UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 FORM 10-K
 
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                 to                
Commission File Number 1-9977
 
 
 
 
(Exact Name of Registrant as Specified in its Charter)
 
 
 
 
Maryland
 
86-0611231
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
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)
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
Title of Each Class
 
Name of Each Exchange on which Registered
Common Stock, $.01 par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
 
 




 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ý     No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨     No  ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data 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   ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨
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
 
ý
  
Accelerated Filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes   ¨    No  ý
The aggregate market value of common stock held by non-affiliates of the registrant (34,187,291shares) as of June 28, 2013, was $1.5 billion based on the closing sales price per share as reported by the New York Stock Exchange on such date.
The number of shares outstanding of the registrant’s common stock on February 18, 2014 was 39,074,341.
DOCUMENTS INCORPORATED BY REFERENCE
Portions from the registrant’s Proxy Statement relating to the 2014 Annual Meeting of Stockholders have been incorporated by reference into Part III, Items 10, 11, 12, 13 and 14.





MERITAGE HOMES CORPORATION
FORM 10-K
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


3




PART I
Item 1. Business
The Company
Meritage Homes is a leading designer and builder of single-family detached homes based on the number of home closings. We primarily build in the historically high-growth regions of the western and southern United States and offer a variety of homes that are designed to appeal to a wide range of homebuyers, including first-time, move-up, active adult and luxury. We have operations in three regions: West, Central and East, which are comprised of eight states: Arizona, California, Texas, Colorado, Florida, North Carolina, South Carolina and Tennessee. Operations within the Carolinas include the Raleigh and Charlotte metropolitan areas, with some Charlotte communities located across the border into South Carolina. These three regions are our principal business segments. Please refer to Note 12 of the consolidated financial statements for information regarding our operating and reporting segments.
Our homebuilding and marketing activities are conducted under the Meritage Homes brand. We also operate under the name Monterey Homes in some locations and in Tennessee we operate as Phillips Builders. At December 31, 2013, we were actively selling homes in 188 communities, with base prices ranging from approximately $130,000 to $1,000,000.
Available Information; Corporate Governance
Meritage Homes Corporation was incorporated in 1988 as a real estate investment trust in the State of Maryland. On December 31, 1996, through a merger, we acquired the homebuilding operations of our predecessor company. We currently focus exclusively on homebuilding and related activities and no longer operate as a real estate investment trust. Meritage Homes Corporation operates as a holding company and has no independent assets or operations. Its homebuilding construction, development and sales activities are conducted through its subsidiaries.
Information about our company and communities is provided on our Internet website at www.meritagehomes.com. The information contained on our website is not considered part of this Annual Report on Form 10-K. Our periodic and current reports, including any amendments, filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) are available, free of charge, on our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).
Meritage operates within a comprehensive plan of corporate governance for the purpose of defining responsibilities and setting high standards for ethical conduct. Our Board of Directors has established an audit committee, executive compensation committee, nominating/governance committee and land committee. All of our employees, including officers and directors, are required to comply with our Code of Ethics and to immediately report through the appropriate channels, any known instances of non-compliance. The charters for each of these committees are available on our website, along with our Code of Ethics, Corporate Governance Principles and Practices and Securities Trading Policy. Our committee charters, Code of Ethics, Corporate Governance Principles and Practices and Securities Trading Policy are also available in print, free of charge, to any stockholder who requests any of them by calling us or by writing to us at our principal executive offices at the following address: Meritage Homes Corporation, 17851 North 85th Street, Suite 300, Scottsdale, Arizona 85255, Attention: General Counsel. Our telephone number is (480) 515-8100. Our address will change effective March 31, 2014 to 8800 East Raintree Drive, Suite 300, Scottsdale, AZ 85260.
Strategy
All facets of our operations are governed by the principles of our strategic model which defines Meritage's culture and operational parameters, ensuring that our actions are aligned around the achievement of our goals. This model combines our entrepreneurial spirit, cutting-edge innovation and organizational agility to strive for industry-leading results in all of our functional areas, including: management, land acquisition and development, finance, marketing, sales, purchasing, construction and customer care. The main tenets of our strategic model are to:
 
Maintain sufficient capital and liquidity to take advantage of market opportunities while holding leverage at moderate levels to optimize shareholder returns;
Ensure that we have the best team available by hiring and nurturing top talent, expecting top level performance and allocating proper resources to drive execution of our business plan;
Utilize our state-of-the-art market research tools to make informed decisions about land purchases;
Employ our knowledge of customer preferences generated through regular surveys and research to align our product offerings with our buyers’ demands;

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Customize our sales techniques for today’s buyers and educate our sales team about the benefits of our Meritage Green offerings and other features of our homes and on the availability of mortgage products;
Re-engineer and constantly evaluate our pricing, product and community amenity offerings to better appeal to potential buyers, while incorporating our Meritage Green concepts and technologies into routine construction practices;
Continuously improve our construction process by working with our vendors to find mutual efficiencies in order to construct high-quality homes at the lowest possible cost;
Provide the highest level of customer service and care by working closely with our buyers throughout the sales and construction process and monitoring their satisfaction routinely after delivery of their homes; and
Provide a shortened and efficient sales-to-close cycle time by refining our processes and streamlining scheduling and production.
These tenets drive our short- and long-term goals and are evident in the operational decisions made in each of our divisions and communities, all of which contribute to the successes we have achieved with our customers, within the marketplace and within our homebuilder peer group.
With our focus on innovation, we employ industry-leading building techniques and technologies through our Meritage Green building program which is aimed at setting the standard for energy-efficient homebuilding. Accordingly, at a minimum, every new home we construct meets ENERGY STAR® standards, with many of our communities greatly surpassing those levels, offering our customers homes that utilize less energy than the standard US home. Our commitment to incorporate these energy standards into all of our homes has resulted in our achievement of design, purchasing and production efficiencies that have allowed us to offer these standard features to our home buyers for nominal additional cost. Through our “green” strategy, we believe we continue to lead the industry by incorporating advanced building technologies into the homes we build that further differentiate our product in the marketplace when compared against both new and resale homes, providing us with a competitive advantage while allowing us and our buyers to be responsible stewards of the environment. The building practices we utilize result in our homeowners’ utility usage on average being less than half of the current national average of US households. We were also the first production builder to offer net-zero homes, which on an annual basis produce as much energy as they use.
In 2013, we proudly issued our first Corporate Sustainability Report, voluntarily reporting our sustainability practices in compliance with the standards of the Global Reporting Initiative Guidelines. A copy of our sustainability report is available on our website. In 2013 we were, once again, widely recognized for our leadership role in advanced green building, including being named:
US EPA 2013 Energy Star, Partner of the Year - Sustained Excellence
2013 One of the Most Trusted Builders in America, Lifestory Research Most Trusted Builders in America Study
2013 "Green Champion" Build it Green San Antonio
We believe our strategic model and our Meritage Green commitment provide us with unique competitive advantages and continue to drive our success in maintaining and growing profitability.







4



Markets
We currently build and sell homes in the following markets:
 
 
 
Markets
Year Entered
Phoenix, AZ
1985
Dallas/Ft. Worth, TX
1987
Austin, TX
1994
Tucson, AZ
1995
Houston, TX
1997
East Bay/Central Valley, CA
1998
Sacramento, CA
1998
San Antonio, TX
2003
Inland Empire, CA
2004
Denver, CO
2004
Orlando, FL
2004
Raleigh, NC
2011
Tampa, FL
2011
Charlotte, NC
2012
Nashville, TN
2013


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Our homes range from entry level to luxury. A summary of activity by region as of and for the years ended December 31, 2013 and 2012 follows (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year Ended December 31, 2013
 
At December 31, 2013
 
 
# of
Homes
Closed
 
Average
Closing
Price
 
# Homes
in
Backlog
 
$ Value of
Backlog
 
# Home Sites
Controlled  (1)
 
# of
Actively
Selling
Communities
West Region
 
 
 
 
 
 
 
 
 
 
 
 
Arizona
 
1,041

 
$
316.9

 
278

 
$
97,239

 
7,402

 
40

California
 
989

 
$
432.6

 
225

 
107,463

 
2,774

 
22

Colorado
 
405

 
$
392.1

 
202

 
92,384

 
2,170

 
14

Nevada
 
38

 
$
234.2

 

 

 
174

 

West Region Total
 
2,473

 
$
374.2

 
705

 
$
297,086

 
12,520

 
76

Central Region
 
 
 
 
 
 
 
 
 
 
 
 
Texas
 
1,834

 
$
268.7

 
792

 
$
245,655

 
7,568

 
70

Central Region Total
 
1,834

 
$
268.7

 
792

 
$
245,655

 
7,568

 
70

East Region
 
 
 
 
 
 
 
 
 
 
 
 
Carolinas
 
239

 
$
390.0

 
108

 
$
43,218

 
1,691

 
17

Florida
 
691

 
$
382.2

 
208

 
89,272

 
3,456

 
20

Tennessee
 
22

 
$
359.2

 
40

 
11,441

 
427

 
5

East Region Total
 
952

 
$
383.6

 
356

 
$
143,931

 
5,574

 
42

Total Company
 
5,259

 
$
339.1

 
1,853

 
$
686,672

 
25,662

 
188

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year Ended December 31, 2012
 
At December 31, 2012
 
 
# of
Homes
Closed
 
Average
Closing
Price
 
# Homes
in
Backlog
 
$ Value of
Backlog
 
# Home Sites
Controlled  (1)
 
# of
Actively
Selling
Communities
West Region
 
 
 
 
 
 
 
 
 
 
 
 
Arizona
 
825

 
$
268.0

 
249

 
$
80,816

 
7,360

 
38

California
 
732

 
$
361.2

 
315

 
124,588

 
2,062

 
17

Colorado
 
292

 
$
331.5

 
142

 
50,089

 
1,446

 
12

Nevada
 
61

 
$
187.6

 
14

 
3,105

 
293

 
1

West Region Total
 
1,910

 
$
310.9

 
720

 
$
258,598

 
11,161

 
68

Central Region
 
 
 
 
 
 
 
 
 
 
 
 
Texas
 
1,655

 
$
236.0

 
500

 
$
132,317

 
6,468

 
65

Central Region Total
 
1,655

 
$
236.0

 
500

 
$
132,317

 
6,468

 
65

East Region
 
 
 
 
 
 
 
 
 
 
 
 
Carolinas
 
117

 
$
358.0

 
49

 
$
17,341

 
774

 
7

Florida
 
556

 
$
284.3

 
203

 
71,010

 
2,414

 
18

East Region Total
 
673

 
$
297.1

 
252

 
$
88,351

 
3,188

 
25

Total Company
 
4,238

 
$
279.5

 
1,472

 
$
479,266

 
20,817

 
158

 
(1)
“Home Sites Controlled” is the estimated number of homes that could be built on unstarted lots we control, including lots available for sale and on undeveloped land.
The 23.3% overall increase in our homesites controlled as of December 31, 2013 as compared to the prior year reflects our efforts to execute on our strategy to expand our land pipeline, as well as grow new markets - the Carolinas and Tennessee.

