Table of Contents

 

 

 

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, 2009

 

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 a checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

Common shares outstanding as of August 4, 2009:  31,672,922

 

 

 



Table of Contents

 

MERITAGE HOMES CORPORATION

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2009

 

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

3

 

 

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008

3

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2008

4

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008

5

 

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

6

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

 

PART II.

OTHER INFORMATION

36

 

 

 

 

 

Item 1.

Legal Proceedings

36

 

 

 

 

 

Item 1A.

Risk Factors

38

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

39

 

 

 

 

 

Item 3.

Not Applicable

 

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

39

 

 

 

 

 

Item 5.

Not Applicable

 

 

 

 

 

 

Item 6.

Exhibits

40

 

 

 

 

SIGNATURES

41

 

 

INDEX OF EXHIBITS

42

 

2



Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

385,310

 

$

205,923

 

Income tax receivables

 

2,146

 

111,508

 

Other receivables

 

25,864

 

31,046

 

Real estate

 

710,129

 

859,305

 

Real estate not owned

 

8,043

 

5,762

 

Deposits on real estate under option or contract

 

16,436

 

51,658

 

Investments in unconsolidated entities

 

14,416

 

17,288

 

Property and equipment, net

 

19,217

 

22,692

 

Intangibles, net

 

4,350

 

5,023

 

Prepaid expenses and other assets

 

14,739

 

16,044

 

 

 

 

 

 

 

Total assets

 

$

1,200,650

 

$

1,326,249

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable

 

$

25,501

 

$

31,655

 

Accrued liabilities

 

98,298

 

125,101

 

Home sale deposits

 

10,561

 

8,486

 

Liabilities related to real estate not owned

 

6,869

 

4,833

 

Senior and senior subordinated notes

 

604,926

 

628,968

 

 

 

 

 

 

 

Total liabilities

 

746,155

 

799,043

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Preferred stock, par value $0.01. Authorized 10,000,000 shares; none issued and outstanding at June 30, 2009 and December 31, 2008

 

 

 

Common stock, par value $0.01. Authorized 125,000,000 shares; issued and outstanding 39,559,272 and 38,588,536 shares at June 30, 2009 and December 31, 2008, respectively

 

396

 

386

 

Additional paid-in capital

 

455,975

 

436,739

 

Retained earnings

 

186,897

 

278,854

 

Treasury stock at cost, 7,891,250 shares at June 30, 2009 and December 31, 2008

 

(188,773

)

(188,773

)

 

 

 

 

 

 

Total stockholders’ equity

 

454,495

 

527,206

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,200,650

 

$

1,326,249

 

 

See accompanying notes to condensed consolidated financial statements

 

3



Table of Contents

 

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,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Home closing revenue

 

$

220,414

 

$

373,923

 

$

451,392

 

$

745,579

 

Land closing revenue

 

1,125

 

1,375

 

1,285

 

3,148

 

Total closing revenue

 

221,539

 

375,298

 

452,677

 

748,727

 

 

 

 

 

 

 

 

 

 

 

Cost of home closings

 

(193,340

)

(322,143

)

(396,537

)

(648,369

)

Cost of land closings

 

(1,044

)

(1,397

)

(1,195

)

(3,084

)

Real estate impairments

 

(66,158

)

(28,512

)

(76,589

)

(72,861

)

Land impairments

 

(222

)

(6,630

)

(259

)

(6,630

)

Total cost of closings and impairments

 

(260,764

)

(358,682

)

(474,580

)

(730,944

)

 

 

 

 

 

 

 

 

 

 

Home closing gross (loss)/profit

 

(39,084

)

23,268

 

(21,734

)

24,349

 

Land closing gross (loss)

 

(141

)

(6,652

)

(169

)

(6,566

)

Total closing gross (loss)/profit

 

(39,225

)

16,616

 

(21,903

)

17,783

 

 

 

 

 

 

 

 

 

 

 

Commissions and other sales costs

 

(18,098

)

(33,669

)

(37,243

)

(67,434

)

General and administrative expenses

 

(13,775

)

(10,453

)

(27,644

)

(31,746

)

Earnings/(loss) from unconsolidated entities, net

 

852

 

(2,089

)

2,249

 

(15,618

)

Interest expense

 

(11,332

)

(5,538

)

(19,662

)

(11,199

)

Other income, net

 

3,099

 

973

 

4,650

 

3,270

 

Gain on extinguishment of debt

 

6,585

 

 

9,390

 

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

(71,894

)

(34,160

)

(90,163

)

(104,944

)

(Provision)/benefit for income taxes

 

(1,708

)

10,692

 

(1,794

)

36,171

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(73,602

)

$

(23,468

)

$

(91,957

)

$

(68,773

)

 

 

 

 

 

 

 

 

 

 

Loss per common share:

 

 

 

 

 

 

 

 

 

Basic and diluted

 

$

(2.37

)

$

(0.79

)

$

(2.97

)

$

(2.46

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares:

 

 

 

 

 

 

 

 

 

Basic and diluted

 

31,055

 

29,594

 

30,933

 

27,953

 

 

See accompanying notes to condensed consolidated financial statements

 

4



Table of Contents

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(91,957

)

$

(68,773

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

4,544

 

6,564

 

Real estate related impairments

 

76,848

 

79,491

 

Increase in deferred taxes

 

 

(9,023

)

Stock-based compensation

 

2,293

 

2,057

 

Gain on early extinguishment of senior subordinated debt, net of transaction costs

 

(9,390

)

 

Equity in (earnings)/losses from unconsolidated entities (includes $0.2 million and $19.7 million of impairments to joint ventures in 2009 and 2008, respectively)

 

(2,249

)

15,618

 

Distributions of earnings from unconsolidated entities

 

3,905

 

5,361

 

Changes in assets and liabilities:

 

 

 

 

 

Decrease in real estate

 

104,197

 

74,686

 

Decrease in deposits on real estate under option or contract

 

5,876

 

6,560

 

Decrease in income tax receivable

 

107,660

 

78,152

 

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

 

8,063

 

(26,453

)

Decrease in accounts payable and accrued liabilities

 

(33,611

)

(60,615

)

Increase/(decrease) in home sale deposits

 

2,075

 

(1,869

)

Net cash provided by operating activities

 

178,254

 

101,756

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Investments in unconsolidated entities

 

(1,151

)

(13,431

)

Distributions of capital from unconsolidated entities

 

1,109

 

1,862

 

Purchases of property and equipment

 

(1,572

)

(4,371

)

Proceeds from sales of property and equipment

 

114

 

105

 

Net cash used in investing activities

 

(1,500

)

(15,835

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net repayments under Credit Facility

 

 

(82,000

)

Purchase of treasury stock

 

 

(3

)

Proceeds from issuance of common stock, net of transaction fees

 

 

82,775

 

Proceeds from stock option exercises

 

2,633

 

783

 

Net cash provided by financing activities

 

2,633

 

1,555

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

179,387

 

87,476

 

Cash and cash equivalents at beginning of period

 

205,923

 

27,677

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

385,310

 

$

115,153

 

 

See supplemental disclosures of cash flow information at Note 11.

 

See accompanying notes to condensed consolidated financial statements

 

5


 


Table of Contents

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED JUNE 30, 2009 AND 2008

 

NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION

 

Organization. Meritage Homes is a leading designer and builder of single-family detached homes in the historically high-growth regions of the western and southern United States based on the number of home closings. We offer first-time, move-up, active adult and luxury homes to our targeted customer base. We have operations in three regions:  West, Central and East, which are comprised of 12 metropolitan areas in Arizona, Texas, California, Nevada, Colorado and Florida. Through our predecessors, we commenced our homebuilding operations in 1985. Meritage Homes Corporation was incorporated in 1988 in the State of Maryland.

 

Our homebuilding and marketing activities are conducted under the name of Meritage Homes in each of our markets, except for Arizona, where we also operate under the name of Monterey Homes, and in Texas, where we also operate as Legacy Homes and Monterey Homes. At June 30, 2009, we were actively selling homes in 178 communities, with base prices ranging from approximately $99,900 to $966,900.

 

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 our results for the interim periods presented.  Certain reclassifications related to the change in income tax receivable have been made to the prior year’s consolidated statement of cash flows in order to conform to the current year presentation.

 

Subsequent Events.  We evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q on August 5, 2009.  We are not aware of any significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on our condensed consolidated financial statements.

