================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 1-9977 MERITAGE CORPORATION (Exact Name of Registrant as Specified in its Charter) MARYLAND 86-0611231 (State of Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 6613 NORTH SCOTTSDALE ROAD, SUITE 200 SCOTTSDALE, ARIZONA 85250 (Address of Principal Executive Offices) (Zip Code) (480) 998-8700 (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 [X] NO [ ] AS OF NOVEMBER 10, 2001, 5,412,006 SHARES OF MERITAGE CORPORATION COMMON STOCK WERE OUTSTANDING. ================================================================================ MERITAGE CORPORATION FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2001 TABLE OF CONTENTS PAGE NO. -------- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS: Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000 ......................... 3 Consolidated Statements of Earnings for the Three and Nine Months ended September 30, 2001 and 2000 (unaudited) ............................................... 4 Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2001 and 2000 (unaudited) ...... 5 Notes to Consolidated Financial Statements ................ 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ....................... 12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ............................................... 16 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K .......................... 17 SIGNATURES ............................................................ S-1 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MERITAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31, 2001 2000 --------- --------- (UNAUDITED) ASSETS Cash and cash equivalents $ 1,456 $ 4,397 Real estate under development 346,277 211,307 Deposits on real estate under option or contract 40,635 24,251 Receivables 4,377 2,179 Deferred tax asset 1,961 543 Goodwill 29,355 17,675 Property and equipment, net 8,949 4,717 Other assets 7,178 2,006 --------- --------- Total Assets $ 440,188 $ 267,075 ========= ========= LIABILITIES Accounts payable and accrued liabilities $ 78,119 $ 48,907 Home sale deposits 15,929 10,917 Notes payable 186,082 86,152 --------- --------- Total Liabilities 280,130 145,976 --------- --------- STOCKHOLDERS' EQUITY Common stock, par value $0.01. Authorized 50,000,000 shares; issued and outstanding 6,208,969 shares at September 30, 2001 and 5,922,822 shares at December 31, 2000 62 59 Additional paid-in capital 106,919 102,526 Retained earnings 64,300 29,530 Treasury stock at cost; 818,963 shares at September 30, 2001 and 811,963 at December 31, 2000 (11,223) (11,016) --------- --------- Total Stockholders' Equity 160,058 121,099 --------- --------- Total Liabilities and Stockholders' Equity $ 440,188 $ 267,075 ========= =========
See accompanying notes to consolidated financial statements. 3 MERITAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 2001 2000 2001 2000 --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Home sales revenue $ 207,177 $ 134,464 $ 497,693 $ 346,919 Land sales revenue -- 1,412 1,598 4,115 --------- --------- --------- --------- 207,177 135,876 499,291 351,034 --------- --------- --------- --------- Cost of home sales (161,468) (105,629) (390,876) (277,111) Cost of land sales -- (1,264) (1,474) (3,648) --------- --------- --------- --------- (161,468) (106,893) (392,350) (280,759) --------- --------- --------- --------- Home sales gross profit 45,709 28,835 106,817 69,808 Land sales gross profit -- 148 124 467 --------- --------- --------- --------- 45,709 28,983 106,941 70,275 Commissions and other sales costs (10,954) (7,291) (27,402) (19,528) General and administrative costs (11,433) (5,364) (24,251) (14,213) Interest expense -- (1) (1) (6) Other income, net 669 319 2,030 1,274 --------- --------- --------- --------- Earnings before income taxes and extraordinary items 23,991 16,646 57,317 37,802 Income taxes (9,316) (6,137) (22,314) (13,949) --------- --------- --------- --------- Earnings before extraordinary items 14,675 10,509 35,003 23,853 Extraordinary items, net of tax effects 212 -- (233) -- --------- --------- --------- --------- Net earnings $ 14,887 $ 10,509 $ 34,770 $ 23,853 ========= ========= ========= ========= Earnings per share: Basic: Earnings before extraordinary items $ 2.73 $ 2.06 $ 6.64 $ 4.57 Extraordinary items, net of tax effects 0.04 -- (0.04) -- --------- --------- --------- --------- Net earnings per share $ 2.77 $ 2.06 $ 6.60 $ 4.57 ========= ========= ========= ========= Diluted: Earnings before extraordinary items $ 2.46 $ 1.85 $ 6.02 $ 4.15 Extraordinary items, net of tax effects 0.04 -- (0.04) -- --------- --------- --------- --------- Net earnings per share $ 2.50 $ 1.85 $ 5.98 $ 4.15 ========= ========= ========= =========