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The average closing price increase in 2013 versus 2012 highlights the combination of our successful efforts to acquire, build and sell lots in more desirable, move-up locations, the overall strength of the market in 2013 and our ability to increase pricing to near normal levels in many of our communities. Our closing volume in 2013 also shifted to states with higher average sales prices, further contributing to the Company-wide increase. We believe our land positioning strategies have helped to pave the way for achieving future growth and profitability.
In the latter half of 2012, we commenced limited operations of our wholly-owned title company, Carefree Title Agency, Inc. ("Carefree Title"). During 2013, we migrated most of our divisions to the Carefree Title platform. Carefree Title's core business lines include title insurance and closing/settlement services for our homebuyers. We previously were involved in title operations through participation in joint ventures in certain locations. Managing our own title operations allows us greater control over the entire escrow and closing cycles in addition to generating additional revenue. Revenue and expense from Carefree Title are included in our Financial Services segment in the accompanying consolidated financial statements.

Recent Industry and Company Developments
During 2013, the positive momentum the housing market experienced in 2012 continued despite some increases in mortgage rates throughout the year. The second half of the year's activity kept pace with expectations, albeit with some slowing from the first half of the year, primarily due to the effect of successive price increases in early 2013. The market continues to be largely driven by housing affordability and decreasing levels of home inventory in many markets and overall market dynamics still indicate that the strong housing market should continue into at least 2014. We benefited from increased customer interest and traffic in our communities and had positive results in key operational metrics in 2013 as compared to the prior year.
We remain focused on strategically positioning ourselves in well-located and highly-desired communities in many of the top real-estate markets in the United States. During the last few quarters, improving demand for homes has allowed us to place more emphasis on increasing prices than on sales pace in order to maximize our profitability in top-producing markets. This has resulted in a decrease in sales pace in some of our most robust markets. We have also begun to actively acquire lot positions through option contracts, more specifically through land banking arrangements that have become more available recently and that allow us to leverage our balance sheet by securing additional land through limited initial cash outlays (see Note 3 for additional information related to option contracts). We believe we also successfully differentiate ourselves from our competition by offering a line-up of plans that highlight the benefits of our industry-leading energy efficient homes. In addition, we also offer our buyers the ability to personalize their homes and we provide a home warranty, further setting us apart from the competition we face with resale homes.
We also carefully manage our goals of maintaining ample liquidity and a strong balance sheet. During 2013, we strengthened our balance sheet through two new senior note issuances, and we increased the capacity of our revolving credit facility. After these capital transactions, we ended the year with cash, cash equivalents, and investments and securities balances totaling $363.8 million. Shortly after year end, we also completed a public equity offering, raising net proceeds of $110.5 million. We also benefited from continued improvement in our key operational metrics over the prior year including orders, closings and backlog and community count, gross margins and net earnings generated both through our strategic advantages as well as the general market recovery. We continued to reinforce our lot positions with well-located lots and are actively evaluating opportunities for expansion into new markets. In the first half of 2011, we entered the promising Raleigh-Durham, North Carolina market and in December 2011 we announced our entry into the Tampa market, expanding our presence in Florida, where we have experienced a high level of success over the last several years. In 2012, we announced entry into Charlotte, North Carolina, and in August 2013, we completed our first acquisition since 2005, entering the Nashville, Tennessee market. We have fully wound down our home building operations in the Las Vegas market.
Our active community count increased at year-end to 188 versus 158 a year ago, due to the contributions of our new divisions and our increased land acquisition efforts. Our orders per average active community during 2013 increased slightly to 32.5 as compared to 30.4 in 2012, reflecting the impact of both the fast sales pace in early 2013 and the tempering of orders volumes in the latter part of the year. Our unsold inventory consisted of 768 homes as of December 31, 2013, approximately one third of which were completed, as compared to prior year unsold inventory of 643 homes.
Land Acquisition and Development
Our current goal is to maintain an approximate four-to-five year supply of lots, which we believe provides an appropriate planning horizon to address regulatory matters and land development and manage to our business plan for future closings. To grow our business and to better leverage our existing overhead, we are currently focused on adding to our current lot positions and expanding our market share in our key markets and their surrounding submarkets while exploring opportunities outside of our existing markets. As of December 31, 2013 we have a 4.9-year supply of lots, based on 2013 closings, although 8.6% of our holdings are in master-planned Active Adult communities that traditionally contain a significantly larger supply of lots and,

7



accordingly, have a longer lot position. We continually evaluate our markets, monitoring and adjusting our lot supplies to ensure we have a sufficient pipeline, and are committed to growing our active community count in key locations through lot and land acquisitions.
We are currently purchasing primarily partially-developed or undeveloped lots. The opportunity to purchase substantially finished lots in desired locations is becoming increasingly more limited and competitive. Finished lots are those on which the development has already been completed by a third party, and they are ready for immediate home construction. As a result, we are spending more dollars on land development as we are purchasing more undeveloped land and partially finished lots than in recent years. Undeveloped land and partially finished lots require a longer lead time to allow for development activities before our new communities are able to open for sales. When evaluating any land acquisition, our selection is based upon a variety of factors, including:
financial feasibility of the proposed project, including projected profit margins, return on capital invested, and the capital payback period;
existing concentration of contracted lots in surrounding markets, including nearby Meritage communities;
suitability for development, generally within a three to five-year time period from the beginning of the development process to the delivery of the last home;
surrounding demographics based on extensive marketing studies, including surveys of both new and resale homebuyers;
the ability to secure governmental approvals and entitlements, if required;
results of environmental and legal due diligence;
proximity to local traffic and employment corridors and amenities;
availability of seller-provided purchase options or agreements that allow us to defer lot purchases until needed for production; and
management’s judgment as to the local real estate market and economic trends, and our experience in particular markets.
When purchasing undeveloped or partially developed land, we generally acquire land only after most necessary entitlements have been obtained so that development or construction may begin as market conditions dictate. The term “entitlements” refers to appropriate zoning, development agreements and preliminary or tentative maps and recorded plats, depending on the jurisdiction within which the land is located. Entitlements generally give the developer the right to obtain building permits upon compliance with conditions that are ordinarily within the developer’s control. Even though entitlements are usually obtained before land is purchased, we are typically still required to secure a variety of other governmental approvals and permits prior to and during development, and the process of obtaining such approvals and permits can be lengthy. We may consider the purchase of unentitled property when we can do so in a manner consistent with our business strategy. Historically, we have developed parcels ranging from 100 to 300 lots and have recently begun acquisitions of this size again, although over the past several years due to the slower housing market, we were primarily focused on limited lot purchases of smaller groups of finished lots.
Once we secure undeveloped land, we generally initiate development through contractual agreements with subcontractors. These activities include site planning and engineering, as well as constructing road, sewer, water, utilities, drainage, landscaping improvements, and recreation facilities and other improvements and refinements. We frequently build homes in master-planned communities with home sites that are along or near major amenities, such as golf courses or recreation facilities.
The factors used to evaluate finished lot purchases are similar to those for land we intend to develop ourselves, although the development risks associated with the undeveloped land—financial, environmental, legal and governmental—have been borne by others. Therefore, these finished lots may be more attractive to us, despite their higher price, as we can immediately bring the community to market and begin home construction.
We develop a design and marketing concept tailored to each community, which includes the determination of size, style and price range of homes. We may also determine street layout, individual lot size and layout, and overall community design for each project we develop. The product lines offered depend upon many factors, including the guidelines, if any, of the existing community, housing generally available in the area, the needs and desired housing product for a particular market, and our lot sizes, though we are increasingly able to use standardized design plans across our communities.
We typically acquire land through land purchase and option contracts. Land purchases are generally financed through our working capital, including corporate borrowings. Acquiring our land through option contracts, when available, allows us to control the timing and volume of lot and land purchases from the third parties and minimizes our up-front cash outlay. Option contracts allow us to purchase finished lots at pre-determined prices during a specified period of time rather than in bulk. These contracts are usually structured to approximate our projected absorption rate at the time the contract is negotiated, are

8



generally non-recourse and typically require the payment of non-refundable deposits of 5% to 15% of the total land purchase price. We believe the use of options limits the market risks associated with land ownership by allowing us to re-negotiate option terms or terminate options in the event of declines in land value and/or market downturns. If we are not successful in these re-negotiations, we might determine that a project is no longer feasible or desirable and cancel the option contracts, usually resulting in the forfeiture of our option deposits and any associated capitalized pre-acquisition costs. Although the recent availability of such option lots was drastically reduced during the recent housing downturn and recession, during 2013 we were successful in securing 3,373 lots through such options.
At December 31, 2013, in addition to our approximately 18,900 owned lots, we also had approximately 6,800 committed lots under option or contract for a total purchase price of approximately $449.8 million, with $49.4 million in cash deposits. Information related to lots and land under option is presented in Note 3—Variable Interest Entities and Consolidated Real Estate Not Owned in the accompanying consolidated financial statements.
All land and lot acquisitions are reviewed by our corporate land acquisition committee, which is comprised of our senior management team and key operating and financial executives. All land acquisitions exceeding pre-specified limits must also be approved by our Board of Directors' Land Committee.
The following table presents information as of December 31, 2013 (dollars in thousands):
 
