UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-9977

MERITAGE HOMES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Maryland		86-0611231
(State or Other Jurisdiction		(I.R.S. Employer
of 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)

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 þ 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 o 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 o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Common shares outstanding as of May 2, 2011: 32,388,003

 

 

MERITAGE HOMES CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2011

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION			3
Item 1. Financial Statements			3
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010			3
Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010			4
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010			5
Notes to Unaudited Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 3. Quantitative and Qualitative Disclosures About Market Risk			35
Item 4. Controls and Procedures			35
PART II. OTHER INFORMATION			36
Item 1. Legal Proceedings			36
Item 1A. Risk Factors			38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			38
Item 3. Not Applicable
Item 4. Removed and Reserved
Item 5. Not Applicable
Item 6. Exhibits			39
SIGNATURES			40
INDEX OF EXHIBITS			40
Exhibit 4.1
Exhibit 4.2
Exhibit 4.3
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

PART I — FINANCIAL INFORMATION

Item 1.		Financial Statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

		March 31,				December 31,
		2011				2010
Assets:
Cash and cash equivalents		$	103,508			$	103,953
Investments and securities			273,944				299,345
Restricted cash			10,270				9,344
Other receivables			19,516				20,835
Real estate			757,653				738,928
Real estate not owned			0				866
Deposits on real estate under option or contract			10,388				10,359
Investments in unconsolidated entities			10,900				10,987
Property and equipment, net			14,175				14,602
Intangibles, net			1,841				2,143
Prepaid expenses and other assets			16,739				13,576
Total assets		$	1,218,934			$	1,224,938
Liabilities:
Accounts payable		$	27,662			$	23,589
Accrued liabilities			80,309				87,811
Home sale deposits			8,459				6,897
Liabilities related to real estate not owned			0				866
Senior and senior subordinated notes			605,937				605,780
Total liabilities			722,367				724,943
Stockholders’ Equity:
Preferred stock, par value $0.01. Authorized 10,000,000 shares; none issued and outstanding at March 31, 2011 and December 31, 2010			0				0
Common stock, par value $0.01. Authorized 125,000,000 shares; issued 40,279,253 and 40,030,136 shares at March 31, 2011 and December 31, 2010, respectively			403				400
Additional paid-in capital			472,048				468,820
Retained earnings			212,889				219,548
Treasury stock at cost, 7,891,250 shares at March 31, 2011 and December 31, 2010			(188,773	)			(188,773	)
Total stockholders’ equity			496,567				499,995
Total liabilities and stockholders’ equity		$	1,218,934			$	1,224,938

See accompanying notes to condensed consolidated financial statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

		Three Months Ended
		March 31,
		2011				2010
Home closing revenue		$	177,489			$	200,582
Land closing revenue			100				1,222
Total closing revenue			177,589				201,804
Cost of home closings			(146,445	)			(162,042	)
Cost of land closings			(91	)			(964	)
Real estate impairments			(664	)			(542	)
Total cost of closings and impairments			(147,200	)			(163,548	)
Home closing gross profit			30,380				37,998
Land closing gross profit			9				258
Total closing gross profit			30,389				38,256
Commissions and other sales costs			(15,315	)			(17,222	)
General and administrative expenses			(15,126	)			(14,693	)
Earnings from unconsolidated entities, net			908				803
Interest expense			(8,023	)			(8,295	)
Other income, net			723				3,932
(Loss)/income before income taxes			(6,444	)			2,781
Provision for income taxes			(215	)			(121	)
Net (loss)/income		$	(6,659	)		$	2,660
(Loss)/earnings per common share:
Basic		$	(0.21	)		$	0.08
Diluted		$	(0.21	)		$	0.08
Weighted average number of shares:
Basic			32,260				31,940
Diluted			32,260				32,197

See accompanying notes to condensed consolidated financial statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

		Three Months Ended
		March 31,
		2011				2010
Cash flows from operating activities:
Net (loss)/income		$	(6,659	)		$	2,660
Adjustments to reconcile net (loss)/income to net cash (used in)/provided by operating activities:
Depreciation and amortization			1,756				1,947
Real-estate-related impairments			664				542
Stock-based compensation			1,713				1,257
Equity in earnings from unconsolidated entities			(908	)			(803	)
Distributions of earnings from unconsolidated entities			1,188				1,340
Other operating expenses			406				0
Changes in assets and liabilities:
Increase in real estate			(19,232	)			(49,920	)
Increase in deposits on real estate under option or contract			(29	)			(1,062	)
(Increase)/decrease in receivables and prepaid expenses and other assets			(1,540	)			90,494
Decrease in accounts payable and accrued liabilities			(3,484	)			(3,438	)
Increase in home sale deposits			1,562				920
Net cash (used in)/provided by operating activities			(24,563	)			43,937
Cash flows from investing activities:
Investments in unconsolidated entities			(138	)			(95	)
Distributions of capital from unconsolidated entities			0				16
Purchases of property and equipment			(1,431	)			(1,955	)
Proceeds from sales of property and equipment			3				31
Maturities of investments and securities			85,000				0
Payments to purchase investments and securities			(59,908	)			(50,024	)
(Increase)/decrease in restricted cash			(926	)			104
Net cash provided by/(used in) investing activities			22,600				(51,923	)
Cash flows from financing activities:
Proceeds from stock option exercises			1,518				1,335
Net cash provided by financing activities			1,518				1,335
Net decrease in cash and cash equivalents			(445	)			(6,651	)
Cash and cash equivalents at beginning of period			103,953				249,331
Cash and cash equivalents at end of period		$	103,508			$	242,680

See supplemental disclosures of cash flow information at Note 9.