See accompanying notes to consolidated financial statements. 4 MERITAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2001 2000 --------- --------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 34,770 $ 23,853 Adjustments to reconcile net earnings to net cash used in operating activities: Depreciation and amortization 3,747 2,320 (Increase) decrease in deferred tax asset before extraordinary item (1,418) 28 Stock option compensation expense -- 73 Tax benefit from stock option exercise 2,376 -- Change in assets and liabilities, net of effect of acquisition in 2001: Increase in real estate under development (80,425) (51,452) Increase in deposits on real estate under option or contract (7,485) (3,394) Increase in receivables and other assets (8,316) (350) Increase in accounts payable and accrued liabilities 22,322 7,455 Increase in home sale deposits 2,509 4,300 --------- --------- Net cash used in operating activities (31,920) (17,167) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash paid for acquisition (65,759) (5,158) Purchases of property and equipment (5,115) (2,206) --------- --------- Net cash used in investing activities (70,874) (7,364) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings 551,809 318,723 Repayments of debt (453,769) (298,093) Repurchase of stock (207) (8,507) Proceeds from exercises of stock options 2,020 564 --------- --------- Net cash provided by financing activities 99,853 12,687 --------- --------- Net decrease in cash and cash equivalents (2,941) (11,844) Cash and cash equivalents at beginning of period 4,397 13,422 --------- --------- Cash and cash equivalents at end of period $ 1,456 $ 1,578 ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: The acquisition of Hancock Communities resulted in the following changes in assets and liabilities: Real estate under development $ (54,545) Deposits on real estate under option or contract (8,899) Receivables and other assets (543) Accounts payable and accrued liabilities 6,890 Home sale deposits 2,503 Goodwill (11,423) Property and equipment (1,632) Borrowings 1,890 --------- Net cash paid for acquisition $ (65,759) =========
See accompanying notes to consolidated financial statements. 5 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION We develop, construct and sell new high-quality, single-family homes in the semi-custom luxury, move-up and entry-level markets. We operate in the Dallas/Fort Worth, Austin and Houston, Texas markets as Legacy Homes, in the Phoenix/Scottsdale and Tucson, Arizona markets as Monterey Homes, Hancock Communities and Meritage Homes, and in the East San Francisco Bay and Sacramento, California markets as Meritage Homes. BASIS OF PRESENTATION. The consolidated financial statements include the accounts of Meritage Corporation and its subsidiaries. Intercompany balances and transactions have been eliminated in consolidation and certain prior period amounts have been reclassified to be consistent with current financial statement presentation. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present our financial position, results of operations and cash flows for the periods presented. The results of operations for any interim period are not necessarily indicative of results to be expected for a full fiscal year. NOTE 2 - REAL ESTATE UNDER DEVELOPMENT AND CAPITALIZED INTEREST The components of real estate under development are (in thousands): SEPTEMBER 30, 2001 DECEMBER 31, 2000 ------------------ ----------------- Homes under contract, in production $159,589 $ 92,881 Finished home sites 84,014 60,630 Home sites under development 55,999 27,636 Model homes and homes held for resale 43,626 26,937 Land held for development 3,049 3,223 -------- -------- $346,277 $211,307 ======== ======== We capitalize certain interest costs incurred during development and construction. Capitalized