Washington, D.C. 20549

 

FORM 10-Q/A

(Amendment No. 1)

 

 

Commission File Number 1-9977

 

MERITAGE HOMES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

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 ý     No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   Yes ý     No o

 

Common shares outstanding as of July 28, 2004:  12,961,027.

 

 

MERITAGE HOMES CORPORATION

FORM 10-Q/A FOR THE QUARTER ENDED JUNE 30, 2004

 

Explanatory Note

 

This Amendment No. 1 on Form 10-Q/A to Form 10-Q of Meritage Homes Corporation, for the quarter ended June 30, 2004 reflects restatements to certain historical financial data and related descriptions as originally filed.  This restatement includes changes to Part I, Items 1, 2 and 4 and relates to our model home lease program.  See Note 10 to our Unaudited Condensed Consolidated Financial Statements for further discussion of this matter.

 

Except for the accounts, data and descriptions relating to our model home lease program, no other information in this report is being changed.  This report continues to speak as of the date of the original filing, and we have not updated the disclosures in this report to speak as of a later date.  We are not required to and we have not updated any forward-looking statements previously included in the Form 10-Q filed on August 5, 2004.

 

TABLE OF CONTENTS

 

PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements:
		Unaudited Condensed Consolidated Balance Sheets as of June 30, 2004 (Restated) and December 31, 2003
		Unaudited Condensed Consolidated Statements of Earnings for the Three and Six Months ended June 30, 2004 (Restated) and 2003
		Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2004 (Restated) and 2003
		Notes to Unaudited Condensed Consolidated Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
PART II.		OTHER INFORMATION
Item 1.		Not Applicable
Item 2.		Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Item 3.		Not Applicable
Item 4.		Submission of Matters to a Vote of Security Holders
Item 5.		Not Applicable
Item 6.		Exhibits and Reports on Form 8-K
SIGNATURES

 

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PART I  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

		June 30, 2004			December 31, 2003
		(As Restated, See Note 10)
Assets
Cash and cash equivalents		$	11,735		$	4,799
Real estate		780,176			678,011
Consolidated real estate not owned		28,336			18,572
Deposits on real estate under option or contract		118,019			105,870
Investments in unconsolidated entities		33,974			23,528
Receivables, net		9,014			8,716
Deferred tax asset, net		1,443			1,204
Goodwill		88,664			75,645
Property and equipment, net		27,495			23,669
Prepaid expenses and other assets		14,468			14,525
Total assets		$	1,113,324		$	954,539
Liabilities
Accounts payable		$	75,628		$	80,737
Accrued liabilities		63,032			67,411
Home sale deposits		38,452			25,352
Obligations related to consolidated real estate not owned		21,839			17,653
Senior notes		417,539			287,991
Loans payable and other borrowings		49,396			63,500
Total liabilities		665,886			542,644
Commitments and Contingencies (Notes 3, 4, and 5)
Stockholders’ Equity
Common stock, par value $0.01. 50,000,000 shares authorized; 15,639,273 and 15,479,558 shares issued at June 30, 2004 and December 31, 2003, respectively		156			155
Additional paid-in capital		206,518			202,678
Retained earnings		294,170			242,615
Treasury stock at cost, 2,602,226 and 2,302,226 shares at June 30, 2004 and December 31, 2003, respectively		(53,406		)	(33,553		)
Total stockholders’ equity		447,438			411,895
Total liabilities and stockholders’ equity		$	1,113,324		$	954,539

 

See accompanying notes to condensed consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except per share amounts)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
		(As Restated, See Note 10)						(As Restated, See Note 10)
Home closing revenue		$	431,275		$	325,733		$	854,777		$	609,143
Land closing revenue		2,660			8,100			2,660			8,100
		433,935			333,833			857,437			617,243
Cost of home closings		(352,568		)	(260,369		)	(692,907		)	(487,425		)
Cost of land closings		(1,731		)	(6,859		)	(1,731		)	(6,859		)
		(354,299		)	(267,228		)	(694,638		)	(494,284		)
Home closing gross profit		78,707			65,364			161,870			121,718
Land closing gross profit		929			1,241			929			1,241
		79,636			66,605			162,799			122,959
Commissions and other sales costs		(25,996		)	(21,328		)	(51,829		)	(41,073		)
General and administrative costs		(16,794		)	(12,076		)	(32,850		)	(24,288		)
Other income, net		2,980			863			5,169			2,072
Earnings before provision for income taxes		39,826			34,064			83,289			59,670
Provision for income taxes		(15,189		)	(12,752		)	(31,733		)	(22,585		)
Net earnings		$	24,637		$	21,312		$	51,556		$	37,085
Weighted average number of shares:
Basic		13,146			12,985			13,190			13,013
Diluted		13,912			13,747			13,982			13,715
Net earnings per common share:
Basic		$	1.87		$	1.64		$	3.91		$	2.85
Diluted		$	1.77		$	1.55		$	3.69		$	2.70