See accompanying notes to condensed consolidated financial statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

Organization. Meritage Homes is a leading designer and builder of single-family detached and attached homes in the historically high-growth regions of the western and southern United States based on the number of home closings. We offer first-time, move-up, active adult and luxury homes to our targeted customer base. We have operations in three regions: West, Central and East, which are comprised of 12 metropolitan areas in Arizona, Texas, California, Nevada, Colorado and Florida. Additionally, in April 2011, we announced our entry into a new market, Raleigh-Durham, North Carolina. We have since contracted for several land parcels in Raleigh-Durham and expect to begin our sales operations in latter 2011. Through our predecessors, we commenced our homebuilding operations in 1985. 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 markets, except for Arizona and Texas, where we also operate under the name of Monterey Homes. At March 31, 2011, we were actively selling homes in 141 communities, with base prices ranging from approximately $90,000 to $620,000.

Basis of Presentation. The accompanying condensed 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, 2010. The condensed 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 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.

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 letters of credit is approximately $40 million. These outstanding letters of credit are secured by corresponding pledges of restricted cash accounts, totaling of $10.3 million and $9.3 million at March 31, 2011 and December 31, 2010, respectively, and are reflected as restricted cash on our consolidated balance sheets.

Investments and Securities. Our investments and securities are comprised of both treasury securities and deposits with banks that are FDIC-insured and secured by treasury-backed investments. 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 typically less than 18 months. The amortized cost of the investments approximates fair value.

Real Estate. Real estate is stated at cost unless the community or land 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, direct overhead costs incurred during development and home construction that benefit the entire community and 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. Cost of home closings includes the specific construction costs of the home and all related 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 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 accrual to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.

Typically, a community’s life cycle ranges from three to five years, commencing with the acquisition of the land and continuing through the land development phase 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 or finished lots. 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 significantly 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 if the fair value of an asset is less 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 at a community level 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 deemed not 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 known variances as determined by our knowledge of the region and general real estate expertise. If a discounted cash flow approach is used, we compute our 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 implemented to stimulate the sales pace 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 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 creation 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 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. In certain cases, we may elect to stop development and/or marketing of (mothball) 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. The decision may be based on financial and/or operational metrics. If we decide to mothball a project, we will impair it to its fair value as discussed above and then cease future development and/or marketing activity until such a time where management believes that market conditions will improve and economic performance will be maximized. Quarterly, we review all communities, including mothballed communities, for potential impairments.

Option 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 contribution margins to be generated by our future communities are 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 also 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, or due to other strategic factors. In such cases, we will impair our pre-acquisition costs and deposits, as necessary, to record an impairment to bring the book value to fair value. Refer to Note 2 of these condensed consolidated financial statements for further information regarding our impairments.

Deposits. Deposits paid related to land options and contracts to purchase land are capitalized when incurred and classified as deposits on real estate under option or contract until the related land is purchased. Deposits are reclassified to a component of real estate 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. As our exposure associated with these non-refundable deposits is limited to the deposit amount, since the acquisition contracts typically do not require specific performance, we do not consider the options a contractual obligation to purchase the land. 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 $10.4 million as of March 31, 2011 and December 31, 2010.

Off-Balance-Sheet Arrangements — Joint Ventures. Historically, 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 desired lots. We currently have only two such active ventures. We also participate in six mortgage and title business joint ventures. The mortgage joint ventures are engaged in, or invest in mortgage companies that engage in, mortgage brokerage activities, and they originate and provide services to both our clients and other homebuyers.

In connection with our joint ventures, we may also provide certain types of guarantees to associated lenders and municipalities. These guarantees can be classified into three categories: (i) Repayment Guarantees, (ii) “Bad Boy Guarantees”, and (iii) Completion Guarantees, described in more detail below (in thousands).

		At March 31, 2011				At December 31, 2010
Repayment guarantees (1)		$	12,006			$	12,491
“Bad Boy” guarantees			0				0
Completion guarantees (2)			0				0
Total guarantees		$	12,006			$	12,491

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 the land development joint ventures. If such a guarantee were ever to be called, 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 March 31, 2011 and December 31, 2010 is illustrated in the table above.

“Bad Boy” Guarantees. In addition, we and/or our joint venture partners occasionally provide guarantees that are only applicable if and when the joint venture directly, or indirectly through agreement with its joint venture partners or other third parties, causes the joint venture to voluntarily file a bankruptcy or similar liquidation or reorganization action or take other actions that limit a lender’s right to exercise remedies against its collateral or which are fraudulent or improper (commonly referred to as “bad boy” guarantees). These types of guarantees typically are on a pro rata basis among the joint venture partners and are designed to protect the secured lender’s remedies with respect to its mortgage or other secured lien on the joint venture or the joint venture’s underlying property. We believe these guarantees, as defined, unless invoked as described above, are not considered guarantees of indebtedness under our senior and senior subordinated indentures.

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. As part of our project acquisition due diligence process to determine potential environmental risks, we generally obtain, or the joint venture entity generally obtains, an independent environmental review. Per the guidance of ASC Subtopic 460-10, Guarantees, we believe these other 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 would 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 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 below for detail of our surety bonds.

The joint venture obligations, guarantees and indemnities discussed above are generally provided by us or one or more 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. In the limited cases where our venture partners, some of whom are homebuilders or developers who may be experiencing financial difficulties as a result of current market conditions, may be unable to fulfill their pro rata share of a joint venture obligation, we may be fully responsible for these commitments if such commitments are joint and several. 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 below and in Note 11 to these condensed consolidated financial statements, as of March 31, 2011 and December 31, 2010, we did not have any such reserves. See Note 11 regarding outstanding litigation for one of our joint ventures and corresponding reserves, some of which relate to completion guarantees.

