UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2005

 

or

 

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.)

 

 

 

8501 E. Princess Drive, Suite 290

 

85255

Scottsdale, Arizona

 

(Zip Code)

(Address of Principal Executive Offices)

 

 

 

(480) 609-3330

(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 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

 

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

 

Common shares outstanding as of November 1, 2005:  27,353,506.

 



 

MERITAGE HOMES CORPORATION

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2005

 

TABLE OF CONTENTS

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Earnings for the Three and Nine Months ended September 30, 2005 and 2004

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2005 and 2004

 

 

 

 

 

 

 

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.

Legal Proceedings

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

 

 

Item 3.

Not Applicable

 

 

 

 

 

 

Item 4.

Not Applicable

 

 

 

 

 

 

Item 5.

Not Applicable

 

 

 

 

 

 

Item 6.

Exhibits

 

 

 

 

 

SIGNATURES

 

 

 

 

 

INDEX OF EXHIBITS

 

 

2



 

PART I - - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

 

 

September 30,

 

December 31,

 

 

 

2005

 

2004

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

40,185

 

$

47,876

 

Real estate

 

1,409,433

 

867,218

 

Real estate not owned

 

2,557

 

18,344

 

Deposits on real estate under option or contract

 

174,764

 

129,072

 

Receivables

 

19,424

 

15,974

 

Goodwill

 

124,062

 

91,475

 

Intangibles, net

 

10,516

 

 

Property and equipment, net

 

34,038

 

27,742

 

Prepaid expenses and other assets

 

16,026

 

16,749

 

Investments in unconsolidated entities

 

57,632

 

50,944

 

 

 

 

 

 

 

Total assets

 

$

1,888,637

 

$

1,265,394

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Accounts payable

 

$

139,073

 

$

77,799

 

Accrued liabilities

 

211,012

 

135,590

 

Home sale deposits

 

79,885

 

41,537

 

Liabilities related to real estate not owned

 

2,143

 

14,780

 

Deferred tax liability, net

 

22,820

 

1,518

 

Loans payable and other borrowings

 

192,096

 

54,419

 

Senior notes

 

479,686

 

416,996

 

 

 

 

 

 

 

Total liabilities

 

1,126,715

 

742,639

 

 

 

 

 

 

 

Minority Interests

 

 

200

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Common stock, par value $0.01. 50,000,000 shares authorized; 33,057,958 and 31,460,050 shares issued at September 30, 2005 and December 31, 2004, respectively

 

331

 

315

 

Additional paid-in capital

 

295,292

 

209,630

 

Retained earnings

 

535,270

 

381,583

 

Treasury stock at cost, 5,704,452 shares

 

(68,971

)

(68,973

)

 

 

 

 

 

 

Total stockholders’ equity

 

761,922

 

522,555

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,888,637

 

$

1,265,394

 

 

 

See accompanying notes to condensed consolidated financial statements

 

3



 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except per share amounts)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Home closing revenue

 

$

753,505

 

$

462,711

 

$

1,956,235

 

$

1,317,488

 

Land closing revenue

 

1,945

 

20,037

 

3,954

 

22,697

 

 

 

755,450

 

482,748

 

1,960,189

 

1,340,185

 

 

 

 

 

 

 

 

 

 

 

Cost of home closings

 

575,494

 

367,826

 

1,506,196

 

1,060,733

 

Cost of land closings

 

1,888

 

12,877

 

3,426

 

14,608

 

 

 

577,382

 

380,703

 

1,509,622

 

1,075,341

 

 

 

 

 

 

 

 

 

 

 

Home closing gross profit

 

178,011

 

94,885

 

450,039

 

256,755

 

Land closing gross profit

 

57

 

7,160

 

528

 

8,089

 

 

 

178,068

 

102,045

 

450,567

 

264,844

 

 

 

 

 

 

 

 

 

 

 

Commissions and other sales costs

 

(39,635

)

(28,077

)

(106,975

)

(79,906

)

General and administrative expenses

 

(31,894

)

(19,822

)

(82,529

)

(52,672

)

Loss on extinguishment of debt

 

 

 

(31,477

)

 

Earnings from unconsolidated entities, net

 

3,594

 

1,841

 

10,108

 

2,046

 

Other income, net

 

2,369

 

1,525

 

6,325

 

6,489

 

 

 

 

 

 

 

 

 

 

 

Earnings before provision for income taxes

 

112,502

 

57,512

 

246,019

 

140,801

 

Provision for income taxes

 

(42,249

)

(21,912

)

(92,331

)

(53,645

)

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

70,253

 

$

35,600

 

$

153,688

 

$

87,156

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

2.57

 

$

1.38

 

$

5.72

 

$

3.33

 

Diluted

 

$

2.40

 

$

1.30

 

$

5.35

 

$

3.142.70

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares:

 

 

 

 

 

 

 

 

 

Basic

 

27,311

 

25,788

 

26,880

 

26,182

 

Diluted

 

29,217

 

27,288

 

28,748

 

27,740

 

 

See accompanying notes to condensed consolidated financial statements

 

4



 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net earnings

 

$

153,688

 

$

87,156

 

Adjustments to reconcile net earnings to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

12,752

 

8,969

 

Write-off of senior note issuance cost

 

4,977

 

 

Increase (decrease) in deferred tax liability

 

1,385

 

(239

)

Tax benefit from stock option exercises

 

9,811

 

1,701

 

Equity in earnings from unconsolidated entities

 

(10,108

)

(2,046

)

Distributions of earnings from unconsolidated entities

 

10,008

 

2,725

 

Changes in assets and liabilities, net of effect of acquisitions:

 

 

 

 

 

Increase in real estate

 

(372,474

)

(179,203

)

Increase in deposits on real estate under option or contract

 

(41,510

)

(19,202

)

Decrease (increase) in receivables and prepaid expenses and other assets

 

1,561

 

(144

)

Increase in accounts payable and accrued liabilities

 

127,793

 

46,759

 

Increase in home sale deposits

 

25,539

 

19,927

 

Net cash used in operating activities

 

(76,578

)

(33,597

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Investments in unconsolidated entities

 

(48,081

)

(21,920

)

Distributions of capital from unconsolidated entities

 

12,496

 

567

 

Cash paid for acquisitions

 

(152,425

)

(24,165

)

Cash paid for earn-out agreements

 

 

(2,791

)

Purchases of property and equipment

 

(15,480

)

(11,967

)

Proceeds from sales of property and equipment

 

488

 

 

Net cash used in investing activities

 

(203,002

)

(60,276

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from loans payable and other borrowings

 

2,250,700

 

1,368,942

 

Repayments of loans payable and other borrowings

 

(2,113,023

)

(1,357,979

)

Proceeds from issuance of senior notes, net

 

343,836

 

130,000

 

Purchase of treasury stock

 

 

(35,418

)

Payments for repurchase of senior notes

 

(285,472

)

 

Proceeds from sale of common stock, net

 

69,699

 

 

Proceeds from stock option exercises

 

6,149

 

2,869

 

Net cash provided by financing activities

 

271,889

 

108,414

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(7,691

)

14,541

 

Cash and cash equivalents at beginning of period

 

47,876

 

4,799

 

Cash and cash equivalents at end of period

 

$

40,185

 

$

19,340

 

 

See supplemental disclosures of cash flow information at Note 10.

