.6
%
Homes closed
251

 
208

 
43

 
20.7
%
Avg sales price
$
317.7

 
$
263.3

 
$
54.4

 
20.7
%
California
 
 
 
 
 
 
 
Dollars
$
124,818

 
$
50,521

 
$
74,297

 
147.1
%
Homes closed
297

 
148

 
149

 
100.7
%
Avg sales price
$
420.3

 
$
341.4

 
$
78.9

 
23.1
%
Colorado
 
 
 
 
 
 
 
Dollars
$
37,001

 
$
26,877

 
$
10,124

 
37.7
%
Homes closed
100

 
80

 
20

 
25.0
%
Avg sales price
$
370.0

 
$
336.0

 
$
34.0

 
10.1
%
Nevada
 
 
 
 
 
 
 
Dollars
$
5,086

 
$
2,093

 
$
2,993

 
143.0
%
Homes closed
21

 
11

 
10

 
90.9
%
Avg sales price
$
242.2

 
$
190.3

 
$
51.9

 
27.3
%
West Region Totals
 
 
 
 
 
 
 
Dollars
$
246,641

 
$
134,263

 
$
112,378

 
83.7
%
Homes closed
669

 
447

 
222

 
49.7
%
Avg sales price
$
368.7

 
$
300.4

 
$
68.3

 
22.7
%
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
116,970

 
$
101,744

 
$
15,226

 
15.0
%
Homes closed
449

 
439

 
10

 
2.3
%
Avg sales price
$
260.5

 
$
231.8

 
$
28.7

 
12.4
%
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
19,273

 
$
9,507

 
$
9,766

 
102.7
%
Homes closed
51

 
26

 
25

 
96.2
%
Avg sales price
$
377.9

 
$
365.7

 
$
12.2

 
3.3
%
Florida
 
 
 
 
 
 
 
Dollars
$
53,156

 
35,826

 
$
17,330

 
48.4
%
Homes closed
152

 
130

 
22

 
16.9
%
Avg sales price
$
349.7

 
275.6

 
$
74.1

 
26.9
%
East Region Totals
 
 
 
 
 
 
 
Dollars
$
72,429

 
$
45,333

 
$
27,096

 
59.8
%
Homes closed
203

 
156

 
47

 
30.1
%
Avg sales price
$
356.8

 
$
290.6

 
$
66.2

 
22.8
%

26

Table of Contents

 
Six Months Ended June 30,
 
Year over Year
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
766,750

 
$
485,362

 
$
281,388

 
58.0
%
Homes closed
2,373

 
1,801

 
572

 
31.8
%
Avg sales price
$
323.1

 
$
269.5

 
$
53.6

 
19.9
%
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
136,885

 
$
93,671

 
$
43,214

 
46.1
%
Homes closed
443

 
350

 
93

 
26.6
%
Avg sales price
$
309.0

 
$
267.6

 
$
41.4

 
15.5
%
California
 
 
 
 
 
 
 
Dollars
$
215,460

 
$
83,827

 
$
131,633

 
157.0
%
Homes closed
525

 
245

 
280

 
114.3
%
Avg sales price
$
410.4

 
$
342.2

 
$
68.2

 
19.9
%
Colorado
 
 
 
 
 
 
 
Dollars
$
69,205

 
$
48,177

 
$
21,028

 
43.6
%
Homes closed
194

 
144

 
50

 
34.7
%
Avg sales price
$
356.7

 
$
334.6

 
$
22.1

 
6.6
%
Nevada
 
 
 
 
 
 
 
Dollars
$
8,655

 
$
3,289

 
$
5,366

 
163.1
%
Homes closed
37

 
17

 
20

 
117.6
%
Avg sales price
$
233.9

 
$
193.5

 
$
40.4

 
20.9
%
West Region Totals
 
 
 
 
 
 
 
Dollars
$
430,205

 
$
228,964

 
$
201,241

 
87.9
%
Homes closed
1,199

 
756

 
443

 
58.6
%
Avg sales price
$
358.8

 
$
302.9

 
$
55.9

 
18.5
%
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
207,675

 
$
173,395

 
$
34,280

 
19.8
%
Homes closed
803

 
756

 
47

 
6.2
%
Avg sales price
$
258.6

 
$
229.4