UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2007

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.)

 

 

 

17851 North 85th Street, Suite 300

 

 

Scottsdale, Arizona

 

85255

(Address of Principal Executive Offices)

 

(Zip Code)

 

(480) 515-8100

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated Filer x

 

Accelerated Filer o

 

Non-Accelerated Filer o

 

Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

Common shares outstanding as of August 6, 2007: 26,249,296.

 




MERITAGE HOMES CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2007

TABLE OF CONTENTS

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of June 30, 2007 (unaudited) and December 31, 2006

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2007 and 2006

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006

 

 

 

 

 

 

 

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 1A.

Risk Factors

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

 

 

Item 3.

Not Applicable

 

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

 

Item 5.

Other Information

 

 

 

 

 

 

Item 6.

Exhibits

 

 

 

 

 

SIGNATURES

 

 

 

 

 

INDEX OF EXHIBITS

 

 




PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

 

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(unaudited)

 

 

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

51,678

 

$

56,710

 

Receivables

 

73,201

 

68,725

 

Real estate

 

1,619,705

 

1,530,602

 

Real estate not owned

 

29,581

 

5,269

 

Deposits on real estate under option or contract

 

126,095

 

167,132

 

Investments in unconsolidated entities

 

95,880

 

114,250

 

Property and equipment, net

 

39,655

 

40,712

 

Deferred tax asset, net

 

61,422

 

28,119

 

Goodwill

 

102,585

 

129,659

 

Intangibles, net

 

8,049

 

9,492

 

Prepaid expenses and other assets

 

21,744

 

19,855

 

 

 

 

 

 

 

Total assets

 

$

2,229,595

 

$

2,170,525

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable

 

$

85,254

 

$

117,443

 

Accrued liabilities

 

213,066

 

266,683

 

Home sale deposits

 

35,807

 

42,022

 

Liabilities related to real estate not owned

 

23,201

 

4,269

 

Loans payable and other borrowings

 

274,611

 

254,640

 

Senior and senior subordinated notes

 

628,719

 

478,636

 

 

 

 

 

 

 

Total liabilities

 

1,260,658

 

1,163,693

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Common stock, par value $0.01. Authorized 125,000,000 shares; issued and outstanding 34,140,364 and 34,035,084 shares at June 30, 2007 and December 31, 2006, respectively

 

341

 

340

 

Additional paid-in capital

 

339,178

 

332,652

 

Retained earnings

 

818,180

 

862,602

 

Treasury stock at cost 7,891,068 shares

 

(188,762

)

(188,762

)

 

 

 

 

 

 

Total stockholders’ equity

 

968,937

 

1,006,832

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

2,229,595

 

$

2,170,525

 

See accompanying notes to condensed consolidated financial statements

3




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

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Home closing revenue

 

$

567,748

 

$

902,851

 

$

1,143,863

 

$

1,749,225

 

Land closing revenue

 

919

 

11,809

 

2,254

 

12,706

 

Total closing revenue

 

568,667

 

914,660

 

1,146,117

 

1,761,931

 

 

 

 

 

 

 

 

 

 

 

Cost of home closings

 

(558,160

)

(683,384

)

(1,044,124

)

(1,315,695

)

Cost of land closings

 

(748

)

(10,658

)

(1,894

)

(11,577

)

Total cost of closings

 

(558,908

)

(694,042

)

(1,046,018

)

(1,327,272

)

 

 

 

 

 

 

 

 

 

 

Home closing gross profit

 

9,588

 

219,467

 

99,739

 

433,530

 

Land closing gross profit

 

171

 

1,151

 

360

 

1,129

 

Total closing gross profit

 

9,759

 

220,618

 

100,099

 

434,659

 

 

 

 

 

 

 

 

 

 

 

Commissions and other sales costs

 

(48,067

)

(52,849

)

(95,405

)

(100,876

)

General and administrative expenses

 

(56,366

)

(51,344

)

(83,029

)

(94,066

)

Earnings from unconsolidated entities, net

 

1,800

 

5,251

 

4,946

 

10,839

 

Interest expense and other income, net

 

3,670

 

3,474

 

6,803

 

5,385

 

 

 

 

 

 

 

 

 

 

 

(Loss) earnings before (benefit) provision for income taxes

 

(89,204

)

125,150

 

(66,586

)

255,941

 

(Benefit) provision for income taxes

 

32,628

 

(48,095

)

25,126

 

(99,150

)

 

 

 

 

 

 

 

 

 

 

Net (loss) earnings

 

$

(56,576

)

$

77,055

 

$

(41,460

)

$

156,791

 

 

 

 

 

 

 

 

 

 

 

(Loss) earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(2.16

)

$

2.90

 

$

(1.58

)

$

5.85

 

Diluted

 

$

(2.16

)

$

2.82

 

$

(1.58

)

$

5.68

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares:

 

 

 

 

 

 

 

 

 

Basic

 

26,232

 

26,609

 

26,199

 

26,792

 

Diluted

 

26,232

 

27,362

 

26,199

 

27,619

 

See accompanying notes to condensed consolidated financial statements

4




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

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) earnings

 

$

(41,460

)

$

156,791

 

Adjustments to reconcile net (loss) earnings to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

9,044

 

10,177

 

Real estate related impairments

 

98,139

 

7,295

 

Goodwill-related impairments

 

27,952

 

 

Increase in deferred taxes

 

(32,503

)

(2,013

)

Stock-based compensation

 

4,222

 

7,329

 

Excess income tax benefit from stock-based awards

 

(346

)

(10,121

)

Equity in earnings from unconsolidated entities, includes $1,120 of impairments to joint venture investments in 2007

 

(4,946

)

(10,839

)

Distributions of earnings from unconsolidated entities

 

8,768

 

7,836

 

Changes in assets and liabilities:

 

 

 

 

 

Increase in real estate

 

(151,735

)

(163,203

)

Increase (decrease) in deposits on real estate under option or contract

 

21,159

 

(7,864

)

Increase in receivables and prepaid expenses and other assets

 

(7,540

)

(6,933

)

Decrease in accounts payable and accrued liabilities

 

(88,807

)

(34,193

)

Decrease in home sale deposits

 

(6,215

)

(8,224

)

Net cash used in operating activities

 

(166,508

)

(53,962

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Investments in unconsolidated entities

 

(19,693

)

(17,270

)

Distributions of capital from unconsolidated entities

 

16,210

 

15,357

 

Purchases of property and equipment

 

(8,254

)

(16,356

)

Proceeds from sales of property and equipment

 

360

 

212

 

Net cash used in investing activities

 

(11,377

)

(18,057

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net borrowings under line of credit agreement

 

25,000

 

135,000

 

Proceeds from loans payable and other borrowings

 

 

855

 

Repayments of loan payable and other borrowings

 

(1,309

)

 

Proceeds from issuance of senior subordinated notes

 

150,000

 

 

Senior subordinated notes issuance costs

 

(3,043

)

 

Purchase of treasury stock

 

 

(101,488

)

Payments of senior notes

 

 

(1,254

)

Excess income tax benefit from stock-based awards

 

346

 

10,121

 

Proceeds from stock option exercises

 

1,859

 

10,438

 

Net cash provided by financing activities

 

172,853

 

53,672

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(5,032

)

(18,347

)

Cash and cash equivalents at beginning of period

 

56,710

 

65,812

 

Cash and cash equivalents at end of period

 

$

51,678

 

$

47,465

 

See supplemental disclosures of cash flow information at Notes 7 and 11.