interest is allocated to real estate under development and charged to cost of sales when the property is delivered to the buyer. A summary of interest capitalized and interest expensed follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Beginning unamortized capitalized interest $ 7,248 $ 4,911 $ 5,426 $ 3,971 Interest capitalized 5,430 2,975 11,868 7,617 Amortized to cost of home and land sales (3,576) (2,203) (8,192) (5,905) -------- -------- -------- -------- Ending unamortized capitalized interest $ 9,102 $ 5,683 $ 9,102 $ 5,683 ======== ======== ======== ======== Interest incurred $ 5,430 $ 2,976 $ 11,869 $ 7,623 Interest capitalized (5,430) (2,975) (11,868) (7,617) -------- -------- -------- -------- Interest expensed $ -- $ 1 $ 1 $ 6 ======== ======== ======== ========
6 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 3 - NOTES PAYABLE Notes payable consists of:
SEPTEMBER 30, DECEMBER 31, 2001 2000 -------- -------- (IN THOUSANDS) $100 million bank revolving construction line of credit, interest payable monthly approximating prime (6.0% at September 30, 2001) or LIBOR (rates varying from 2.57% to 2.66% at September 30, 2001) plus 2.0%, payable at the earlier of close of escrow, maturity date of individual homes and lots within the collateral pool or over a 24-month period beginning June 1, 2003, secured by first deeds of trust on real estate $ 9,880 $ 50,354 $75 million bank revolving construction line of credit, interest payable monthly approximating prime or LIBOR plus 2.0%, payable at the earlier of close of escrow, maturity date of individual homes and lots within the line or May 31, 2002, secured by first deeds of trust on real estate 14,998 17,269 Acquisition and development seller carry back financing, interest payable monthly at fixed rates of 9% and 10% per annum; payable at the maturity date of the individual projects, secured by first deeds of trust on land 6,204 3,516 Senior unsecured notes, maturing June 1, 2011, annual interest of 9.75% payable semi-annually 155,000 -- Senior unsecured notes, paid in full May 30, 2001 -- 15,000 Other -- 13 -------- -------- Total $186,082 $ 86,152 ======== ========
7 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 4 - EARNINGS PER SHARE Basic and diluted earnings per share were calculated as follows (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------- ---------------------- 2001 2000 2001 2000 -------- -------- -------- -------- BASIC: Earnings before extraordinary items $ 14,675 $ 10,509 $ 35,003 $ 23,853 Extraordinary items, net of tax effects 212 -- (233) -- -------- -------- -------- -------- Net earnings $ 14,887 $ 10,509 $ 34,770 $ 23,853 ======== ======== ======== ======== Weighted average number of shares outstanding 5,367 5,097 5,264 5,224 -------- -------- -------- -------- Basic earnings per share before extraordinary items $ 2.73 $ 2.06 $ 6.64 $ 4.57 Extraordinary items .04 -- (.04) -- -------- -------- -------- -------- Basic earnings per share $ 2.77 $ 2.06 $ 6.60 $ 4.57 ======== ======== ======== ======== DILUTED: Earnings before extraordinary items $ 14,675 $ 10,509 $ 35,003 $ 23,853 Extraordinary items, net of tax effects 212 -- (233) -- -------- -------- -------- -------- Net earnings $ 14,887 $ 10,509 $ 34,770 $ 23,853 ======== ======== ======== ======== Weighted average number of shares outstanding 5,367 5,097 5,264 5,224 Effect of dilutive securities: Contingent shares and warrants -- -- -- 25 Options to acquire common stock 596 582 546 496 -------- -------- -------- -------- Diluted weighted common shares outstanding 5,963 5,679 5,810 5,745 -------- -------- -------- -------- Diluted earnings per share before extraordinary items $ 2.46 $ 1.85 $ 6.02 $ 4.15 Extraordinary items 0.04 -- (0.04) -- -------- -------- -------- -------- Diluted earnings per share $ 2.50 $ 1.85 $ 5.98 $ 4.15 ======== ======== ======== ======== Antidilutive stock options not included in diluted EPS -- 102 -- 265 ======== ======== ======== ========