Off-Balance-Sheet Arrangements — Other. We often acquire lots from various development entities pursuant to option and purchase agreements. The purchase price typically approximates the market price at the date the contract is executed, although in light of recent economic conditions over the last couple of years, we have been successful in renegotiating more preferential terms on some lots we have under contract. See Note 3 for further discussion.

We provide letters of credit and performance, maintenance and other bonds in support of our related obligations with respect to option deposits and the development of our projects and other corporate purposes. The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities. In the event a letter of credit or bond is drawn upon, we would be obligated to reimburse the issuer. We believe it is unlikely that any significant amounts of these letters of credit or bonds will be drawn upon. The table below outlines our letter of credit and surety bond obligations (in thousands):

		March 31, 2011								December 31, 2010
						Estimated work								Estimated work
						remaining to								remaining to
		Outstanding				complete				Outstanding				complete
Sureties:
Sureties related to joint ventures		$	1,594			$	32			$	1,594			$	32
Sureties related to owned projects and lots under contract			61,096				26,996				57,399				26,968
Total sureties		$	62,690			$	27,028			$	58,993			$	27,000
Letters of Credit (“LOCs”):
LOCs in lieu of deposit for contracted lots		$	0				N/A			$	0				N/A
LOCs for land development			2,342				N/A				2,488				N/A
LOCs for general corporate operations			6,460				N/A				6,460				N/A
Total LOCs		$	8,802				N/A			$	8,948				N/A

Accrued Liabilities. Accrued liabilities consist of the following (in thousands):

		At				At
		March 31, 2011				December 31, 2010
Accruals related to real estate development and construction activities		$	11,298			$	10,689
Payroll and other benefits			7,636				12,146
Accrued taxes			3,650				2,820
Warranty reserves			27,210				29,265
Other accruals			30,515				32,891
Total		$	80,309			$	87,811

Warranty Reserves. We have certain obligations related to post-construction warranties and defects for closed homes. With the assistance of an actuary, we have estimated these reserves based on the number of home closings and historical data and trends for our communities. We also use industry averages with respect to similar product types and geographic areas in markets where our experience is not robust enough to facilitate a meaningful conclusion. We regularly review our warranty reserves and adjust them, as necessary, to reflect changes in trends as information becomes available. A summary of changes in our warranty reserves follows (in thousands):

		Three Months Ended
		March 31,
		2011				2010
Balance, beginning of period		$	29,265			$	33,541
Additions to reserve from new home deliveries			1,257				1,477
Warranty claims			(2,923	)			(2,787	)
Adjustments to pre-existing reserves			(389	)			(77	)
Balance, end of period		$	27,210			$	32,154

Warranty reserves are included in accrued liabilities on the accompanying condensed consolidated balance sheets, and additions and adjustments to the reserves are included in cost of home closings within the accompanying condensed consolidated statements of operations. 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 and the general liability insurance we maintain, are sufficient to cover our general warranty obligations.

During the first quarter of 2009, we became aware that a limited number of the homes we constructed were exhibiting symptoms typical of defective Chinese drywall. Defective Chinese Drywall is an industry-wide issue that has affected many homebuilders. As of March 31, 2011, we have confirmed that 97 homes we built in 2005 and 2006 were constructed using defective Chinese drywall installed by subcontractors. Of those homes, 90 are located in Florida and seven are located in the Houston, Texas area. We recently discovered the seven Houston area homes and we are still conducting investigations to determine if other Texas homes are impacted, although it currently appears that the exposure in Texas may be limited. As of March 31, 2011, we have completed the repair of 66 homes and we are in the process of repairing an additional 11 homes. The $27.2 million of warranty reserves we have recorded as of March 31, 2011 includes reserves sufficient to complete our repair of the remaining affected homes and the resulting damage related to defective Chinese drywall. If our continuing investigations reveal other homes containing defective Chinese drywall, it may be necessary to increase our warranty reserves. We have started to receive and continue to seek reimbursement of the costs we have incurred or expect to incur related to defective Chinese drywall from the manufacturers, suppliers, and installers of the defective drywall and their insurers as well as from our general liability insurance carrier.

Recently Issued Accounting Pronouncements. There were no new accounting pronouncements that were either issued or became effective during the first three months of 2011 that are expected to have a material impact on our financial results or existing disclosures.

NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST

Real estate consists of the following (in thousands):

		At				At
		March 31, 2011				December 31, 2010
Homes under contract under construction (1)		$	101,127			$	96,844
Unsold homes, completed and under construction (1)			86,536				86,869
Model homes (1)			36,579				36,966
Finished home sites and home sites under development			477,755				454,718
Land held for development or sale (2)			55,656				63,531
		$	757,653			$	738,928

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 current 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 fair value of such assets is less than their carrying amounts. Our determination of fair value is based on projections and estimates. Based on these reviews of all our communities, we recorded the following real-estate and joint-venture impairment charges during the three-month periods ended March 31, 2011 and 2010 (in thousands):

		Three Months Ended
		March 31,
		2011				2010
Terminated option/purchase contracts and related pre-acquisition costs:
West		$	0			$	0
Central			0				0
East			0				0
Total		$	0			$	0
Real estate inventory impairments (1):
West		$	200			$	82
Central			335				460
East			129				0
Total		$	664			$	542
Impairments of joint venture investments:
West		$	0			$	0
Central			0				0
East			0				0
Total		$	0			$	0
Impairments of land held for sale:
West		$	0			$	0
Central			0				0
East			0				0
Total		$	0			$	0
Total impairments:
West		$	200			$	82
Central			335				460
East			129				0
Total		$	664			$	542