 

See accompanying notes to condensed consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Six Months Ended June 30,
		2004			2003
		(As Restated, See Note 10)
Cash flows from operating activities:
Net earnings		$	51,556		$	37,085
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization		5,764			3,746
Deferred income tax provision		(239		)	(90		)
Tax benefit from stock option exercises		1,701			—
Equity in earnings from unconsolidated entities		(1,491		)	(1,063		)
Net increase in assets not owned		(5,578		)	(1,445		)
Changes in assets and liabilities, net of effect of acquisition:
Increase in real estate		(65,584		)	(126,348		)
Increase in deposits on real estate under option or contract		(10,279		)	(13,025		)
(Increase) decrease in receivables and prepaid expenses and other assets		(339		)	2,928
(Decrease) increase in accounts payable and accrued liabilities		(11,193		)	17,532
Increase in home sale deposits		13,013			8,784
Net cash used in operating activities		(22,669		)	(71,896		)
Cash flows from investing activities:
Investments in unconsolidated entities		(10,929		)	(5,816		)
Distributions from unconsolidated entities		1,975			1,174
Cash paid for acquisition		(24,165		)	—
Purchases of property and equipment		(8,648		)	(5,385		)
Increase in goodwill		(1,805		)	(723		)
Net cash used in investing activities		(43,572		)	(10,750		)
Cash flows from financing activities:
Proceeds from loans payable		776,000			519,535
Repayments of loans payable		(815,100		)	(464,212		)
Proceeds from issuance of senior notes		130,000			51,625
Purchase of treasury stock		(19,853		)	(5,180		)
Proceeds from stock option exercises		2,130			833
Net cash provided by financing activities		73,177			102,601
Net increase in cash and cash equivalents		6,936			19,955
Cash and cash equivalents at beginning of period		4,799			6,600
Cash and cash equivalents at end of period		$	11,735		$	26,555

 

See supplemental disclosures of cash flow information at Note 8.

 

See accompanying notes to condensed consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2004 AND 2003

 

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

 

Basis of Presentation.  The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and include the accounts of Meritage Homes Corporation and those of our consolidated subsidiaries. Intercompany balances and transactions have been eliminated in consolidation and certain prior year items have been reclassified to conform to our current financial statement presentation.  In our opinion, these unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of 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 or for any future periods.  These financial statements should be read in conjunction with our consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.

 

Stock-Based Compensation.  At June 30, 2004, we had a stock-based employee compensation plan under which officers, key employees, non-employee directors and consultants may be granted options to purchase shares of our common stock.  We apply the intrinsic value-based method of accounting for stock-based compensation prescribed in Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees”, as allowed by SFAS No. 123 “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”  Under this method, compensation expense is recorded on the date of the grant only if the market price of the underlying stock on the date of the grant was greater than the exercise price.  SFAS No. 123 established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans.  We have adopted the disclosure requirements of SFAS No. 123.  We have not issued options with exercise prices below the market value on the date of the grant; therefore, we have not recognized compensation expense for our stock-based plan.  Had compensation cost for this plan been determined pursuant to SFAS No. 123, our net earnings and earnings per share would have been reduced to the following pro forma amounts.  For the purpose of this disclosure, the value of the options is estimated by applying a Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.

 

				Three Months Ended June 30,						Six Months Ended June 30,
				(in thousands, except per share amounts)
				2004			2003			2004			2003
Net earnings		As reported		$	24,637		$	21,312		$	51,556		$	37,085
		Deduct*		(1,179		)	(887		)	(2,037		)	(1,762		)
		Pro forma		$	23,458		$	20,425		$	49,519		$	35,323
Basic earnings per share		As reported		$	1.87		$	1.64		$	3.91		$	2.85
		Pro forma		$	1.78		$	1.57		$	3.75		$	2.71
Diluted earnings per share		As reported		$	1.77		$	1.55		$	3.69		$	2.70
		Pro forma		$	1.69		$	1.49		$	3.54		$	2.58

 

*Deduct: Total stock-based employee compensation expense determined under fair value based method for awards, net of related tax effects.