See accompanying notes to condensed consolidated financial statements

5




MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006

NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION

Organization.  Meritage Homes is a leading designer and builder of single-family attached and detached homes in the growth regions of the western and southern United States based on the number of home closings.  We offer first-time, move-up, active adult and luxury homes to our targeted customer base.  We have operations in three regions:  West, Central and East, which are comprised of 14 metropolitan areas in Arizona, Texas, California, Nevada, Colorado and Florida.  Through our successors, we commenced our homebuilding operations in 1985.  Meritage Homes Corporation was incorporated in 1988 in the State of Maryland.

Our homebuilding and marketing activities are conducted under the name of Meritage Homes in each of our markets, except for certain communities in Arizona, where we also operate under the name of Monterey Homes, and in Texas, where we also operate in certain communities as Legacy Homes and Monterey Homes.  At June 30, 2007, we were actively selling homes in 222 communities, with base prices ranging from approximately $118,000 to $1,187,000.

Basis of Presentation.  The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States 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 of variable interest entities (see note 3) in which we are deemed the primary beneficiary (collectively, “us”, “we”, “our” and the “Company”).  Intercompany balances and transactions have been eliminated in consolidation.  In the opinion of management, the accompanying financial statements include all adjustments necessary for the fair presentation of the interim periods presented.

Real Estate.  Real estate is stated at cost and includes the costs of land acquisition, land development and home construction, capitalized interest, real estate taxes and direct overhead costs incurred during development and home construction that benefit the entire community.  Land and development costs are typically allocated to individual lots on a relative value basis. The costs of these lots are transferred to homes under construction when construction begins.  Home construction costs are accumulated on a per-home basis.  Cost of home closings includes the specific construction costs of the home and all related land acquisition, land development and other common costs (both incurred and expected to be incurred) based upon the total number of homes expected to be closed in each community.  Any changes to the estimated total development costs of a community are allocated on a relative value basis to the remaining homes in the community.  When a home is closed, we may have not yet paid all costs incurred to complete it.  At the time of close, we record a liability and a charge to cost of sales for the amount we expect will ultimately be paid to complete the home.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment of Disposal of Long-Lived Assets” (“SFAS No. 144”), land inventory and related communities under development are reviewed for potential write-downs annually or when impairment indicators are present.  SFAS No. 144 requires that in the event the undiscounted cash flows projected for those assets are less than their carrying amounts, an impairment charge is recorded to bring the assets to fair value.  Our determination of fair value is based on projections and estimates, including future sales prices, construction costs and absorption rates.  Changes in these expectations may lead to a change in the outcome of our impairment analysis.  Our analysis is completed at the community level; therefore, changes in local conditions may affect one or several of our communities.  For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount exceeds the fair value of the assets.

6




The impairment charges recorded during the three- and six-month period ended June 30, 2007 and June 30, 2006 were as follows (in thousands):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Terminated option/purchase contracts

 

 

 

 

 

 

 

 

 

West

 

$

6,784

 

$

2,364

 

$

12,211

 

$

2,364

 

Central

 

2,970

 

71

 

4,750

 

71

 

East

 

10,408

 

400

 

19,158

 

400

 

Total

 

$

20,162

 

$

2,835

 

$

36,119

 

$

2,835

 

 

 

 

 

 

 

 

 

 

 

Real estate inventory impairments

 

 

 

 

 

 

 

 

 

West

 

$

48,522

 

$

3,711

 

$

48,522

 

$

3,711

 

Central

 

5,748

 

749

 

6,046

 

749

 

East

 

4,430

 

 

5,212

 

 

Total

 

$

58,700

 

$

4,460

 

$

59,780

 

$

4,460

 

 

 

 

 

 

 

 

 

 

 

Impairments of joint venture investments

 

 

 

 

 

 

 

 

 

West

 

$

1,120

 

$

 

$

1,120

 

$

 

Central

 

 

 

 

 

East

 

 

 

 

 

Total

 

$

1,120

 

$

 

$

1,120

 

$

 

 

 

 

 

 

 

 

 

 

 

Total impairments

 

 

 

 

 

 

 

 

 

West

 

$

56,426

 

$

6,075

 

$

61,853

 

$

6,075

 

Central

 

8,718

 

820

 

10,796

 

820

 

East

 

14,838

 

400

 

24,370

 

400

 

Total

 

$

79,982

 

$

7,295

 

$

97,019

 

$

7,295

 

 

The impairment charges were based on our fair value calculations, which are affected by current market conditions, such as the continued downturn of the homebuilding market, assumptions and expectations, all of which are highly subjective and may differ significantly from actual results if market conditions change.

Off-Balance Sheet Arrangements.  We often acquire finished building lots from various development entities pursuant to option and purchase agreements.  The purchase price typically approximates the market price at the date the contract is executed.  We believe this lot acquisition strategy reduces the financial requirements and risks associated with direct land ownership and land development.  Under these option and purchase agreements, we are usually required to make deposits in the form of cash or letters of credit, which may be forfeited if we fail to perform under the applicable agreements.  As of June 30, 2007, we had entered into option and purchase agreements with an aggregate purchase price of approximately $1.7 billion and had made deposits of approximately $132.5 million in the form of cash and approximately $41.3 million in letters of credit.

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.  Our participation in joint ventures continues to be an important part of our business model.  We and/or our joint venture partners may provide limited repayment guarantees on a pro rata basis on debt of certain unconsolidated land acquisition and development joint ventures.  At June 30, 2007, our share of these limited pro rata repayment guarantees was $40.1 million.

In addition, we and/or our joint venture partners may provide guarantees that are only applicable if and when the joint venture directly, or indirectly through agreement with its joint venture partners or other third parties, causes the joint venture to voluntarily file a bankruptcy or similar liquidation or reorganization action or take other actions that are fraudulent or improper (commonly referred to as “bad boy guarantees”).  These types of guarantees typically are on a pro rata basis and are designed to protect the respective secured lender’s remedies with respect to its mortgage or other secured lien on the joint venture’s underlying property.  To date, no such guarantees have been invoked and we believe it is unlikely that such a guarantee would be invoked in the future as it would require us to voluntarily take actions that would generally be

7




disadvantageous to the joint venture and to us.  At June 30, 2007, we had outstanding guarantees of this type totaling approximately $74.1 million.  We believe that these guarantees, as defined, unless invoked as described above, are not considered guarantees or indebtedness under our revolving credit facility or senior and senior subordinated indentures.

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 the terms of these completion agreements, 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, our exposure under these indemnities is limited.  These indemnities generally 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, or the joint venture entity generally obtains, 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 June 30, 2007, we had approximately $45.3 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.

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, 2007, we had approximately $43.0 million in outstanding letters of credit and $253.2 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.