 
 
Number of
Lots Owned (1)
 
Number of
Lots  Under Contract
or Option (1)(2)
 
Total Number
of Lots
Controlled
 
 
Finished
 
Under Development
and Held for Sale
 
West Region
 
 
 
 
 
 
 
 
Arizona
 
1,687

 
4,891

 
824

 
7,402

California
 
745

 
1,437

 
592

 
2,774

Colorado
 
321

 
831

 
1,018

 
2,170

Nevada
 
174

 

 

 
174

West Region Total
 
2,927

 
7,159

 
2,434

 
12,520

Central Region
 
 
 
 
 
 
 
 
Texas
 
1,726

 
4,115

 
1,727

 
7,568

Central Region Total
 
1,726

 
4,115

 
1,727

 
7,568

East Region
 
 
 
 
 
 
 
 
Carolinas
 
365

 
321

 
1,005

 
1,691

Florida
 
641

 
1,346

 
1,469

 
3,456

Tennessee
 
30

 
246

 
151

 
427

East Region Total
 
1,036

 
1,913

 
2,625

 
5,574

Total Company
 
5,689

 
13,187

 
6,786

 
25,662

Total book cost (3)
 
$
366,299

 
$
546,937

 
$
49,429

 
$
962,665

 
(1)
Excludes lots with finished homes or homes under construction. The number of lots is an estimate and is subject to change.
(2)
There can be no assurance that we will actually acquire any lots controlled under option or purchase contract. These amounts do not include 3,821 lots under contract with $2.2 million of refundable earnest money deposits, for which we have not completed due diligence and, accordingly, have no money at risk and are under no obligation to perform under the contracts.
(3)
For lots owned, book cost primarily represents land, development and capitalized interest. For lots under contract or option, book cost primarily represents earnest and option deposits.



9



Investments in Unconsolidated Entities — Joint Ventures
In the past, we have entered into 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. Although purchasing land through a joint venture can be beneficial, we do not view joint ventures as critical to the success of our homebuilding operations and have not entered into any new land joint ventures since 2008. We currently have only two such active ventures. We also participate in two mortgage and one title business joint ventures. The mortgage joint ventures are engaged in mortgage activities, and they provide services to both our customers and other homebuyers.
In connection with our land development joint ventures, we may also provide certain types of guarantees to associated lenders and municipalities. See Note 4 in the accompanying consolidated financial statements for additional information regarding guarantees.
Construction Operations
We typically act as the general contractor for our projects and hire experienced subcontractors on a geographic basis to complete construction at a fixed price. We usually enter into agreements with subcontractors and materials suppliers on an individual basis after receiving competitive bids. We obtain information from prospective subcontractors and suppliers with respect to their financial condition and ability to perform their agreements before formal bidding begins. We also enter into longer-term and national or regional contracts with subcontractors and suppliers, where possible, to obtain more favorable terms, minimizing construction costs and control product consistency and availability. Our contracts require that our subcontractors comply with all laws and labor practices pertaining to their work, follow local building codes and permits, and meet performance, warranty and insurance requirements and standards. Our purchasing and construction managers coordinate and supervise the activities of subcontractors and suppliers, and monitor compliance with zoning, building and safety codes. At December 31, 2013, we employed approximately 300 full-time construction operations personnel.
We specify that quality durable materials be used in construction of our homes and we do not maintain significant inventories of construction materials, except for work in process materials for homes under construction. When possible, we negotiate price and volume discounts and rebates with manufacturers and suppliers on behalf of our subcontractors so we can take advantage of production volume. Our raw materials consist primarily of lumber, concrete, drywall and similar construction materials and are frequently purchased on a national or regional level. Such materials have historically been available from multiple suppliers and therefore we do not believe there is a supplier risk concentration. However, because such materials are substantially comprised of natural resource commodities, their cost and availability is subject to national and worldwide price fluctuations and inflation, each of which could be impacted by legislation or regulation relating to energy and climate change.
We generally build and sell homes in phases within our larger projects, which we believe creates efficiencies in land development and home construction operations and cash management, as well as improves customer satisfaction by reducing the number of vacant lots and construction activity surrounding a completed home. Our homes are typically completed within three to five months from the start of construction, depending upon the geographic location and the size and complexity of the home. Construction schedules may vary depending on the size of the home, availability of labor, materials and supplies, product type, location and weather. Our homes are usually designed to promote efficient use of space and materials, and to minimize construction costs and time. We typically do not enter into any derivative contracts to hedge against weather or materials fluctuations as we do not believe they are particularly advantageous to our operations, although we do lock in short and mid-term pricing with our vendors for certain key construction commodities.
Marketing and Sales
We believe that we have an established reputation for building attractive, high quality and efficient homes, which helps generate demand in each new project. We also use advertising and other promotional activities, including our website at www.meritagehomes.com, social media outlets, magazine and newspaper advertisements, brochures, direct mailings and the placement of strategically located signs in the vicinities around our developments. Our marketing strategy is aimed at differentiating us from other new homebuilders, and resale homes.
We use furnished model homes as a marketing tool to demonstrate to prospective homebuyers the advantages of the designs and features of our homes. We generally employ or contract with interior and landscape designers who create attractive model homes that highlight the features and options available for the product line within a project. We typically build between one and three model homes for each actively selling community, depending upon the number of homes to be built in the project and the products to be offered. We strive to implement marketing strategies that will educate our buyers on how our unique building techniques and the energy efficient features in our homes differentiate us from other homes. In our Meritage Green communities, we have built "learning centers" in order to inform our buyers about energy-efficient features and help them understand how and to what extent a Meritage home can reduce utility bills and provide improved livability and comfort. In conjunction with the learning centers, our sales and marketing efforts use testimonials from actual homebuyers in order to

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showcase real-life experiences of how our green features impact the bottom line of our buyers’ utility bills as well as the livability of their homes.
In select cases, we sell and lease back some of our model homes from individual buyers who do not intend to occupy the home immediately. At December 31, 2013, we owned 221 and leased one model home and had an additional 39 models under construction.
Our homes generally are sold by our commissioned sales associate employees who typically work from a sales office located in one of the model homes for each project. We also employ a team of online sales associates who offer assistance to potential buyers viewing our communities and products over the Internet. At December 31, 2013, we had approximately 350 full-time sales and marketing personnel. Our goal is to ensure that our sales force has extensive knowledge of our housing product, our green features, our sales strategies, mortgage options, and community dynamics, in order to fully execute our marketing message. To achieve this goal, we train our sales associates and conduct regular meetings to update them on our product, sales techniques, competitive products in the area, financing availability and credit score repair opportunities, construction schedules, marketing and advertising plans, available product lines, pricing, options and warranties offered, as well as the numerous benefits and savings our green product provides. Our sales associates are licensed real estate agents where required by law. Our sales associates assist our customers to make standard selections and to select available options and upgrades, which we design to appeal to local consumer demands. In some divisions, we contract with third-party design studios that specialize in assisting our homebuyers with those selections to personalize their homes. Utilizing such third-party design studios typically allows us to manage our overhead and costs more efficiently. We may also offer various sales incentives, including price concessions, assistance with closing costs, and landscaping or interior upgrades, to attract buyers. The use, type and amount of incentives depends largely on economic and local competitive market conditions. Third-party brokers may also sell our homes, and are usually paid a sales commission based on the price of the home.
We have taken significant strides in further setting ourselves apart from our competitors through the superior design and value of our communities and homes, our Meritage Green strategy and our ongoing surveying and product research efforts. We believe our commitment to design and build energy-efficient homes is aligned with buyer sensitivities about how eco-friendly designs, features and materials help impact the environment and the livability of homes, as well as their pocketbooks. We further believe it is strategies such as this that helped us weather the pre-2012 decline in the homebuilding market and allowed us to maintain our status as one of the leading homebuilders in the U.S.
Backlog
Our sales contracts require cash deposits and are frequently subject to certain contingencies such as the buyer’s ability to qualify for financing. Additional deposits are usually collected upon the selection of options and upgrades. Homes covered by such sales contracts but which are not yet closed are considered “backlog” and are representative of potential future revenues. Started homes are excluded from backlog until a sales contract is signed and are referred to as unsold or “spec” inventory. A sale contingent upon the sale of a customer’s existing home is not considered a sale until the contingency is removed. We generally require a signed sales contract to release a lot to start construction, although on a regular basis we also start a certain number of homes for speculative sales inventory, as we have had a high level of success with these quick move-in opportunities, particularly in communities that appeal to the renter and first-time buyer demographic. We may also start construction on such homes to accelerate the close-out of a community. At December 31, 2013 1,351 of our 1,853 homes in backlog were under construction.
We do not recognize any revenue from home sales until a finished home is delivered to the homebuyer, payment is collected and other criteria for sale and profit recognition are met. At December 31, 2013, of our total homes in inventory excluding model homes, 17.2% were under construction without sales contracts and 9.5% were completed homes without sales contracts. A portion of the unsold homes resulted from homesites that began construction with valid sales contracts that were subsequently canceled. We believe that during 2014 we will deliver to customers substantially all homes in backlog at December 31, 2013 under existing or, in the case of cancellations, replacement sales contracts.
Our backlog increased 25.9% to 1,853 units with a value of approximately $686.7 million at December 31, 2013 from 1,472 units with a value of approximately $479.3 million at December 31, 2012. These increases are due both to our improved orders volume during most of 2013 as well as higher average prices on orders in 2013 as compared to the prior year.