 

The fair value for options granted in the first half of 2004 and 2003 was established at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions.

 

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The weighted average fair value of options was $36.77 and $18.62 for the six months ended June 30, 2004 and 2003, respectively.

 

We have generally granted options only to employees and non-employee directors.  To date, the amount of compensation expense recorded in association with granting options to other individuals has not been material.

 

Common Stock Repurchase. In August 2002, our Board of Directors authorized the expenditure of up to $32 million, with an increase of $26.8 million approved in January 2004, to repurchase shares of our common stock.  No date for completing the program has been determined, but we may purchase shares subject to applicable securities laws, and at times and in amounts as management deems appropriate.  By June 30, 2004, we had repurchased 964,300 shares of our common stock under the August 2002 program at an average price of $43.74 per share.  300,000 of these shares were repurchased in the second quarter of 2004, at an average price of $66.18.  In July 2004, we repurchased an additional 100,000 shares at an average price of $60.87.

 

Off-Balance Sheet Arrangements.  We often acquire finished building lots at market prices from various development entities under fixed price purchase agreements.  This lot acquisition strategy reduces the financial requirements and risks associated with the direct ownership of undeveloped land.  Under these purchase agreements, we are usually required to make deposits in the form of cash or letter of credit, which may be forfeited if we fail to perform under the agreement.  At June 30, 2004, we had entered into purchase agreements with an aggregate purchase price of approximately $1.4 billion, by making deposits of approximately $124.5 million in the form of cash and approximately $41.1 million in letters of credit.

 

On a limited basis, we also purchase finished lots from joint venture limited liability companies (“LLCs”).  These LLCs are structured such that we are a non-controlling member and we are typically at risk only for the amounts we have invested.  We enter into standard fixed price purchase agreements to buy lots from the LLCs, and we are not a borrower, guarantor or obligor on any of the LLCs’ debt.

 

We also obtain letters of credit and performance, maintenance, and other bonds in support of our related obligations with respect to the development of our projects.  The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities.  In the event the letters of credit or bonds are drawn upon, we would be obligated to reimburse the issuer of the letter of credit or bond.  At June 30, 2004, we had approximately $8.7 million in outstanding letters of credit and guarantees and $173.4 million in performance bonds for such purposes.  We believe it is unlikely that any of these letters of credit or bonds will be drawn upon.

 

Warranty Reserves.  We have certain obligations related to post-construction warranties and defects related to homes sold.  We have estimated these reserves based on historical data and trends with respect to similar product types and geographical areas.  At June 30, 2004, we had approximately $10.4 million in

 

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reserve for various warranty claims, an amount which we believe to be adequate, recorded in accrued liabilities on the accompanying consolidated balance sheets.  Changes in our warranty reserve follow (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Balance, beginning of period		$	9,987		$	7,212		$	9,253		$	6,676
Additions to reserve		2,143			1,678			4,414			3,333
Warranty claims and expenses		(1,769		)	(1,167		)	(3,306		)	(2,286		)
Balance, end of period		$	10,361		$	7,723		$	10,361		$	7,723

 

Recent Accounting Pronouncements.  In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46R), which governs whether certain transactions should be accounted for as on- or off-balance sheet transactions.  We have adopted FIN 46R, and a discussion of its impact on our consolidated financial statements can be found in Note 3 – Variable Interest Entities and Consolidated Real Estate Not Owned.

 

NOTE 2 – REAL ESTATE AND CAPITALIZED INTEREST

 

Real estate consists of the following (in thousands):

 

		June 30, 2004			December 31, 2003
Homes under contract under construction		$	370,029		$	281,931
Finished home sites		187,030			166,456
Home sites under development		114,978			97,141
Unsold homes completed and under construction		56,691			96,576
Model homes		48,277			22,170
Land held for development		3,171			13,737
		$	780,176		$	678,011

 

We capitalize all development period interest costs incurred in connection with the development and construction of real estate. Capitalized interest is allocated to real estate when incurred and charged to cost of home closings when the related property is delivered.  Certain information regarding interest follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Capitalized interest, beginning of period		$	14,583		$	10,412		$	13,074		$	8,781
Interest incurred and capitalized		9,441			6,457			17,632			12,119
Amortization to cost of home closings		(7,217		)	(4,829		)	(13,899		)	(8,860		)
Capitalized interest, end of period		$	16,807		$	12,040		$	16,807		$	12,040

 

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

 

FIN 46R “Consolidation of Variable Interest Entities” requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity.  Prior to the issuance of FIN 46R, entities were generally consolidated by an enterprise when it had a controlling financial interest through ownership of a majority voting interest in the entity.  FIN 46R applied immediately to variable interests created after January 31, 2003, and with respect to variable interests created before February 1, 2003, FIN 46R application was deferred and not required to be applied until the end of the first reporting period ending after March 15, 2004.  Accordingly, we fully implemented FIN 46R by March 31, 2004.