 

Real Estate. Real estate is stated at cost unless the community or land is determined to be impaired, at which point the inventory is written down to fair value as required by Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Accounting Standards Codification (“ASC”) Sub-Topic 360-10, Property, Plant and Equipment)Inventory includes the costs of land acquisition, land development, home construction, capitalized interest, real estate taxes, direct overhead costs incurred during development and home construction that benefit the entire community and impairments, if any.  Land and development costs are typically allocated and transferred to homes under construction when construction begins.  Home construction costs are accumulated on a per-home basis.  Cost of home closings includes the specific construction costs of the home and all related land acquisition, land development and other common costs (both incurred and estimated to be incurred) that are allocated based upon the total number of homes expected to be closed in each community or phase.  Any changes to the estimated total development costs of a community or phase are allocated to the remaining homes in the community or phase.  When a home closes, we may have incurred costs for goods and services that have not yet been paid.  Therefore, an accrual to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.

 

Typically, a community’s life cycle ranges from three to five years, commencing with the acquisition of the entitled land and continuing through the land development phase and concluding with the sale, construction and closing of the homes.  Actual community lives will vary based on the size of the community, the sales absorption rate and whether the land purchased was raw or finished lots.  Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving smaller finished lot purchases may be significantly shorter.

 

All of our land inventory and related real estate assets are reviewed for recoverability when impairment indicators are present, as our inventory is considered “long-lived” in accordance with U.S. generally accepted accounting principles.   Impairment charges are recorded if the fair value of an asset is less than its carrying amount.  Our determination of fair value is based on projections and estimates.  Changes in these expectations may lead to a change in the outcome of our impairment analysis.  Our analysis is completed on a quarterly basis at a community level with each community or land parcel evaluated individually.  For those assets deemed to be impaired, the impairment recognized is measured as the amount by which the assets’ carrying value exceeds their fair value.

 

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Existing and continuing communities When projections for the remaining income expected to be earned from existing communities are no longer positive, the underlying real estate assets are deemed not fully recoverable, and further analysis is performed to determine the required impairment.  The fair value of the community’s assets is determined using either a discounted cash flow model for projects we intend to build out or a market-based approach for projects we intend to sell or that are in the preliminary development stage and product types have not yet been finalized.  Impairments are charged to cost of home closing in the period during which it is determined that the fair value is less than the assets’ carrying amount.  If a market-based approach is used, we determine fair value based on recent comparable purchase and sale activity in the local market, adjusted for known variances as determined by our knowledge of the region and general real estate expertise. Our key estimates in deriving fair value under our cash flow model are (i) home selling prices in the community adjusted for current and expected sales discounts and incentives, (ii) costs related to the community - both land development and home construction - including costs spent to date and budgeted remaining costs to spend, (iii) projected sales absorption rates, reflecting any product mix change strategies implemented to stimulate the sales pace, (iv) alternative land uses including disposition of all or a portion of the land owned and (v) our discount rate, which is currently 14-16%.  These assumptions vary widely across different communities and geographies and are largely dependent on local market conditions.  Community-level factors that may impact our key estimates include:

 

·                       The presence and significance of local competitors, including their offered product type and competitive actions;

 

·                       Economic and related demographic conditions for the population of the surrounding community; and

 

·                       Desirability of the particular community, including unique amenities or other favorable or unfavorable attributes.

 

These local circumstances may significantly impact our assumptions and the resulting computation of fair value. We typically do not project market improvements in our discounted cash flow models, but may do so in limited circumstances in the latter years of a long-lived master planned community.  The models are also evaluated by regional and corporate personnel for consistency and integration, as decisions that affect pricing or absorption at one community may have resulting consequences for neighboring communities.  Impairments are allocated on a straight-line basis to all lots within a project.

 

Option deposits and pre-acquisition costsWe also evaluate assets associated with future communities for impairments on a quarterly basis.  Using similar techniques described in the existing and continuing communities section above, we determine if the contribution margins to be generated by our future communities are acceptable to us.  If the projections indicate that a community is still meeting our internal investment guidelines and is generating a profit, those assets are determined to be fully recoverable and no impairments are required.  In cases where we decide to abandon a project, we will fully impair all assets related to such project and will expense and accrue any additional costs that we are contractually obligated to incur.  We may also elect to continue with a project because it has positive cash flows, even though it may not be generating an accounting profit, or due to other strategic factors.  In such cases, we will impair our pre-acquisition costs and deposits, as necessary, to record an impairment to bring the book value to fair value.  Refer to Note 2 of these consolidated financial statements for further information regarding our impairments.

 

Deposits. Deposits paid related to land options and contracts to purchase land are capitalized when incurred and classified as deposits on real estate under option or contract until the related land is purchased. Deposits are recorded as a component of real estate at the time the deposit is used to offset the acquisition price of the lots based on the terms of the underlying agreements. To the extent they are non-refundable, deposits are charged to expense if the land acquisition is terminated or no longer considered probable.  The review of the likelihood of the acquisition of contracted lots is completed in conjunction with the real estate impairment analysis noted above.  Our deposits were $16.4 million and $51.7 million as of June 30, 2009 and December 31, 2008 respectively.

 

Off-Balance-Sheet Arrangements — Joint Ventures.  Historically, we have participated in land development joint ventures as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base.  We currently have three such active ventures.  We also participate in eight mortgage and title business joint ventures.  The mortgage joint ventures are engaged in mortgage brokerage activities, and they originate and provide services to both our customers and other homebuyers.  See Note 4 for additional information.

 

Off-Balance-Sheet Arrangements — Other.  We often acquire lots from various development entities pursuant to option and purchase agreements.  The purchase price typically approximates the market price at the date the contract is executed.  See Note 3 for further discussion.

 

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We provide letters of credit and performance, maintenance and other bonds in support of our related obligations with respect to the development of both our on- and off-balance-sheet projects.  The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities.  In the event a letter of credit or bond is drawn upon, we would be obligated to reimburse the issuer of the letter of credit or bond.  At June 30, 2009, we had approximately $12.7 million in outstanding letters of credit and $118.2 million of surety bonds outstanding subject to these indemnity arrangements, of which only $40.2 million of work remains to be completed.  We believe it is unlikely that any significant amounts of these letters of credit or bonds will be drawn upon.

 

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

 

 

 

At
June 30, 2009

 

At
December 31, 2008

 

Accruals related to real estate development and construction activities

 

$

27,195

 

$

35,494

 

Payroll and other benefits

 

7,034

 

13,702

 

Accrued taxes

 

2,988

 

2,913

 

Warranty reserves

 

28,596

 

28,891

 

Other accruals

 

32,485

 

44,101

 

Total

 

$

98,298

 

$

125,101

 

 

Warranty Reserves.  We have certain obligations related to post-construction warranties and defects for closed homes.  With the assistance of an actuary, we have estimated these reserves based on the number of home closings, historical data and trends with respect to similar product types and geographic areas.  We regularly review our warranty reserves and adjust them, as necessary, to reflect changes in trends as information becomes available.  A summary of changes in our warranty reserves follows (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Balance, beginning of period

 

$

27,490

 

$

35,742

 

$

28,891

 

$

36,633

 

Additions to reserve from new home deliveries

 

1,760

 

2,876

 

3,628

 

4,790

 

Warranty claims

 

(410

)

(3,193

)

(2,068

)

(5,193

)

Adjustments to pre-existing reserves

 

(244

)

(1,149

)

(1,855

)

(1,954

)

Balance, end of period

 

$

28,596

 

$

34,276

 

$

28,596

 

$

34,276

 

 

Warranty reserves are included in accrued liabilities on the accompanying condensed consolidated balance sheets, and additions to the reserves are included in cost of sales within the accompanying condensed consolidated statements of operations.

 

There has recently been publicity about homes constructed with allegedly defective drywall manufactured in China (“Chinese drywall”).  During the first quarter of 2009, we became aware (from customer inquiries) that a limited number of the homes we constructed in the Ft. Myers, Florida area in 2005 and 2006 are exhibiting symptoms typical of the potentially defective Chinese drywall.  As of June 30, 2009, Meritage has not been named as a defendant in any lawsuit pertaining to Chinese drywall, although it is possible that we may in the future become subject to such litigation.