Customer Financing
We refer homebuyers who require financing to mortgage lenders that offer a variety of financing options. While our homebuyers may obtain financing from any mortgage provider of their choice, we have entered into two joint venture arrangements with established mortgage brokers that allow one of those ventures to act as a preferred mortgage broker to our buyers in most of our markets to help facilitate the sale and closing process as well as generate additional fee income. In some

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markets we also use unaffiliated preferred mortgage lenders. We may pay a portion of the closing costs to assist homebuyers who obtain financing from our preferred lenders. Since many customers use long-term mortgage financing to purchase homes, the decrease of availability of mortgage loans and tighter underwriting standards have somewhat reduced the availability of such loans, although due to the move-up nature of our product and homebuyers, we have been less affected by these conditions. Additionally, as some homebuyers with a foreclosure or short sale in 2008 and 2009 are now once again eligible for mortgage financing, we have experienced an increase in buyers able to qualify for mortgages that were unable to do so just a few years ago but are able to do so today. Our mortgage joint ventures are equipped to assist and facilitate these types of buyers through the financing process, enabling us to capture a portion of this demographic.
Customer Relations, Quality Control and Warranty Programs
We believe that positive customer relations and an adherence to stringent quality control standards are fundamental to our continued success, and that our commitment to buyer satisfaction and quality control has significantly contributed to our reputation as a high-quality builder.
In accordance with our company-wide standards, a Meritage project manager or superintendent and/or a customer relations representative generally monitor compliance with quality control standards for each community. These representatives perform the following tasks:
 
oversee home construction;
monitor subcontractor and supplier performance;
manage scheduling and construction completion deadlines;
conduct formal inspections as specific stages of construction are completed; and
manage warranty and customer care efforts.
We generally provide a one-to-two-year limited warranty on workmanship and building materials and a ten-year warranty for structural defects on homes we build. We require our subcontractors to provide a warranty and indemnity to us as well as evidence of insurance before beginning work, and therefore any claims relating to workmanship and materials are generally the subcontractors’ responsibility. Although our subcontractors are generally required to repair and replace any product or labor defects, we are, during applicable warranty periods, ultimately responsible to the homeowner for making such repairs. Accordingly, with the assistance of an actuary, we have estimated and established reserves for future structural warranty costs based on the number of home closings and historical data trends for our communities. Warranty reserves generally range from 0.2% to 0.6% of a home’s sale price. Those projections are subject to variability due to uncertainties regarding structural defect claims for the products we build, the markets in which we build, claim settlement history, and insurance and legal interpretations, among other factors and we are, therefore, constantly monitoring such reserves. Historically, these reserves have been sufficient to cover net out-of-pocket warranty costs.
Competition and Market Factors
The construction and sale of homes is a highly-competitive industry. We compete for sales in each of our markets with national, regional and local developers and homebuilders, as well as existing resale homes, foreclosures, and to a lesser extent, condominiums and rental housing. Some of our competitors have significantly greater financial resources and may have lower costs than we do. Competition among residential homebuilders of all sizes is based on a number of interrelated factors, including location, reputation, amenities, design, quality and price. We believe that we compare favorably to other homebuilders in the markets in which we operate due to our:
 
experience within our geographic markets which allows us to develop and offer products that provide superior design and quality and are in line with the needs and desires of the targeted demographic;
streamlined construction processes that allow us to save on material, labor and time and pass those savings to our customers in the form of lower prices;
ENERGY STAR® standards in all of our communities and incremental green features that create a variety of benefits to our customers and differentiate our product from competing new and existing home inventories;
ability to recognize and adapt to changing market conditions, from both a capital and human resource perspective;
ability to capitalize on opportunities to acquire land on favorable terms; and
reputation for outstanding service and quality products and our exceptional customer and warranty service.

Our product offerings and strategic locations are successfully competing with both existing homes inventory and surrounding new-home communities as evidenced by our strong orders growth and relative size in most of our markets. We expect that the strengths noted above will continue to provide us with long-term competitive advantages.

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We have an extensive market research department that assists our divisions in each of our markets to better compete with other homebuilders, and the inventory of re-sale homes in surrounding neighborhoods. Our strategic operations team conducts in-depth community-level reviews in each of our markets, including a detailed analysis of existing inventory, pricing, buyer demographics and the identification of each location’s key buyer metrics. This analysis and resulting analytical tools assist in decision-making regarding product designs, positioning, and pricing and underwriting standards for land and lot purchases and land development. Additionally, our market research department is focused on evaluating and identifying new market opportunities. The analysis of entry into a new market includes comprehensive research and surveys of buyer demographics and demands, competitor composition and performance, the surrounding job market and employment statistics, foreclosure activity and desirability of the market in general. Based on the results of our market research, we successfully entered the Raleigh-Durham and Tampa markets in 2011, the Charlotte market in 2012 and the Nashville market in 2013.
Government Regulation and Environmental Matters
To the extent that we acquire undeveloped land, it is primarily acquired after all or most entitlements have been obtained. Construction may begin almost immediately on such entitled land upon compliance with and receipt of specified permits, approvals and other conditions, which generally are within our control. The time needed to obtain such approvals and permits affects the carrying costs of unimproved property acquired for development and construction. The continued effectiveness of permits already granted is subject to factors such as changes in government policies, rules and regulations, and their interpretation and application. To date, the government approval processes discussed above have not had a material adverse effect on our development activities, although there is no assurance that these and other restrictions will not adversely affect future operations as, among other things, sunset clauses may exist on some of our entitlements and they could lapse.
Local and state governments have broad discretion regarding the imposition of development fees for projects under their jurisdictions. These fees are normally established when we receive recorded maps or plats and building permits. Governing agencies may also require concessions or may require the builder to construct certain improvements to public places such as parks and streets. In addition, governing agencies may impose construction moratoriums. Because most of our land is entitled, construction moratoriums generally would not affect us in the near term unless they arise from health, safety or welfare issues, such as insufficient water, electric or sewage facilities. In the long term, we could become subject to delays or may be precluded entirely from developing communities due to building moratoriums, “no growth” or “slow growth” initiatives or building permit allocation ordinances, which could be implemented in the future.
In addition, there is a variety of new legislation being enacted, or considered for enactment at the federal, state and local level relating to energy and climate change. This legislation relates to items such as carbon dioxide emissions control and building codes that impose energy efficiency standards. New building code requirements that impose stricter energy efficiency standards could significantly increase our cost to construct homes, although our green initiatives meet, and in many instances exceed, current and expected energy efficiency thresholds. As climate change concerns continue to grow, legislation and regulations of this nature are expected to continue and may result in increased costs and longer approval and development timelines. Similarly, energy-related initiatives affect a wide variety of companies throughout the United States and the world, and because our operations are heavily dependent on significant amounts of raw materials, such as lumber, steel, and concrete, such initiatives could have an indirect adverse impact on our operations and profitability to the extent the manufacturers and suppliers of our materials are burdened with expensive carbon dioxide emissions control and energy related regulations.
We are also subject to a variety of local, state, and federal statutes, ordinances, rules and regulations concerning the protection of health and the environment. In some markets, we are subject to environmentally sensitive land ordinances that mandate open space areas with public elements in housing developments, and prevent development on hillsides, wetlands and other protected areas. We must also comply with flood plain restrictions, desert wash area restrictions, native plant regulations, endangered species acts and view restrictions. These and similar laws and regulations may result in delays, cause substantial compliance and other costs, and prohibit or severely restrict development in certain environmentally sensitive regions or areas. To date, compliance with such laws and regulations has not materially affected our operations, although it may do so in the future.
We usually will condition our obligation to acquire property on, among other things, an environmental review of the land. To date, we have not incurred any material unanticipated liabilities relating to the removal of unknown toxic wastes or other environmental matters. However, there is no assurance that we will not incur material liabilities in the future relating to toxic waste removal or other environmental matters affecting land currently or previously owned.
In order for our homebuyers to finance their home purchases with FHA-insured or VA-guaranteed or USDA-guaranteed mortgages, we are required to build such homes in accordance with the regulatory requirements of those agencies.
Some states have statutory disclosure requirements governing the marketing and sale of new homes. These requirements vary widely from state to state.

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Some states require us to be registered as a licensed contractor, a licensed real estate broker and in some markets our sales agents are required to be registered as licensed real estate agents.
Employees, Subcontractors and Consultants
At December 31, 2013, we had approximately 1,050 full-time employees, including approximately 400 in management and administration, 350 in sales and marketing, and 300 in construction operations. Our operations are carried out through both local and centralized corporate management. Local operations are made up of our division employees, led by management with significant homebuilding experience and who typically possess a depth of knowledge in their particular markets. Our centralized corporate management sets our strategy and leads decisions related to the Company's land acquisition, risk management, finance, cash management and information systems. Our employees are not unionized, and we believe that we have good employee relationships. We pay for a substantial portion of our employees’ insurance costs, with the balance contributed by the employees. We also have a 401(k) savings plan, which is available to all employees who meet the plan’s participation requirements.
We act solely as a general contractor, and all construction operations are supervised by our project managers and field superintendents who manage third party subcontractors. We use independent consultants and contractors for architectural, engineering, advertising and some legal services, and we strive to maintain good relationships with our subcontractors and independent consultants and contractors.
Seasonality
Historically, we experienced seasonal variations in our quarterly operating results and capital requirements. We typically sell more homes in the first half of the fiscal year than in the second half, which creates additional working capital requirements in the second and third quarters to build our inventories to satisfy the deliveries in the second half of the year. We typically benefit from the cash generated from home closings in the third and fourth quarters. We expect this seasonal pattern to continue over the long term, although it has been and may continue to be affected by volatility in the homebuilding industry.
Executive Officers of the Registrant
The names, ages, positions and business experience of our executive officers are listed below (all ages are as of March 1, 2014). Other than the terms and provisions of various employment and change of control agreements between the Company and the listed officers, there are no understandings between any of our executive officers and any other person pursuant to which any executive officer was selected to his office.
 