 

Pursuant to FIN 46R, a variable interest entity, or VIE, is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur.

 

Based on the provisions of FIN 46R, we have concluded that when we enter into option or purchase agreements to acquire land or lots from an entity and pay a non-refundable deposit, a VIE is created because we are deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity’s expected losses if they occur.  For each VIE created where the fair value of the land or lots under contract are not more than half of the total fair value of the entity’s assets, we are not deemed to be the primary beneficiary of the VIE and therefore do not consolidate the assets on our financial statements.  For each VIE created where the fair value of the land or lots under contract are more than half of the total fair value of the entity’s assets, then we compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46R.  If we are deemed to be the primary beneficiary of the VIE, because we are obligated to absorb the majority of the expected losses, receive the majority of the residual returns, or both, we will consolidate the VIE in our consolidated financial statements.  Not all of our option agreements are determined to be VIEs.

 

We have applied FIN 46R by developing a methodology to determine whether or not we are the primary beneficiary of the VIE.  Part of this methodology requires the use of estimates in assigning probabilities to various future cash flow possibilities relative to changes in the fair value and changes in the development costs associated with the property.  Although we believe that our accounting policy properly identifies our primary beneficiary status with these VIEs, changes in the probability estimates could produce different conclusions regarding our primary beneficiary status.

 

We generally do not have any ownership interest in the VIEs that hold the lots and land under option or contract, and accordingly, we generally do not have legal or other access to the VIE’s books or records.  Therefore, it is not possible for us to compel the VIEs to provide financial or other data to us in performing our primary beneficiary evaluation.  Accordingly, this lack of information from the VIEs may result in our evaluation being conducted primarily based on management judgments and estimates.

 

Creditors, if any, of the entities with which we have option agreements have no recourse against us.  In most cases, the maximum exposure to loss in our option agreements is limited to our option deposit.  Occasionally, we may be at risk for items over budget related to land development on property we have under option.  In these cases, we have contracted to complete development at a fixed cost on behalf of the land owner.  Some of our option deposits may be refundable if certain contractual conditions are not performed by the party selling the lots.

 

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We have evaluated all of our existing joint venture agreements and have determined that none of these joint ventures are VIEs.  Therefore, we have not consolidated any of our joint venture agreements pursuant to the requirements of FIN 46R.

 

At June 30, 2004, the amount of lot option contracts recorded on our balance sheet under the category “Consolidated real estate not owned” is approximately $28.3 million, of which approximately $12.3 million represents the estimated fair value of specific performance options, and the remaining $16.0 million represents the estimated fair value of consolidated VIEs.  The corresponding credit relating to these assets of $21.8 million is included under the category “Obligations related to consolidated real estate not owned”, which is net of option deposits totaling approximately $6.5 million.

 

Below is a summary of our lots under option at June 30, 2004 (dollars in thousands):

 

										Option/Earnest Money Deposits
		# of Lots		Fair Value			Purchase Price			Cash			Letters of Credit
Specific performance options (1)		275		$	12,292		$	12,292		$	778		—
Options recorded on balance sheet (2)		535		16,044			16,158			5,719			—
Total options recorded on balance sheet (2)		810		28,336			28,450			6,497			—
Options/purchase contracts not consolidated on balance sheet –non-refundable deposits (2)		27,681		—			1,243,406			112,204			$	41,080
Options/purchase contracts not consolidated on balance sheet –refundable deposits (3)		4,986		—			90,937			5,815			—
Total options not consolidated on balance sheet		32,667		—			1,334,343			118,019			41,080
Total lots under option		33,477		$	28,336		$	1,362,793		$	124,516		$	41,080

 

Note:  Except for our specific performance options, none of our option agreements require us to purchase lots.  Our option to purchase lots remains effective so long as we purchase a pre-established minimum number of lots each month or quarter, as determined by the agreement.  The pre-established number of lots typically is structured to approximate our expected rate of home orders.