		Three Months Ended
		March 31,
		2011				2010
Individual home impairments:
West		$	200			$	82
Central			335				460
East			129				0
Total		$	664			$	542

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. A summary of our capitalized interest is as follows (in thousands):

		Three Months Ended
		March 31,
		2011				2010
Capitalized interest, beginning of period		$	11,679			$	14,187
Interest incurred			10,849				10,402
Interest expensed			(8,023	)			(8,295	)
Interest amortized to cost of home, land closings and impairments			(2,196	)			(3,218	)
Capitalized interest, end of period (1)		$	12,309			$	13,076

NOTE 3 — VARIABLE INTEREST ENTITIES AND CONSOLIDATED REAL ESTATE NOT OWNED

We enter into option and purchase agreements for land or lots as part of the normal course of business. These option and purchase agreements enable us to defer acquiring properties until we have determined whether to exercise our option to purchase. This helps reduce our financial risk associated with land acquisitions and holdings.

Based on the provisions of the relevant accounting guidance, we have concluded that when we enter into an option or purchase agreement to acquire land or lots from an entity and pay a non-refundable deposit, a variable interest entity, or “VIE”, may be created because we are deemed to have provided subordinated financial support that will absorb some or all of an entity’s expected losses if they occur. ASC 810, Consolidations, requires that for each VIE, we assess whether we are the primary beneficiary by first determining if 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 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 potentially a significant amount of the VIE’s expected gains. If we are the primary beneficiary of the VIE, we will 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. At March 31, 2011 and December 31, 2010, we had $0 and $866, respectively, of assets identified as “real estate not owned”.

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 savings or shortfalls are borne by us. Some of our option deposits may be refundable to us if certain contractual conditions are not performed by the party selling the lots.

The table below presents a summary of our lots under option or contract at March 31, 2011 (dollars in thousands):

										Option/Earnest
										Money Deposits
		Number of				Purchase								Letters of
		Lots				Price				Cash				Credit
Option contracts recorded on balance sheet as real estate not owned (1)			0			$	0			$	0			$	0
Option contracts not recorded on balance sheet — non-refundable deposits, committed (1)			1,991				85,895				9,520				0
Purchase contracts not recorded on balance sheet — non-refundable deposits, committed (1)			162				5,752				433				0
Purchase contracts not recorded on balance sheet — refundable deposits, committed			284				13,760				335
Total committed (on and off balance sheet)			2,437				105,407				10,288				0
Purchase contracts not recorded on balance sheet — refundable deposits, uncommitted (2)			276				6,231				100				0
Total uncommitted			276				6,231				100				0
Total lots under option or contracts			2,713				111,638				10,388				0
Total option contracts not recorded on balance sheet			2,713			$	111,638			$	10,388	(3)		$	0

Generally, our options 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. Although the pre-established number is typically structured to approximate our expected rate of home construction starts, during a weakened homebuilding market, as we have recently been experiencing, we may purchase lots at an absorption level that exceeds our sales and home starts pace to meet the pre-established minimum number of lots or we may try to restructure our original contract to include terms that more accurately reflect our revised sales pace expectations.

NOTE 4 — SENIOR AND SENIOR SUBORDINATED NOTES

Senior and senior subordinated notes consist of the following (in thousands):

		At				At
		March 31, 2011				December 31, 2010
6.25% senior notes due 2015. At March 31, 2011 and December 31, 2010, there was approximately $558 and $594 in unamortized discount, respectively		$	284,442			$	284,406
7.731% senior subordinated notes due 2017			125,875				125,875
7.15% senior notes due 2020. At March 31, 2011 and December 31, 2010, there was approximately $4,380 and $4,501 in unamortized discount, respectively			195,620				195,499
		$	605,937			$	605,780

The indentures for our 6.25% senior notes and 7.731% senior subordinated notes contain covenants that require maintenance of certain minimum financial ratios, place limitations on investments we can make and the payment of dividends and redemptions of equity, and limit the incurrence of additional indebtedness, asset dispositions, mergers, certain investments and creations of liens, among other items. As of and for the quarter ended March 31, 2011, we believe we were in compliance with our covenants. The indenture for our 7.15% senior notes contains covenants including, among others, limitations on the amount of secured debt we may incur, and limitations on sale and leaseback transactions and mergers. The covenants contained in the 7.15% senior notes are generally no more restrictive, and in many cases less restrictive, than the covenants contained in the indentures for the 6.25% senior notes and 7.731% senior subordinated notes.

Obligations to pay principal and interest on the senior and senior subordinated notes are guaranteed by all of our wholly-owned subsidiaries (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. We do not provide separate financial statements of the Guarantor Subsidiaries because Meritage (the parent company) has no independent assets or operations, the guarantees are full and unconditional and joint and several, and any subsidiaries of Meritage Homes Corporation other than the non-guarantor subsidiaries are, individually and in the aggregate, minor. There are no significant restrictions on the ability of the Company or any Guarantor Subsidiary to obtain funds from their respective subsidiaries, as applicable, by dividend or loan.

NOTE 5 — FAIR VALUE DISCLOSURES

We account for the non-recurring fair value measurements of our non-financial assets and liabilities in accordance with ASC Subtopic 820-10, Fair Value Measurement and Disclosure. This guidance defines fair value, establishes a framework for measuring fair value and expands 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.