Intangibles, Net.  Intangible assets consist primarily of non-compete agreements, tradenames and home plan designs acquired in connection with our September 2005 acquisition of Greater Homes.  These intangible assets were valued at the acquisition date utilizing accepted valuation procedures and are being amortized over their estimated useful lives.  The cost and accumulated amortization of our intangible assets was $7.4 million and $5.2 million, respectively, at June 30, 2007.  In the first six months of 2007, amortization expense was $0.6 million.  Amortization expense is expected to be approximately $0.4 million in the remaining six months of 2007 and $0.7, $0.7 and $0.4 million per year in 2008, 2009 and 2010, respectively.  During the second quarter of 2007, we wrote off $1.1 million of intangible assets related to non-compete agreements acquired in connection with our acquisition of Colonial Homes in February 2005, which represented all remaining intangible assets related to this acquisition.

Additionally, in accordance with AICPA Statement of Position 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use,” we have capitalized software costs at June 30, 2007 with a basis of $5.4 million, which is net of accumulated amortization of $6.9 million.  In the first six months of 2007, amortization expense was approximately $1.5 million related to the capitalized software costs and is expected to be approximately $0.7 million for the remaining six months of 2007 and $1.2, $1.2, $1.2, $0.9 and $0.2 million in 2008, 2009, 2010, 2011 and 2012, respectively.  Additionally, we have $0.4 million of capitalized software costs that are still in the application stage.

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

 

At
June 30, 2007

 

At
December 31, 2006

 

Accruals related to real estate development and construction activities

 

$

103,405

 

$

120,604

 

Payroll and other benefits

 

33,822

 

54,893

 

Accrued taxes

 

2,962

 

9,112

 

Warranty reserves

 

30,986

 

28,437

 

Other accruals

 

41,891

 

53,637

 

Total

 

$

213,066

 

$

266,683

 

 

8




Warranty Reserves.  As is customary in the homebuilding industry, we have obligations related to post-construction warranties and defects related to 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 consolidated statements 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 reserves follows (in thousands):

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Balance, beginning of period

 

$

30,319

 

$

26,229

 

$

28,437

 

$

25,168

 

Additions to reserve

 

4,350

 

5,165

 

10,712

 

10,393

 

Warranty claims and expenses

 

(3,683

)

(4,900

)

(8,163

)

(9,067

)

Balance, end of period

 

$

30,986

 

$

26,494

 

$

30,986

 

$

26,494

 

Recently Issued Accounting Pronouncements.  There were no new accounting pronouncements issued during the quarter ended June 30, 2007 that are expected to have a material effect on our operating results or financial position.

FIN 48.    We adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109” (“FIN 48”) on January 1, 2007. FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. This interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in a company’s income tax returns.  The cumulative effect of adopting FIN 48 was an increase in tax reserves and a decrease of $3.0 million to the January 1, 2007 retained earnings balance.

At January 1, 2007, our unrecognized tax benefits were $19.2 million, which would, if recognized, provide a benefit to us of $6.5 million and decrease our effective tax rate.  We record interest and penalties related to uncertain tax positions in income tax expense.  At January 1, 2007, approximately $1.9 million of the unrecognized tax benefits represents potential interest and penalties on uncertain tax positions.  The decrease in unrecognized tax benefits during the first six months of 2007 was $13.7 million and includes $1.0 million of interest.   There are currently no unrecognized tax benefits that relate to items which would be affected by expiring statutes of limitation within the next 12 months.

We conduct business and are subject to tax in the U.S and several states.  With few exceptions, we are no longer subject to U.S. federal, state, or local income tax examinations by tax authorities for years prior to 2002. Our U.S. income tax return for 2003 has been examined by the IRS.  The examination was completed in the second quarter of 2007, and there were no material changes to report.

9




NOTE 2 – REAL  ESTATE AND CAPITALIZED INTEREST

Real estate consists of the following (in thousands):

 

At
June 30, 2007

 

At
December 31, 2006

 

 

 

 

 

 

 

Homes under contract under construction

 

$

586,142

 

$

589,241

 

Finished home sites and home sites under development

 

675,416

 

592,949

 

Unsold homes, completed and under construction

 

267,199

 

271,559

 

Model homes

 

53,800

 

39,131

 

Model home lease program

 

23,111

 

26,831

 

Land held for development

 

14,037

 

10,891

 

 

 

$

1,619,705

 

$

1,530,602

 

 

Subject to sufficient qualifying assets, we capitalize development period interest costs incurred in connection with the development and construction of real estate. Capitalized interest is allocated to qualified real estate assets as incurred and charged to cost of home closings when the associated revenue is recognized.  Certain information regarding capitalized interest follows (in thousands):

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Capitalized interest, beginning of period

 

$

38,929

 

$

24,753

 

$

33,016

 

$

23,939

 

Interest incurred

 

16,751

 

12,600

 

30,636

 

24,175

 

Interest expensed

 

(319

)

 

(319

)

 

Interest amortized to cost of home closings

 

(9,847

)

(9,518

)

(17,819

)

(20,279

)

Capitalized interest, end of period

 

$

45,514

 

$

27,835

 

$

45,514

 

$

27,835

 

At June 30, 2007, approximately $3.9 million of the capitalized interest is related to our joint venture investments and is a component of  “Investments in unconsolidated entities” on our balance sheet.

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

FASB Interpretation No. 46 (as revised), “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 when an enterprise had a controlling financial interest through ownership of a majority voting interest in the entity.

Based on the provisions of FIN 46R, we have concluded that when we enter into an option or purchase agreement to acquire land or lots and pay a non-refundable deposit, a variable interest entity, or VIE, may be created because we are deemed to have provided subordinated financial support that will absorb some or all of an entity’s expected losses if they occur.  For each VIE created, we compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46R.  If we are the primary beneficiary of the VIE, we will consolidate the VIE in our financial statements.

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 methodology properly identifies our primary beneficiary status with these VIEs, changes in the probability and other estimates could produce different conclusions.

In most cases, creditors of the entities with which we have option agreements have no recourse against us and the maximum exposure to loss in our option agreements is limited to our option deposit and any capitalized pre-acquisition costs.  Often, we are at risk for items over budget related to land development on property we have under option.  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 to us.

10




The table below presents a summary of our lots under option or contract at June 30, 2007 (dollars in thousands):

 

 

 

 

 

 

Option/Earnest
Money Deposits

 

 

 

Number of
Lots

 

Purchase
Price

 

Cash

 

Letters of 
Credit

 

 

 

 

 

 

 

 

 

 

 

Options recorded on balance sheet as real estate not owned (1), (2)

 

525

 

$

29,581

 

$

6,380

 

$

 

Option contracts not recorded on balance sheet – non-refundable deposits (1)

 

23,427

 

$

1,310,721

 

$

97,587

 

$

40,841

 

Purchase contracts not recorded on balance sheet – non-refundable deposits (1)

 

5,193

 

180,075

 

27,315

 

484

 

Purchase contracts not recorded on balance sheet – refundable deposits (3)

 

3,459

 

129,832

 

1,193

 

 

Total options not recorded on balance sheet

 

32,079

 

1,620,628

 

126,095

(4)

41,325

 

Total lots under option or contract

 

32,604

 

$

1,650,209

 

$

132,475

 

$

41,325

 

 


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

(2)                               The purpose and nature of these consolidated lot option contracts (VIEs) is to provide the Company the option to purchase these lots in anticipation of building homes on these lots in the future.  Specific performance contracts are included in this balance.

(3)                               Deposits are refundable at our sole discretion.  We have not completed our acquisition evaluation process and we have not internally committed to purchase these lots.