 

(1)  Fair value of specific performance options approximates purchase price due to the short-lived nature of the options.

(2)  Deposits are non-refundable except if certain contractual conditions are not performed by the selling party.

(3)  Deposits are refundable at our sole discretion.  Includes 2,449 lots under control for which we have not completed our acquisition evaluation process and we have not internally committed to purchase.

 

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NOTE 4 – LOANS PAYABLE AND OTHER BORROWINGS AND SENIOR NOTES

 

Loans payable and other borrowings consist of the following (in thousands):

 

		June 30, 2004			December 31, 2003
$400 million unsecured revolving credit facility maturing May 2007 with extension provisions, and interest payable monthly approximating prime (4.0% at June 30, 2004) or LIBOR (approximately 1.635% at June 30, 2004) plus 2.0%.		$	16,400		$	62,900
Acquisition and development seller carry back financing, interest payable at a fixed rate of 7.0% per annum, principal and interest payable on January 10, 2005, secured by a first deed of trust on real estate.		600			600
Model home lease program, with interest payable monthly approximating LIBOR (approximately 1.635% at June 30, 2004) plus 4.25%		32,396			—
Total loans payable and other borrowings		$	49,396		$	63,500

 

Effective April 1, 2004, costs associated with model homes that we use to market our communities and that are built by us on lots owned by a third party and leased from them during our sales process, are included in the Company’s financial statements.  We do not legally own the model homes, but are reimbursed by the owner for our construction costs, and we have the right, but not the obligation, to purchase these homes.  Any amounts received from the third party owner are recorded as debt and is generally repaid when the home is sold.  Should we elect not to exercise our rights to purchase these model homes, the outstanding balance under the model home lease program will be eliminated upon the termination of the lease, which is generally between one and three years.

 

At June 30, 2004, our outstanding 9.75% senior notes due 2011 totaled approximately $287.4 million, which includes $155.0 million in principal amount issued in May 2001, and add-ons of $51.3 million and $81.1 million, including unamortized premiums, issued in February 2003 and September 2003, respectively.  The add-on offerings of $50 million and $75 million in aggregate principal amount of our 9.75% senior notes were issued at prices of 103.25% and 109.0% of their face amounts to yield 9.054% and 7.642%, respectively, and together with the May 2001 offering, constitute a single series of notes.

 

On April 21, 2004, we issued $130 million aggregate principal amount of 7% Senior Notes due 2014.  The notes were priced to us at a slight premium implying an interest rate to us of 6.99%.  We used the proceeds from the offering to pay down our senior credit facility and to repurchase shares of our common stock.  At June 30, 2004, the outstanding balance on these notes totaled approximately $130.1 million, including unamortized premium.

 

The bank credit facility and senior unsecured notes contain covenants which require maintenance of certain levels of tangible net worth and compliance with certain minimum financial ratios, place restrictions on 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 six months ended June 30, 2004, we were in compliance with these covenants.  The revolving credit facility and senior notes restrict our ability to pay dividends.

 

Obligations to pay principal and interest on the bank credit facility and senior unsecured notes are guaranteed by all of our subsidiaries, each of which is directly or indirectly 100% owned by Meritage Homes Corporation (Guarantor Subsidiaries), other than certain minor subsidiaries (collectively, Non-Guarantor Subsidiaries).  Such guarantees are full and unconditional, and joint and several.  Separate financial statements

 

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of the Guarantor Subsidiaries are not provided because Meritage Homes Corporation (the parent company) has no independent assets or operations, the guarantees are full and unconditional and joint and several, and the Non-Guarantor Subsidiaries are, individually and in the aggregate, minor.  There are no significant restrictions on the ability of the parent company or any guarantor to obtain funds from its subsidiaries by dividend or loan.

 

NOTE 5 – ACQUISITIONS AND GOODWILL

 

Citation Homes of Southern California Acquisition.  Effective January 1, 2004, we purchased the homebuilding and related assets of Citation Homes of Southern California (“Citation”), which primarily operates in the Inland Empire region of the greater Los Angeles area.   The purchase price was approximately $24.2 million in cash, and we agreed to an earn-out of 20% of the pre-tax profits of the Southern California operations after capital charges, as defined, payable in cash over three years.  The results of the Southern California operations are included in our consolidated financial statements beginning as of the effective date of the acquisition.  See Note 8 for additional information regarding this acquisition.