 
 
 
 
 
Name
 
Age
 
Position
Steven J. Hilton
 
52
 
Chairman of the Board and Chief Executive Officer
Larry W. Seay
 
58
 
Chief Financial Officer, Executive Vice President
C. Timothy White
 
53
 
General Counsel, Executive Vice President and Secretary
Steven M. Davis
 
55
 
Chief Operating Officer, Executive Vice President
Steven J. Hilton co-founded Monterey Homes in 1985, which merged with our predecessor in December 1996. Mr. Hilton served as Co-Chairman and Co-Chief Executive Officer from July 1997 to May 2006 and has been the Chairman and Chief Executive Officer since May 2006.
Larry W. Seay has been Chief Financial Officer since December 1996 and was appointed Executive Vice President in October 2005.
C. Timothy White has been General Counsel, Executive Vice President and Secretary since October 2005 and served on our Board of Directors from December 1996 until October 2005.
Steven M. Davis has been Chief Operating Officer, Executive Vice President since December 2008. From October 2006 to December 2008, Mr. Davis was Executive Vice President of National Homebuilding Operations.
Each member of our Executive management team has in excess of 25 years of residential real estate experience.
Item 1A. Risk Factors
The risk factors discussed below are factors that we believe could significantly impact our business, if they occur. These factors could cause results to differ materially from our historical results or our future expectations.
Risk Factors Related to our Business

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Our long-term success depends on the availability of lots and land that meet our land investment criteria.
The availability of lots and land that meet our investment and marketing standards depends on a number of factors outside of our control, including land availability in general, competition with other homebuilders and land buyers, credit market conditions, legal and government agency processes and regulations, inflation in land prices, zoning, our ability and the costs to obtain building permits, the amount of impact fees, property tax rates and other regulatory requirements. Should suitable lots or land become less available, the number of homes that we may be able to build and sell could be reduced, and the cost of attractive land could increase, which could adversely impact our financial results. The availability of suitable land assets could also affect the success of our strategic land acquisition strategy, which may impact our ability to increase the number of actively selling communities and to maintain profitability.
Decreases in mortgage availability and increases in interest rates may make purchasing a home more difficult and may negatively impact the ability to sell new and existing homes.
In general, housing demand is adversely affected by a lack of availability of mortgage financing and increases in interest rates. Most of our buyers finance their home purchases through our mortgage joint ventures or third-party lenders providing mortgage financing. If mortgage interest rates increase and, consequently, the ability of prospective buyers to finance home purchases is adversely affected, home sales, gross margins and cash flow may also be adversely affected and the impact may be material. Although long-term interest rates currently remain near historically low levels, it is impossible to predict future increases or decreases in market interest rates.
Homebuilding activities also depend, in part, upon the availability and costs of mortgage financing for buyers of homes owned by potential customers, as those customers (move-up buyers) often must sell their residences before they purchase our homes. Mortgage lenders are subject to increasing restrictive underwriting standards by the regulatory authorities which oversee them. Additionally, potential home buyers who have previously experienced a foreclosure or a short-sale of their homes may be precluded from obtaining a mortgage for several years. Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank Act”), was signed into law in 2010, which established several new standards and requirements relating to the origination, securitization and servicing of residential consumer mortgage loans. These and other regulations, standards and requirements, as and when implemented, could further restrict the availability of loans and/or increase the costs to borrowers to obtain such loans. Continued legislative and regulatory actions and more stringent underwriting standards could have a material adverse effect on our business if certain buyers are unable to obtain mortgage financing. A prolonged tightening of the financial markets could also negatively impact our business.
Shortages in the availability of subcontract labor may delay construction schedules and increase our costs.
We conduct our construction operations only as a general contractor. Virtually all architectural, construction and development work is performed by unaffiliated third-party consultants and subcontractors. As a consequence, we depend on the continued availability of and satisfactory performance by these consultants and subcontractors for the design and construction of our homes and to provide related materials. As the homebuilding market returns to full capacity, we have experienced and may continue to experience skilled labor shortages. The cost of labor may also be adversely affected by shortages of qualified trades people, changes in laws and regulations relating to union activity and changes in immigration laws and trends in labor migration. We cannot be assured that there will be a sufficient supply or satisfactory performance by these unaffiliated third-party consultants and subcontractors, which could have a material adverse effect on our business.
Expirations, amendments or changes to tax laws, incentives or credits currently available to our homebuyers may negatively impact our business.
Significant changes to existing tax laws that currently benefit our homebuyers may result in an increase in the total cost of home ownership and may make the purchase of a home less attractive to our buyers. Many homeowners receive substantial tax benefits in the form of tax deductions against their personal taxable income for mortgage interest and property tax payments and the loss or reduction of these deductions would affect most homeowners' net cost of owning a home. If federal or state governments further changes income tax laws by eliminating, limiting or substantially reducing these or other associated income tax benefits, the after-tax cost of owning a home could increase substantially, which could adversely impact demand for and/or selling prices of our homes, and the effect on our consolidated financial statements could be material. Also, federal or state governments have in the past provided for substantial benefits in the form of tax credits for buyers of new or used homes. For example, from 2008 to April 2011, many homebuyers took advantage of the federal homebuyer tax credit. We believe this tax credit resulted in a greater increase in home sales during 2008 to early 2011 period than would have otherwise occurred in the absence of the credit. Currently, under the American Taxpayer Relief Act of 2012, which was signed into law in January 2013, the federal government enacted higher income tax rates and limits on the value of tax deductions for certain high-income individuals and households which may have an indirect impact on our operations.

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If home prices decline, potential buyers may not be able to sell their existing homes, which may negatively impact our sales.
As a homebuilder, we are subject to market forces beyond our control. In general, housing demand is impacted by the affordability of housing. Many homebuyers need to sell their existing homes in order to purchase a new home from us, and a weakness in the home resale market could adversely affect that ability. Declines in home prices would have an adverse effect on our homebuilding business margins and cash flows.
High cancellation rates may negatively impact our business.
Our backlog reflects the number and value of homes for which we have entered into non-contingent sales contracts with customers but have not yet delivered those homes. While we may accept sales contracts on a contingent basis in limited circumstances, they are not included in our backlog until the contingency is removed. Although these sales contracts typically require a cash deposit and do not allow for the sale to be contingent on the sale of the customer’s existing home, a customer may in certain circumstances cancel the contract and receive a complete or partial refund of the deposit as a result of local laws or contract provisions. If home prices decline, the national or local homebuilding environment weakens or interest rates increase, homebuyers may have an incentive to cancel their contracts with us, even where they might be entitled to no refund or only a partial refund. Significant cancellations have previously had, and could in the future have, a material adverse effect on our business as a result of lost sales revenue and the accumulation of unsold housing inventory.
If the current economic recovery reverses, it would have negative consequences on our operations, financial position and cash flows.
The recent recession and downturn in the homebuilding industry had an adverse effect on us. If the current recovery reverses, it could require that we write off or write down assets, dispose of assets, reduce operations, restructure our debt and/or raise new equity or debt to pursue our business plan, any of which could have a detrimental effect on our current stakeholders. Additional external factors, such as foreclosure rates, mortgage pricing and availability, and unemployment rates could put pressure on our results.

Our future operations may be adversely impacted by high inflation.
We, like other homebuilders, may be adversely affected during periods of high inflation, mainly from higher land, construction, labor and materials costs. Also, higher mortgage interest rates may significantly affect the affordability of mortgage financing to prospective buyers. Inflation could increase our cost of financing, materials and labor and could cause our financial results or profitability to decline. Traditionally, we have attempted to pass cost increases on to our customers through higher sales prices. Although inflation has not historically had a material adverse effect on our business, sustained increases in material costs have recently had and would continue to have a material adverse effect on our business if we are unable to correspondingly increase home sale prices.
A reduction in our sales absorption levels may force us to incur and absorb additional community-level costs.
We incur certain overhead costs associated with our communities, such as marketing expenses and costs associated with the upkeep and maintenance of our model and sales complexes. If our sales absorptions pace decreases and the time required to close out our communities is extended, we would likely incur additional overhead costs, which would negatively impact our financial results. Additionally, we incur various land development improvement costs for a community prior to the commencement of home construction. Such costs include infrastructure, utilities, taxes and other related expenses. Reduction in home absorption rates increases the associated holding costs, our time to recover such costs, and the value of such assets. Declines in the homebuilding market may also require us to evaluate the recoverability of costs relating to land acquired more recently.
The value of our real estate inventory may decline, leading to impairments and reduced profitability.
In prior years, we had to impair many of our real-estate assets to fair-value, incurring large charges which negatively impacted our financial results. Another decline in the homebuilding market may require us to re-evaluate the value of our land holdings and we could incur additional impairment charges, which would decrease both the book value of our assets and stockholders’ equity.
Reduced levels of sales may cause us to re-evaluate the viability of existing option contracts, resulting in a potential termination of these contracts which may lead to further impairment charges.
Historically, a significant portion of our lots were controlled under option contracts. Such options generally require a cash deposit that will be forfeited if we do not exercise the option or proceed with the purchase(s). During the recent downturn, we forfeited significant amounts of deposits and wrote off significant amounts of related pre-acquisition costs related to projects

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we no longer deemed feasible, as they were not generating acceptable returns. Although our remaining pool of optioned projects has significantly decreased due to limited availability of economically feasible option arrangements, another downturn in the homebuilding market may cause us to re-evaluate the feasibility of our optioned projects, which may result in writedowns that would reduce our assets and stockholders’ equity.
Our business may be negatively impacted by natural disasters.
Our homebuilding operations include operations in Texas, California, the Carolinas and Florida. These markets occasionally experience extreme weather conditions such as tornadoes and/or hurricanes, earthquakes, wildfires, flooding, landslides, sink-holes and other natural disasters in recent years. We do not insure against some of these risks. These occurrences could damage or destroy some of our homes under construction or our building lots, which may result in uninsured or underinsured losses. We could also suffer significant construction delays or substantial fluctuations in the pricing or availability of building materials due to such disasters. Any of these events could cause a decrease in our revenue, cash flows and earnings.
If we are unable to successfully compete in the highly competitive housing industry, our financial results and growth may suffer.
The housing industry is highly competitive. We compete for sales in each of our markets with national, regional and local developers and homebuilders, existing home resales (including foreclosures) and, to a lesser extent, condominiums and available rental housing. Some of our competitors have significantly greater financial resources and some may have lower costs than we do. Competition among homebuilders of all sizes is based on a number of interrelated factors, including location, reputation, amenities, design, quality and price. Competition is expected to continue and may become more intense, and there may be new entrants in the markets in which we currently operate and in markets we may enter in the future and our industry may also experience some consolidations. If we are unable to successfully compete, our financial results and growth could suffer.