 

See accompanying notes to condensed consolidated financial statements

 

5



 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005 AND 2004

 

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

 

                Organization.  We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and active adult homes to our targeted customer base.

 

                We operate in Texas as Legacy Homes, Monterey Homes, Meritage Homes and Hammonds Homes; in Arizona as Meritage Homes and Monterey Homes; in Florida as Meritage Homes, Colonial Homes and Greater Homes and in Northern California, Nevada and Colorado as Meritage Homes.  At September 30, 2005, we were actively selling homes in 174 communities, with base prices ranging from $102,000 to $1,000,000.

 

                Basis of Presentation.  The accompanying unaudited 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, partnerships and other entities in which we have a controlling financial interest, and variable interest entities (see Note 3) in which we are deemed the primary beneficiary (collectively, the “Company”). Intercompany balances and transactions have been eliminated in consolidation and certain previously reported amounts have been reclassified to be consistent with current financial statement presentation.  In our consolidated statement of cash flows for the nine months ended September 30, 2005, we changed the classification of distributions of income from unconsolidated entities to present such changes as an operating activity.  We previously presented such changes as an investing activity.  In the accompanying consolidated statements of cash flows for the nine months ended September 30, 2004, this reclassification resulted in a $7.6 million increase to operating cash flows and a corresponding decrease to investing cash flows from the amounts previously reported.  In our opinion, these unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly 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 audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2004.

 

                The Company designs, constructs and sells a wide range of homes designed to meet the specific needs of each of its markets.  Because each of our geographic homebuilding regions has similar economic characteristics, housing products and class of prospective buyers, the geographic homebuilding regions have been aggregated into a single homebuilding segment.

 

                Stock-Based Compensation.  At September 30, 2005, 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 currently apply the intrinsic value-based method of accounting 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 is 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, which we have adopted.  We have not issued options with exercise prices below the market value on the date of the grant; therefore, no compensation expense for our stock-based plan has been recognized.  Had compensation cost for this plan been determined pursuant to SFAS No. 123, our net earnings and earnings per common 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.

 

6



 

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

2005

 

2004 *

 

2005

 

2004 *

 

Net earnings

 

As reported

 

$

70,253

 

$

35,600

 

$

153,688

 

$

87,156

)

 

 

Deduct**

 

(2,039

)

(1,531

)

(5,464

)

(3,034

)

 

 

Pro forma

 

$

68,214

 

$

34,069

 

$

148,224

 

$

84,122

 

Basic earnings per share

 

As reported

 

$

2.57

 

$

1.38

 

$

5.72

 

$

3.33

 

 

 

Pro forma

 

$

2.50

 

$

1.32

 

$

5.51

 

$

3.22

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

As reported

 

$

2.40

 

$

1.30

 

$

5.35

 

$

3.14

 

 

 

Pro forma

 

$

2.33

 

$

1.25

 

$

5.16

 

$

3.04

 


*                     Per share amounts reflect a 2-for-1 stock split in the form of a stock dividend that occurred in January 2005.

 

**              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 nine months of 2005 and 2004 was established at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions.

 

 

 

Nine Months Ended
September 30

 

 

 

2005

 

2004

 

Expected dividend yield

 

0

%

0

%

Risk-free interest rate

 

4.41

%

4.40

%

Expected volatility

 

52

%

56

%

Expected life (in years)

 

7

 

7

 

Weighted average fair value of options

 

$

34.96

 

$

19.08

 

 

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

 

                Common Stock Repurchase.  In August 2004, the Board of Directors approved a stock buyback program authorizing the expenditure of up to $50 million to repurchase shares of our common stock.  As of September 30, 2005, we had not purchased any shares under this program.  No date for completing the program has been determined, but we may purchase shares subject to applicable securities law, and at times and in amounts as management deems appropriate.  In November 2005, we repurchased 85,000 shares at an average price of $61.87.

 

                Off-Balance Sheet Arrangements.  We often acquire finished homesites at market prices from various development entities under fixed price purchase agreements.  We consider this lot acquisition strategy, which reduces the financial requirements and risks associated with direct land ownership and land development, an important aspect of our business model.  We are subject to customary obligations associated with these purchase agreements, which typically require us to make deposits in the form of cash or letters of credit that may be forfeited if we fail to perform under the agreement.  Often, we contract to complete a project at a fixed cost on behalf of the development entity and are at risk for items over budget related to land development on property we have under contract.  As of September 30, 2005, we had entered into purchase agreements with purchase prices aggregating approximately $2.6 billion, by making deposits of approximately $174.8 million in the form of cash, most of which is non-refundable, and approximately $67.1 million in letters of credit.

 

7



 

                Occasionally, we enter into land development joint ventures.  We and/or our joint venture partners occasionally provide limited repayment guarantees on debt of certain unconsolidated entities on a pro rata share basis.  As of September 30, 2005, we had limited repayment guarantees of approximately $31.2 million.

 

                We and our joint venture partners are also typically obligated to the project lenders to complete 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 environmental indemnities to joint venture project lenders.  In some instances, these indemnities are subject to caps.  These indemnities obligate us to reimburse the project lenders only for claims related to environmental matters for which such lenders are held responsible.  As part of our project acquisition due diligence process to determine potential environmental risks, we generally obtain an independent environmental review from outside consultants.

 

                Additionally, we and our joint venture partners sometimes agree to 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 indemnify the surety.  These surety indemnity arrangements are generally joint and several obligations with our other joint venture partners.  As of September 30, 2005, we had approximately $26.4 million of surety bonds outstanding subject to these indemnity arrangements.  None of these bonds have been called to date and we believe it is unlikely that any of these bonds will be called in the future.