NOTE 5 - EXTRAORDINARY ITEMS During the quarter ended September 30, 2001 we recognized an extraordinary gain of $212,000, net of related income tax effect of $136,000. This gain resulted from the purchase and retirement of $10 million in principal of our 9.75% senior notes due June 1, 2011, which we bought back at 93.25. The nine months ended September 30, 2001, includes as an extraordinary item a $446,000 loss, net of a $285,000 tax benefit, due to the early extinguishment of $15 million of senior unsecured debt in May 2001. 8 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 6 - INCOME TAXES Total income tax expense for the three and nine months ended September 30, 2001 was allocated as follows (in thousands): THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2001 SEPTEMBER 30, 2001 ------------------ ------------------ Income from continuing operations $ 9,316 $ 22,314 Extraordinary items 136 (149) ------- -------- $ 9,452 $ 22,165 ======= ======== Income tax expense attributable to income from continuing operations consists of (in thousands): THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Current: Federal $ 8,743 $ 5,263 $ 20,162 $ 12,202 State 1,933 710 3,571 1,719 -------- -------- -------- -------- 10,676 5,973 23,733 13,921 -------- -------- -------- -------- Deferred: Federal (1,178) 147 (1,212) 25 State (182) 17 (207) 3 -------- -------- -------- -------- (1,360) 164 (1,419) 28 -------- -------- -------- -------- Total $ 9,316 $ 6,137 $ 22,314 $ 13,949 ======== ======== ======== ======== NOTE 7 - SEGMENT INFORMATION We classify our operations into three primary geographic segments: Texas, Arizona and California. These segments generate revenue through the sale of homes to external customers. We are not dependent on any one major customer. Operational information relating to the different business segments follows. Certain information has not been included by segment due to the immateriality of the amount to the segment or in total. We evaluate segment performance based on several factors, of which the primary financial measure is earnings before interest and taxes (EBIT). The accounting policies of the business segments are the same as those described in Notes 1 and 2. There are no significant transactions between segments. 9 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 7 - SEGMENT INFORMATION (CONT.)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 2001 2000 2001 2000 --------- --------- --------- --------- (IN THOUSANDS) HOME SALES REVENUE: Texas $ 62,306 $ 58,932 $ 185,264 $ 160,643 Arizona 100,794 45,168 201,154 99,367 California 44,077 30,364 111,275 86,909 --------- --------- --------- --------- Total $ 207,177 $ 134,464 $ 497,693 $ 346,919 ========= ========= ========= ========= EBIT: Texas $ 10,892 $ 10,449 $ 31,954 $ 26,228 Arizona 10,063 4,862 19,487 8,619 California 8,098 5,033 17,392 12,975 Corporate and other (1,486) (1,493) (3,323) (4,109) --------- --------- --------- --------- Total $ 27,567 $ 18,851 $ 65,510 $ 43,713 ========= ========= ========= ========= AMORTIZATION OF CAPITALIZED INTEREST: Texas $ 625 $ 585 $ 1,772 $ 1,876 Arizona 2,001 1,213 4,417 2,724 California 950 405 2,003 1,305 --------- --------- --------- --------- Total $ 3,576 $ 2,203 $ 8,192 $ 5,905 ========= ========= ========= ========= AT AT SEPTEMBER 30, DECEMBER 31, 2001 2000 -------- -------- (IN THOUSANDS) ASSETS: Texas $140,077 $108,238 Arizona 217,497 102,746 California 80,722 53,723 Corporate 1,892 2,368 -------- -------- Total $440,188 $267,075 ======== ========
NOTE 8 - HANCOCK ACQUISITION On May 30, 2001, we acquired substantially all of the homebuilding and related assets of HC Builders, Inc. and Hancock Communities, L.L.C. (collectively "Hancock"). The purchase price was $65.8 million in cash, plus the assumption of trade payables, accrued liabilities and customer deposit liabilities totaling $9.4 million and a note totaling $1.9 million. In addition, we granted to Greg Hancock, the founder of Hancock Communities, an earn-out, payable over three years, equal to 20% of Hancock's pre-tax net income after a 10.5% charge on capital. Hancock designs, builds and markets a wide range of high-quality homes in the Phoenix, Arizona area with a focus on serving the entry-level and move-up single-family housing markets and is currently developing affordable age-restricted adult communities. During 2000, Hancock closed 1,143 homes at an average selling price of $160,700, resulting in total revenues of $183.7 million and EBITDA of $16.9 million. 