(4)                               Amount is reflected in our balance sheet in the line item “deposits on real estate under option or contract” as of June 30, 2007.

Generally, our options to purchase lots remain effective so long as we purchase a pre-established minimum number of lots each month or quarter, as determined by the respective agreement.  Although the pre-established number is typically structured to approximate our expected rate of home construction starts, during a weakened homebuilding market as we are currently experiencing, we may purchase lots at an absorption level that exceeds our sales and home starts pace.

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.  Based on the structure of these joint ventures, they may or may not be consolidated into our results.  Our joint venture partners generally are other homebuilders, land sellers or other real estate investors.  We also enter into mortgage and title business joint ventures.  These unconsolidated entities follow accounting principles generally accepted in the United States of America and we generally share in their profits and losses in accordance with our ownership interests.

For land development joint ventures, we, and in some cases our joint venture partners, usually receive an option or other similar arrangement to purchase portions of the land held by the joint venture.  Option prices are generally negotiated prices that approximate market value when we enter into the option contract.  For homebuilding and land development joint ventures, our share of the joint venture earnings relating to lots we purchase from the joint ventures is deferred until homes are delivered by us and title passes to a homebuyer. Therefore, we allocate such joint venture earnings to the land acquired by us as a reduction in the basis of the property.

We and/or our joint venture partners occasionally provide limited repayment guarantees on a pro rata basis on the debt of the land development joint ventures.  At June 30, 2007, our share of these limited pro rata repayment guarantees was approximately $40.1 million.

11




In addition, we and/or our joint venture partners occasionally provide guarantees that are only applicable if and when the joint venture directly, or indirectly through agreement with its joint venture partners or other third parties, causes the joint venture to voluntarily file a bankruptcy or similar liquidation or reorganization action or take other actions that are fraudulent or improper (commonly referred to as “bad boy guarantees”).  These types of guarantees typically are on a pro rata basis and are designed to protect the respective secured lender’s remedies with respect to its mortgage or other secured lien on the joint venture’s underlying property.  To date, no such guarantees have been invoked and we believe it is unlikely that such a guarantee would be invoked in the future as it would require us to voluntarily take actions that would generally be disadvantageous to the joint venture and to us.  At June 30, 2007, we had outstanding guarantees of this type totaling approximately $74.1 million.  We believe these guarantees, as defined, unless invoked as described above, are not considered guarantees or indebtedness under our revolving credit facility or senior and senior subordinated indentures.

Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method follows (in thousands):

 

At
June 30, 2007

 

At
December 31, 2006

 

Assets:

 

 

 

 

 

Cash

 

$

17,416

 

$

14,392

 

Real estate

 

674,445

 

723,753

 

Other assets

 

26,761

 

25,722

 

Total assets

 

$

718,622

 

$

763,867

 

 

 

 

 

 

 

Liabilities and equity:

 

 

 

 

 

Accounts payable and other liabilities

 

$

18,019

 

$

26,639

 

Notes and mortgages payable

 

425,391

 

471,197

 

Equity of:

 

 

 

 

 

Meritage

 

81,555

 

93,792

 

Others

 

193,657

 

172,239

 

Total liabilities and equity

 

$

718,622

 

$

763,867

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenues

 

$

34,874

 

$

18,804

 

$

48,260

 

$

45,932

 

Costs and expenses

 

(28,588

)

(8,437

)

(38,554

)

(17,664

)

Net earnings of unconsolidated entities

 

$

6,286

 

$

10,367

 

$

9,706

 

$

28,268

 

Meritage’s share of pre-tax earnings (1) (2)

 

$

1,850

 

$

5,251

 

$

5,019

 

$

11,530

 

 


(1)                               The joint venture financial statements above represent the most recent information available to us.  As our portion of pre-tax earnings is recorded on the accrual basis and includes both actual earnings reported to us as well as accrued expected earnings for the period noted above not yet provided to us by our joint venture partners, our relative portion of total net earnings of the unconsolidated joint ventures in the table may not be a meaningful number/percentage.

(2)                               Our share of pre-tax earnings is recorded in “Earnings from unconsolidated entities, net” on our consolidated statements of earnings.  Our share of pre-tax earnings excludes joint venture earnings related to lots we purchased from the joint ventures.  Those earnings are deferred until homes are delivered by us and title passes to a homebuyer.

At June 30, 2007 and December 31, 2006, our investments in unconsolidated entities includes $4.7 million and $2.8 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 as the assets of the respective joint ventures are sold.  We amortized approximately $119,000 and $27,000 in the second quarters of 2007 and 2006, respectively.  We amortized approximately $261,000 and $763,000 in the first six months of 2007 and 2006, respectively.

In addition to joint ventures accounted for under the equity method summarized in the above table, our investments in unconsolidated entities include joint ventures recorded under the cost method.  These joint ventures were formed to acquire large parcels of land, to perform off-site development work and to sell lots to the joint venture members and other

12




third parties.  At June 30, 2007, and December 31, 2006, our investments in unconsolidated entities recorded under the cost method were $9.6 and $17.7 million, respectively.

At June 30, 2007, our total investment in unconsolidated joint ventures of $95.9 million is primarily comprised of $17.8 million in our West Region and $73.9 million in our Central Region.  At December 31, 2006, our total investment in unconsolidated joint ventures of $114.3 million was primarily comprised of $35.2 million in our West Region and $74.7 million in our Central Region.

NOTE 5 - LOANS PAYABLE AND OTHER BORROWINGS

Loans payable consists of the following (in thousands):

 

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

$850 million unsecured revolving credit facility maturing May 2011 with extension provisions, and interest payable monthly at LIBOR (5.32% at June 30, 2007) plus 1.25% or prime (8.25% at June 30, 2007)

 

$

251,500

 

$

226,500

 

 

 

 

 

 

 

Model home lease program, with interest in the form of lease payments payable monthly approximating 7.82% at June 30, 2007

 

23,111

 

26,831

 

 

 

 

 

 

 

Other borrowings, acquisition and development financing

 

 

1,309

 

 

 

 

 

 

 

Total loans payable and other borrowings

 

$

274,611

 

$

254,640

 

 

On May 18, 2007, we amended our senior unsecured revolving credit facility (the “Credit Facility”) with Guaranty Bank and various other financial institutions to extend the maturity to May 18, 2011 and make changes to certain covenants and definitions, including (i) changing certain aggregate asset-type limitations within the borrowing base, (ii) increasing the minimum consolidated tangible net worth requirement to $600 million plus 50% of consolidated net income (as defined) for each full fiscal quarter ending after December 31, 2006, plus an amount equal to 50% of the aggregate increases in consolidated tangible net worth (as defined) after December 31, 2006 by reason of the issuance and sale of equity interests, plus an amount equal to the net worth of any person that becomes a guarantor after December 31, 2006 by reason of merger or acquisition and (iii) changing the covenants relating to restrictions on the total land and unsold units that we may own.  The total borrowing capacity of the credit facility remains at $850 million.

The construction costs and related debt associated with certain model homes that are owned and leased to us by others and that we use to market our communities are required to be included on our balance sheet.  We do not legally own these 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 it 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 generally has a maturity date of one to three years from the origination of the lease.  During the first six months of 2007, $3.7 million of such leases were exercised or terminated, $2.3 million of which were exercised or terminated in the second quarter of 2007.