A summary of our long-lived real-estate assets re-measured at fair value on March 31, 2011 and 2010 is as follows (in thousands):

						Fair Value Measurements of Reporting Date Using
		As of March 31, 2011(1)				Level 1				Level 2				Level 3
Description:
Long-lived real-estate assets		$	7,754				0				0			$	7,754

						Fair Value Measurements of Reporting Date Using
		As of March 31, 2010(1)				Level 1				Level 2				Level 3
Description:
Long-lived real-estate assets		$	9,273				0				0			$	9,273

Of the total $757.7 million of long-lived real-estate assets as of March 31, 2011, some of which have previously been written down to fair value, long-lived assets held and used with an initial basis of $8.4 million were impaired and written down to their fair value of $7.8 million during the three months ended March 31, 2011, resulting in an impairment of $664,000, which is included in our condensed consolidated statement of operations for the three months ended March 31, 2011.

During the quarter ended March 31, 2010, long-lived assets held and used with an initial basis of $9.8 million were impaired and written down to their fair value of $9.3 million, resulting in an impairment of $542,000, which is included in our condensed consolidated statement of operations for the three months ended March 31, 2010.

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):

		March 31, 2011								December 31, 2010
		Aggregate				Estimated				Aggregate				Estimated
		Principal				Fair Value				Principal				Fair Value
Financial Liabilities:
6.25% senior notes		$	285,000			$	286,425			$	285,000			$	285,000
7.731% senior subordinated notes		$	125,875			$	116,510			$	125,875			$	114,861
7.15% senior notes		$	200,000			$	200,000			$	200,000			$	198,500

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.

NOTE 6 — (LOSS)/EARNINGS PER SHARE

Basic and diluted (loss)/earnings per common share were calculated as follows (in thousands, except per share amounts):

		Three Months Ended
		March 31,
		2011				2010
Basic weighted average number of shares outstanding			32,260				31,940
Effect of dilutive securities:
Stock options and restricted stock (1)			0				257
Diluted weighted average shares outstanding			32,260				32,197
Net (loss)/income		$	(6,659	)		$	2,660
Basic (loss)/earnings per share		$	(0.21	)		$	0.08
Diluted (loss)/earnings per share (1)		$	(0.21	)		$	0.08
Antidilutive stock options not included in the calculation of diluted earnings per share			1,880				763

NOTE 7 — STOCK-BASED COMPENSATION

We have two stock compensation plans, the Meritage Stock Option Plan, which was adopted in 1997 and amended from time to time (the “1997 Plan”), and the 2006 Stock Incentive Plan that was adopted in 2006 and amended from time to time (the “2006 Plan” and together with the 1997 Plan, the “Plans”). The Plans were approved by our stockholders and are administered by our Board of Directors. The provisions of the Plans are generally consistent with the exception that the 2006 Plan allows for the grant of stock appreciation rights, restricted stock awards, performance share awards and performance-based awards in addition to the non-qualified and incentive stock options allowed under the 1997 Plan.

Compensation cost related to stock-based compensation arrangements granted under the Plans are recognized on a straight-line basis over the remaining respective vesting periods. Below is a summary of compensation expense and stock award activity (dollars in thousands):

		Three Months Ended March 31,
		2011				2010
Stock-based compensation expense		$	1,713			$	1,257
Non-vested shares granted			343,750				300,500
Performance-based non-vested shares granted			56,250				67,500

The expense associated with the performance-based non-vested shares will only be recognized when it is determined to be probable that the target performance thresholds will be met and the shares will vest. We did not grant any stock option awards during the three months ended March 31, 2011 or March 31, 2010. The following table includes additional information regarding our Plans (dollars in thousands):

		As of
		March 31, 2011				December 31, 2010
Unrecognized stock-based compensation cost		$	13,029			$	7,816
Weighted average years remaining vesting period			2.68				2.16
Total equity awards outstanding (vested and unvested)			2,074,401				2,000,518

The Plans authorize awards to officers, key employees, non-employee directors and consultants for up to 7,750,000 shares of common stock, of which 483,545 shares remain available for grant at March 31, 2011. 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. Restricted stock awards are usually granted with either a three-year or five-year ratable vesting period.

NOTE 8 — INCOME TAXES

Components of the income tax provision are (in thousands):

		Three Months Ended
		March 31,
		2011				2010
Federal		$	0			$	(7	)
State			(215	)			(114	)
Total		$	(215	)		$	(121	)

Due to the effects of the deferred tax asset valuation allowance, federal and state tax NOLs, and changes in unrecognized tax benefits, the effective tax rates in 2011 and 2010 are not meaningful percentages as there is no correlation between effective tax rates and the amount of pre-tax income or losses for those periods.

At March 31, 2011 and December 31, 2010, 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 will be sustained on audit and do not anticipate any adjustments that will result in a material change. Interest and penalties are accrued on unrecognized tax benefits and included in federal income tax expense.

In accordance with ASC 740-10, Income Taxes, we evaluate our deferred tax assets, including the benefit from net operating losses (“NOLs”), 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 current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and our experience of utilizing tax credit carryforwards and tax planning alternatives. Given the downturn in the homebuilding industry over the past several years, the degree of the economic recession, the instability and deterioration of the financial markets, and the resulting uncertainty in projections of our future taxable income, we recorded a full valuation allowance against our deferred tax assets during 2008. We continue to maintain a full non-cash valuation allowance against the entire amount of our remaining net deferred tax assets at March 31, 2011 as we have determined that the weight of the negative evidence exceeds that of the positive evidence at this time, and therefore it continues to currently be more likely than not that we will not be able to utilize all of our deferred tax assets relating to our federal and state NOL carryovers.