Some homebuyers may cancel their home purchase contracts with us because their deposits are generally a small percentage of the purchase price and are potentially refundable.
In connection with the purchase of a home, our policy is to generally collect a deposit from our customers, although typically, this deposit reflects a small percentage of the total purchase price, and due to local regulations, the deposit may, in certain circumstances, be fully or partially refundable prior to closing. If the prices for our homes in a given community decline, our neighboring competitors reduce their sales prices (or increase their sales incentives), interest rates increase, the availability of mortgage financing tightens or there is a downturn in local, regional or national economies, homebuyers may elect to cancel their home purchase contracts with us. Uncertainty in the homebuilding market could adversely impact our cancellation rates, which would have a negative effect on our results of operations.
We are subject to construction defect and home warranty claims arising in the ordinary course of business, which may lead to additional reserves or expenses.
Construction defect and home warranty claims are common in the homebuilding industry and can be costly. Therefore, in order to account for future potential obligations, we establish a warranty reserve in connection with every home closing. Additionally, we maintain general liability insurance and generally require our subcontractors to provide a warranty and indemnity to us and insurance coverage for liabilities arising from their work; however, we cannot be assured that our warranty reserves and those subcontractors warranty insurance and indemnities will be adequate to cover all construction defect and warranty claims for which we may be held responsible. For example, we may be responsible for applicable self-insured retentions, and certain claims may not be covered by insurance or may exceed applicable coverage limits.
Our income tax provision and other tax liabilities may be insufficient if taxing authorities initiate and are successful in asserting tax positions that are contrary to our position.
In the normal course of business, we are audited by various federal, state and local authorities regarding income tax matters. Significant judgment is required to determine our provision for income taxes and our liabilities for federal, state, local and other taxes. We are not currently under any tax audits. Although we believe our approach to determining the appropriate tax treatment is supportable and in accordance with tax laws and regulations and relevant accounting literature, it is possible that the final tax authority will take a tax position that is materially different than ours. As each audit is conducted, adjustments, if any, are appropriately recorded in our consolidated financial statements in the period determined. Such differences could have a material adverse effect on our income tax provision or benefit, or other tax reserves, in the reporting period in which such determination is made and, consequently, on our results of operations, financial position and/or cash flows for such period.

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Our ability to acquire and develop raw or partially finished lots may be negatively impacted if we are unable to secure additional performance bonds.
In connection with land development work we are required to complete on our raw or partially finished land, we oftentimes provide performance bonds or other assurances for the benefit of the respective municipalities or governmental authorities. These performance bonds provide assurance to the beneficiaries that the development will be completed, or that in case we do not perform, that funds from the bonds are available for the municipality or governmental agency to finish such work. In the future, additional performance bonds may be difficult to obtain, or may become difficult to obtain on terms that are acceptable to us. Additionally, in recent years various surety providers have significantly reduced bonding capacities made available to the homebuilding industry. If we are unable to secure such required bonds, progress on affected projects may be delayed or halted or we may be required to expend additional cash to secure other forms of sureties which may adversely affect our financial position and ability to grow our operations.
Our joint ventures with independent third parties may be illiquid, and we may be adversely impacted by our joint venture partners’ failure to fulfill their obligations.
Historically, we have participated in land acquisition and development joint ventures with independent third parties, in which we have less than a controlling interest. Our participation in these types of joint ventures has significantly decreased over the last few years for a number of reasons including size of projects and the complexity of managing projects with partners, and we have reduced our involvement in such ventures to just two active land joint ventures as of December 31, 2013. In the past, these joint ventures were structured to provide us with a means of accessing larger parcels and lot positions and to help us expand our marketing opportunities and manage our risk profile. However, these joint ventures often acquire parcels of raw land without entitlements and as such are subject to a number of development risks that exceed our typical land acquisition criterion. For example, the risk of construction and development cost overruns can be greater for a joint venture where it acquires unentitled raw land compared to our typical acquisition of entitled lots. These increased development and entitlement risks could have a material adverse effect on our financial position or results of operations if one or more joint venture projects is delayed, canceled or terminated or we are required, whether contractually or for business reasons, to invest additional funds in the joint venture to facilitate the success of a particular project.
Our joint venture investments are generally very illiquid both because we often lack a controlling interest in the ventures and because most of our joint ventures are structured to require super-majority or unanimous approval of the members to sell a substantial portion of the joint venture’s assets or for a member to receive a return of their invested capital. Our lack of a controlling interest also results in the risk that the joint venture will take actions that we disagree with, or fail to take actions that we desire, including actions regarding the sale or financing of the underlying property. Occasionally, we provide letters of credit and performance, maintenance and other bonds in support of our related obligations with respect to the development of our joint venture projects. We had no such letters of credit or bonds as of December 31, 2013. In limited cases, we may also offer pro-rata limited repayment guarantees on our portion of the joint venture debt or other debt repayment guarantees. We had no limited such repayment guarantees as of December 31, 2013.
At times, we and our joint venture partners may agree to complete land development improvements if the joint venture does not perform the required development, which could require significant expenditures. In addition, we and our joint venture partners sometimes agree to indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures. In the event the letters of credit or bonds are drawn upon, we, and in the case of a joint venture, our joint venture partners, would be obligated to reimburse the surety or other issuer of the letter of credit or bond if the obligations the bond or guarantee secures are not performed by us (or the joint venture). If one or more bonds, letters of credit or other guarantees were drawn upon or otherwise invoked, we could have additional financial obligations.
The loss of key personnel may negatively impact us.
Our success largely depends on the continuing services of certain key employees and our ability to attract and retain qualified personnel. We have employment agreements with certain key employees who we believe possess valuable industry knowledge, experience and leadership abilities that would be difficult in the short term to replicate. The loss of the services of such key employees could harm our operations and business plans.
Failure to comply with laws and regulations by our employees or representatives may harm us.
We are required to comply with applicable laws and regulations that govern all aspects of our business including land acquisition, development, home construction, mortgage origination, title and escrow operations, sales and warranty. It is possible that individuals acting on our behalf could intentionally or unintentionally violate some of these laws and regulations. Although we endeavor to take immediate action if we become aware of such violations, we may incur fines or penalties as a result of these actions and our reputation with governmental agencies and our customers may be damaged. Further, other acts of bad judgment may also result in negative publicity and/or financial consequences.

18




Our lack of geographic diversification could adversely affect us if the homebuilding industry in our market declines.
We have operations in Texas, Arizona, California, Colorado, Florida, the Carolinas and Tennessee. Although we have recently expanded our operations to new markets, our geographic diversification is still limited and could adversely impact us if the homebuilding business in our current markets should decline, since we may not have a balancing opportunity in other geographic regions.
We experience fluctuations and variability in our operating results on a quarterly basis and, as a result, our historical performance may not be a meaningful indicator of future results.
We historically have experienced, and expect to continue to experience, variability in home sales and results of operations on a quarterly basis. As a result of such variability, our historical performance may not be a meaningful indicator of future results. Factors that contribute to this variability include:
 
timing of home deliveries and land sales;
the changing composition and mix of our asset portfolio;
delays in construction schedules due to adverse weather, acts of God, reduced subcontractor availability and governmental restrictions;
timing of write-offs and impairments;
conditions of the real estate market in areas where we operate and of the general economy;
the cyclical nature of the homebuilding industry;
changes in prevailing interest rates and the availability of mortgage financing;
our ability to acquire additional land or options for additional land on acceptable terms; and
costs and availability of materials and labor.
Our level of indebtedness may adversely affect our financial position and prevent us from fulfilling our debt obligations.
The homebuilding industry is capital intensive and requires significant up-front expenditures to secure land and pursue development and construction on such land. Accordingly, we incur substantial indebtedness to finance our homebuilding activities. At December 31, 2013, we had approximately $905.1 million of indebtedness and $363.8 million of cash, and investments and securities. If we require working capital greater than that provided by operations, our current liquidity position, and our capacity under our credit facility, we may be required to seek additional capital in the form of equity or debt financing from a variety of potential sources, including bank financing and securities offerings. There can be no assurance we would be able to obtain such additional capital on terms acceptable to us, if at all. The level of our indebtedness could have important consequences to our stockholders, including the following:
 
our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes could be impaired;
we could have to use a substantial portion of our cash flow from operations to pay interest and principal on our indebtedness, which would reduce the funds available to us for other purposes such as land and lot acquisition, development and construction activities;
we have a moderate level of indebtedness and a lower volume of cash and cash equivalents than some of our competitors, which may put us at a competitive disadvantage and reduce our flexibility in planning for, or responding to, changing conditions in our industry, including increased competition; and
we may be more vulnerable to economic downturns and adverse developments in our business than some of our competitors.

We expect to generate cash flow to pay our expenses and to pay the principal and interest on our indebtedness with cash flow from operations or from existing working capital. Our ability to meet our expenses thus depends, to a large extent, on our future performance, which will be affected by financial, business, economic and other factors. We will not be able to control many of these factors, such as economic conditions in the markets where we operate and pressure from competitors. If we do not have sufficient funds, we may be required to refinance all or part of our existing debt, sell assets or borrow additional funds. We cannot guarantee that we will be able to do so on terms acceptable to us, if at all. In addition, the terms of existing or future debt agreements may restrict us from pursuing any of these alternatives.
Our ability to obtain third-party financing may be negatively affected by any downgrade of our credit rating from a rating agency

19



We consider the availability of third-party financing to be a key component of our long-term strategy to grow our business either through acquisitions or through internal expansion. As of December 31, 2013, our credit ratings were B+, Ba3, and B+ by Standard and Poor’s Financial Services, Moody’s Investor Services and Fitch Ratings, respectively, the three primary rating agencies. Any downgrades from these ratings may impact our ability in the future to obtain additional financing, or to obtain such financing at terms that are favorable to us and therefore, may adversely impact our future operations.
We may not be successful in future expansion and integrating future acquisitions.
We may consider growth or expansion of our operations in our current markets or in other areas of the country. We may not be successful in future expansion and integrating future acquisitions including our recent acquisition in Nashville. Our expansion into new or existing markets could have a material adverse effect on our cash flows and/or profitability. The magnitude, timing and nature of any future expansion will depend on a number of factors, including suitable additional markets and/or acquisition candidates, the negotiation of acceptable terms, our financial capabilities, the size of the new business, and general economic and business conditions. New acquisitions may result in the incurrence of additional debt. Acquisitions also involve numerous risks, including difficulties in the assimilation and integration of the acquired company’s operations, the incurrence of unanticipated liabilities or expenses, the diversion of management’s attention from other business concerns, risks of entering markets in which we have limited or no direct experience and the potential loss of key employees of the acquired company.
We are subject to extensive government regulations that could cause us to incur significant liabilities or restrict our business activities.
Regulatory requirements could cause us to incur significant liabilities and costs and could restrict our business activities. We are subject to local, state and federal statutes and rules regulating certain developmental matters, as well as building and site design. We are subject to various fees and charges of government authorities designed to defray the cost of providing certain governmental services and improvements. We may be subject to additional costs and delays or may be precluded entirely from building projects because of “no-growth” or “slow-growth” initiatives, building permit ordinances, building moratoriums, or similar government regulations that could be imposed in the future due to health, safety, climate, welfare or environmental concerns. We must also obtain licenses, permits and approvals from government agencies to engage in certain activities, the granting or receipt of which are beyond our control and could cause delays in our homebuilding projects.