 

As of June 30, 2009, we have confirmed that 44 of the homes we constructed in the Ft. Myers, Florida area have exhibited symptoms of and thus are suspected of containing defective Chinese drywall.  The defective drywall was delivered and installed in those 44 homes during an approximate six-month period in 2006.  We believe there may be up to an additional 50 homes in the Ft. Myers area that had drywall installed during the same time period and believe it is possible that some of those homes may also contain defective Chinese drywall.  We are continuing our investigation of homes constructed during the relevant time period to determine whether there are homes that we have not yet inspected that contain defective Chinese drywall. Based on our investigation to date, we do not believe defective Chinese drywall was used in homes constructed by us in other areas of Florida or in our other markets outside of Florida.

 

The above established reserves represent reserves for post-construction warranties and defects for closed homes.  These reserves are intended to cover costs associated with our contractual and statutory warranty obligations, which include, among other items, claims involving defective workmanship and materials.  We believe that the $28.6 million warranty reserve we have as of June 30, 2009 is sufficient to cover the costs associated with the repair of the 44 homes identified with defective Chinese drywall after taking into account anticipated insurance proceeds from our insurance carrier and those of other responsible parties.  As of June 30, 2009, we have not established any reserves for any additional homes that may contain the defective drywall, although based on the number of homes ultimately identified with Chinese drywall, our net

 

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insurance proceeds and our final determination of our required warranty accrual based on management’s review and our actuary’s analysis, we may have additional capacity under our warranty reserves or our insurance proceeds to absorb at least a portion of such costs, if any.  We maintain general liability insurance, subject to a self-insured retention obligation, that we believe would cover a portion of our ultimate defective Chinese drywall exposure.

 

We are currently unable to reasonably estimate our total possible loss or exposure relating to Chinese drywall because, among other reasons: determining the number of homes that contain potentially defective Chinese drywall is difficult as we are still in the process of doing so; we did not directly purchase the drywall materials used to construct our Ft. Myers area homes, rather, our subcontractors purchased and provided that drywall; the possible means and related costs to remedy any defective conditions is still being evaluated; homes containing defective Chinese drywall seem to be exhibiting different levels of symptoms attributed to defective Chinese drywall and may dictate different repair or remedial efforts; the group of other potentially responsible parties, including, but not limited to, manufacturers, subcontractors, retailers, wholesalers, distributors, and their legal obligations for the problem and remedy, together with their financial resources, have not been determined; and the extent of our insurance coverage for defective Chinese drywall resulting charges and related costs and claims is still being determined.

 

The outcome of our investigation and analysis may result in the need to establish additional warranty reserves; however, we do not currently expect the total charge to have a material adverse effect on our operations as we believe our exposure is limited due to the relatively limited number of our homes that appear to be impacted, our existing warranty reserves and available insurance.

 

Recently Issued Accounting Pronouncements.  In June 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Statement of Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 168”) (ASC sub-topic 105-10, Generally Accepted Accounting Principles (ASC 105-10)).  This Statement replaces SFAS No. 162 and establishes The FASB Accounting Standards Codification as the source of authoritative accounting principles to be applied by all non-governmental entities.  SFAS No. 168 (ASC 105-10) is effective for interim and annual periods ending after September 15, 2009.  The adoption of this Statement is not expected to have a material impact on our financial results.

 

In May 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS No. 167”) (ASC Subtopic 810-10, Consolidation (ASC 810-10))This Statement amends FIN 46(R) and revises accounting and reporting requirements for entities’ involvement with variable interest entities. The provisions of SFAS No. 167 (ASC 810-10) are effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2009.  We are currently evaluating what impact, if any, the adoption of the Statement will have on our consolidated financial statements.

 

In May 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets-an amendment of FASB SFAS No. 140 (“SFAS No. 166”) (ASC Subtopic 860-10, Transfers and Servicing (ASC 860-10)).  This Statement amends SFAS No. 140 and revises accounting and reporting requirements for the transfers of financial assets, the transferor’s continuing involvement (if any) in the transferred financial assets and how such transfers affect the transferor’s financial position, financial performance and cash flows.  The provisions of SFAS No. 166 (ASC 860-10) are effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2009.  We do not believe the adoption of SFAS No. 166 (ASC 860-10) will have a material impact on our consolidated financial statements.

 

In May 2009, the FASB issued Staff Position No. 165, Subsequent Events (ASC Subtopic 855-10, Subsequent Events (ASC 855-10)), to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The new disclosure requirement is effective for interim reporting periods ending after June 15, 2009.  The adoption of this staff position resulted in additional quarterly disclosures only.

 

In April 2009, the FASB issued Staff Position No. 107-1 and APB 28-1 (“FSP FAS 107-1”), which amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments and APB Opinion NO. 28, Interim Financial Reporting (ASC Subtopic 825-10-50, Financial Instruments (ASC 825-10-50)), to require disclosures about the fair value of financial instruments during interim reporting periods. The new disclosure requirements are effective for interim reporting periods ending after June 15, 2009.  The adoption of this staff position resulted in additional quarterly disclosures only.

 

In April 2009, the FASB issued Staff Position No. 157-4 (“FSP FAS 157-4”), Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (ASC Subtopic 820-10, Fair Value Measurement and Disclosures (ASC 820-10)), which provides further clarification for guidance provided by SFAS No. 157, Fair Value Measurements, regarding measurement of fair values of assets and liabilities when the market activity has significantly decreased and in identifying transactions that are not orderly.  FSP FAS 157-4 (ASC 820-10) is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this staff position did not have a material impact on our financial results.

 

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In December 2007, the FASB issues SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an Amendment of ARB 51 (ASC Subtopic 810-10. Consolidation (ASC 810-10)).  This statement amends ARB 51 and revises accounting and reporting requirements for noncontrolling interests (formerly minority interests) in a subsidiary and for the deconsolidation of a subsidiary.  Upon its adoption, noncontrolling interests will be classified as equity, and income attributed to the noncontrolling interest will be included in the Company’s income.  The provisions of this standard are applied retrospectively upon adoption.  We adopted this pronouncement on January 1, 2009, and it did not have a material impact on our consolidated results.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, (“SFAS No. 141(R)”) (ASC Subtopic 805-10, Business Combinations (ASC 805-10)).  SFAS No. 141(R) (ASC 805-10) clarifies and amends the accounting guidance for how an acquirer in a business combination recognizes and measures the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree.  The provisions of SFAS No. 141(R) (ASC 805-10) are effective for us for any business combinations occurring on or after January 1, 2009, and the adoption did not have a material impact on our financial statements.

 

NOTE 2 – REAL ESTATE AND CAPITALIZED INTEREST

 

Real estate consists of the following (in thousands):

 

 

 

At
June 30, 2009

 

At
December 31, 2008

 

 

 

 

 

 

 

Homes under contract under construction (1)

 

$

160,649

 

$

170,347

 

Finished home sites and home sites under development

 

375,015

 

455,048

 

Unsold homes, completed and under construction

 

78,654

 

158,378

 

Model homes

 

40,855

 

48,608

 

Land held for development or sale

 

54,956

 

26,924

 

 

 

$

710,129

 

$

859,305

 

 


(1)  Also includes the allocated land and land development costs associated with each lot for these homes.

 

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As previously noted, each of our land inventory and related real estate assets is reviewed for recoverability when impairment indicators are present, as our inventory is considered “long-lived” in accordance with U.S. generally accepted accounting principles.  Due to the current economic environment, we evaluate all of our real estate and joint venture assets for impairment on a quarterly basis.  If an asset is deemed not recoverable, impairment charges are recorded if the fair value of such assets is less than their carrying amounts.  Our determination of fair value is based on projections and estimates.  Based on these reviews of all our communities, we recorded the following real-estate and joint-venture impairment charges during the three- and six-month periods ended June 30, 2009 and 2008 (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Terminated option/purchase contracts and related pre-acquisition costs:

 

 

 

 

 

 

 

 

 

West

 

$

5,855

 

$

2,806

 

$

5,922

 

$

15,480

 

Central

 

55,403

 

589

 

55,989

 

2,184

 

East

 

 

943

 

544

 

1,303

 

Total

 

$

61,258

 

$

4,338

 

$

62,455

 

$

18,967

 

 

 

 

 

 

 

 

 

 

 

Real estate inventory impairments (1):

 

 

 

 

 

 

 

 

 

West

 

$

2,888

 

$

15,869

 

$

8,497

 

$

29,963

 

Central

 

1,340

 

5,584

 