 

                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 September 30, 2005, we had approximately $14.0 million in outstanding letters of credit and $201.2 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.  As is customary in the homebuilding industry, we have obligations related to post-construction warranties and defect claims for homes closed.  We have established reserves for these obligations based on historical data and trends with respect to similar product types and geographic areas.  Warranty reserves are included in accrued liabilities on the accompanying consolidated balance sheets.  Additions to warranty reserves are included in cost of sales within the accompanying statement of earnings. We periodically review the adequacy of our warranty reserves, and believe they are sufficient to cover potential costs for materials and labor related to post-construction warranties and defects.  A summary of changes in our warranty reserve follow (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

Balance, beginning of period

 

$

17,218

 

$

10,361

 

$

14,967

 

$

9,253

 

Additions to reserve

 

5,420

 

2,658

 

12,622

 

7,072

 

Warranty claims and expenses

 

(2,912

)

(1,655

)

(7,863

)

(4,961

)

Balance, end of period

 

$

19,726

 

$

11,364

 

$

19,726

 

$

11,364

 

 

                Recently Issued Accounting Pronouncements.  In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), effective

 

8



 

for the first fiscal year beginning after June 15, 2005.  SFAS 123R requires that all stock-based compensation be treated as a cost that is reflected in the financial statements.  The Company is required to adopt the new standard for its fiscal year beginning January 1, 2006.  The Company is currently reviewing the effect of this statement on the Company’s consolidated financial statements.

 

 

NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST

 

Real estate consists of the following (in thousands):

 

 

 

September 30, 2005

 

December 31, 2004

 

 

 

 

 

 

 

Homes under contract under construction

 

$

887,154

 

$

492,378

 

Finished home sites and home sites under development

 

371,584

 

263,041

 

Unsold homes, completed and under construction

 

71,068

 

53,098

 

Model homes

 

35,863

 

1,294

 

Model home lease program

 

40,696

 

53,819

 

Land held for development

 

3,068

 

3,588

 

 

 

$

1,409,433

 

$

867,218

 

 

                Subject to sufficient qualifying assets, 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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Capitalized interest, beginning of period

 

$

22,029

 

$

16,807

 

$

19,701

 

$

13,074

 

Interest incurred and capitalized

 

10,358

 

10,275

 

30,197

 

27,907

 

Amortization to cost of home closings

 

(9,514

)

(7,482

)

(27,025

)

(21,381

)

Capitalized interest, end of period

 

$

22,873

 

$

19,600

 

$

22,873

 

$

19,600

 

 

 

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

 

                FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”) 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.

 

                Under 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.

 

9



 

                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 by us 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 consolidated financial statements. For each VIE created where the fair value of the land or lots under contract by us are more than half of the total fair value of the entity’s assets, 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 purchase or 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’s judgments and estimates.

 

                In most cases, creditors, if any, 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 our option deposit.  Often, we are 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.

 

10



 

                The table below presents a summary of our lots under option or contract at September 30, 2005 (dollars in thousands):

 

 

 

 

 

 

 

 

 

Option/Earnest
Money Deposits

 

 

 

# of Lots

 

Fair Value

 

Purchase Price

 

Cash

 

Letters of Credit

 

Specific performance options(1)

 

53

 

$

2,557

 

$

2,557

 

$

414

 

$

 

Options recorded on balance sheet

 

 

 

 

 

 

Total options recorded on balance sheet as real estate not owned(2)

 

53

 

2,557

 

2,557

 

414

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Option contracts not recorded on balance sheet — non-refundable deposits(2)

 

31,550

 

 

1,868,338

 

133,136

 

67,051

 

Purchase contracts not recorded on Balance sheet — non-refundable deposits(2)

 

16,503

 

 

665,843

 

38,646

 

 

Purchase contracts not recorded on Balance sheet — refundable deposits(3)

 

5,543

 

 

112,325

 

2,982

 

 

Total options not recorded on balance sheet

 

53,596

 

 

2,646,506

 

174,764

 

67,051

 

Total lots under option or contract

 

53,649

 

$

2,557

 

$

2,649,063

 

$

175,178

 

$

67,051

 


(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.

 

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.

 

 

NOTE 4 — INVESTMENTS IN UNCONSOLIDATED ENTITIES

 

                We participate in homebuilding and land development joint ventures from time to time 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.  We had equity investments of 50% or less and did not have controlling financial interests in these unconsolidated entities at September 30, 2005.  Our joint venture partners generally are other homebuilders, land sellers or other real estate investors.  We also enter into mortgage and title business joint ventures from time to time.  These unconsolidated entities follow accounting principles generally accepted in the United States of America and we share in their profits and losses generally in accordance with our ownership interests.

 

                For homebuilding and land development joint ventures, we, and in some cases our joint venture partners, usually receive an option or other similar arrangement to purchase portions of the land held by the unconsolidated joint ventures.  Option prices are generally negotiated prices that approximate market value when we enter into the option contract.  Our share of the joint venture earnings is deferred until homes are ultimately delivered by us and title passes to a homebuyer. At such time, we allocate our joint venture earnings to the land acquired by us as a reduction in the basis of the property. Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method was as follows (in thousands):

 

11



 

 

 

September 30,

 

December 31,

 

 

 

2005

 

2004

 

Assets:

 

 

 

 

 

Cash

 

$

17,296

 

$

8,689

 

Real estate

 

175,651

 

227,104

 

Other assets

 

25,300

 

13,026

 

Total assets

 

$

218,247

 

$

248,819

 

 

 

 

 

 

 

Liabilities and equity:

 

 

 

 

 

Accounts payable and other liabilities

 

$

20,743

 

$

13,284

 

Notes and mortgages payable

 

106,090

 

145,209

 

Equity of:

 

 

 

 

 

Meritage

 

41,787

 

40,785

 

Others

 

49,627

 

49,541

 

Total liabilities and equity

 

$

218,247

 

$

248,819

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

17,757

 

$

4,375

 

$

101,292

 

$

11,584

 

Costs and expenses

 

8,697

 

2,499

 

68,073

 

6,303

 

Net earnings of unconsolidated entities

 

$

9,060

 

$

1,876

 

$

33,219

 

$

5,281

 

Meritage’s share of pre-tax earnings *

 

$

3,594

 

$

1,841

 

$

11,192

 

$

2,046

 


*            Our share of net earnings includes any applicable management fees but excludes earnings related to properties acquired by us.

 

              At September 30, 2005 and December 31, 2004, our investments in unconsolidated entities includes $1.2 million and $2.9 million, respectively, related to the difference between the amounts at which our investments are carried and the amount of underlying equity in net assets.  These amounts are amortized to equity of earnings of unconsolidated entities over the lives of the respective joint ventures, which offsets their related earnings.  During the three months ended September 30, 2005, no amortization was recorded as no earnings activities related to these joint ventures took place during the period. Amortization was $1.1 million for the nine months ended September 30, 2005.  There was no amortization recorded in 2004.