13




NOTE 6 - SENIOR AND SENIOR SUBORDINATED NOTES

Senior notes consist of the following (in thousands):

 

 

June 30,
2007

 

December 31,
2006

 

7.73% senior subordinated notes due 2017

 

$

150,000

 

$

 

6.25% senior notes due 2015. At June 30, 2007 and December 31, 2006, there was approximately $1.3 and $1.4 million in unamortized discount, respectively

 

348,658

 

348,571

 

7.0% senior notes due 2014. At both June 30, 2007, and December 31, 2006, there was approximately $0.1 million in unamortized premium

 

130,061

 

130,065

 

 

 

$

628,719

 

$

478,636

 

 

Our Credit Facility and indentures for all our senior and senior subordinated notes contain covenants that 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 June 30, 2007, we were in compliance with these covenants. After considering our most restrictive bank covenants, we have additional borrowing availability under the Credit Facility of $515.9 million at June 30, 2007. The Credit Facility and indentures relating to our senior and senior subordinated notes restrict our ability to pay dividends, and at June 30, 2007, our maximum permitted amount available to pay dividends was $353.2 million.

Obligations to pay principal and interest on the Credit Facility and senior and senior subordinated 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.  Such guarantees are full and unconditional, and joint and several.  We do not provide separate financial statements of the Guarantor Subsidiaries because Meritage (the parent company) has no independent assets or operations, the guarantees are full and unconditional and joint and several and there are no non-guarantor subsidiaries.  There are no significant restrictions on the ability of the Company or any Guarantor Subsidiary to obtain funds from their respective subsidiaries, as applicable, by dividend or loan.

NOTE 7 - GOODWILL

Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the assets acquired. The changes in the carrying amount of goodwill for the six months ended June 30, 2007, follow (in thousands):

 

 

Corporate

 

West

 

Central

 

East

 

Total

 

Balance at December 31, 2006

 

$

1,323

 

$

37,277

 

$

53,970

 

$

37,089

 

$

129,659

 

Goodwill impairment

 

 

 

 

(26,886

)

(26,886

)

Non-cash amortization of excess tax basis

 

 

(59

)

(36

)

(93

)

(188

)

Balance at June 30, 2007

 

$

1,323

 

$

37,218

 

$

53,934

 

$

10,110

 

$

102,585

 

 

Under the guidelines contained in SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is reviewed for impairment annually or more frequently if certain trigger events or conditions exist.  During the second quarter of 2007, we determined that economic conditions had deteriorated to a level requiring the recoverability of goodwill to be re-assessed.  Therefore, we re-performed a goodwill impairment analysis as of June 30, 2007, which resulted in a write-down of $26.9 million in our East Region related to goodwill generated by our acquisition of Colonial Homes in February 2005.  This write-down reflects the continued difficult homebuilding environments in Ft. Myers/Naples and our anticipation that such conditions will continue for the foreseeable future, resulting in operations that can no longer support the goodwill that was associated with this division.

14




NOTE 8 – EARNINGS (LOSS) PER SHARE

Basic and diluted earnings per common share are presented in conformity with SFAS No. 128, “Earnings Per Share”.  The following table presents the calculation of basic and diluted earnings per common share (in thousands, except per share amounts):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Basic weighted average number of shares outstanding

 

26,232

 

26,609

 

26,199

 

26,792

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and restricted stock (1)

 

 

753

 

 

827

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted average shares outstanding

 

26,232

 

27,362

 

26,199

 

27,619

 

 

 

 

 

 

 

 

 

 

 

Net (loss) earnings

 

$

(56,576

)

$

77,055

 

$

(41,460

)

$

156,791

 

 

 

 

 

 

 

 

 

 

 

Basic (loss) earnings per share

 

$

(2.16

)

$

2.90

 

$

(1.58

)

$

5.85

 

 

 

 

 

 

 

 

 

 

 

Diluted (loss) earnings per share (1)

 

$

(2.16

)

$

2.82

 

$

(1.58

)

$

5.68

 

 


(1)                                  For periods with a net loss, basic weighted average shares outstanding are used for diluted calculations as required by accounting principles generally accepted in the United States.

At June 30, 2007, all 2.4 million outstanding options were anti-dilutive.  For the three and six months ended June 30, 2006, 760 and 679 options, respectively, were anti-dilutive.

NOTE 9 - STOCK-BASED COMPENSATION

We have two stock compensation plans  (together, the “Plans”), which were approved by our stockholders and are administered by our Board of Directors.  The Plans authorize awards to officers, key employees, non-employee directors and consultants for up to 6,600,000 shares of common stock, of which 473,542 shares remain available for grant at June 30, 2007.  We believe that such awards provide a means of performance-based compensation to attract and retain qualified employees and better align the interests of our employees with those of our stockholders.  Generally, option awards are granted with an exercise price equal to the market price of Meritage stock at the date of grant, a five-year ratable vesting period and a seven-year contractual term.

The fair values of option awards are estimated using a Black-Scholes option pricing model that uses the assumptions noted in the following table:

 

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

Expected volatility

 

42.6

%

46-48

%

Expected dividends

 

0

%

0

%

Expected term (in years)

 

4.56

 

4.80-5.85

 

Risk-free interest rate

 

4.90

%

5.04 – 5.05

%

Weighted average grant date fair value of options granted

 

$

20.51

 

$

25.63

 

 

As of June 30, 2007, we had $29.5 million of total unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Plans that will be recognized on a straight-line basis over the remaining vesting periods, which we expect to be recognized over a weighted-average period of 3.6 years.  For the three months

15




ended June 30, 2007 and 2006, our total stock-based compensation expense was $1.9 million ($1.6 million net of tax) and $4.7 million ($3.3 million net of tax), respectively.  For the six months ended June 30, 2007 and 2006, our total stock-based compensation expense was $4.2 million ($3.2 net of tax) and $7.3 million ($5.3 net of tax), respectively.  We granted 755,667 options and 96,333 shares of restricted stock during the first six months of 2007.

NOTE 10 - INCOME TAXES

Components of the provision for income taxes (benefit) are (in thousands):

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Federal

 

$

(28,729

)

$

41,614

 

$

(22,431

)

$

85,995

 

State

 

(3,899

)

6,481

 

(2,695

)

13,155

 

Total

 

$

(32,628

)

$

48,095

 

$

(25,126

)

$

99,150

 

 

NOTE 11 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

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

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

27,066

 

$

22,072

 

Income taxes

 

$

31,581

 

$

150,515

 

Non-cash operating activities:

 

 

 

 

 

Real estate not owned

 

$

24,312

 

$

(1,464

)

FIN 48 adoption – unrecognized tax benefits

 

$

2,962

 

$

 

Non-cash investing activities:

 

 

 

 

 

Distributions from unconsolidated entities

 

$

13,531

 

$

4,011

 

 

NOTE 12 — OPERATING AND REPORTING SEGMENTS

As defined in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” we have six operating segments (the six states in which we operate).  The operating segments aggregating into our three reporting segments have been determined to have similar economic characteristics such as: historical and projected future operating results, employment trends, land acquisition and land constraints, municipality behavior, and also meet the other qualitative aggregation criteria.  Our reportable homebuilding segments are as follows:

West:       California and Nevada

Central: Texas, Arizona and Colorado

East:       Florida

Management’s evaluation of segment performance is based on segment operating income, which we define as homebuilding and land revenues less cost of home construction, commissions and other sales costs, land development and other land sales costs and other costs incurred by or allocated to each segment.  Each reportable segment follows the same accounting policies described in Note 1, “Organization and Basis of Presentation,” to the consolidated financial statements in our 2006 Annual Report on Form 10-K.  Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity for the periods presented.  The following segment information is in thousands:

16




 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenue (1):

 

 

 

 

 

 

 

 

 

West

 

$

120,905

 

$

288,691

 

$

238,317

 

$

609,730

 

Central

 

404,664

 

556,483

 

824,839

 

1,008,413

 

East

 

43,098

 

69,486

 

82,961

 

143,788

 

Consolidated total

 

$

568,667

 

$

914,660

 

$

1,146,117

 

$

1,761,931

 

 

 

 

 

 

 

 

 

 

 

Operating (loss) income (2):

 

 

 

 

 

 

 

 

 

West

 

$

(63,441

)

$

41,396

 

$

(70,993

)

$

105,519

 

Central

 

21,060

 

90,562

 

60,631

 

159,637

 

East

 

(17,477

)

9,118

 

(25,568

)

18,884

 

 

 

 

 

 

 

 

 

 

 

Segment operating (loss) income

 

(59,858

)

141,076

 

(35,930

)

284,040

 

Corporate and unallocated (3)

 

(34,816

)

(24,651

)

(42,405

)

(44,323

)

Earnings from unconsolidated entities, net

 

1,800

 

5,251

 

4,946

 

10,839

 

Interest expense and other income, net

 

3,670

 

3,474

 

6,803

 

5,385

 

 

 

 

 

 

 

 

 

 

 

(Loss) earnings before (benefit) provision for income taxes

 

$

(89,204

)

$

125,150

 

$

(66,586

)

$

255,941

 

 

 

 

At June 30, 2007

 

At December 31, 2006

 

Assets

 

 

 

 

 

West

 

$

654,865

 

$

602,039

 

Central

 

1,215,263

 

1,183,533

 

East

 

144,813

 

168,010

 

Corporate and unallocated (4)

 

214,654

 

216,943

 

Consolidated total

 

$

2,229,595

 

$

2,170,525

 

 


(1)                                Revenue includes the following land closing revenue, by segment (in thousands): three months ended June 30, 2007 - $919 in Central Region; three months ended June 30, 2006 - $11,474 in West Region and $335 in Central Region.  Six months ended June 30, 2007 - $2,254 in Central Region; six months ended June 30, 2006 - $11,474 in West Region and $1,232 in Central Region.

(2)                                See Note 1 for a breakout of real estate-related impairments by Region.

(3)                                Balance consists primarily of corporate costs and numerous shared service functions such as finance, legal and treasury that are not allocated to the operating segments.

(4)                                Balance consists primarily of goodwill and intangibles and other corporate assets not allocated to the segments.

See additional segment discussions in Notes 4 and 7.

17




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

Overview

We are a leading designer and builder of single-family attached and detached homes in the growth regions of the western and southern United States based on the number of home closings.  We focus on providing a broad range of first-time, move-up, active adult and luxury homes to our targeted customer base.  Despite the difficult national market conditions for the homebuilders, we believe that the relatively strong population, job and income growth, as well as the favorable migration characteristics in our markets will continue to provide significant long-term growth opportunities for us.  At June 30, 2007, we were actively selling homes in 222 communities, with base prices ranging from $118,000 to $1,187,000.

We operate in the following geographic regions, which are presented as our reportable business segments:

West:       California and Nevada

Central: Texas, Arizona and Colorado

East:       Florida

Total home closing revenue was $567.7 million for the three months ended June 30, 2007, decreasing 37.1% from $902.9 million for the same period last year.  Net earnings for the second quarter of 2007 decreased $133.7 million to a loss of ($56.6) million from earnings of $77.1 million in the same period last year.  This decrease is primarily due to the $28.0 million (pre-tax) of goodwill-related impairments and $80.0 million (pre-tax) of real estate-related impairments recorded in the second quarter of 2007 as compared to $7.3 million of real-estate impairments in the same period of 2006 (there were no goodwill impairments in 2006).  The decline was also impacted by the continued weakened homebuilding market experienced in 2007 compared to 2006.  For the six months ended June 30, 2007, home closing revenue and net income were $1.1 billion and a loss of ($41.5) million, down $605.4 million and $198.3 million, respectively, from the same time in the prior year.  These declines are due to the lower average home prices from competitive pressures and the increased use of incentives, as well as the sales mix of homes closed and $125.0 million (pre-tax) of real estate-related and goodwill-related impairments for the first half of 2007.  Additionally, our 2007 revenue is the result of closing orders taken during late 2006 and early 2007, a period of weaker sales volumes as well for the homebulding market.

We began experiencing slowdowns in our northern California markets in the fourth quarter of 2005.  The downturn eventually affected the rest of the country in subsequent quarters throughout 2006, resulting in a decline in order dollars and volume.  During the first half of 2007, we have also begun to see some slowing in Texas, although not to the extent of other markets.  Due to the relatively stable conditions in Texas, it now comprises a larger percentage of our total closings and orders.  Based on the homebuilding market downturn and increased presence in Texas, we expect our home closing gross margins to continue to trend lower throughout 2007 and in 2008.

It is also our expectation that sales in our markets that experienced robust sales activity in 2005 and 2006 will continue to decrease, and we expect the home order rate to continue to be soft during the remainder of 2007.  At June 30, 2007, our backlog of approximately $1.2 billion shows a decrease of 38.8% when compared to June 30, 2006, but decreased only 5.2% compared to March 31, 2007.  These decreases are due to fewer home sales, compounded by increased price concessions and incentives, as the average sales price in backlog decreased from $335,000 at June 30, 2006 to $319,200 at March 31, 2007 to $312,200 at June 30, 2007.  In the second quarter of 2007, our cancellation rate on sales orders increased to 36.6% of gross orders (or 25.2% of beginning backlog) as compared to 31.6% (15.2% of beginning backlog), in the same period a year ago, and also increased from 27.4% (21.2% of beginning of backlog) for the three months ended March 31, 2007.  The increased levels of cancellations demonstrate that: buyers are still not confident that their new home purchases will retain their value and are waiting for a sign that the market is stabilizing before buying a new home; that buyers may not be able to sell their existing homes and elect to cancel their new home purchases; and the constriction of the mortgage availability to our homebuyers and to the buyers of their existing homes.  We believe our experiences are consistent with the overall trends in the homebuilding industry.  During the remainder of 2007 and beyond, based on current market conditions, we expect average closing sales prices to continue to decline, as reflected by the lower average sales price in backlog.  Margins will also remain compressed due to price competition resulting from the excess of new and existing home inventories and higher land costs from land contracts negotiated during the homebuilding market peak.

Critical Accounting Policies

The accounting policies we deem most critical to us include revenue recognition, real estate, goodwill, warranty reserves, off-balance-sheet arrangements, valuation of deferred tax assets and share-based payments.  There have been no significant changes to our critical accounting policies during the three and six months ended June 30, 2007 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2006 Annual Report on Form 10-K.