4,354

 

15,211

 

East

 

672

 

2,721

 

1,283

 

8,720

 

Total

 

$

4,900

 

$

24,174

 

$

14,134

 

$

53,894

 

 

 

 

 

 

 

 

 

 

 

Impairments of joint venture investments:

 

 

 

 

 

 

 

 

 

West

 

$

219

 

$

168

 

$

219

 

$

1,622

 

Central

 

 

400

 

 

14,762

 

East

 

 

3,305

 

 

3,305

 

Total

 

$

219

 

$

3,873

 

$

219

 

$

19,689

 

 

 

 

 

 

 

 

 

 

 

Impairments of land held for sale:

 

 

 

 

 

 

 

 

 

West

 

$

323

 

$

5,551

 

$

323

 

$

5,551

 

Central

 

(101

)

1,079

 

(64

)

1,079

 

East

 

 

 

 

 

Total

 

$

222

 

$

6,630

 

$

259

 

$

6,630

 

 

 

 

 

 

 

 

 

 

 

Total impairments:

 

 

 

 

 

 

 

 

 

West

 

$

9,285

 

$

24,394

 

$

14,961

 

$

52,616

 

Central

 

56,642

 

7,652

 

60,279

 

33,236

 

East

 

672

 

6,969

 

1,827

 

13,328

 

Total

 

$

66,599

 

$

39,015

 

$

77,067

 

$

99,180

 

 


(1)          Included in the real estate inventory impairments are impairments of individual homes in a community where the underlying community was not also impaired, as follows (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Individual home impairments (in thousands):

 

 

 

 

 

 

 

 

 

West

 

$

1,266

 

$

9,936

 

$

6,875

 

$

18,546

 

Central

 

1,072

 

5,473

 

4,083

 

8,689

 

East

 

672

 

1,811

 

1,283

 

6,621

 

Total

 

$

3,010

 

$

17,220

 

$

12,241

 

$

33,856

 

 

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The tables below reflect the number of communities with real estate inventory impairments for the three- and six-month periods ended June 30, 2009 and 2008, excluding home-specific impairments (as noted above) and the fair value of these communities as of June 30, 2009 and 2008 (dollars in thousands):

 

 

 

Three Months Ended June 30, 2009

 

 

 

Number of Communities
Impaired

 

Impairment
Charges

 

Fair Value of Communities
Impaired
(Carrying Value less Impairments)

 

 

 

 

 

 

 

 

 

West

 

3

 

$

1,622

 

$

6,038

 

Central

 

1

 

268

 

1,072

 

East

 

 

 

 

Total

 

4

 

$

1,890

 

$

7,110

 

 

 

 

Three Months Ended June 30, 2008

 

 

 

Number of Communities
Impaired

 

Impairment
Charges

 

Fair Value of Communities
Impaired
(Carrying Value less Impairments)

 

 

 

 

 

 

 

 

 

West

 

11

 

$

5,933

 

$

72,564

 

Central

 

3

 

111

 

3,353

 

East

 

2

 

910

 

8,706

 

Total

 

16

 

$

6,954

 

$

84,623

 

 

 

 

Six Months Ended June 30, 2009

 

 

 

Number of Communities
Impaired

 

Impairment
Charges

 

Fair Value of Communities
Impaired
(Carrying Value less Impairments)

 

 

 

 

 

 

 

 

 

West

 

3

 

$

1,622

 

$

6,038

 

Central

 

2

 

271

 

1,401

 

East

 

 

 

 

Total

 

5

 

$

1,893

 

$

7,439

 

 

 

 

Six Months Ended June 30, 2008

 

 

 

Number of Communities
Impaired

 

Impairment
Charges

 

Fair Value of Communities
Impaired
(Carrying Value less Impairments)

 

 

 

 

 

 

 

 

 

West

 

20

 

$

11,417

 

$

153,123

 

Central

 

18

 

6,522

 

57,595

 

East

 

2

 

2,099

 

8,706

 

Total

 

40

 

$

20,038

 

$

219,424

 

 

Subject to sufficient qualifying assets, we capitalize interest incurred during the development and construction of real estate. Capitalized interest is allocated to qualified real estate assets as incurred and charged to the statement of operations as a component of closing costs. A summary of our capitalized interest is as follows (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Capitalized interest, beginning of period

 

$

26,629

 

$

38,478

 

$

29,779

 

$

41,396

 

Interest incurred

 

13,352

 

10,543

 

25,004

 

24,465

 

Interest expensed

 

(11,332

)

(5,538

)

(19,662

)

(11,199

)

Interest amortized to cost of home, land closings and impairments

 

(9,065

)

(6,648

)

(15,537

)

(17,827

)

Capitalized interest, end of period

 

$

19,584

 

$

36,835

 

$

19,584

 

$

36,835

 

 

At June 30, 2009, approximately $1.3 million of the capitalized interest is related to our joint venture investments and is a component of “Investments in unconsolidated entities” on our condensed consolidated balance sheets.

 

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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”) (ASC 810-10) requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, or receives a majority of the entity’s expected residual returns if no party absorbs the majority of expected losses, as a result of ownership, contractual or other financial interests in the entity.

 

Based on the provisions of the relevant accounting guidance, we have concluded that when we enter into an option or purchase agreement to acquire land or lots from an entity and pay a non-refundable deposit, a variable interest entity, or VIE, may be created because we are deemed to have provided subordinated financial support that will absorb some or all of an entity’s expected losses if they occur.  For each VIE created, we compute expected losses and residual returns based on the probability of future cash flows.  If we are the primary beneficiary of the VIE, based on the entity’s expected profits and losses and the cash flows associated with changes in the fair value of land under contract, we will consolidate the VIE in our financial statements and reflect such assets and liabilities as “Real estate not owned.”  The liabilities related to consolidated VIEs are excluded from our debt covenant calculations.

 

We have developed a methodology to determine whether 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 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 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 non-refundable option deposits and any capitalized pre-acquisition costs.  Often, we are at risk for items over budget related to land development on property we have under option.  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 to us if certain contractual conditions are not performed by the party selling the lots.

 

The table below presents a summary of our lots under option or contract at June 30, 2009 (dollars in thousands):

 

 

 

 

 

 

 

Option/Earnest
Money Deposits

 

 

 

Number of

 

Purchase

 

 

 

Letters of

 

 

 

Lots

 

Price

 

Cash

 

Credit

 

 

 

 

 

 

 

 

 

 

 

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

 

343

 

$

8,043

 

$

1,174

 

$

 

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

 

4,151

 

177,148

 

16,284

 

5,983

 

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

 

 

 

 

 

Total committed (on and off balance sheet)

 

4,494

 

185,191

 

17,458

 

5,983

 

Option contracts not recorded on balance sheet – non-refundable, uncommitted (1)(3)

 

250

 

3,120

 

50

 

 

Purchase contracts not recorded on balance sheet – refundable deposits, uncommitted (4)

 

217

 

18,583

 

102

 

 

Total uncommitted

 

467

 

21,703

 

152

 

 

Total lots under option or contracts

 

4,961

 

206,894

 

17,610

 

5,983

 

 

 

 

 

 

 

 

 

 

 

Total option contracts not recorded on balance sheet

 

4,618

 

$

198,851

 

$

16,436

(5)

$

5,983

 

 


(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 us the option to purchase these lots in the future, in anticipation of building homes on these lots in the future. Specific performance contracts, if any, are included in this balance.  All contracts that are not specific performance contracts are not considered to be firm contractual obligations.

 

(3)                                 Although we have made minimal non-refundable deposits, we have not completed our acquisition evaluation process and we have not internally committed to purchase these lots.

 

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(4)                                 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.

 

(5)                                 Amount is reflected in our condensed consolidated balance sheet in the line item “Deposits on real estate under option or contract” as of June 30, 2009.

 

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 elect to purchase lots at an absorption level that exceeds our sales and home starts pace needed to meet the pre-established minimum number of lots.

 

NOTE 4 - INVESTMENTS IN UNCONSOLIDATED ENTITIES

 

Historically, we have entered into homebuilding and land development joint ventures as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base. 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 generally do not have a controlling interest in these ventures, which means our joint venture partners could cause the venture to take actions we disagree with, or fail to take actions we believe should be undertaken, including the sale of the underlying property to repay debt or recoup all or part of the partners’ investments.  As of June 30, 2009, we had three active land ventures.  Due to the current homebuilding environment, although we view our involvement with land joint ventures to be beneficial, we do not view such involvement as critical to the success of our homebuilding operations.