 

              In addition to joint ventures accounted for under the equity method summarized in the above table, at September 30, 2005, and December 31, 2004, our investments in unconsolidated entities included joint ventures recorded under the cost method.  These joint ventures were formed to obtain large parcels of land, to perform off-site development work and to sell lots to the joint venture members.  As of September 30, 2005, and December 31, 2004, our investments in unconsolidated entities recorded under the cost method were $14.6 and $7.2 million, respectively. As of September 30, 2005, we have not recorded any income or distributions from these joint ventures.

 

12



 

NOTE 5 — LOANS PAYABLE AND OTHER BORROWINGS

 

Loans payable consist of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2005

 

2004

 

$400 million unsecured revolving credit facility maturing May 2009 with extension provisions, and interest payable monthly approximating LIBOR plus 2.0% or prime. The rates ranged from 6.04% to 6.75% at September 30, 2005.

 

$

151,400

 

$

 

 

 

 

 

 

 

Model home lease program, with interest in the form of lease payments payable monthly approximating LIBOR (approximately 4.04% at September 30, 2005) plus 2.5%

 

40,696

 

53,819

 

 

 

 

 

 

 

Acquisition and development seller carry back financing, paid in full in 2005

 

 

600

 

 

 

 

 

 

 

Total loans payable and other borrowings

 

$

192,096

 

$

54,419

 

 

                During January 2005 we determined that the construction costs and related debt associated with model homes which are owned and leased to us by others and that we use to market our communities are required to be included on our balance sheets.  We do not legally own the model 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.  Although we have no legal obligation to repay any amounts received from the third-party owner, such amounts are recorded as debt and are typically deemed repaid when we simultaneously exercise our option to purchase the model home and sell such model home to a third-party home buyer.  Should we elect not to exercise our rights to purchase these model homes, the model home costs and related debt under the model lease program will be eliminated upon the termination of the lease, which is generally between one and three years from the origination of the lease.

 

                Our revolving credit facility contains covenants which require maintenance of certain levels of tangible net worth and compliance with certain minimum financial ratios, place limitations 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 quarter ended September 30, 2005, we were in compliance with these covenants.  After considering our most restrictive bank covenants, our borrowing availability under the revolving credit facility was approximately $167.5 million at September 30, 2005 as determined by borrowing base limitations defined by our agreement with the lending banks.  The revolving credit facility restricts our ability to pay dividends, and at September 30, 2005, our maximum permitted amount available to pay dividends was approximately $108.5 million.

 

 

NOTE 6 — SENIOR NOTES

 

                In April 2004 we issued $130 million in aggregate principal amount of our 7% senior notes due 2014.  The notes were priced to us at a slight premium implying an interest rate to us of 6.99%.  At September 30, 2005 and December 31, 2004, these notes totaled approximately $130.1 million, including unamortized premium of approximately $0.1 million.

 

                In March 2005 we completed the private placement of $350 million in aggregate principal amount of our 6.25% senior notes due 2015 which resulted in net proceeds to the Company, after commissions, discounts and fees, of approximately $343.8 million.  At September 30, 2005, our outstanding 6.25% senior notes due 2015 totaled approximately $348.4 million, which includes unamortized discounts of approximately $1.6 million.

 

13



 

                During the first quarter of 2005, we used the proceeds from the issuance of the 6.25% senior notes to repurchase pursuant to a tender offer and consent solicitation approximately $276.8 million of our outstanding 9.75% senior notes due 2011 and to pay down our bank credit facility.  The balance of these notes outstanding at December 31, 2004 was $286.9 million, including $6.9 million of unamortized premium.  In connection with this tender offer and repurchase, we recorded a one-time pre-tax charge of approximately $31.3 million for premiums, commissions and expenses associated with the tender offer and the write-off of existing offering costs associated with the 9.75% senior notes, net of the accretion of existing note premiums on the 9.75% senior notes and taxes.  During the second quarter of 2005, we subsequently repurchased $2.0 million of our outstanding 9.75% senior notes and incurred a pre-tax charge of $0.2 million for premiums, commissions and expenses.  Approximately $1.2 million in aggregate principal amount of the 9.75% senior notes remained outstanding at September 30, 2005.

 

                Our senior notes contain covenants which require maintenance of certain levels of tangible net worth and compliance with certain minimum financial ratios, place limitations 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 quarter ended September 30, 2005, we were in compliance with these covenants.

 

                Obligations to pay principal and interest on the bank credit facility and senior notes are guaranteed by all of our subsidiaries (collectively, the Guarantor Subsidiaries), each of which is directly or indirectly 100% owned by Meritage Homes Corporation, other than certain minor subsidiaries (collectively, Non-Guarantor Subsidiaries).  Such guarantees are full and unconditional, and joint and several.  Separate financial statements of the Guarantor Subsidiaries are not provided because Meritage (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 7 — ACQUISITIONS, GOODWILL AND INTANGIBLES

 

                Greater Homes Acquisition.  In September 2005 we purchased all of the outstanding stock of Greater Homes, Inc. (“Greater Homes”), a builder of single-family and vacation homes in Orlando, Florida.  The purchase price was approximately $86.2 million in cash, including the repayment of existing debt of approximately $27.7 million.  The results of Greater Homes’ operations have been included in our financial statements since September 1, 2005, the effective date of the acquisition.  We also assumed accounts payable, accrued liabilities and home sale deposits of approximately $15.9 million.  In addition, we agreed to a bonus pay-out for certain key Greater Homes employees, which is contingent upon their fulfillment of certain employment obligations.  The bonus pay-out is equal to 20% of the pre-tax profits of Greater Homes, less a capital charge, payable in cash over three years, with the total payments restricted to a maximum of $16.0 million.  Assets and liabilities were recorded at their estimated fair market value at the date of acquisition, and are subject to change when the Company finalizes its analysis.

 

                 Colonial Homes Acquisition.  In February 2005, we purchased the homebuilding and related assets of Colonial Homes of Florida (“Colonial Homes”), which operates primarily in the Ft. Myers/Naples area.  The purchase price was approximately $66.2 million in cash.   The results of Colonial Homes operations have been included in our consolidated financial statements as of the effective date of acquisition, February 1, 2005.

 

                Goodwill and Intangibles.  Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the assets acquired.  The acquisitions of Colonial Homes and Greater Homes were recorded using the purchase method of accounting.  The purchase price for each was allocated based on estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition.  The excess purchase price over the

 

14



 

fair value of the net assets acquired of $22.1 and $9.5 million for Colonial Homes and Greater Homes, respectively, was recorded as goodwill.