We are also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the protection of health and the environment. Environmental laws or permit restrictions may result in project delays, may cause substantial compliance and other costs and may prohibit or severely restrict development in certain environmentally sensitive regions or geographic areas. Environmental regulations can also have an adverse impact on the availability and price of certain raw materials, such as lumber.
In addition, there is a variety of new legislation being enacted, or considered for enactment at the federal, state and local level relating to energy and climate change. This legislation relates to items such as carbon dioxide emissions control and building codes that impose energy efficiency standards. New building code requirements that impose stricter energy efficiency standards could significantly increase our cost to construct homes. As climate change concerns continue to grow, legislation and regulations of this nature are expected to continue and become more costly to comply with. Similarly, energy-related initiatives affect a wide variety of companies throughout the United States and the world and because our operations are heavily dependent on significant amounts of raw materials, such as lumber, steel, and concrete, they could have an indirect adverse impact on our operations and profitability to the extent the manufacturers and suppliers of our materials are burdened with expensive cap and trade and similar energy related regulations.
We participate in two mortgage joint ventures and one title business joint venture.  In addition, we recently formed our wholly-owned title company, Carefree Title Agency.  Carefree Title Agency provides title insurance and closing settlement services for our homebuyers.  The mortgage joint ventures are engaged in mortgage broker activities and they provide services both to our clients and other homebuyers.  The mortgage industry remains under intense scrutiny and continues to face increasing regulation at the federal, state and local level. Although we do not originate mortgages, we are directly or indirectly subject to certain of these regulations.   The title and settlement services provided by Carefree Title Agency are subject to various regulations, including regulation by state banking and insurance regulations.  Potential changes to federal and state laws and regulations could have the effect of limiting our activities or how our joint ventures conduct their operations and this could have an adverse effect on our results of operations.  In addition, if we are determined to have violated federal or state regulations, we face the loss of our licenses or other required approvals or we could be subject to fines, penalties, civil actions or we could be required to suspend our activities, each of which could have an adverse effect on our reputation, results and operations.
Acts of war may seriously harm our business.

20



Acts of war or any outbreak or escalation of hostilities throughout the world may cause disruption to the economy, our Company, our employees and our customers, which could impact our revenue, costs and expenses and financial condition.
Our ability to build “Green” technologies at a profitable price point may be replicated by other builders in the future, which could reduce our competitive advantage.
We believe we currently have a competitive advantage over other production homebuilders by virtue of our Meritage Green technology. Our green communities offer a high level of energy-saving features included in the base price of our homes, and most of our communities are engineered to add on optional solar features to further optimize energy savings. If other builders are able to replicate our green technologies and offer them at a similar price point, it could diminish our competitive advantage in the marketplace.
Information technology failures and data security breaches could harm our business.
We use information technology and other computer resources to carry out important operational and marketing activities as well as maintain our business records. Many of these resources are provided to us and/or maintained on our behalf by third-party service providers pursuant to agreements that specify certain security and service level standards. Although we and our service providers employ what we believe are adequate security, disaster recovery and other preventative and corrective measures, our ability to conduct our business may be impaired if these resources are compromised, degraded, damaged or fail, whether due to a virus or other harmful circumstance, intentional penetration or disruption of our information technology resources by a third party, natural disaster, hardware or software corruption or failure or error (including a failure of security controls incorporated into or applied to such hardware or software), telecommunications system failure, service provider error or failure, intentional or unintentional personnel actions (including the failure to follow our security protocols), or lost connectivity to our networked resources.
A significant and extended disruption in the functioning of these resources could damage our reputation and cause us to lose customers, sales and revenue, result in the unintended public disclosure or the misappropriation of proprietary, personal and confidential information (including information about our homebuyers and business partners), and require us to incur significant expense to address and resolve these kinds of issues. The release of confidential information may also lead to litigation or other proceedings against us by affected individuals and/or business partners and/or by regulators, and the outcome of such proceedings, which could include penalties or fines, could have a material and adverse effect on our consolidated financial statements. In addition, the costs of maintaining adequate protection against such threats, depending on their evolution, pervasiveness and frequency and/or government-mandated standards or obligations regarding protective efforts, could be material to our consolidated financial statements.
Any of the above risk factors could have a material adverse effect on your investment in our bonds and common stock. As a result, you could lose some or all of your investment.

Special Note of Caution Regarding Forward-Looking Statements
In passing the Private Securities Litigation Reform Act of 1995 (“PSLRA”), Congress encouraged public companies to make “forward-looking statements” by creating a safe-harbor to protect companies from securities law liability in connection with forward-looking statements. We intend to qualify both our written and oral forward-looking statements for protection under the PSLRA.
The words “believe,” “expect,” “anticipate,” “forecast,” “plan,” “intend,” “may,” “will,” “should,” “could,” “estimate,” and “project” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. All statements we make other than statements of historical fact are forward-looking statements within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. Forward-looking statements in this Annual Report include statements concerning our belief that we have ample liquidity; our intentions and the expected benefits and advantages of our strategic model and Meritage Green initiatives as well as our land positioning strategies; the benefits of our use of options to acquire land; increasing profit trends relating to Carefree Title; our exposure to supplier concentration risk; that we will not incur material impairments relating to our mothballed communities; our delivery of substantially all of our backlog existing as of year-end; management estimates regarding future joint venture exposure; our positions and our expected outcome relating to litigation in general and specifically to the litigation we are involved with concerning the South Edge/Inspirada joint venture; our intentions to not pay dividends; the sustainability of our tax positions; whether certain guarantees relating to our joint ventures will be triggered; expectations regarding our industry and our business into 2014 and beyond, and that we expect our cash expenditures will exceed our cash generated by operations as we expand our business; the demand for and the pricing of our homes; our land and lot acquisition strategy (including that we will redeploy cash to acquire well-positioned finished lots and that we may participate in joint ventures or opportunities outside of our existing markets if opportunities arise); that we may expand into new markets; the availability of suppliers; that we do not

21



expect to utilize our share repurchase program in the foreseeable future; that we may seek additional debt or equity capital; our intention to hold investments and securities until maturity; demographic and other trends related to the homebuilding industry in general; our expectation that existing guarantees, letters of credit and performance and surety bonds will not be drawn on; the sufficiency of our insurance coverage and warranty reserves; the expected outcome of legal proceedings we are involved in; the sufficiency of our capital resources to support our business strategy; our ability and willingness to acquire land under option or contract; the impact of new accounting standards and changes in accounting estimates; trends and expectations concerning sales prices, sales orders, cancellations, construction costs, gross margins and profitability and future home inventories; our future cash needs; trends and expectations relating to our community count and lot inventory; the impact of seasonality; and our future compliance with debt covenants and actions we may take with respect thereto.
Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements, and that could negatively affect our business are discussed in this report under the heading “Risk Factors.”
Forward-looking statements express expectations of future events. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties that could cause actual events or results to differ materially from those projected. Due to these inherent uncertainties, the investment community is urged not to place undue reliance on forward-looking statements. In addition, we undertake no obligations to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to projections over time.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate office is in a leased building located in Scottsdale, Arizona. The lease expires in March 2014. Our new corporate office is also located in Scottsdale, Arizona, with 63,819 square feet and a September 30, 2023 lease expiration.
We lease an aggregate of approximately 205,000 square feet of office space (of which approximately 61,000 square feet is currently subleased by us to third parties) in our markets for our operating divisions, corporate and executive offices.

Item 3. Legal Proceedings
We are involved in various routine legal and regulatory proceedings, including, without limitation, claims and litigation alleging construction defects. In general, the proceedings are incidental to our business, and most exposure is subject to and should be covered by warranty and indemnity obligations of our consultants and subcontractors. Additionally, some such claims are also covered by insurance. With respect to the majority of pending litigation matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and, in most cases, any potential losses related to these matters are not considered probable. Historically, most disputes regarding warranty claims are resolved prior to litigation. We believe there are not any pending legal or warranty matters that could have a material adverse impact upon our consolidated financial condition, results of operations or cash flows that have not been sufficiently reserved.

Joint Venture Litigation

Since 2008, we have been involved in litigation initiated by the lender group for a large Nevada-based land acquisition and unconsolidated development joint venture in which the lenders were seeking damages in two separate actions on the basis of enforcement of completion guarantees and other related claims (JP Morgan Chase Bank, N.A. v. KB HOME Nevada, et al., U.S. District Court, District of Nevada (Case No. 08-CV-01711 PMP Consolidated)). Our interest in this joint venture is comparatively small, totaling 3.53%, but we have vigorously defended and otherwise sought resolution of these actions. We are the only builder joint venture partner to have fully performed its obligations with respect to takedowns of lots from the joint venture, having completed our first takedown in April 2007 and having tendered full performance of our second and final takedown in April 2008. The joint venture and the lender group rejected our tender of performance for our second and final takedown, and we contend, among other things, that the rejection by the joint venture and the lender group of our tender of full performance was wrongful and constituted a breach of contract and should release us of liability with respect to the takedown and extinguish or greatly reduce our exposure under all guarantees. Pursuant to the lenders’ request and stipulation of the parties, on January 23, 2012, the Court dismissed all of the lenders’ claims against Meritage in this consolidated lawsuit without prejudice.