At March 31, 2011 and December 31, 2010, we had a valuation allowance of against deferred tax assets as follows (in thousands):

		March 31, 2011				December 31, 2010
Federal		$	65,579			$	63,409
State			26,282				26,591
Total Valuation Allowance		$	91,861			$	90,000

Our future deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws. Federal net operating loss carryforwards may be used to offset future taxable income for 20 years and expire in 2030. State net operating loss carryforwards may be used to offset future taxable income for a period of time ranging from 5 to 20 years, depending on the state, and begin to expire in 2012. Deferred tax assets include tax-effected federal and state net operating loss carryforwards. On an ongoing basis, we will continue to review all available evidence to determine if and when we expect to realize our deferred tax assets and NOL carryovers.

At March 31, 2011, the income tax payable of $2.8 million 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 a prior-year federal tax return. The federal loss carryback period reverted back to two years for our 2011 fiscal year and there is no available taxable income in the two-year carryback period for us to utilize any tax loss coming out of 2011.

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 2006. There are no ongoing federal or state income tax audits at this time.

The tax benefits from the Company’s net operating losses, built-in losses, and tax credits would be materially reduced or potentially eliminated if the Company experienced an “ownership change” as defined under IRC §382. Based on the Company’s analysis performed as of March 31, 2011, the Company does not believe that it has 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 helps us avoid an unintended ownership change and thereby preserve the value of our tax benefits for future utilization.

NOTE 9 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The following presents certain supplemental cash flow information (in thousands):

		Three Months Ended
		March 31,
		2011				2010
Cash paid during the period for:
Interest, net of interest capitalized		$	8,153			$	11,225
Income taxes		$	2				0
Non-cash operating activities:
Real estate not owned		$	(866	)		$	(1,062	)
Non-cash investing activities:
Distributions from unconsolidated entities		$	0			$	1,340

NOTE 10 — OPERATING AND REPORTING SEGMENTS

As defined in ASC Subtopic 280-10, Segment Reporting, we have six operating segments (the six states in which we operate). 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 operating segments into a reporting segment based on similar long-term economic characteristics and geographical proximity. Our reporting segments are as follows:

West:		California and Nevada
Central:		Texas, Arizona and Colorado
East:		Florida

Management’s evaluation of segment performance is based on segment operating income/(loss), which we define as homebuilding and land revenue 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 Note 1, “Organization and Basis of Presentation,” to the consolidated financial statements in our 2010 Annual Report on Form 10-K. Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity. The following is our segment information (in thousands):

		Three Months Ended
		March 31,
		2011				2010
Revenue (1):
West		$	24,150			$	41,404
Central			132,506				145,154
East			20,933				15,246
Consolidated total			177,589				201,804
Operating income/(loss) (2):
West			(984	)			2,941
Central			4,226				7,086
East			2,237				1,308
Segment operating earnings			5,479				11,335
Corporate and unallocated (3)			(5,531	)			(4,994	)
Earnings from unconsolidated entities, net			908				803
Interest expense			(8,023	)			(8,295	)
Other income, net			723				3,932
(Loss)/income before income taxes		$	(6,444	)		$	2,781

		At March 31, 2011
														Corporate and
		West				Central				East				Unallocated (1)				Total
Deposits on real estate under option or contract		$	50			$	9,594			$	744			$	0			$	10,388
Real estate			196,871				507,376				53,406				0				757,653
Investments in unconsolidated entities			180				10,370				37				313				10,900
Other assets			6,499				35,197				6,922				391,375				439,993
Total assets		$	203,600			$	562,537			$	61,109			$	391,688			$	1,218,934

		At December 31, 2010
														Corporate and
		West				Central				East				Unallocated (1)				Total
Deposits on real estate under option or contract		$	50			$	9,754			$	555			$	0			$	10,359
Real estate			191,882				499,176				47,870				0				738,928
Investments in unconsolidated entities			110				10,507				29				341				10,987
Other assets			3,501				32,961				7,873				420,329				464,664
Total assets		$	195,543			$	552,398			$	56,327			$	420,670			$	1,224,938

NOTE 11 — COMMITMENTS AND CONTINGENCIES

We are involved in various routine legal proceedings incidental to our business, some of which are covered by insurance. With respect to the majority of pending litigation matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and, in most cases, any potential losses related to those matters are not considered probable. We have reserved approximately $11.2 million for losses related to litigation and asserted claims where our ultimate exposure is considered probable and the potential loss can be reasonably estimated, which is classified within accrued liabilities, “other” accruals, on our March 31, 2011 balance sheet as discussed in Note 1 to these financial statements. Additionally, we have $27.2 million of warranty reserves, primarily relating to the correction of home construction defects, foundation issues and general customer claims. Historically, most of these matters are resolved prior to litigation. We believe that none of these matters will have a material adverse impact upon our consolidated financial condition, results of operations, or cash flows.

Joint Venture Litigation

We, along with our joint venture partners (and their respective parent companies) in an unconsolidated joint venture, are defendants in lawsuits initiated by the lender group regarding a large Nevada-based land acquisition and development joint venture in which the lenders are seeking damages on the basis of enforcement of completion guarantees and other related claims (JP Morgan Chase Bank, N.A. v. KB HOME Nevada, et al., U.S. District Court, District of Nevada (Case No. 08-CV-01711 PMP)). While our interest in this joint venture is comparatively small, totaling 3.53%, we are vigorously defending and otherwise seeking resolution of these actions. Meritage is the only builder joint venture partner to have fully performed its obligations with respect to takedowns of lots from the joint venture, having completed its first takedown in April 2007 and having tendered full performance of its second and final takedown in April 2008. The joint venture and the lender group rejected Meritage’s tender of performance and of its second and final takedown, and Meritage contends, among other things, that the rejection by the joint venture and the lender group of Meritage’s tender of full performance was wrongful and should release Meritage of liability with respect to the takedown and all guarantees. We have fully impaired our investment in this joint venture in a prior period.