10 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) This acquisition was accounted for using the purchase method of accounting. Accordingly, the Company recorded goodwill of approximately $11.4 million, which represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired and liabilities assumed. Such amount is being amortized over a period of 20 years. The following unaudited pro forma financial data for the three and nine months ended September 30, 2001 and 2000 has been prepared as if the acquisition of the assets and liabilities of Hancock on May 30, 2001 had occurred on January 1, 2000. Unaudited pro forma financial data is presented for informational purposes only and is based on historical information. This information may not be indicative of the actual amounts of the Company had the events occurred on the date listed above, nor does it purport to represent future periods (in thousands except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------- --------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Revenue $207,177 $194,294 $552,001 $486,925 Earnings before extraordinary items 14,675 12,671 40,728 28,311 Net earnings 14,887 12,671 40,940 27,865 Diluted EPS before extraordinary items 2.46 2.23 7.01 4.93 Diluted EPS after extraordinary items 2.50 2.23 7.05 4.85
NOTE 9 - NEW ACCOUNTING PRONOUNCEMENTS On October 3, 2001, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While Statement No. 144 supersedes FASB Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, it retains many of the fundamental provisions of that Statement. Statement No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS--REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS, for the disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a COMPONENT OF AN ENTITY that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. By broadening the presentation of discontinued operations to include more disposal transactions, the FASB has enhanced managements' ability to provide information that helps financial statement users to assess the effects of a disposal transaction on the ongoing operations of an entity. Statement No. 144 is effective for fiscal years beginning after December 15, 2001. At the current time, management believes that the adoption of this statement on January 1, 2002 will not have a material impact on our financial position. 11 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) In July 2001, the FASB issued Statement No. 141, BUSINESS COMBINATIONS, and Statement No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. The Company is required to adopt the provisions of Statement 141 immediately, except with regard to business combinations initiated prior to July 1, 2001, and Statement 142 effective January 1, 2002. Furthermore, any goodwill and any intangible assets determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment, in accordance with the appropriate pre-Statement 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until the adoption of Statement 142. Statement 141 will require, upon adoption of Statement 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. As of September 30, 2001, the Company had unamortized goodwill in the amount of approximately $29.4 million, which will be subject to the transition provisions of Statement 142. Amortization expense related to goodwill was $1,004,000 and $1,067,000 for the nine months ended September 30, 2001 and for the year ended December 31, 2000, respectively. The Company has not determined the impact of the immediate adoption of Statement 141 or the adoption of Statement 142 on January 1, 2002. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward-looking statements. The words "believe," "expect," "anticipate," and "project" and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. Such statements include the expected benefits of the Hancock acquisition, including future closings and Hancock's contribution to our revenue and earnings, projections of revenue, income or loss, capital expenditures, backlog, plans for future operations, financing needs or plans and liquidity, and plans relating to our housing products or services, as well as assumptions relating to the foregoing. Our past performance or past or present economic conditions in our housing markets may not be indicative of future performance and conditions. 