 

                The changes in the carrying amount of goodwill for the nine months ended September 30, 2005, follow (in thousands):

 

Balance at December 31, 2004

 

$

91,475

 

Goodwill acquired — Colonial Homes

 

22,111

 

Goodwill acquired — Greater Homes

 

9,545

 

Increase due to earn-out agreements

 

1,476

 

Purchase accounting adjustments

 

(545

)

Balance at September 30, 2005

 

$

124,062

 

 

                Under the guidelines contained in SFAS No. 142, “Goodwill and Other Intangible Assets,” in the first quarter of 2005 management performed its annual assessment of goodwill and determined that no impairment existed.

 

                Intangible assets consist primarily of non-compete agreements, tradenames and floor plan designs acquired in connection with our February 1, 2005 acquisition of Colonial Homes and our September 1, 2005 acquisition of Greater Homes.  These intangible assets were valued at the acquisition dates utilizing accepted valuation procedures.  The non-compete agreements, tradenames and floor plan designs are being amortized over their estimated useful lives.  The acquired cost and accumulated amortization of our intangible assets was $11.5 million and $1.0 million, respectively, at September 30, 2005.  Amortization expense for the quarter ended September 30, 2005 was $0.5 million, and is expected to be approximately $0.9 million in the fourth quarter of 2005, $2.9 million in 2006 and $2.8, $2.3 and $1.1 million per year in 2007, 2008 and 2009, respectively.

 

 

NOTE 8 — EARNINGS PER SHARE

 

Basic and diluted earnings per share for the three and nine months ended September 30, 2005 and 2004 were calculated as follows (in thousands, except per share amounts):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004 *

 

2005

 

2004 *

 

 

 

 

 

 

 

 

 

 

 

Basic average number of shares outstanding

 

27,311

 

25,788

 

26,880

 

26,182

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Options to acquire common stock

 

1,906

 

1,500

 

1,868

 

1,558

 

 

 

 

 

 

 

 

 

 

 

Diluted average shares outstanding

 

29,217

 

27,288

 

28,748

 

27,740

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

70,253

 

$

35,600

 

$

153,688

 

$

87,156

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

2.57

 

$

1.38

 

$

5.72

 

$

3.33

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

2.40

 

$

1.30

 

$

5.35

 

$

3.14

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

36

 

 


                * Amounts reflect a 2-for-1 stock split in the form of a stock dividend that occurred in January 2005.

 

 

NOTE 9 — INCOME TAXES

 

15



 

                Components of the provision for income taxes for the three and nine months ended September 30, 2005 and 2004 are (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Federal

 

$

36,440

 

$

19,410

 

$

79,833

 

$

47,520

 

State

 

5,809

 

2,502

 

12,498

 

6,125

 

Total

 

$

42,249

 

$

21,912

 

$

92,331

 

$

53,645

 

 

 

NOTE 10 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

                The January 2004 acquisition of Citation Homes, the February 2005 acquisition of Colonial Homes and the September 2005 acquisition of Greater Homes resulted in the following changes in assets and liabilities during the first nine months of 2005 and 2004 (in thousands):

 

 

 

2005

 

2004

 

Increase in real estate

 

$

(140,538

)

$

(12,036

)

Increase in deposits on real estate under option or contract

 

(5,170

)

(1,870

)

Increase in receivables and other assets

 

(7,640

)

(747

)

Increase in goodwill

 

(31,656

)

(11,214

)

Increase in intangibles

 

(11,493

)

 

Increase in property and equipment

 

(826

)

(89

)

Increase in accounts payable and accrued liabilities

 

12,172

 

1,704

 

Increase in home sale deposits

 

12,809

 

87

 

Increase in deferred tax liability

 

19,917

 

 

 

 

 

 

 

 

Net cash paid for acquisition

 

$

(152,425

)

$

(24,165

)

 

 

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

27,311

 

$

16,653

 

Income taxes

 

$

60,201

 

$

49,246

 

 

 

 

 

 

 

Non-cash distributions from unconsolidated entities

 

$

29,291

 

$

4,854

 

 

16


 


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 statements other than of historical fact are within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements may include, but are not limited to, statements concerning 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 operations and growth strategy; the impact of new accounting standards; the likelihood that performance or surety bonds will be called; the sufficiency of our warranty reserves and our ability to continue positive operative results in light of current economic and political conditions, as well as assumptions related 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 and in our Annual Report on Form 10-K for the year ended December 31, 2004, 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

 

              We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and active adult homes to our targeted customer base.  We and our predecessors have operated in Arizona since 1985, in Texas since 1987 and in Northern California since 1989.  We entered the move-up market in the Las Vegas, Nevada area in 2002 with our acquisition of Perma-Bilt Homes and the Inland Empire region of the greater Los Angeles area in January 2004 with our acquisition of Citation Homes of Southern California.  We began start-up operations in the Denver, Colorado and Orlando, Florida markets in 2004, and in Reno, Nevada in March 2005.  We acquired Colonial Homes, a homebuilder that serves the Ft. Myers/Naples, Florida market, in February 2005, and in September 2005 we strengthened our position in the Orlando, Florida market with our acquisition of Greater Homes, Inc.  We now have a presence in 14 dynamic housing markets in the Western and Southern regions of the country.  We operate in these states, predominantly in one industry, homebuilding, and thus have only one single reportable segment.

 

              Total home closing revenue was $753.5 million for the three months ended September 30, 2005, increasing $290.8 million, or 63% from $462.7 million for the same period last year.  Net earnings for the third quarter of 2005 increased $34.7 million, or 97%, to $70.3 million from $35.6 million in the same quarter of 2004.

 

              These results reflect our very strong first nine months of 2005. Through September 30, 2005, we benefited in most of our markets from strong order demand and strong pricing power, which resulted in record orders, closings and backlog. Our ability to obtain price increases, which have exceeded increases in land and construction costs, resulted in our gross margin for the first nine months of fiscal 2005, increasing to 23.01% from 19.49% in the comparable period a year ago.