 

Goodwill.  Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the assets acquired.  The acquisition of the Southern California division was recorded using the purchase method of accounting.  The purchase price was allocated based on estimated fair value of the assets and liabilities at the date of the acquisition.  Intangible assets, equal to the excess purchase price over the fair value of the net assets, of $11.2 million for the Southern California division were recorded as goodwill, which is presented on our consolidated balance sheet.  The changes in the carrying amount of goodwill for the six months ended June 30, 2004 follow (in thousands):

 

 

Under the guidelines contained in SFAS No. 142, “Goodwill and Other Intangible Assets,” we are required to test goodwill for impairment annually or more frequently if circumstances change or an event occurs that may reduce the value of an operating segment below its carrying value.  In the first quarter of 2004 management performed a goodwill impairment analysis on each of our operating segments and determined that no impairment exists.

 

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NOTE 6 – EARNINGS PER SHARE

 

Basic and diluted earnings per share for the three and six months ended June 30, 2004 and 2003 were calculated as follows (in thousands, except per share amounts):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Basic average number of shares outstanding		13,146			12,985			13,190			13,013
Effect of dilutive securities: Options to acquire common stock		766			762			792			702
Diluted average shares outstanding		13,912			13,747			13,982			13,715
Net earnings		$	24,637		$	21,312		$	51,556		$	37,085
Basic earnings per share		$	1.87		$	1.64		$	3.91		$	2.85
Diluted earnings per share		$	1.77		$	1.55		$	3.69		$	2.70
Antidilutive stock options not included in the calculation of diluted earnings per share		—			10			—			153

 

NOTE 7 – INCOME TAXES

 

Components of income tax expense for the three and six months ended June 30, 2004 and 2003 are (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Federal		$	13,452		$	11,505		$	28,110		$	20,019
State		1,737			1,247			3,623			2,566
Total		$	15,189		$	12,752		$	31,733		$	22,585

 

NOTE 8 – SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 

Additional information related to our Consolidated Statement of Cash Flows follows (in thousands):

 

The January 2004 acquisition of our Southern California division resulted in the following changes in assets and liabilities during the second quarter of 2004:

 

Increase in real estate		$		(12,036	)
Increase in deposits on real estate under option or contract		(1,870			)
Increase in receivables and other assets		(747			)
Increase in goodwill		(11,214			)
Increase in property and equipment		(89			)
Increase in accounts payable and accrued liabilities		1,704
Increase in home sale deposits		87
Net cash paid for acquisition		$	(24,165		)

 

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		Six Months Ended June 30,
		2004			2003
Cash paid during the period for:
Interest		$	15,677		$	11,211
Income taxes		$	36,948		$	26,166

 

NOTE 9 – SEGMENT INFORMATION

 

We design, construct and build a broad range of single-family homes targeted to the needs of each of our markets.  We are organized into five geographic homebuilding regions for internal reporting purposes.  Each of these homebuilding regions have similar housing products, economic characteristics and class of prospective buyers, therefore, we have aggregated our geographic homebuilding regions into a single segment.

 

The accounting policies for the homebuilding regions are the same as ours.  Prior to this quarter, we reported our regions (Texas, Arizona, California and Nevada) as separate segments, but after recent review and analysis, have concluded that consolidation into one segment is appropriate, as homebuilding is our primary business.

 

NOTE 10 – RESTATEMENT

 

In January 2005 we determined that construction costs associated with model homes used to market our communities and that are built by us on lots owned by a third party and leased from them during our sales process, should be included in the Company’s financial statements.  We do not legally own the models homes, but we are reimbursed by the owner for our construction costs, and we have the right, but not the obligation, to purchase these homes.  For accounting purposes, we are deemed to be the owner of the model homes, and due to our “continuing involvement” with these assets, we are unable to derecognize the model homes upon their completion and commencement of the lease.  Amounts received by us from the third party owners for reimbursement of our construction costs are recorded as debt in our financial statements, which is generally deemed repaid when the homes are sold.  In addition, we determined that payments related to the lease program should be recognized as interest expense, subject to capitalization, rather than commissions and other sales costs, which is included in cost of home closings.  As a result, the accompanying unaudited condensed consolidated financial statements as of and for the three and six months ended June 30, 2004 have been restated from the amounts previously reported to reflect the above described treatment for our model home lease program.  The restated amounts reflect an additional $32.4 million of real estate assets and debt and approximately $0.4 million in lease payments under our model home lease program since April 1, 2004 as interest, which is  included in cost of home closings rather than commissions and other sales costs.  Financial statements for periods prior to June 30, 2004 were not materially affected and have not been restated. There was no material impact resulting from the change on net earnings and basic and diluted EPS for the three and six months ended June 30, 2004.