12 Actual results may differ materially from those expressed in forward-looking statements. Risks identified in Exhibit 99 to this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2000, including under the captions "Business", "Market for the Registrant's Common Stock and Related Stockholder Matters", in the Notes to the Consolidated Financial Statements and in "Management's Discussion and Analysis of Financial Condition and Results of Operations, Factors That May Affect Our Future Results and Financial Condition," and "Special Note of Caution Regarding Forward-Looking Statements" describe factors, among others, that could contribute to or cause such differences. These factors may also affect our business generally. Additional factors that could cause actual results to differ materially from those expressed in such forward-looking statements and that could affect our business generally, are described in our Form S-4 filed with the SEC on July 18, 2001. As a result of these factors, the Company's stock and bond prices may fluctuate dramatically. RESULTS OF OPERATIONS The following discussion and analysis provides information regarding our results of operations for the three and nine month periods ended September 30, 2001 and 2000. All material balances and transactions between us and our subsidiaries have been eliminated in consolidation. In management's opinion, the data reflects all adjustments, consisting of only normal recurring adjustments, necessary to fairly present our financial position and results of operations for the periods presented in accordance with accounting principles generally accepted in the United States of America. The results of operations for any interim period are not necessarily indicative of results expected for a full fiscal year. HOME SALES REVENUE, SALES CONTRACTS AND NET SALES BACKLOG The data provided below shows operating and financial data regarding our homebuilding activities (dollars in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, PERCENTAGE SEPTEMBER 30, PERCENTAGE ------------------------ INCREASE ----------------------- INCREASE HOME SALES REVENUE 2001 2000 (DECREASE) 2001 2000 (DECREASE) --------- --------- ---------- --------- --------- ---------- TOTAL Dollars $ 207,177 $ 134,464 54% $ 497,693 $ 346,919 43% Homes closed 938 588 60% 2,227 1,553 43% Average sales price $ 220.9 $ 228.7 (3)% $ 223.5 $ 223.4 * TEXAS Dollars $ 62,306 $ 58,932 6% $ 185,263 $ 160,643 15% Homes closed 357 334 7% 1,077 939 15% Average sales price $ 174.5 $ 176.4 (1)% $ 172.0 $ 171.1 * ARIZONA Dollars $ 100,794 $ 45,168 123% $ 201,155 $ 99,367 102% Homes closed 469 165 184% 863 361 139% Average sales price $ 214.9 $ 273.7 (22)% $ 233.1 $ 275.3 (15)% CALIFORNIA Dollars $ 44,077 $ 30,364 45% $ 111,275 $ 86,909 28% Homes closed 112 89 26% 287 253 13% Average sales price $ 393.5 $ 341.2 15% $ 387.7 $ 343.5 13%
- ---------- * Less than one percent 13
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, PERCENTAGE SEPTEMBER 30, PERCENTAGE ------------------------ INCREASE ----------------------- INCREASE SALES CONTRACTS 2001 2000 (DECREASE) 2001 2000 (DECREASE) --------- --------- ---------- --------- --------- ---------- TOTAL Dollars $ 161,486 $173,930 (7)% $ 513,237 $ 470,601 9% Homes ordered 723 731 (1)% 2,220 1,950 14% Average sales price $ 223.4 $ 237.9 (6)% $ 231.2 $ 241.3 (4)% TEXAS Dollars $ 50,409 $ 71,684 (30)% $ 193,241 $ 190,166 2% Homes ordered 297 422 (30)% 1,156 1,094 6% Average sales price $ 169.7 $ 169.9 * $ 167.2 $ 173.8 (4)% ARIZONA Dollars $ 84,197 $ 59,912 41% $ 220,025 $ 148,771 48% Homes ordered 359 194 85% 814 474 72% Average sales price $ 234.5 $ 308.8 (24)% $ 270.3 $ 313.9 (14)% CALIFORNIA Dollars $ 26,880 $ 42,334 (37)% $ 99,971 $ 131,664 (24)% Homes ordered 67 115 (42)% 250 382 (35)% Average sales price $ 401.2 $ 368.1 9% $ 399.9 $ 344.7 16%