 

              At September 30, 2005, we had a record backlog of 7,536 homes with a value of approximately $2.5 billion. This backlog gives us good visibility into our anticipated results over the next few quarters. The homebuilding industry as a whole has generally benefited over the last few years from strong demand and strong pricing power. Because of the extended time period required to construct homes, i.e., from the contracting of raw land through the entitlement process to the construction of homes, strong pricing power has a favorable impact on homebuilders’ gross margins because the underlying land (a significant component of the cost of a home) was contracted for several years earlier in a lower price environment. Thus, we believe, based on our significant backlog, that in the near term we will be able to continue to achieve strong gross margins, unless we experience an unusually high number of order cancellations or construction costs increase significantly. In the mid- to longer-term, however, a slowing or decline in home sales prices could have an adverse effect on our gross margins because the land relating to homes sold in the longer term future will generally have been contracted for in a comparatively higher price environment. In addition, our gross margins could be adversely impacted if home price increases do not keep pace with construction cost increases.

 

              We increased the dollar value of home orders in the third quarter by 51% to $971 million, and for the first nine months of fiscal 2005 we increased the dollar value of home orders by 48% to $2.9 billion. We are aware of investor concerns about demand trends. Overall, our sales orders in 2005 have been strong and we believe that most of our markets continue to be strong. We have noticed a slowdown in October 2005 in our Northern California market with respect to orders and sales prices and an increase in the number of cancellations and it is our expectation that price appreciation in some of our other more robust markets will moderate. Nevertheless, we remain optimistic about the future and we continue to believe that we are offering the right product at the right price and in the right locations.

 

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, 2004.  Certain of these policies involve significant judgments, assumptions and estimates by management that have a material impact on revenues and costs and on the carrying value of certain assets and liabilities.  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

 

17



 

assumptions on an on-going basis. Because of the nature of the judgments and assumptions we have made, actual results may differ from these judgments and estimates, which could have a material impact on our results of operations and on the carrying values of assets and liabilities.

 

              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 complying with 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 implementation 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 consolidated unaudited financial statements for the three and nine months ended September 30, 2005 and 2004.  All material balances and transactions between us and our subsidiaries have been eliminated.  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.  The results of operations for any interim period are not necessarily indicative of results expected for a full fiscal year.

 

Home Closing Revenue, Home Orders and Order Backlog

 

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

 

18



 

 

 

Three Months Ended
September 30,

 

%

 

Nine Months Ended
September 30,

 

%

 

Home Closing Revenue

 

2005

 

2004

 

Change

 

2005

 

2004

 

Change

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

753,505

 

$

462,711

 

63

%

$

1,956,235

 

$

1,317,488

 

48

%

Homes closed

 

2,310

 

1,671

 

38

%

6,192

 

4,860

 

27

%

Average sales price

 

$

326.2

 

$

276.9

 

18

%

$

315.9

 

$

271.1

 

17

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Texas

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

197,926

 

$

152,060

 

30

%

$

538,110

 

$

469,709

 

15

%

Homes closed

 

879

 

700

 

26

%

2,452

 

2,171

 

13

%

Average sales price

 

$

225.2

 

$

217.2

 

4

%

$

219.5

 

$

216.4

 

1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Arizona

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

213,975

 

$

127,516

 

68

%

$

562,038

 

$

340,983

 

65

%

Homes closed

 

765

 

560

 

37

%

2,109

 

1,414

 

49

%

Average sales price

 

$

279.7

 

$

227.7

 

23

%

$

266.5

 

$

241.1

 

11

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

244,703

 

$

166,819

 

47

%

$

667,602

 

$

421,529

 

58

%

Homes closed

 

406

 

367

 

11

%

1,130

 

968

 

17

%

Average sales price

 

$

602.7

 

$

454.5

 

33

%

$

590.8

 

$

435.5

 

36

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nevada

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

52,980

 

$

16,316

 

225

%

$

109,662

 

$

85,267

 

29

%

Homes closed

 

138

 

44

 

214

%

292

 

307

 

(5

)%

Average sales price

 

$

383.9

 

$

370.8

 

4

%

$

375.6

 

$

277.7

 

35

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Florida *

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

43,921

 

n/a

 

n/a

 

$

78,823

 

n/a

 

n/a

 

Homes closed

 

122

 

n/a

 

n/a

 

209

 

n/a

 

n/a

 

Average sales price

 

$

360.0

 

n/a

 

n/a

 

$

377.1

 

n/a

 

n/a

 


*         The number and dollar amount of homes closed include the effect of the Colonial Homes and Greater Homes acquisitions in February and September 2005, respectively.

 

19



 

 

 

Three Months Ended
September 30,

 

%

 

Nine Months Ended
September 30,

 

%

 

Home Orders

 

2005

 

2004

 

Change

 

2005

 

2004

 

Change

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

970,535

 

$

642,923

 

51

%

$

2,857,492

 

$

1,935,064

 

48

%

Homes ordered

 

2,929

 

2,203

 

33

%

8,499

 

6,952

 

22

%

Average sales price

 

$

331.4

 

$

291.8

 

14

%

$

336.2

 

$

278.3

 

21

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Texas

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

304,346

 

$

173,816

 

75

%

$

760,437

 

$

593,729

 

28

%

Homes ordered

 

1,318

 

805

 

64

%

3,358

 

2,774

 

21

%

Average sales price

 

$

230.9

 

$

215.9

 

7

%

$

226.5

 

$

214.0

 

6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Arizona

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

328,379

 

$

219,349

 

50

%

$

914,374

 

$

689,741

 

33

%

Homes ordered

 

954

 

914

 

4

%

2,852

 

2,777

 

3

%

Average sales price

 

$

344.2

 

$

240.0

 

43

%

$

320.6

 

$

248.4

 

29

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

236,709

 

$

215,685

 

10

%

$

844,942

 

$

561,241

 

51

%

Homes ordered

 

400

 

391

 

2

%

1,437

 

1,143

 

26

%

Average sales price

 

$

591.8

 

$

551.6

 

7

%

$

588.0

 

$

491.0

 

20

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nevada

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

66,791

 

$

34,073

 

96

%

$

194,435

 

$

90,353

 

115

%

Homes ordered

 

165

 

93

 

77

%

515

 

258

 

100

%

Average sales price

 

$

404.8

 

$

366.4

 

10

%

$

377.5

 

$

350.2

 

8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Florida

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

23,262

 

n/a

 

n/a

 

$

129,234

 

n/a

 

n/a

 

Homes ordered

 

61

 

n/a

 

n/a

 

298

 

n/a

 

n/a

 

Average sales price

 

$

381.3

 

n/a

 

n/a

 

$

433.7

 

n/a

 

n/a

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Colorado

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollars

 

$

11,048

 

n/a

 

n/a

 

$

14,070

 

n/a

 

n/a

 

Homes ordered

 

31

 

n/a

 

n/a

 

39

 

n/a

 

n/a

 

Average sales price

 

$

356.4

 

n/a

 

n/a

 

$

360.8

 

n/a

 

n/a

 