 

A summary of the significant effects of the restatement is as follows:

 

		As of June 30, 2004
		As Previously Reported			As Restated
		(in thousands)
Real estate		$	747,780		$	780,176
Total assets		1,080,928			1,113,324
Loans payable and other borrowings		17,000			49,396
Total liabilities		633,490			665,886
Total liabilities and stockholders’ equity		1,080,928			1,113,324

 

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		Three Months Ended June 30, 2004						Six Months Ended June 30, 2004
		As Previously Reported			As Restated			As Previously Reported			As Restated
		(in thousands)						(in thousands)
Cost of home closings		$	(352,208	)	$	(352,568	)	$	(692,547	)	$	(692,907	)
Commissions and other sales costs		(26,356		)	(25,996		)	(52,189		)	(51,829		)

 

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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,” “forecast”, “plan” and “project” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made.  All such statements are within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements may include, but are not limited to, projections of revenue, income or loss, capital expenditures and backlog; plans for future operations; financing needs or plans and liquidity; the impact of changes in interest rates; plans relating to our products or services, acquisitions, and new or planned development projects; the demand for and pricing of our homes; the expected outcome of legal proceedings against us; the growth potential of the markets we operate in; the sufficiency of our capital resources to support our growth strategy; the sufficiency of our warranty and other reserves; the number of new communities we plan to open in Nevada during the remainder of 2004; the impact of new accounting principles; and our ability to continue positive operating results in light of current economic and political conditions, as well as assumptions relating to the foregoing.

 

Actual events and results may differ materially from those expressed in forward-looking statements due to a number of factors.  Risks identified in Exhibit 99.1 to this Quarterly Report on Form 10-Q/A and in our Annual Report on Form 10-K for the year ended December 31, 2003, including those under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Our Future Results and Financial Condition” describe factors, among others, that could contribute to or cause such differences.  These factors may also affect our business generally and as a result, our stock and note prices may fluctuate dramatically.

 

Overview

 

Meritage Homes Corporation is a leading designer and builder of single-family homes in the rapidly growing Sunbelt states of Texas, Arizona, California and Nevada, based on the number of homes closed.  We focus on providing a broad range of first-time, move-up and luxury homes to our targeted customer base.  We have operated in Arizona since 1985, in Texas since 1987, in California since 1989 and in Nevada since 2002.  We entered the Inland Empire market of Southern California in January 2004 with our acquisition of Citation Homes of Southern California (See Notes 5 and 8 to the condensed consolidated financial statements).  In April 2004 we began start-up operations in the Denver, Colorado market.  We operate in these states, predominantly in one industry, homebuilding, and thus have only one single reportable segment.

 

We operate in Texas as Legacy Homes, Monterey Homes and Hammonds Homes, in Arizona as Monterey Homes and Meritage Homes, in California and Colorado as Meritage Homes and in Nevada as Perma-Bilt Homes.  At June 30, 2004, we were actively selling homes in 137 communities, with base prices ranging from $98,000 to $867,000.

 

Total home closing revenue was $431.3 million for the three months ended June 30, 2004, increasing $105.6 million, or 32% from $325.7 million for the same period last year.  Net earnings for the second quarter of 2004 increased $3.3 million, or 16%, to $24.6 million from $21.3 million in the same quarter of 2003.  These increases were primarily driven by the effect of higher home closings and revenues.

 

In April 2004 we issued $130 million aggregate principal amount of 7% senior notes due 2014. The proceeds from this offering were used to pay down our senior credit facility and to repurchase shares of our common stock.  We believe this will provide us with long-term strategic capital at an attractive cost.

 

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Critical Accounting Policies

 

We have established various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation and presentation of our consolidated financial statements.  Our significant policies are described in Note 1 of the consolidated financial statements in our Annual Report on Form 10-K for December 31, 2003.  Certain of these policies involve significant judgments, assumptions and estimates made by management that have a material impact on the carrying value of certain assets and liabilities, and revenues and costs.  The judgments, assumptions and estimates we use and believe to be critical to our business are based on historical experience, knowledge of the accounts and other factors, which we believe to be reasonable under the circumstances.  We evaluate our judgments and assumptions on an on-going basis. Because of the nature of the judgments and assumptions made, actual results may differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities, and the results of our operations.