 

We also participate in eight mortgage and title business joint ventures. The mortgage joint ventures are engaged in mortgage brokerage activities and they originate and provide services to both our clients and other homebuyers. The mortgages originated by these ventures are primarily funded by third-party mortgage lenders with limited recourse back to our joint ventures. Our investments in mortgage and title joint ventures as of June 30, 2009 and December 31, 2008 were $0.8 million and $1.4 million, respectively.

 

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 these ventures, our share of the joint venture profit 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 the portion of such joint venture profit to the land acquired by us as a reduction in the basis of the property.

 

Repayment Guarantees.  We and/or our land development joint venture partners occasionally provide limited repayment guarantees on a pro rata basis on the debt of the land development joint ventures.  If such a guarantee were ever to be called, the maximum exposure to Meritage would generally be only our pro-rata share of the amount of debt outstanding that was in excess of the fair value of the underlying land securing the debt.  At June 30, 2009 and December 31, 2008, our share of these limited pro rata repayment guarantees was approximately $8.5 million, of which $7.1 million are “bad boy” guarantees (see below for a discussion about “bad boy” guarantees); however, as the other joint venture partners could trigger such guarantees without our consent, we have classified this $7.1 million as repayment guarantees.

 

“Bad Boy” Guarantees.  In addition, we and/or our joint venture partners occasionally provide guarantees that are only applicable if and when the joint venture directly, or indirectly through agreement with its joint venture partners or other third parties, causes the joint venture to voluntarily file a bankruptcy or similar liquidation or reorganization action or take other actions that are fraudulent or improper (commonly referred to as “bad boy” guarantees).  These types of guarantees typically are on a pro rata basis among the joint venture partners and are designed to protect the secured lender’s remedies with respect to its mortgage or other secured lien on the joint venture or the joint venture’s underlying property.  To date, no such guarantees have been invoked and we believe that the actions that would trigger a guarantee would generally be disadvantageous to the joint venture and to us, and therefore are unlikely to occur; however, there can be no assurances that certain of our ventures will not elect to take actions that could trigger a bad boy guarantee, as it may be considered in their economic best interest to do so.  At June 30, 2009 and December 31, 2008, we had outstanding guarantees of this type totaling approximately $72.5 million.  We believe these guarantees, as defined, unless invoked as described above, are not considered guarantees of indebtedness under our Credit Facility or senior and senior subordinated indentures.

 

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Other Guarantees.  We and our joint venture partners are also typically obligated to the project lender(s) to complete construction of the land development improvements if the joint venture does not perform the required development.  Provided we and the other joint venture partners are in compliance with these completion obligations, the project lenders are generally obligated to fund these improvements through any financing commitments available under the applicable joint venture development and construction loans.  In addition, we and our joint venture partners have from time to time provided unsecured indemnities to joint venture project lenders.  These indemnities generally obligate us to reimburse the project lenders only for claims and losses related to matters for which such lenders are held responsible and our exposure under these indemnities is limited to specific matters such as environmental claims.  As part of our project acquisition due diligence process to determine potential environmental risks, we generally obtain, or the joint venture entity generally obtains, an independent environmental review.  Per the guidance of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others (ASC Subtopic 460-10,  Guaranties (ASC 460-10), we believe these other guarantees are either not applicable or not material to our financial results.

 

Surety Bonds.  We and our joint venture partners also indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures.  If a joint venture does not perform its obligations, the surety bond could be called.  If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners would be obligated to make such payments.  These surety indemnity arrangements are generally joint and several obligations with our joint venture partners.  Although a majority of the required work may have been performed, these bonds are typically not released until all development specifications have been met.  As of June 30, 2009, we had approximately $1.7 million of surety bonds outstanding subject to these indemnity arrangements, of which only $0.3 million of work remains to be completed.  At December 31, 2008, we had approximately $2.4 million of such surety bonds with only $0.5 million of work remaining to be completed.  None of these bonds have been called to date and we believe it is unlikely that any of these bonds will be called.

 

The joint venture obligations, guarantees and indemnities discussed above are generally provided by us or one or more of our subsidiaries.  In joint ventures involving other homebuilders or developers, support for these obligations is generally provided by the parent companies of the joint venture partners.  In connection with our periodic real estate impairment reviews, we may accrue for any such commitments where we believe our obligation to pay is probable and can be reasonably estimated.  In such situations, our accrual represents the portion of the total joint venture obligation related to our relative ownership percentage.  In the limited cases where our venture partners, some of whom are homebuilders or developers who may be experiencing financial difficulties as a result of current market conditions, may be unable to fulfill their pro rata share of a joint venture obligation, we may be fully responsible for these commitments if such commitments are joint and several.  We continue to monitor these matters and reserve for these obligations if and when they become probable and can be reasonably estimated.  As of June 30, 2009 and December 31, 2008, we did not have any such reserves.

 

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

 

 

 

At
June 30, 2009

 

At
December 31, 2008

 

Assets:

 

 

 

 

 

Cash

 

$

4,333

 

$

6,817

 

Real estate

 

549,272

 

528,433

 

Other assets

 

7,228

 

11,356

 

Total assets

 

$

560,833

 

$

546,606

 

 

 

 

 

 

 

Liabilities and equity:

 

 

 

 

 

Accounts payable and other liabilities

 

$

5,810

 

$

11,166

 

Notes and mortgages payable

 

383,806

 

381,228

 

Equity of:

 

 

 

 

 

Meritage (1)

 

47,096

 

47,871

 

Others

 

124,121

 

106,341

 

Total liabilities and equity

 

$

560,833

 

$

546,606

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Revenues

 

$

4,442

 

$

5,673

 

$

7,983

 

$

11,621

 

Costs and expenses

 

(2,143

)

(2,831

)

(4,244

)

(7,502

)

Net earnings of unconsolidated entities

 

$

2,299

 

$

2,842

 

3,739

 

$

4,119

 

Meritage’s share of pre-tax earnings (2) (3)

 

$

676

 

$

1,786

 

$

2,097

 

$

4,075

 

 


(1)         Balance represents Meritage’s interest, as reflected in the financial records of the respective joint ventures. This balance may differ from the balance reflected in our condensed consolidated balance sheets due to the following reconciling items: (i) timing differences for revenue and distributions recognition, (ii) step-up basis and corresponding amortization, (iii) income deferrals as discussed in Note (3) below and (iv) joint-venture asset impairments recorded only in our financial statements.

 

(2)         The joint venture financial statements above represent the most recent information available to us. For joint ventures where we have impaired our investment, the joint venture partners may have not yet reached a consensus or finalized the write-down amount and, therefore, the financial statements of the ventures may not yet reflect any real estate impairment charges. We believe, in some cases, that the fair values of the ventures may be less than the related debt. For the three and six months ended June 30, 2009, we recorded $0.2 million of such impairments. For the three and six months ended June 30, 2008, we recorded $3.9 million and $19.7 million, respectively, of impairments related to our joint venture investments. As our portion of pre-tax earnings is recorded on the accrual basis and included 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 reflect a different time frame than that represented by the joint venture financials. See Note 2, “Real Estate and Capitalized Interest”, for detail of our joint venture-related impairments.

 

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

 

Our investments in unconsolidated entities includes $1.4 million and $1.6 million at June 30, 2009 and December 31, 2008, 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 $71,000 and $104,000 of such assets in the first six months of 2009 and 2008, respectively.

 

Of the balance of joint venture assets and liabilities, $500.2 million and $362.4 million, respectively, relate to four joint ventures in which we have interests ranging from 20% - 50%.  Of our “bad boy” debt guarantees, the entire $72.5 million related to two of these ventures.  These ventures own assets in difficult markets and are currently in default of their debt agreements.  Although we and our joint venture partners continue to work with the respective lenders to renegotiate the debt or reach other satisfactory alternatives, all debt for these ventures is non-recourse to the partners and the investment in three of the ventures has been fully impaired and is $2.4 million in the fourth venture as of June 30, 2009.  At this time we believe there is limited exposure to us from these investments.

 

The other venture assets and liabilities noted in the table above primarily represent our other active land ventures, financial ventures and various inactive ventures in which we have a total investment of $12.0 million.  As of June 30, 2009, the debt of these ventures is in compliance with their respective agreements, and except for $1.5 million of our limited repayment guarantees, the debt is non-recourse to us.  These ventures have no “bad boy” guarantees.