In one of the ongoing lawsuits related to this venture, all members of the joint venture participated in an arbitration regarding their respective performance obligations in response to one of the members’ claims (the “Focus Lawsuit”). On July 6, 2010, the arbitration decision was issued, which denied the specific performance claim, but did award approximately $37 million of damages to one member on other claims. The parties involved have jointly appealed the arbitration panel’s decision (Meritage has also appealed on independent grounds) to the United States Courts of Appeal for the Ninth Circuit, Focus South Group, LLC, et al. v. KB HOME Nevada Inc, et al., (Case No. 10-17562), and the case is pending. We believe our potential share of the award, if any, will not be material to our financial position. Our existing legal reserves cover the expected claim.

Additionally, certain lenders in the lender group filed a Chapter 11 involuntary bankruptcy petition against the joint venture in the United States Bankruptcy Court, District of Nevada, (JP Morgan Chase Bank, N.A. v. South Edge, LLC (Case No. 10-32968-bam)). On February 3, 2011, the Bankruptcy Court entered an order for relief and appointed a trustee to manage the ongoing operations of the venture. It is anticipated that the lender group may try to use the bankruptcy filing as a means to trigger springing repayment guarantees of the members. Meritage will vigorously contest any such action and demand. While all members believe they have potential offsets and defenses to prevent or minimize enforcement of the springing repayment guarantees, Meritage has additional defenses (that are not available to the other members) because it is the only member that tendered full performance to the lender group and believes this fact will operate to prevent enforcement of the springing repayment guarantee against Meritage. The initial balance of the loan with the springing guarantees was $585 million and as of March 31, 2011, the outstanding principal balance was approximately $328 million, of which our potential maximum pro rata exposure would be $11.6 million. While, for the reasons noted above, we do not believe that a full repayment of this obligation is probable, we have recorded a legal reserve in an amount we believe represents the most probable exposure for legal and settlement costs. This reserve is in addition to a reserve we have established for our estimated share of legal and settlement costs relating to the Focus Lawsuit. Although the final disposition of these suits and related actions, claims and demands remains uncertain, we do not, at this time, anticipate outcomes that will have a material impact on our financial position or results of operations.

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

Overview and Outlook

During the first quarter of 2011, the spring selling season produced weaker sales results than was generally anticipated. Homebuilders continue to be negatively impacted by a slow sales pace after the expiration of the federal home-buyer tax credit program in April 2010. Although some economic indicators have started to improve, such as the oversupply of inventory homes — while still inflated — dropped to less than half of 2010 levels, and unemployment rates decreasing, we believe that until unemployment rates and inventory levels further decline and the pace of foreclosures decreases significantly, consumer confidence and housing demand will not improve substantially. We have had some indications that the homebuilding cycle may have reached a bottom and certain of our markets are experiencing positive operational results, but we do not know when or at what pace the national recovery will gain momentum.

Summary Company Results

As noted above, our results for the quarter ended March 31, 2011 reflect the challenging sales environment the homebuilding industry has experienced after the homebuyer tax credit expiration in the second quarter of 2010. Additionally, the uneven economic environment, weak consumer demand, and low December 2010 backlog contributed to the decline in our operational results for the first three months of 2011 as compared to the results of the same period a year ago. While we experienced decreases in our year-over-year results, we did recognize sequential increases in sales, sales pace and backlog from the fourth quarter of 2010 to the first quarter of 2011, partially due to the seasonal increases in sales traditionally experienced during the first half of the year.

Total home closing revenue was $177.5 million for the three months ended March 31, 2011, decreasing 11.5% from the same period last year, as our low beginning backlog numbers translated into fewer closings in the first three months of the year. We reported net loss of $6.7 million for the three-month period ended March 31, 2011 as compared to net income of $2.7 million for the same period in 2010. Our 2010 income was almost fully attributed to the benefit of a $2.4 million gain from a legal settlement.

At March 31, 2011, our backlog of $244.9 million reflects a decrease of 31.1% or $110.5 million when compared to the backlog at March 31, 2010. The 2010 backlog numbers benefitted from elevated sales as a result of the federal homebuyer tax credit program. Sales have been slow to regain strength; however, the 840 sales units in the first three months of 2011 is our highest quarter of sales since the expiration of the tax credit program. In the first quarter of 2011, our cancellation rate on sales orders remained relatively flat at 17% of gross orders as compared to 18% in the same period a year ago.

Company Actions and Positioning

Throughout this continued difficult homebuilding market, we have remained focused on our main goals: return to and maintain profitability, and strengthen our balance sheet. In order to meet these goals, over the past several years we began and continue to execute on the following initiatives:

•

Redesigning product offering to reduce costs and sales prices, tailoring our product to meet today’s buyers’ affordability demands;

•

Continue to innovate and incorporate the Meritage Green energy efficiency program, where every new home we construct, at a minimum, meets ENERGY STAR® standards, including the construction of our first net-zero production home, designed to produce as much energy as it uses annually;

•

Changing sales and marketing efforts to generate additional traffic and compete with resale homes;

•

Renegotiating construction costs with our subcontractors where possible;

•

Exercising tight control over cash flows;

•

Managing our total lot supply and future growth of active communities by actively contracting new well-priced lots in strategic submarkets;

•

Monitoring our customer satisfaction scores and working toward improving them based on the results of the surveys;

•

Executing our company-wide operating strategy, Meritage Forward, and the roll-out of associated initiatives such as the Simply Smart SeriesTM and 99-day closing guarantee; and

•

Continuing to consolidate overhead functions at all of our divisions and corporate offices to hold down general and administrative cost burden.