 

20



 

 

 

At September 30,

 

%

 

Order Backlog

 

2005

 

2004

 

Change

 

Total

 

 

 

 

 

 

 

Dollars

 

$

2,498,948

 

$

1,349,321

 

85

%

Homes in backlog

 

7,536

 

4,747

 

59

%

Average sales price

 

$

331.6

 

$

284.2

 

17

%

 

 

 

 

 

 

 

 

Texas

 

 

 

 

 

 

 

Dollars

 

$

535,417

 

$

365,439

 

47

%

Homes in backlog

 

2,391

 

1,722

 

39

%

Average sales price

 

$

223.9

 

$

212.2

 

6

%

 

 

 

 

 

 

 

 

Arizona

 

 

 

 

 

 

 

Dollars

 

$

889,723

 

$

587,117

 

52

%

Homes in backlog

 

2,734

 

2,195

 

25

%

Average sales price

 

$

325.4

 

$

267.5

 

22

%

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

Dollars

 

$

568,611

 

$

338,041

 

68

%

Homes in backlog

 

1,002

 

655

 

53

%

Average sales price

 

$

567.5

 

$

516.1

 

10

%

 

 

 

 

 

 

 

 

Nevada

 

 

 

 

 

 

 

Dollars

 

$

163,976

 

$

58,724

 

179

%

Homes in backlog

 

460

 

175

 

163

%

Average sales price

 

$

356.5

 

$

335.6

 

6

%

 

 

 

 

 

 

 

 

Florida *

 

 

 

 

 

 

 

Dollars

 

$

327,151

 

n/a

 

n/a

 

Homes in backlog

 

910

 

n/a

 

n/a

 

Average sales price

 

$

359.5

 

n/a

 

n/a

 

 

 

 

 

 

 

 

 

Colorado

 

 

 

 

 

 

 

Dollars

 

$

14,070

 

n/a

 

n/a

 

Homes in backlog

 

39

 

n/a

 

n/a

 

Average sales price

 

$

360.8

 

n/a

 

n/a

 


*         The number and dollar amount of homes in backlog include the effect of the Colonial Homes and Greater Homes acquisitions in February and September 2005, respectively.

 

 

Home Closing Revenue.

 

Home closing revenue for the quarter ended September 30, 2005 increased 63% to $753.5 million compared to the same period a year ago, the result of a 38% increase in the number of homes closed to 2,310 and an 18% increase in the average selling price of those homes to approximately $326,200.  The increase in average selling price was attributable in part to deliveries in Florida and increased deliveries in Las Vegas, where the average price of homes closed exceeded the company average.  In the very competitive Texas housing market, home closing revenue and the number of homes closed for the third quarter were up 30% and 26%, respectively, though some deliveries were delayed to the fourth quarter in Houston due to Hurricane Rita.  Our Arizona and California markets show continued strength as evidenced by a 68% increase in home closing revenue in Arizona and a 47% increase in California during the third quarter 2005, compared to the same period a year ago.  Home closing revenue and the number of homes closed during the third quarter 2005 increased significantly compared to the same period a year ago in Nevada, which can be attributed to the

 

21



 

tripling of active communities from two to six.  These results are despite some delays in receiving electric hookups from the municipal government, which has pushed some closings from the third to the fourth quarter.  In Florida, we closed 122 homes in the third quarter of 2005 generating $43.9 million in home closing revenue.  Our Florida closings are primarily attributable to Colonial Homes, which we acquired in February 2005 and Greater Homes, which we acquired in September 2005.  In addition, we closed our first homes in Orlando under the Meritage brand name as part of our start-up division.  The demand for our homes in all of our markets continues to be healthy, and we believe this is supported by demographics in our markets as well as the desirability of the markets we are in.

 

Home Orders.

 

Home orders for any period represent the aggregate sales price of all homes ordered by customers, net of cancellations.  We do not include orders contingent upon the sale of a customer’s existing home as a sales contract until the contingency is removed.  Historically, we have experienced a cancellation rate of less than 25% of the gross sales, which we believe is consistent with industry norms.  Overall, demand for our homes remains quite strong, with the number of home orders increasing 33% in the third quarter of 2005 to 2,929 from 2,203 compared to the same period a year ago, producing an increase of 51% in the dollar value of homes ordered to $970.5 million.  During the third quarter of 2005, home orders increased 64% in the very competitive Texas market and the dollar value of those orders rose 75% reflecting increased job growth and the expansion of our product line to focus not only on move-up homes but also on the entry-level and semi-custom luxury markets.  In Arizona, we continue to have pricing power due to strong demand and we are still limiting sales in some of our communities in order to align sales with production capacity.  The dollar value of orders taken in Arizona increased 50% on a 4% increase in the number of homes ordered in the third quarter 2005 compared to same period a year earlier.  We experienced a short-term delay in home orders in California in the third quarter 2005 due to the closing out of some communities earlier than we had anticipated, although we did increase the dollar value of homes ordered by 10% compared to the third quarter of 2004.  In Nevada, home orders rose 77% during the third quarter of 2005, primarily due to the active communities increasing from two to six.  As a result, the dollar value of sales orders increased 96% to $66.8 million compared to the same period a year ago.  In our start-up operation in Colorado, we took 31 home orders with a dollar value of $11.0 million in the third quarter of 2005.  With a larger percentage of home orders coming from Florida and Nevada, which have higher average selling prices than the company as a whole, the average selling price for our homes increased 14% over the third quarter 2004 to $331,400 in the third quarter 2005.

 

Order Backlog.

 

Our backlog represents net sales contracts that have not yet closed.  We began 2005 with a very strong backlog and with a robust first nine months of sales orders in 2005, our backlog at September 30, 2005 was $2.5 billion, an increase of 85% compared to the same time a year ago.  The number of homes in backlog increased 59% compared to 4,747 at September 30, 2004.  This increase in backlog is primarily due to the strong order demand along with pricing power we have in many of our markets.  Demand for our homes is strong in Texas due in large part to our product line expansion there, which is illustrated by the fact that the number of homes in backlog is up 39% compared to the same period a year ago.  The dollar value of our Nevada, California and Arizona order backlog increased 179%, 68% and 52%, respectively, from the same period a year ago due to positive demographic factors, strong housing demand and an increase in the number of actively selling communities.  The February 2005 acquisition of Colonial Homes and our September 2005 acquisition of Greater Homes, combined with our start-up operation in Orlando, we produced a backlog in Florida of 910 homes valued at $327.2 million at September 30, 2005.  We had 174 actively selling communities at the end of the third quarter 2005, an increase of 29% compared to September 30, 2004.