 

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In addition to joint ventures accounted for under the equity method summarized in the above table, our investments in unconsolidated entities include two 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 third parties.  Our ownership percentage in these ventures is between 3% - 4%.  Both ventures have been notified of default events on their debt, and one has since dispossessed its assets in a trustee sale and, accordingly, its debt was extinguished.  The lenders of both ventures have filed suit against the joint ventures and/or their members alleging liability under the completion guarantees executed severally by each of the members and their parent companies, including Meritage.  We dispute the allegations contained in each of the lawsuits and intend to vigorously defend our position that no amounts are due under these completion guarantees.  We continue to believe that the debt obligations of the remaining venture with land holdings are non-recourse to the partners and are only payable by the partners if a “bad boy” guarantee is triggered.  We have fully impaired our investment in these joint ventures as of June 30, 2009.  As of December 31, 2008, we had fully impaired our investment in the joint venture that has lost its property to foreclosure and had an investment balance of $0.9 million in the other venture.  The one venture that still has land holdings and corresponding debt has a $7.1 million “bad boy” guaranty that could be triggered upon events beyond our control and, accordingly, is reported as a limited repayment guaranty.

 

At June 30, 2009, our total investment in unconsolidated joint ventures of $14.4 million is primarily comprised of $14.1 million in our Central Region and $0.3 million in our West Region.  At December 31, 2008, our total investment in unconsolidated joint ventures of $17.3 million is primarily comprised of $15.9 million in our Central Region and $1.1 million in our West Region.

 

NOTE 5 - LOANS PAYABLE AND OTHER BORROWINGS

 

Loans payable consists of the following (in thousands):

 

 

 

At
June 30, 2009

 

At
December 31, 2008

 

$150 million unsecured revolving credit facility, interest payable monthly at LIBOR (0.32% at June 30, 2009) plus 2.63% or prime (3.25% at June 30, 2009) (1)

 

$

 

$

 

 

 

 

 

 

 

Total loans payable and other borrowings

 

$

 

$

 

 


(1)                                  On  May 19, 2009, we amended our Senior Unsecured Credit Facility (“Credit Facility”) to reduce the borrowing capacity to $150 million from $500 million.

 

We had no outstanding loans or other borrowing balances at June 30, 2009 or December 31, 2008.  Our Credit Facility matures in May 2011.

 

We are planning to terminate our Credit Facility in the third quarter of 2009.  We expect to record an approximate $1 million charge from the write-off of remaining capitalized origination fees, but expect an approximate $2 million savings in fees over the remaining life of the facility.  We do not anticipate the need for Credit Facility availability through May 2011 and intend to enter into new credit commitments for about $40-$50 million to replace our current $22 million in letters of credit supported by the current Credit Facility, as well as our future letter of credit needs.

 

NOTE 6 - SENIOR AND SENIOR SUBORDINATED NOTES

 

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

 

 

 

At
June 30, 2009

 

At
December 31, 2008

 

7.0% senior notes due 2014. At June 30, 2009, and December 31, 2008, there was approximately $43 and $47 in unamortized premium, respectively

 

$

130,043

 

$

130,047

 

6.25% senior notes due 2015. At June 30, 2009 and December 31, 2008, there was approximately $0.9 and $1.1 million in unamortized discount, respectively

 

349,008

 

348,921

 

7.731% senior subordinated notes due 2017

 

125,875

 

150,000

 

 

 

$

604,926

 

$

628,968

 

 

Our Credit Facility and indentures for 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, 2009, we were in compliance with our covenants.

 

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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.

 

During the six months ended June 30, 2009, we retired $24.1 million of our 7.731% senior subordinated notes maturing in 2017 by issuing approximately 783,000 shares of our common stock in a privately negotiated transaction.  The transaction was completed at an average discount of 41% from the face value of the notes, resulting in a $6.6 million and $9.4 million gain on early extinguishment of debt which is reflected in our statement of operations for the three- and six-month periods ending June 30, 2009, respectively.

 

NOTE 7 – FAIR VALUE DISCLOSURES

 

Effective January 1, 2009, we adopted SFAS No. 157 (ASC 820-10) for non-recurring fair value measurements of our non-financial assets and liabilities.  This guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This standard establishes a three-level hierarchy for fair value measurements based upon the significant inputs used to determine fair value.  Observable inputs are those which are obtained from market participants external to the company while unobservable inputs are generally developed internally, utilizing management’s estimates, assumptions and specific knowledge of the assets/liabilities and related markets.  The three levels are defined as follows:

 

·                  Level 1 – Valuation is based on quoted prices in active markets for identical assets and liabilities.

 

·                  Level 2 –Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active, or by model-based techniques in which all significant inputs are observable in the market.

 

·                  Level 3 – Valuation is derived from model-based techniques in which at least one significant input is unobservable and based on the company’s own estimates about the assumptions that market participants would use to value the asset or liability.

 

If the only observable inputs are from inactive markets or for transactions which the company evaluates as “distressed”, the use of Level 1 inputs should be modified by the company to properly address these factors, or the reliance of such inputs may be limited, with a greater weight attributed to Level 3 inputs.

 

A summary of our assets re-measured at fair value on June 30, 2009 is as follows (in thousands):

 

 

 

 

 

Fair Value Measurements of Reporting Date Using

 

 

 

As of June 30, 2009

 

Level 1

 

Level 2

 

Level 3

 

Description:

 

 

 

 

 

 

 

 

 

Long-lived assets held and used

 

$

18,825

 

 

 

$

18,825

 

 

During the three months ended June 30, 2009, long-lived assets held and used with an initial basis of $23.7 million were impaired and written down to their fair value of $18.8 million, resulting in an impairment of $4.9 million, which is included in our consolidated statement of operations for the quarter ended June 30, 2009.

 

Financial Instruments.    The value of our fixed-rate debt is derived from quoted market prices by independent dealers.

 

The estimated fair value of our 7.0% senior notes at June 30, 2009 and December 31, 2008 was $100.8 and $78.7 million, respectively.  The aggregate principal amount of these notes at June 30, 2009 and December 31, 2008 was $130.0 million.

 

The estimated fair value of our 6.25% senior notes at June 30, 2009 and December 31, 2008 was $269.5 and $197.8 million, respectively.  The aggregate principal amount of these notes at December 31, 2008 was $350.0 million.

 

The estimated fair value of our 7.731% senior subordinated notes at June 30, 2009 and December 31, 2008 was $88.1 and $71.2 million, respectively.  The aggregate principal amount of these notes at June 30, 2009 and December 31, 2008 was $125.9 million and $150.0 million, respectively.

 

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Table of Contents

 

Due to the short-term nature of other financial assets and liabilities, we consider the carrying amounts of our other short-term financial instruments to approximate fair value.

 

NOTE 8 – LOSS PER SHARE

 

Basic and diluted loss per common share is presented in conformity with SFAS No. 128, “Earnings per Share” (ASC Subtopic 260-10, Earnings Per Share (ASC 260-10)). The following table presents the calculation of basic and diluted loss per common share (in thousands, except per share amounts):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Basic weighted average number of shares outstanding

 

31,055

 

29,594

 

30,933

 

27,953

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and restricted stock (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted average shares outstanding

 

31,055

 

29,594

 

30,933

 

27,953

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(73,602

)

$

(23,468

)

$

(91,957

)

$

(68,773

)

 

 

 

 

 

 

 

 

 

 

Basic loss and diluted loss per share (1)

 

$

(2.37

)

$

(0.79

)

$

(2.97

)

$

(2.46

)

 

 

 

 

 

 

 

 

 

 

Total antidilutive stock options outstanding not included in the calculation of diluted loss per share

 

1,848

 

2,391

 

1,848

 

2,391

 

 


(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 because all options and non-vested shares outstanding are considered anti-dilutive.