- ---------- * Less than one percent AT SEPTEMBER 30, PERCENTAGE ------------------------- INCREASE NET SALES BACKLOG 2001 2000 (DECREASE) ---- ---- ---------- TOTAL Dollars $432,968 $344,566 26% Homes in backlog 1,849 1,390 33% Average sales price $ 234.2 $ 247.9 (6)% TEXAS Dollars $127,542 $123,505 3% Homes in backlog 774 721 7% Average sales price $ 164.8 $ 171.3 (4)% ARIZONA Dollars $241,604 $143,722 68% Homes in backlog 905 437 107% Average sales price $ 267.0 $ 328.9 (19)% CALIFORNIA Dollars $ 63,822 $ 77,339 (18)% Homes in backlog 170 232 (27)% Average sales price $ 375.4 $ 333.4 13% HOME SALES REVENUE. The increases in total home sales revenue and number of homes closed in the third quarter and first nine months of 2001 compared to the same periods of 2000 resulted mainly from strong markets at the time the orders for these closings were taken in all of our divisions, continued growth in our mid-priced communities in Arizona and the addition of Hancock Communities to our operations in Phoenix, Arizona, which was acquired on May 30, 2001. During the three and nine months ended September 30, 2000, 313 and 383 Hancock homes were closed, respectively. 14 SALES CONTRACTS. Sales contracts for any period represent the aggregate sales price of all homes ordered by customers, net of cancellations. We do not include sales contingent upon the sale of a customer's existing home as a sales contract until the contingency is removed. Sales contracts for the nine months ended September 30, 2001 are up from the previous year, due to 304 contracts from the Hancock acquisition and the strength of our markets earlier in the year. Total sales contracts decreased in the third quarter of 2001 compared to the same period of 2000 due mainly, we believe, to a combination of factors, including a difficult comparison to the prior year's very strong sales results, slowing in our high-end Monterey Scottsdale product and in our move-up Austin product, compounded by the events of September 11. These factors were mostly offset by the inclusion of 234 Hancock sales contracts in the third quarter of 2001. Historically, we have experienced a cancellation rate approximating 23% of gross sales, which we believe is consistent with industry norms. For the quarter, cancellation rates increased to 31% which we believe was caused by September 11. NET SALES BACKLOG. Backlog represents net sales contracts that have not closed. Total dollar backlog at September 30, 2001 increased 26% over the September 30, 2000 amount due to an increase in the number of homes in backlog. The number of homes in backlog at September 30, 2001 increased 33% over the same date in the prior year. These increases resulted mainly from our Hancock acquisition. OTHER OPERATING INFORMATION
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------------- ---------------------------------- PERCENTAGE PERCENTAGE INCREASE INCREASE 2001 2000 (DECREASE) 2001 2000 (DECREASE) ---- ---- ---------- ---- ---- ---------- HOME SALES GROSS PROFIT Dollars $45,709 $28,835 58.5% $106,817 $69,808 53.0% Percentage of home sales revenues 22.1% 21.4% * 21.5% 20.1% 1.4% COMMISSIONS AND OTHER SALES COSTS Dollars $10,954 $ 7,291 50.2% $ 27,402 $19,528 40.3% Percent of home sales revenue 5.3% 5.4% * 5.5% 5.6% * GENERAL AND ADMINISTRATIVE COSTS Dollars $11,433 $ 5,364 113.1% $ 24,251 $14,213 70.6% Percent of total revenue 5.5% 3.9% 1.6 4.9% 4.0% * INCOME TAXES Dollars $ 9,316 $ 6,137 51.8% $ 22,314 $13,949 60.0% Percent of income before taxes and extraordinary items 38.8% 36.9% 1.9% 38.9% 36.9% 2.0%
* Less than one percent HOME SALES GROSS PROFIT. Gross profit equals home sales revenue, net of housing cost of sales, which include developed lot costs, home construction costs, amortization of common community costs (such as the cost of model complex and architectural, legal and zoning costs), interest, sales tax, warranty, construction overhead and closing costs. The dollar increases in gross profit for the three and nine months ended September 30, 2001 are attributable to the greater number of home closings and due to the strong housing markets that existed at the time these homes were sold. We were also able to benefit from a reasonably favorable environment for controlling construction costs. COMMISSIONS AND OTHER SALES COSTS. Commissions and other sales costs, such as advertising and sales office expenses, were approximately $11.0 million, or 5.3% of home sales revenue, in the three months ended September 30, 2001, as compared to approximately $7.3 million, or 5.4% of home sales revenue, in the third quarter of 2000. For the first nine months of 2001, commissions and other sales costs were approximately $27.4 million or 5.5% of home sales revenue, compared with $19.5 million, or 5.6% of home sales revenue, for the nine months of 2000. 