 

22



 

Other Operating Information (dollars in thousands)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

Home Closing Gross Profit

 

 

 

 

 

 

 

 

 

Dollars

 

$

178,011

 

$

94,885

 

$

450,039

 

$

256,755

 

Percent of home closing revenue

 

23.62

%

20.51

%

23.01

%

19.49

%

 

 

 

 

 

 

 

 

 

 

Commissions and Other Sales Costs

 

 

 

 

 

 

 

 

 

Dollars

 

$

39,635

 

$

28,077

 

$

106,975

 

$

79,906

 

Percent of home closing revenue

 

5.26

%

6.07

%

5.47

%

6.07

%

 

 

 

 

 

 

 

 

 

 

General and Administrative Costs

 

 

 

 

 

 

 

 

 

Dollars

 

$

31,894

 

$

19,822

 

$

82,529

 

$

52,672

 

Percent of total revenue

 

4.22

%

4.11

%

4.21

%

3.93

%

 

 

 

 

 

 

 

 

 

 

Income Taxes

 

 

 

 

 

 

 

 

 

Dollars

 

$

42,249

 

$

21,912

 

$

92,331

 

$

53,645

 

Percent of earnings before income taxes

 

37.55

%

38.10

%

37.53

%

38.10

%

 

 

Home Closing Gross Profit.

 

        For the three and nine months ended September 30, 2005, our home closing gross margin increased to 23.62% and 23.01%, respectively, compared to the same periods a year ago.  This increase was primarily a result of pricing power in many of our strong western markets, and our ability to effectively manage our construction and land costs.

 

Commissions and Other Sales Costs.

 

        For the three and nine months ended September 30, 2005, our commissions and other sales costs as a percent of home closing revenue decreased to 5.26% and 5.47%, respectively, primarily due to our strong housing markets, which has somewhat reduced the involvement of external real estate agents to whom we pay higher commissions than our internal sales force.

 

General and Administrative Costs.

 

        General and administrative expenses represent corporate and divisional overhead expenses such as salaries and bonuses, occupancy, insurance and travel expenses.  General and administrative costs as a percent of total revenue remained relatively consistent for the three months ended September 30, 2005, compared to the same period a year ago.  For the nine-month period ended September 30, 2005, general and administrative costs increased as a percentage of total revenue primarily due to our start-up operations in Reno, Denver and Orlando, combined with additional overhead costs across the Company to support recent and future growth.

 

Income Taxes.

 

        The decrease in the effective tax rate to 37.55% for the third quarter ended September 30, 2005 from 38.10% in the prior year’s third quarter is primarily attributable to a tax benefit from the enactment of Internal Revenue Code Section 199, which provides for a deduction for domestic production activities.  This decrease was partially offset by higher state income tax rates due to increased activity in Florida.

 

23



 

Loss on Extinguishment of Debt

 

        During the first quarter of 2005, we used the proceeds from the issuance of $350 million in aggregate principal amount of 6.25% senior notes due 2015 to repurchase approximately $276.8 million of our 9.75% senior notes due 2011.  In connection with this tender offer and repurchase, we incurred a one-time pre-tax charge of $31.3 million for premiums, commissions and expenses associated with the tender offer, net of accretion of existing premiums on the 9.75% senior notes.  During the second quarter of 2005, we subsequently repurchased $2.0 million of our outstanding 9.75% senior notes and incurred a pre-tax charge of $0.2 million for premiums, commissions and expenses.  Approximately $1.2 million in aggregate principal amount of the 9.75% senior notes remained outstanding at September 30, 2005.

 

Liquidity and Capital Resources

 

        Our principal uses of capital for the nine months ended September 30, 2005 were operating expenses, land and property purchases, lot development, home construction, income taxes, investments in joint ventures, the payment of various liabilities and the acquisition of Colonial Homes and Greater Homes.  We use a combination of borrowings and funds generated by operations to meet our short-term working capital requirements.

 

        Cash flows for each of our communities depend on the status of the development cycle, and can differ substantially from reported earnings.  Early stages of development or expansion require significant cash outlays for land acquisitions, plat and other approvals, and construction of model homes, roads, utilities, general landscaping and other amenities.  Because these costs are capitalized, income reported for financial statement purposes during those early stages may significantly exceed cash flow.  In the later stages of development, future cash flows may significantly exceed earnings reported for financial statement purposes, as cost of closings includes charges for substantial amounts of previously expended costs.

 

        We enter into various options and purchase contracts for land in the normal course of business.  Except for our specific performance options, none of these agreements require us to purchase lots.  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.  The pre-established number is typically structured to approximate our expected rate of home construction starts.  At September 30, 2005, our total option and purchase contracts had purchase prices in the aggregate of approximately $2.6 billion, on which we had made deposits of approximately $174.8 million in cash along with approximately $67.1 million in letters of credit.  Additional information regarding our purchase agreements and related deposits is presented in Note 3 — Variable Interest Entities and Consolidated Real Estate Not Owned in the accompanying consolidated financial statements.

 

        At September 30, 2005 there was approximately $151.4 million outstanding under our senior unsecured revolving credit facility and approximately $81.1 million was outstanding in letters of credit that collateralize our obligations under various land purchase, land development and other contracts.  After considering our most restrictive bank covenants and borrowing base limitations, the remaining balance of the bank credit facility (approximately $167.5 million) is available for us to borrow.

 

        At September 30, 2005, our outstanding 9.75% senior notes due 2011 totaled approximately $1.2 million, our outstanding 7% senior notes due 2014 totaled approximately $130.1 million, which includes unamortized premiums of approximately $0.1 million, and our outstanding 6.25% senior notes due 2015 totaled approximately $348.4 million, which includes unamortized discounts of approximately $1.6 million.

 

        We believe that our current borrowing capacity, cash on hand and anticipated net cash flows from operations are and will be sufficient to meet liquidity needs for the foreseeable future.  We believe our future cash needs will include funds for the completion of projects that are underway, the acquisition of land and property for new projects, the maintenance of our day-to-day operations, and the acquisition or start-up of additional homebuilding operations, should the opportunities arise.  There is no assurance, however, that future cash flows will be sufficient to meet future capital needs.  The amount and types of indebtedness that we incur

 

24



 

may be limited by the terms of the indentures governing our senior notes and by the terms of the credit agreement governing our senior unsecured credit facility.

 

Off-Balance Sheet Arrangements

 

Reference is made to Notes 1, 3 and 4 in the accompanying Notes to consolidated financial statements included in this Form 10-Q.  These notes discuss our off-balance sheet arrangements