 

The accounting policies that we deem most critical to us, and involve the most difficult, subjective or complex judgments, include our estimates of costs to complete our individual projects, the ultimate recoverability (or impairment) of these costs, goodwill impairment, the likelihood of closing lots held under option or contract, the ability to determine the fair value of consolidated real estate not owned and liabilities related to such, certain estimates and assumptions related to applying FIN 46R, and the ability to estimate expenses and accruals, including legal and warranty reserves.  Should we under or over estimate costs to complete individual projects, gross margins in a particular period could be misstated and the ultimate recoverability of costs related to a project from home sales may be uncertain.  Furthermore, non-refundable deposits paid for land options or contracts may have no economic value to us if we do not ultimately purchase the land.  Our inability to accurately estimate expenses, accruals, or an impairment of real estate or goodwill could result in charges, or income, in future periods, which relate to activities or transactions in a preceding period.  The estimates and assumptions we make relating to our application of FIN 46R, if not accurate, could result in us incorrectly including, or excluding, certain contractual land acquisition arrangements as variable interest entities in, or from, respectively, our consolidated financial statements.

 

Results Of Operations

 

The following discussion and analysis of financial condition and results of operations is based on our unaudited condensed consolidated financial statements for the three and six-month periods ended June 30, 2004 and 2003.

 

Home Closing Revenue, Home Orders and Order Backlog

 

The information below presents operating and financial data regarding our homebuilding activities (dollars in thousands).

 

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		Three Months Ended June 30,						%		Six Months Ended June 30,						%
		2004			2003			Change		2004			2003			Change
Home Closing Revenue
Total
Dollars		$	431,275		$	325,733		32	%	$	854,777		$	609,143		40	%
Homes closed		1,620			1,258			29	%	3,189			2,394			33	%
Average sales price		$	266.2		$	258.9		3	%	$	268.0		$	254.4		5	%
Texas
Dollars		$	160,377		$	130,253		23	%	$	317,649		$	251,756		26	%
Homes closed		741			641			16	%	1,471			1,247			18	%
Average sales price		$	216.4		$	203.2		6	%	$	215.9		$	201.9		7	%
Arizona
Dollars		$	115,535		$	83,184		39	%	$	213,467		$	150,309		42	%
Homes closed		473			291			63	%	854			541			58	%
Average sales price		$	244.3		$	285.9		(15	)%	$	250.0		$	277.8		(10	)%
California
Dollars		$	123,840		$	77,952		59	%	$	254,710		$	145,255		75	%
Homes closed		294			176			67	%	601			334			80	%
Average sales price		$	421.2		$	442.9		(5	)%	$	423.8		$	434.9		(3	)%
Nevada
Dollars		$	31,523		$	34,344		(8	)%	$	68,951		$	61,823		12	%
Homes closed		112			150			(25	)%	263			272			(3	)%
Average sales price		$	281.5		$	229.0		23	%	$	262.2		$	227.3		15	%
Home Orders
Total
Dollars		$	700,142		$	463,189		51	%	$	1,292,141		$	876,053		47	%
Homes ordered		2,556			1,877			36	%	4,749			3,459			37	%
Average sales price		$	273.9		$	246.8		11	%	$	272.1		$	253.3		7	%
Texas
Dollars		$	220,056		$	181,602		21	%	$	419,913		$	342,737		23	%
Homes ordered		1,022			883			16	%	1,969			1,674			18	%
Average sales price		$	215.3		$	205.7		5	%	$	213.3		$	204.7		4	%
Arizona
Dollars		$	262,004		$	153,252		71	%	$	470,392		$	276,905		70	%
Homes ordered		1,056			605			75	%	1,863			1,052			77	%
Average sales price		$	248.1		$	253.3		(2	)%	$	252.5		$	263.2		(4	)%
California
Dollars		$	185,725		$	75,095		147	%	$	345,556		$	164,870		110	%
Homes ordered		387			169			129	%	752			349			115	%
Average sales price		$	479.9		$	444.3		8	%	$	459.5		$	472.4		(3	)%
Nevada
Dollars		$	32,357		$	53,240		(39	)%	$	56,280		$	91,541		(39	)%
Homes ordered		91			220			(59	)%	165			384			(57	)%
Average sales price		$	355.6		$	242.0		47	%	$	341.1		$	238.4		43	%

 

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