18




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

Home Closing Revenue

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Total

 

 

 

 

 

 

 

 

 

Dollars

 

$

567,748

 

$

902,851

 

$

1,143,863

 

$

1,749,225

 

Homes closed

 

1,858

 

2,722

 

3,654

 

5,250

 

Average sales price

 

$

305.6

 

$

331.7

 

$

313.0

 

$

333.2

 

West Region

 

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

 

 

Dollars

 

$

99,256

 

$

208,111

 

$

201,391

 

$

454,994

 

Homes closed

 

208

 

361

 

402

 

784

 

Average sales price

 

$

477.2

 

$

576.5

 

$

501.0

 

$

580.3

 

Nevada

 

 

 

 

 

 

 

 

 

Dollars

 

$

21,649

 

$

69,106

 

$

36,926

 

$

143,262

 

Homes closed

 

58

 

172

 

103

 

361

 

Average sales price

 

$

373.3

 

$

401.8

 

$

358.5

 

$

396.8

 

West Region Totals

 

 

 

 

 

 

 

 

 

Dollars

 

$

120,905

 

$

277,217

 

$

238,317

 

$

598,256

 

Homes closed

 

266

 

533

 

505

 

1,145

 

Average sales price

 

$

454.5

 

$

520.1

 

$

471.9

 

$

522.5

 

Central Region

 

 

 

 

 

 

 

 

 

Arizona

 

 

 

 

 

 

 

 

 

Dollars

 

$

120,735

 

$

290,124

 

$

303,024

 

$

515,983

 

Homes closed

 

358

 

888

 

856

 

1,624

 

Average sales price

 

$

337.2

 

$

326.7

 

$

354.0

 

$

317.7

 

Texas

 

 

 

 

 

 

 

 

 

Dollars

 

$

273,200

 

$

252,386

 

$

496,088

 

$

471,470

 

Homes closed

 

1,074

 

1,075

 

1,986

 

2,027

 

Average sales price

 

$

254.4

 

$

234.8

 

$

249.8

 

$

232.6

 

Colorado

 

 

 

 

 

 

 

 

 

Dollars

 

$

9,810

 

$

13,638

 

$

23,473

 

$

19,728

 

Homes closed

 

28

 

37

 

61

 

53

 

Average sales price

 

$

350.4

 

$

368.6

 

$

384.8

 

$

372.2

 

Central Region Totals

 

 

 

 

 

 

 

 

 

Dollars

 

$

403,745

 

$

556,148

 

$

822,585

 

$

1,007,181

 

Homes closed

 

1,460

 

2,000

 

2,903

 

3,704

 

Average sales price

 

$

276.5

 

$

278.1

 

$

283.4

 

$

271.9

 

East Region

 

 

 

 

 

 

 

 

 

Florida

 

 

 

 

 

 

 

 

 

Dollars

 

$

43,098

 

$

69,486

 

$

82,961

 

$

143,788

 

Homes closed

 

132

 

189

 

246

 

401

 

Average sales price

 

$

326.5

 

$

367.7

 

$

337.2

 

$

358.6

 

 

Companywide.  Home closing revenue for the quarter ended June 30, 2007 decreased 37.1% to $567.7 million from $902.9 million for the same time period a year ago as a result of a 31.7% decrease in homes closed and a 7.9% decrease in average sales price.  The home closing decreases reflect lower sales prices as a result of competitive pricing pressures experienced in late 2006, the period during which these sales were generated, as well as an increase in cancellations due to the lack of buyers’ confidence, as previously discussed.

19




West.  The West Region’s $156.3 million decrease in home closing revenue for the second quarter of 2007 compared to the same time period in 2006 is due to significant decreases for both California and Nevada.  In California, the number of homes closed and the average sales price of those homes declined 42.4% and 17.2%, respectively.  The Region’s decreases were further impacted by the poor performance in Nevada, which experienced a $47.5 million or 68.7% decrease in home closing revenue due to a 66.3% decrease in number of homes closed and a 7.1% decrease in average sales price, our largest per-state decreases.  For the six months ended June 30, 2007, home closing revenue was $238.3, down $360.0 million or 60.2% from the first six months of 2006.  These significant declines highlight the difference between the 2007 closings that resulted from late 2006 and early 2007 sales, where both the slower absorption rate and price constraints of the current homebuilding downturn are evident, as compared to the second quarter 2006 closings from late 2005 sales, which occurred during the height of the housing cycle.  We expect that the slow sales pace we experienced in 2006 (compared to 2005) will continue throughout 2007 and will affect closings in California and Nevada throughout 2007 and 2008.

Central.  During the three months ended June 30, 2007, the Central Region reported a $152.4 million decrease in home closing revenue as compared to the prior year due to a decrease in number of homes closed of 27.0% to 1,460, although average sales price held steady at $276,500 in 2007 as compared to $278,100 in 2006.  Texas still remains one of the strongest homebuilding areas in the country, closing 1,074 homes in the second quarter of 2007, consistent with 1,075 in the same period of 2006; additionally, higher average sales prices on these homes resulted in an 8.2% increase for Texas’ second quarter home closing revenue when compared to the second quarter of the prior year.  Arizona and Colorado, however, continue to struggle, reporting $169.4 million and $3.8 million declines in home closing revenue, respectively, in the second quarter of 2007 as compared to the second quarter of 2006.  For the six months ended June 30, 2007, home closing revenue was $822.6 for the Region, down $184.6 million or 18.3% from the first six months of 2006 due primarily to the poor performance in Arizona, as noted.

East.  In the East Region, closing revenue and homes closed were down $26.4 million and 57 units for the quarter ended June 30, 2007, decreases of 38.0% and 30.2%, respectively, versus the same quarter in the prior year.  For the six months ended June 30, 2007, home closing revenue was $83.0 million, down $60.8 million or 42.3% from the first six months of 2006.  These decreases reflect the significantly eroded revenue of Ft. Myers/Naples, where we believe the homebuilding industry is one of the weakest in the nation.  Also, our results in Central Florida, although not as weak as the Ft. Myers/Naples area, are down compared to 2006.  We currently do not have any new communities scheduled to open in Ft. Myers/Naples, and we are in the process of selling and closing our remaining inventory for this division.  Going forward, unless conditions change, Central Florida, which has lower average sales prices but higher sales volumes, will comprise the majority of the East Region’s sales and closing activity.