15 GENERAL AND ADMINISTRATIVE COSTS. General and administrative costs were approximately $11.4 million, or 5.5% of total revenue, in the third quarter of 2001, as compared to approximately $5.4 million, or 3.9% of total revenue, in 2000. General and administrative costs were approximately $24.3 million, or 4.9% of total revenue, in the first nine months of 2001, as compared to approximately $14.2 million, or 4.0% of total revenue, for the same period of 2000. General and administrative costs in 2001 were higher as a percentage of revenue, in comparison to the prior year due to a general overall increase in these costs, and due to the strong closing performance of our Northern California region, which resulted in a larger-than-typical earn-out payment per the terms of the purchase contract when we acquired the division. The earn-out, which terminates in June 2002, is calculated based on 20 percent of the pre-tax earnings of the Northern California region after reduction for a capital charge. INCOME TAXES. The increases in income taxes for the quarter and nine months ended September 30, 2001 from the prior year resulted from an increase in pre-tax income, along with a slightly higher effective tax rate. LIQUIDITY AND CAPITAL RESOURCES Our principal uses of working capital are land purchases, lot development and home construction. We use a combination of borrowings and funds generated by operations to meet our working capital requirements. At September 30, 2001, we had short-term secured revolving construction loan and acquisition and development facilities totaling $185.0 million, of which approximately $24.9 million was outstanding. An additional $123.7 million of unborrowed funds supported by approved collateral were available under our credit facilities at that date, subject to compliance with the financial and other covenants in our loan agreements. This additional borrowing is limited to approximately $69 million under such loan covenants. In September 2001, we purchased and retired $10 million in principal amount of our 9.75% senior notes due June 1, 2011. The purchases were made at 93.25% of par and resulted in an extraordinary gain of $212,000, net of related income tax effect of $136,000. The 9.75% senior unsecured notes require us to comply with a number of covenants including: 1) Limitations on additional indebtedness, 2) Limitations on the payment of dividends, redemption of equity interests and certain investments, 3) Maintenance of a minimum level of consolidated tangible net worth, 4) Limitations on liens securing certain obligations, and 5) Limitations on the sale of assets, mergers and consolidations and transactions with affiliates. We believe that our current borrowing capacity, cash on hand at September 30, 2001 and anticipated cash flows from operations are sufficient to meet liquidity needs for the foreseeable future. There is no assurance, however, that future amounts available from our sources of liquidity will be sufficient to meet future capital needs. The amount and types of indebtedness that we incur may be limited by the terms of the indenture governing our senior notes and by the terms of our other credit agreements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not enter into derivative financial instruments for trading purposes, although we do have other financial instruments in the form of notes payable and senior debt. Our lines of credit and credit facilities are at variable interest rates and are subject to market risk in the form of interest rate fluctuations. The interest rate on our senior debt is at a fixed rate. 16 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS
EXHIBIT PAGE OR NUMBER DESCRIPTION METHOD OF FILING ------ ----------- ---------------- 10.1 Employment Agreement between the Company and Larry W. Seay, dated October 1, 2001 Filed herewith 99 Private Securities Litigation Reform Act of 1995 Safe Harbor Compliance Statement for Forward-Looking Statements Filed herewith
(B) REPORTS ON FORM 8-K None. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly cause this report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, this 14th day of November 2001. MERITAGE CORPORATION, a Maryland Corporation BY /s/ LARRY W. SEAY ------------------------------------ Larry W. Seay Chief Financial Officer and Vice President-Finance (Principal Financial Officer and Duly Authorized Officer) S-1