Additionally, we are evaluating opportunities for expansion into new markets that have been less impacted by the homebuilding downturn over the past several years. We are looking to redeploy our capital into projects that present better opportunities to produce higher margins, both within our geographic footprint and through entry into new markets. As a result, in April 2011 we announced our entry into the Raleigh-Durham, North Carolina market.

Despite the progress we have made with these initiatives, we recorded a net loss for the three months ended March 31, 2011. The net loss is reflective of the lower volume of homes delivered, due primarily to our lower starting backlog and the continued weakness of the homebuilding market. We continue to believe that many of our communities, particularly our newer acquisitions, are located in highly-sought after markets that compete well in the marketplace. In these locations, we believe the value and desirability of the community and our product differentiation strategies will allow us to maintain our pricing and improve absorptions, lessening the impact of the current economic conditions. In the first quarter of 2011, we opened 13 new communities while closing out 23 older communities, ending the quarter with 141 active communities. Based on the volume of new communities in our pipeline, we expect to reach at least 150 actively selling communities by June 30, 2011. We continue to believe in the long-term viability of the domestic homebuilding market and that builders with in-depth industry expertise and successful business and operational strategies will benefit when the housing market recovers.

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, valuation of deferred tax assets and share-based payments. There have been no significant changes to our critical accounting policies during the three months ended March 31, 2011 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2010 Annual Report on Form 10-K.

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 March 31,								Quarter over Quarter
		2011				2010				Chg $				Chg %
Total
Dollars		$	177,489			$	200,582			$	(23,093	)			(11.5	)%
Homes closed			678				808				(130	)			(16.1	)%
Avg sales price		$	261.8			$	248.2			$	13.6				5.5	%
West Region
California
Dollars		$	21,171			$	37,085			$	(15,914	)			(42.9	)%
Homes closed			62				105				(43	)			(41.0	)%
Avg sales price		$	341.5			$	353.2			$	(11.7	)			(3.3	)%
Nevada
Dollars		$	2,979			$	4,319			$	(1,340	)			(31.0	)%
Homes closed			15				22				(7	)			(31.8	)%
Avg sales price		$	198.6			$	196.3			$	2.3				1.2	%
West Region Totals
Dollars		$	24,150			$	41,404			$	(17,254	)			(41.7	)%
Homes closed			77				127				(50	)			(39.4	)%
Avg sales price		$	313.6			$	326.0			$	(12.4	)			(3.8	)%
Central Region
Arizona
Dollars		$	31,967			$	33,952			$	(1,985	)			(5.8	)%
Homes closed			127				168				(41	)			(24.4	)%
Avg sales price		$	251.7			$	202.1			$	49.6				24.5	%
Texas
Dollars		$	84,810			$	101,359			$	(16,549	)			(16.3	)%
Homes closed			354				428				(74	)			(17.3	)%
Avg sales price		$	239.6			$	236.8			$	2.8				1.2	%
Colorado
Dollars		$	15,629			$	8,621			$	7,008				81.3	%
Homes closed			49				30				19				63.3	%
Avg sales price		$	319.0			$	287.4			$	31.6				11.0	%
Central Region Totals
Dollars		$	132,406			$	143,932			$	(11,526	)			(8.0	)%
Homes closed			530				626				(96	)			(15.3	)%
Avg sales price		$	249.8			$	229.9			$	19.9				8.7	%
East Region
Florida
Dollars		$	20,933			$	15,246			$	5,687				37.3	%
Homes closed			71				55				16				29.1	%
Avg sales price		$	294.8			$	277.2			$	17.6				6.3	%

Home Orders (1)

		Three Months Ended March 31,								Quarter over Quarter
		2011				2010				Chg $				Chg %
Total
Dollars		$	220,612			$	268,468			$	(47,856	)			(17.8	)%
Homes ordered			840				1,064				(224	)			(21.1	)%
Avg sales price		$	262.6			$	252.3			$	10.3				4.1	%
West Region
California
Dollars		$	27,149			$	41,129			$	(13,980	)			(34.0	)%
Homes ordered			78				115				(37	)			(32.2	)%
Avg sales price		$	348.1			$	357.6			$	(9.5	)			(2.7	)%
Nevada
Dollars		$	4,022			$	4,745			$	(723	)			(15.2	)%
Homes ordered			19				25				(6	)			(24.0	)%
Avg sales price		$	211.7			$	189.8			$	21.9				11.5	%
West Region Totals
Dollars		$	31,171			$	45,874			$	(14,703	)			(32.1	)%
Homes ordered			97				140				(43	)			(30.7	)%
Avg sales price		$	321.4			$	327.7			$	(6.3	)			(1.9	)%
Central Region
Arizona
Dollars		$	34,342			$	48,008			$	(13,666	)			(28.5	)%
Homes ordered			149				233				(84	)			(36.1	)%
Avg sales price		$	230.5			$	206.0			$	24.5				11.9	%
Texas
Dollars		$	109,681			$	139,908			$	(30,227	)			(21.6	)%
Homes ordered			446				573				(127	)			(22.2	)%
Avg sales price		$	245.9			$	244.2			$	1.7				0.7	%
Colorado
Dollars		$	22,182			$	12,543			$	9,639				76.8	%
Homes ordered			71				41				30				73.2	%
Avg sales price		$	312.4			$	305.9			$	6.5				2.1	%
Central Region Totals
Dollars		$	166,205			$	200,459			$	(34,254	)			(17.1	)%
Homes ordered			666				847				(181	)			(21.4	)%
Avg sales price		$	249.6			$	236.7			$	12.9				5.4	%
East Region
Florida
Dollars		$	23,236			$	22,135			$	1,101				5.0	%
Homes ordered			77				77				0				0.0	%
Avg sales price		$	301.8			$	287.5			$	14.3				5.0	%