20




Home Orders

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Total

 

 

 

 

 

 

 

 

 

Dollars

 

$

501,466

 

$

694,360

 

$

1,142,082

 

$

1,526,978

 

Homes ordered

 

1,734

 

2,116

 

3,807

 

4,706

 

Average sales price

 

$

289.2

 

$

328.1

 

$

300.0

 

$

324.5

 

West Region

 

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

 

 

Dollars

 

$

104,407

 

$

161,857

 

$

244,391

 

$

299,213

 

Homes ordered

 

243

 

291

 

534

 

528

 

Average sales price

 

$

429.7

 

$

556.2

 

$

457.7

 

$

566.7

 

Nevada

 

 

 

 

 

 

 

 

 

Dollars

 

$

24,769

 

$

33,241

 

$

55,635

 

$

82,649

 

Homes ordered

 

70

 

82

 

154

 

211

 

Average sales price

 

$

353.8

 

$

405.4

 

$

361.3

 

$

391.7

 

West Region Totals

 

 

 

 

 

 

 

 

 

Dollars

 

$

129,176

 

$

195,098

 

$

300,026

 

$

381,862

 

Homes ordered

 

313

 

373

 

688

 

739

 

Average sales price

 

$

412.7

 

$

523.1

 

$

436.1

 

$

516.7

 

Central Region

 

 

 

 

 

 

 

 

 

Arizona

 

 

 

 

 

 

 

 

 

Dollars

 

$

104,824

 

$

165,475

 

$

257,166

 

$

425,285

 

Homes ordered

 

369

 

457

 

847

 

1,190

 

Average sales price

 

$

284.1

 

$

362.1

 

$

303.6

 

$

357.4

 

Texas

 

 

 

 

 

 

 

 

 

Dollars

 

$

222,270

 

$

293,439

 

$

500,814

 

$

608,586

 

Homes ordered

 

908

 

1,170

 

2,004

 

2,482

 

Average sales price

 

$

244.8

 

$

250.8

 

$

249.9

 

$

245.2

 

Colorado

 

 

 

 

 

 

 

 

 

Dollars

 

$

20,449

 

$

7,652

 

$

38,969

 

$

24,646

 

Homes ordered

 

56

 

22

 

104

 

64

 

Average sales price

 

$

365.2

 

$

347.8

 

$

374.7

 

$

385.1

 

Central Region Totals

 

 

 

 

 

 

 

 

 

Dollars

 

$

347,543

 

$

466,566

 

$

796,949

 

$

1,058,517

 

Homes ordered

 

1,333

 

1,649

 

2,955

 

3,736

 

Average sales price

 

$

260.7

 

$

282.9

 

$

269.7

 

$

283.3

 

East Region

 

 

 

 

 

 

 

 

 

Florida

 

 

 

 

 

 

 

 

 

Dollars

 

$

24,747

 

$

32,696

 

$

45,107

 

$

86,599

 

Homes ordered

 

88

 

94

 

164

 

231

 

Average sales price

 

$

281.2

 

$

347.8

 

$

275.0

 

$

374.9

 

 

Companywide.  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.

Except for Texas, where demand is more stable, demand has remained soft in our markets since the latter half of 2006.  We believe buyers are waiting for indications that the market has reached a bottom, and that new home purchases will retain their value.  Home orders declined by 18.0% to 1,734 homes during the quarter ended June 30, 2007 with a value of $501.5 million, a decrease of 27.8% compared to the same quarter a year ago.  Our actively selling community count

21




increased 8.8% to 222 at June 30, 2007, over the same quarter a year ago, helping to partially offset slowing sales rates per community.

For the six months ended June 30, 2007, total orders declined $384.9 million to $1.1 billion from the same period a year ago.  Our cancellation rates for the quarter ended June 30, 2007 were 36.6% of gross unit sales for the quarter and 25.2% of beginning backlog as compared to 31.6% and 15.2%, respectively, for the same time period a year ago.  The cancellation rates reflect the continuing hesitancy of our buyers to commit to a home purchase until they are confident the homebuilding market downturn has reached the bottom of its decline or because of difficulties in selling their existing homes.  In response to these market conditions, we have increased incentives to home buyers in many of our markets.  As the incentives reduce the sales price of our homes, the effect of these incentives is highlighted in the decline in average order sales price to $289,200 for the second quarter of 2007, down from $328,100 in the same quarter of the prior year.

West.  During the second quarter of 2007, our West Region continued to experience softer market conditions due to decreasing demand from investors and speculative buyers, higher inventory levels of unsold homes and homebuyers electing to defer purchase decisions in this transitional market.  These factors all contributed to the three- and six-month home order declines of $65.9 million and $81.8 million, respectively, over the same periods of the prior year.  These declines are due to 21.1% and 15.6% declines in average selling prices coupled with 16.1% and 6.9% declines in units sold, respectively, for the three- and six-month periods ended June 30, 2007, as compared to the same periods in 2006.  The 35.5% decline in home order dollars in California to $104.4 million for the current quarter as compared to $161.9 million for the second quarter of 2006 is attributed to the continued erosion in average selling price and is further impacted by the decrease in units sold.   Nevada also continues to be challenged by the current homebuilding market, with declines in homes ordered and average sales prices for both the three- and six-month periods in 2007 as compared to 2006.

Central.  For the second quarter of 2007, homes ordered declined by 316 homes to 1,333, and average sales prices dropped 7.8% leading to a $119.0 million decrease in the value of homes ordered over the prior year.  For the six months ended June 30, 2007, home orders declined 781 units, or 20.9%, from the same period of the prior year.  These declines are due to the continuing downturn in the homebuilding market in this Region, which most sharply affected Arizona with a $60.7 million decline in dollar value in the second quarter, primarily due to a 19.3% decline in number of home sales to 369 compared with 457 in the prior year.  Although Texas remains one of our strongest markets, its sales decreased 22.4% and 19.3%, respectively, in the units of homes ordered in the quarter and six months ended June 30, 2007 as compared to the same periods in 2006.

East.  In our East Region, we had net orders of 88 homes with a dollar value of $24.7 million for the three months ended June 30, 2007, decreases of 6.4% and 24.3%, respectively, for the same time period a year ago.  The East Region continues to be most significantly impacted by our Ft. Myers/Naples operation, which we believe is one of the softest homebuilding markets in the country.  As noted, going forward we expect the average sales prices of homes to continue to decline as Central Florida, a lower-priced area, comprises the significant portion of the East Region mix.  We have been unable to renegotiate prior land options and contracts for new land parcels at prices that are reasonable and, therefore, we are not adding new communities or new phases to existing communities in Ft. Myers.  Unless we initiate new projects in Ft. Myers/Naples, due to our limited existing lot inventory, sales volumes for this area will continue to decline until our existing inventory is sold out.

22




Order Backlog

 

 

At June 30,

 

 

 

2007

 

2006

 

Total

 

 

 

 

 

Dollars

 

$

1,198,280

 

$

1,959,353

 

Homes in backlog

 

3,838

 

5,849

 

Average sales price

 

$

312.2

 

$

335.0

 

West Region

 

 

 

 

 

California

 

 

 

 

 

Dollars

 

$

172,816

 

$

265,183

 

Homes in backlog

 

358

 

457

 

Average sales price

 

$

482.7

 

$

580.3

 

Nevada

 

 

 

 

 

Dollars

 

$

40,434

 

$

65,787

 

Homes in backlog

 

108

 

199

 

Average sales price

 

$

374.4

 

$

330.6

 

West Region Totals

 

 

 

 

 

Dollars

 

$

213,250

 

$

330,970

 

Homes in backlog

 

466

 

656

 

Average sales price

 

$

457.6

 

$

504.5

 

Central Region

 

 

 

 

 

Arizona

 

 

 

 

 

Dollars

 

$

301,448

 

$

748,004

 

Homes in backlog

 

896

 

1,993

 

Average sales price

 

$

336.4

 

$

375.3

 

Texas

 

 

 

 

 

Dollars

 

$

586,889

 

$

646,581

 

Homes in backlog

 

2,227

 

2,628

 

Average sales price

 

$

263.5

 

$

246.0

 

Colorado

 

 

 

 

 

Dollars

 

$

34,279

 

$

16,740