 

NOTE 9 - STOCK-BASED COMPENSATION

 

We have two stock compensation plans (together, the “Plans”).  The Plans, which have been amended from time to time, 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 7,500,000 shares of common stock, of which 727,504 shares remain available for grant at June 30, 2009.  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.  Option awards are generally granted with an exercise price equal to the closing market price of Meritage stock on 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 using the following assumptions:

 

 

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

Expected volatility

 

86.48

%

54.52

%

Expected dividends

 

0

%

0

%

Expected term (in years)

 

3.7

 

4.6

 

Risk-free interest rate

 

1.6

%

3.0

%

Weighted average grant date fair value of options granted

 

$

8.22

 

$

7.79

 

 

As of June 30, 2009, we had $11.7 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 respective vesting periods — a weighted-average period of 3.53 years. For the three months ended June 30, 2009 and 2008, our total stock-based compensation expense was $1.2 million ($0.8 million net of tax) and $0.7 million ($0.4 million net of tax), respectively.  For the six months ended June 30, 2009 and 2008, our total stock-based compensation expense was $2.3 million ($1.4 million net of tax) and $2.1 million ($1.3 million net of tax), respectively.  We granted 325,500 options and 205,000 non-vested shares during the first six months of 2009.  We also granted an additional 202,500 non-vested shares that will only vest if certain performance criteria are met.  The expense associated with these performance-based non-vested shares will only be recognized when it is determined to be likely that the target performance thresholds will be met and the shares will vest.

 

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NOTE 10 - INCOME TAXES

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Federal

 

$

1,740

 

$

(11,255

)

$

1,778

 

$

(35,460

)

State

 

(32

)

563

 

16

 

(711

)

Total

 

$

1,708

 

$

(10,692

)

$

1,794

 

$

(36,171

)

 

Our unrecognized tax benefits were $3.0 million at June 30, 2009 and include interest and penalties related to uncertain tax positions.  There have been no material changes in unrecognized tax benefits during the quarter ended June 30, 2009.  The total amount of interest and penalties on uncertain tax positions included in income tax expense for the three months ended June 30, 2009 was $38,000 of interest accrued on continuing positions.    We currently have approximately $2.3 million in unrecognized tax benefits related to the deduction of executive compensation that will be affected by expiring statutes of limitations within the next twelve months.

 

In accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”) (ASC Subtopic 740-10, Income Taxes (ASC 740-10)), we evaluate our deferred tax assets, including the benefit from net operating losses (“NOLs”), to determine if a valuation allowance is required. Companies must assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified.  This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and our experience of utilizing tax credit carryforwards and tax planning alternatives.  Given the downturn in the homebuilding industry over the past several years, the degree of the economic recession, the instability and deterioration of the financial markets, and the resulting uncertainty in projections of our future taxable income, we recorded a valuation allowance against our deferred tax assets during 2008.  We have determined that the weight of the negative evidence continues to exceed that of the positive evidence and that it is more likely than not that we will not be able to utilize all of our deferred tax assets.  Therefore, we continue to maintain a full valuation allowance on our deferred tax asset balance by recording additional valuation reserves against any tax benefit from NOLs, as there is no available taxable income to offset our losses in the two-year carryback period.

 

At June 30, 2009 and December 31, 2008, we had a valuation allowance of $162.1 million and $127.1 million, respectively, against deferred tax assets which include the tax benefit from NOL carryovers.  Our future deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws, which currently would allow us to offset future taxable income generated through 2029.  On an ongoing basis, we will continue to review all available information to determine if and when we expect to realize our deferred tax assets and NOL carryovers.

 

At June 30, 2009 and December 31, 2008, the income tax receivable of $2.1 million and $111.5 million, respectively, consists of net tax refunds that we expect to receive within one year.   We collected $107.7 million of our December 31, 2008 receivable in the first half of 2009.  In the second quarter of 2009, we adjusted our 2008 receivable by $1.5 million based on better information obtained in the process of preparing the consolidated federal income tax return.  Due to the valuation allowance on the deferred tax assets, there was no corresponding deferred tax offset to the receivable adjustment.

 

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 2004.  In 2008, the IRS commenced an audit of our consolidated U.S. tax return and refund claim for 2007.  The audit is still in progress and there are no adjustments to report at this time.  During the first quarter of 2009, the State of California commenced an audit of our 2005 and 2006 California tax returns.  The audit is substantially complete and, as a result, we will be required to make a nominal payment for additional taxes and interest.

 

At our Special Meeting of Stockholders held on February 16, 2009, our stockholders approved an amendment to our Articles of Incorporation that will help preserve the value of our NOLs and our ability to use our NOLs to offset future taxable income.  The amendment restricts certain transfers of our common stock in order to avoid the limitations imposed by Internal Revenue Code (the “Code”) §382, which addresses the use of NOL carryforwards subsequent to an ownership change, as defined by that Code Section.

 

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Table of Contents

 

NOTE 11 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

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

 

 

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

Cash paid during the period for:

 

 

 

 

 

Interest, net of interest capitalized

 

$

16,707

 

$

18,481

 

Non-cash operating activities increase:

 

 

 

 

 

Real estate not owned

 

$

2,281

 

$

1,007

 

Non-cash investing activities:

 

 

 

 

 

Distributions from unconsolidated entities

 

$

261

 

$

7,580

 

Non-cash financing activities:

 

 

 

 

 

Equity issued for debt extinguishment

 

$

14,312

 

$

 

Changes in model home lease program

 

$

 

$

(12,982

)

 

NOTE 12 — OPERATING AND REPORTING SEGMENTS

 

As defined in SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (ASC 280-10, Segment Disclosures), we have six operating segments (the six states in which we operate). We have aggregated our operating segments into three reporting segments based on similar long-term economic characteristics and geographical proximity. Our reporting segments are as follows:

 

West:

California and Nevada

Central:

Texas, Arizona and Colorado

East:

Florida

 

Management’s evaluation of segment performance is based on segment operating (loss)/income, which we define as homebuilding and land revenue less cost of home construction, commissions and other sales costs, land development and other land sales costs and other costs incurred by or allocated to each segment, including impairments. Each reportable segment follows the same accounting policies described in Note 1, “Business and Summary of Significant Accounting Policies,” to the consolidated financial statements in our 2008 Annual Report on Form 10-K. Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity. The following is our segment information (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Revenue (1):

 

 

 

 

 

 

 

 

 

West

 

$

30,520

 

$

80,790

 

$

72,812

 

$

171,007

 

Central

 

179,580

 

270,842

 

356,639

 

529,544

 

East

 

11,439

 

23,666

 

23,226

 

48,176

 

Consolidated total

 

221,539

 

375,298

 

452,677

 

748,727

 

 

 

 

 

 

 

 

 

 

 

Operating (loss)/income (2):

 

 

 

 

 

 

 

 

 

West

 

(11,419

)

(28,863

)

(18,746

)

(62,807

)

Central

 

(53,607

)

2,565

 

(55,127

)

(3,001

)

East

 

(1,037

)

(4,150

)

(2,343

)

(11,172

)

 

 

 

 

 

 

 

 

 

 

Segment operating loss

 

(66,063

)

(30,448

)

(76,216

)

(76,980

)

Corporate and unallocated (3)

 

(5,035

)

2,942

 

(10,574

)

(4,417

)

Earnings/(loss) from unconsolidated entities, net

 

852

 

(2,089

)

2,249

 

(15,618

)

Interest expense

 

(11,332

)

(5,538

)

(19,662

)

(11,199

)

Other income, net

 

3,099

 

973

 

4,650

 

3,270

 

Gain on extinguishment of debt, net of transaction costs

 

6,585

 

 

9,390

 

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

$

(71,894

)

$

(34,160

)

$

(90,163

)

$

(104,944

)

 

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Table of Contents

 

 

 

At June 30, 2009

 

 

 

West

 

Central

 

East

 

Corporate and
Unallocated (4)

 

Total

 

Deposits on real estate under option or contract

 

$

131

 

$

16,125

 

$

180

 

$

 

$

16,436

 

Real estate

 

131,169

 

538,813

 

40,147

 

 

710,129

 

Investments in unconsolidated entities

 

260

 

13,873

 

61

 

222

 

14,416

 

Other assets

 

8,978

 

48,689

 

3,931

 

398,071

 

459,669

 

Total assets

 

$

140,538

 

$

617,500

 

$

44,319

 

$

398,293

 

$

1,200,650

 

 

 

 

At December 31, 2008

 

 

 

West

 

Central

 

East

 

Corporate and
Unallocated (4)

 

Total

 

Deposits on real estate under option or contract

 

$

268

 

$

49,944

 

$

1,446

 

$

 

$

51,658

 

Real estate

 

184,437

 

631,015

 

43,853

 

 

859,305

 

Investments in unconsolidated entities

 

1,157

 

15,659

 

200

 

272

 

17,288

 

Other assets

 

9,264

 

54,529

 

2,247

 

331,958

 

397,998

 

Total assets

 

$

195,126

 

$

751,147

 

$

47,746

 

$

332,230

 

$

1,326,249

 

 


(1)

Revenue includes the following land closing revenue, by segment (in thousands): three months ended June 30, 2009 - $1,125 in Central Region; three months ended June 30, 2008 - $1,375 in Central Region; six months ended June 30, 2009 - $1,285 in the Central Region; six months ended June 30, 2008 - $63 in the West Region and $3,085 in Central Region.

 

 

(2)

See Note 2 of this Quarterly Report on Form 10-Q for a breakout of real estate-related impairments by region.

 

 

(3)

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

 

 

(4)

Balance consists primarily of cash and other corporate assets not allocated to the reporting segments.

 

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

 

Overview, Industry Outlook and Company Actions

 

During the first half of 2009, our operations continued to be impacted by the economic recession resulting in difficult year-over-year comparisons of our operational results.  Competition for home buyers remained intense with existing home foreclosures, and the selection of mortgage financing products remains limited with more restrictive underwriting standards.  Therefore, even though home affordability has significantly improved over the past several years, benefiting from both low prices and low interest rates, we have not yet seen a significant market recovery, although we are beginning to see some signs of stabilization in certain of our markets as our sales pace strengthened during the spring selling season, an early indicator of a potential shift in consumer confidence.  We have adjusted our operations to reflect this prolonged industry contraction by reducing our active community count by 16.4%, or 35 communities, over a year ago.  As such, although our home orders declined 22.1% and 31.3%, respectively, in the three and six months ended June 30, 2009 as compared to the prior year, our absorptions per active community remained relatively stable, with 6.6 sales per community for the current quarter as compared to 6.9 comparable sales in the second quarter of 2008.

 

During the first half of 2009, we continued to focus on our goals to generate positive cash flow and strengthen our balance sheet.  We have had positive cash flows from operations for the past seven quarters, including the collection of $107.7 million in income tax refunds in the first half of 2009, and we grew our cash balance to a Company record of $385.3 million at June 30, 2009.  We believe this liquidity provides us with flexibility given the current difficult market conditions but also allows us to take advantage of unique opportunities to purchase deeply-discounted lots in select markets in which we have a short supply of buildable lots.

 

During this downturn, we have repositioned much of our product to increase affordability to appeal to customers at lower price points. Our lower cost structure is enabling us, in most cases, to decrease the selling price of these new homes below the FHA pricing cap and allows us to successfully compete with foreclosures. We are reducing or eliminating certain standard features from our base home models to re-align them with current market demands, while continuing to provide a wide selection of upgrade options, allowing our customers to personalize their new homes with the features they consider most important.  All divisions have been re-negotiating material and subcontract labor contracts to achieve further cost savings. 

 

To appeal to our target customers in the first-time and first-time move-up demographic, we are also planning to temporarily increase our spec starts to ensure we have a sufficient supply of completed homes for buyers looking for an immediate move-in.  Approximately half of our sales during the second quarter of 2009 were from spec sales, which contributed to the decline in our unsold inventory to $78.7 million, or 491 homes, at June 30, 2009, as compared to $158.4 million at December 31, 2008, comprised of 768 homes.

 

Summary Company Results

 

Total home closing revenue was $220.4 and $451.4 million for the three and six months ended June 30, 2009, respectively, decreasing 41.1% and 39.5% from the same periods last year. Net loss for the first quarter and first half of 2009 increased $50.1 and $23.2 million to a loss of $73.6 and $92.0 million. The quarter-over-quarter decline is primarily due to impairments, with $66.6 million (pre-tax) of real estate-related impairments recorded in the first quarter of 2009 as compared to $39.0 million in the same period of 2008.  The second quarter impairments in 2009 are primarily comprised of a $55.4 million write-off related to the abandonment of our last significant optioned project.  The project, a 1,200 lot parcel in North Phoenix, was no longer projected to generate profits sufficient to justify the additional investment needed to move forward with its purchase.  The six-month net loss decline is primarily due to the $36.2 million tax benefit recorded during 2008.  As we fully reserved our deferred tax assets in the third quarter of 2008, no tax benefits are reflected in our 2009 results, although we will be able to use our $162.1 million deferred tax asset to offset an estimated $450 million of future taxable income.

 

At June 30, 2009, our backlog of $382.3 million reflects a decrease of 47.7% or $349.2 million when compared to the backlog at June 30, 2008 but improved $43.1 million from our March 31, 2009 balance of $339.2 million due to our increased sequential sales, as previously discussed. The year-over-year decreases are due to the declines in demand, compounded by increased price concessions and incentives, as the average sales price in backlog decreased from $273,000 at June 30, 2008 to $240,000 at June 30, 2009. In the second quarter of 2009, our cancellation rate on sales orders improved to 23% of gross orders as compared to 29% in the same period a year ago.

 

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Table of Contents

 

Critical Accounting Policies

 

The accounting policies we deem most critical to us and that involve the most difficult, subjective or complex judgments include revenue recognition, real estate, warranty reserves, off-balance-sheet arrangements, valuation of deferred tax assets and share-based payments. There have been no significant changes to our critical accounting policies during the six months ended June 30, 2009 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2008 Annual Report on Form 10-K.

 

The tables below present operating and financial data that we consider most critical to managing our operations (dollars in thousands):

 

Home Closing Revenue

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Total

 

 

 

 

 

 

 

 

 

Dollars

 

$

220,414

 

$

373,923

 

$

451,392

 

$

745,579

 

Homes closed

 

890

 

1,388

 

1,822

 

2,716

 

Average sales price

 

$

247.7

 

$

269.4

 

$

247.7

 

$

274.5

 

 

 

 

 

 

 

 

 

 

 

West Region

 

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

 

 

Dollars

 

$

22,299

 

$

64,548

 

$

55,723

 

$

134,827

 

Homes closed

 

64

 

152

 

156

 

325

 

Average sales price

 

$

348.4

 

$

424.7

 

$

357.2

 

$

414.9

 

Nevada

 

 

 

 

 

 

 

 

 

Dollars

 

$

8,221

 

$

16,242

 

$

17,089

 

$

36,117

 

Homes closed

 

41

 

61

 

79

 

134

 

Average sales price

 

$

200.5

 

$

266.3

 

$

216.3

 

$

269.5

 

West Region Totals

 

 

 

 

 

 

 

 

 

Dollars

 

$

30,520

 

$

80,790

 

$

72,812

 

$

170,944

 

Homes closed

 

105

 

213

 

235

 

459

 

Average sales price

 

$

290.7

 

$

379.3

 

$

309.8

 

$

372.4

 

 

 

 

 

 

 

 

 

 

 

Central Region

 

 

 

 

 

 

 

 

 

Arizona

 

 

 

 

 

 

 

 

 

Dollars

 

$

30,786

 

$

68,432

 

$

72,446

 

$

129,868

 

Homes closed

 

152

 

266

 

350

 

475

 

Average sales price

 

$

202.5

 

$

257.3

 

$

207.0

 

$

273.4

 

Texas

 

 

 

 

 

 

 

 

 

Dollars

 

$

137,473

 

$

191,839

 

$

260,838

 

$

374,611

 

Homes closed

 

552

 

789

 

1,068

 

1,528

 

Average sales price

 

$

249.0

 

$

243.1

 

$

244.2

 

$

245.2

 

Colorado

 

 

 

 

 

 

 

 

 

Dollars

 

$

10,196

 

$

9,197

 

$

22,070

 

$

21,981

 

Homes closed

 

30

 

26

 

69

 

64

 

Average sales price

 

$

339.9

 

$

353.7

 

$

319.9

 

$

343.5

 

Central Region Totals

 

 

 

 

 

 

 

 

 

Dollars

 

$

178,455

 

$

269,468

 

$

355,354

 

$

526,460

 

Homes closed

 

734

 

1,081

 

1,487

 

2,067

 

Average sales price

 

$

243.1

 

$

249.3

 

$

239.0

 

$

254.7

 

 

 

 

 

 

 

 

 

 

 

East Region

 

 

 

 

 

 

 

 

 

Florida

 

 

 

 

 

 

 

 

 

Dollars

 

$

11,439

 

$

23,665

 

$