22



On December 9, 2010, three of the lenders filed a petition seeking to place the venture into an involuntary bankruptcy (JP Morgan Chase Bank, N.A. v. South Edge, LLC (Case No. 10-32968-bam)). On June 6, 2011, we received a demand letter from the lenders, requesting full payment of $13.2 million the lenders claimed to be owed under the springing repayment guarantee, including past-due interest and penalties. The lenders claim that the involuntary bankruptcy filed by three of the co-lenders triggered the springing repayment guarantee. We do not believe the lenders have an enforceable position associated with their $13.2 million claim and do not believe we should be required to pay such amount because, among other reasons, the lenders breached their contract with us by refusing to accept the April 2008 tender of our performance and by refusing to release their lien in connection with our second and final takedown in this project and we do not believe the repayment guarantee was triggered by the lenders’ filing of the involuntary bankruptcy. As a result, on August 19, 2011, we filed a lawsuit against JP Morgan Chase Bank, NA (“JP Morgan”) in the Court of Common Pleas in Franklin County, Ohio (Case No. 11CVH0810353) regarding the repayment guarantee. In reaction to that lawsuit, on August 25, 2011, JP Morgan filed a lawsuit against us in the US District Court of Nevada, which is currently being prosecuted in the name of JP Morgan's agent, ISG Insolvency Group, Inc. regarding most of the same issues addressed in the Ohio litigation (Case No. 2: 11-CV-01364-PMP). The Ohio and Nevada actions have been consolidated into a single action. On October 26, 2011, the Bankruptcy Court approved a plan pursuant to which (i) the lenders have received all payments to which they are entitled, (ii) the project has been conveyed to Inspirada Builders, LLC, which is an entity owned by four of the co-venturers in the South Edge entity (KB Home, Toll Brothers, Pardee Homes and Beazer Homes), and (iii) the four co-venturer builders claim to have succeeded to the lenders’ repayment guarantee claim against Meritage.
On September 4, 2012, the Court ruled on a motion for summary judgment that JP Morgan has standing to pursue its repayment guarantee claims against Meritage, and that Meritage was liable thereunder to JP Morgan and that the parties should be permitted to conduct discovery with respect to the amount of damages to which JP Morgan is entitled under the repayment guarantee. Following limited discovery, JP Morgan filed a motion for summary judgment with respect to damages, and on June 17, 2013 the Court granted the motion, ruling that Meritage owes JP Morgan $15,053,857. Later, on July 8, 2013, the Court entered Judgment in favor of JP Morgan in the amount of $15,753,344, which included an additional $699,487 for pre-judgment interest that accrued between December 6, 2012 and the date of the Judgment. We immediately appealed the Court's rulings, and on July 17, 2013 posted a supersedeas bond in the amount of $16,050,604 staying enforcement of the Judgment, which was approved by the Court on July 17, 2013. Pursuant to a stipulation between the parties, the bond amount included the amount of the Judgment and additional sums for a potential award of post-judgment interest and attorneys' fees on appeal. We disagree with many of the conclusions and findings contained in the Court's order, and have challenged and will continue to challenge the ruling on appeal which is currently pending. In addition, we believe that four co-venturers in the South Edge entity (KB Home, Toll Brothers, Pardee Homes and Beazer Homes) are liable to Meritage for any amounts that Meritage may ultimately be required to pay under the repayment guarantee, and we have filed claims against those builders to, among other things, recover from them any amounts Meritage may be required to pay under the arbitration repayment guarantee.
In March 2012, Inspirada Builders, LLC (an entity owned by the above named four co-venturers), as Estate Representative of bankrupt South Edge, LLC (the original joint venture) filed demand for arbitration in the United States Bankruptcy Court in the District of Nevada against Meritage Homes of Nevada, Inc. There were two main demands against us contained in this filing. The first is a demand for $13.5 million, relating to alleged breaches of the Operating Agreement of South Edge, LLC, ironically for not paying the amount Meritage fully tendered but South Edge (at the direction of or as a result of acts of or the failure to perform by the above-named co-venture members) rejected in 2008. The second demand was for $9.8 million relating to our supposed pro rata share of alleged future infrastructure improvement costs to be incurred by Inspirada Builders, LLC, which is the new owner of the project, having purchased it through bankruptcy proceedings. The second demand was dismissed on June 27, 2013. The $13.5 million claim identified above represents the same alleged obligation that is the subject of the already pending repayment guarantee litigation between us and JP Morgan that is described above. Meritage has filed a response to Inspirada Builders' arbitration claims denying liability, together with cross-claims against the four above-named co-venture builders for breach of contract, breach of the implied covenant of good faith and fair dealing, and indemnity. The balance of the parties' claims are currently pending and were set to be resolved at an arbitration hearing in late 2013 but pursuant to a stipulation of the parties that arbitration has now been stayed pending resolution of our pending appeal of the Court's rulings in favor of JP Morgan in the federal court action. We do not believe there is any additional exposure to us related to this new claim beyond that already disclosed and discussed in this Legal Proceedings section.
Item 4. Mine Safety Disclosures
Not applicable.


23



PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “MTH”. The high and low sales prices per share of our common stock for the periods indicated, as reported by the NYSE, follow.
 
 
 
2013
 
2012
Quarter Ended
 
High
 
Low
 
High
 
Low
March 31
 
$
48.62

 
$
37.82

 
$
29.32

 
$
23.19

June 30
 
$
52.95

 
$
39.02

 
$
34.20

 
$
24.31

September 30
 
$
48.46

 
$
38.42

 
$
42.59

 
$
32.96

December 31
 
$
48.19

 
$
38.92

 
$
42.28

 
$
32.33

The following Performance Graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
 
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
Meritage Homes Corporation
 
100.00

 
158.83

 
182.42

 
190.55

 
306.90

 
394.33

S&P 500 Index
 
100.00

 
122.10

 
137.43

 
137.82

 
156.44

 
202.15

Dow Jones US Home Construction Index
 
100.00

 
116.01

 
116.51

 
112.00

 
203.38

 
223.38


24



The above graph compares the five-year total return of our common stock with the S&P 500 Index and the Dow Jones US Home Construction Index. The graph assumes 100 invested as of December 31, 2008 in Meritage Common Stock the S&P 500 Index and the Dow Jones US Home Construction Index, and the re-investment of all dividends. The performance of our common stock depicted in the graphs is not indicative of future performance.
On February 3, 2014 there were approximately 240 owners of record and approximately 12,800 beneficial owners of common stock.
The transfer agent for our common stock is Computershare Investor Services, LLC, 480 Washington Blvd., Jersey City, NJ 07310 (www.cpushareownerservices.com).

Historically, we have not declared cash dividends, nor do we intend to declare cash dividends in the foreseeable future. We plan to retain our earnings to finance the continuing development of the business. Future cash dividends, if any, will depend upon our financial condition, results of operations, capital requirements, compliance with certain restrictive debt covenants, as well as other factors considered relevant by our Board of Directors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” and Note 5 in the accompanying consolidated financial statements.
Reference is made to Note 8 in the accompanying consolidated financial statements for a description of our stock-based compensation plans.
Issuer Purchases of Equity Securities
We did not acquire any shares of our common stock during the twelve months ended December 31, 2013. During 2012, we canceled and retired all of our treasury shares. These shares remain as authorized and unissued shares.
On February 21, 2006, we announced that the Board of Directors approved a stock repurchase program, authorizing the expenditure of up to $100 million to repurchase shares of our common stock. In August 2006, the Board of Directors authorized an additional $100 million under this program. There is no stated expiration date for this program. As of December 31, 2013, we had approximately $130.2 million of the authorized amount available to repurchase shares under this program. We have no plans to purchase additional shares under this program in the foreseeable future.


25



Item 6. Selected Financial Data
The following table presents selected historical consolidated financial and operating data of Meritage Homes Corporation and subsidiaries as of and for each of the last five years ended December 31, 2013. The financial data has been derived from our audited consolidated financial statements and related notes for the periods presented. This table should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Annual Report. These historical results may not be indicative of future results.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Historical Consolidated Financial Data
Years Ended December 31,
 
 
($ in thousands, except per share amounts)
 
 
2013
 
2012
 
2011
 
2010
 
2009
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
 
Homebuilding:
 
 
 
 
 
 
 
 
 
 
Total closing revenue
 
$
1,814,659

 
$
1,193,674

 
$
861,244

 
$
941,656

 
$
970,313

Total cost of closings
 
(1,417,254
)
 
(973,466
)
 
(704,812
)
 
(767,509
)
 
(840,046
)
Impairments
 
(987
)
 
(2,009
)
 
(15,324
)
 
(6,451
)
 
(126,216
)
Gross profit
 
396,418

 
218,199

 
141,108

 
167,696

 
4,051

Financial services profit
 
15,954

 
10,255

 
6,563

 
7,091

 
7,626

Commissions and other sales costs
 
(126,716
)
 
(94,833
)
 
(74,912
)
 
(76,798
)
 
(78,683
)
General and administrative expenses
 
(91,510
)
 
(68,185
)
 
(64,184
)
 
(59,784
)
 
(59,461
)
Loss from unconsolidated entities, net (1)
 
(378
)
 
(224
)
 
(714
)
 
(1,848
)
 
(3,613
)
Interest expense
 
(15,092
)
 
(24,244
)
 
(30,399
)
 
(33,722
)
 
(36,531
)
Other income/(loss), net
 
2,792

 
(6,342
)
 
2,162

 
3,303

 
2,422

(Loss)/gain on extinguishment of debt
 
(3,796
)
 
(5,772
)
 

 
(3,454
)
 
9,390

Earnings/(loss) before income taxes
 
177,672

 
28,854

 
(20,376
)
 
2,484

 
(154,799
)
(Provision for)/benefit from income taxes
 
(53,208
)
 
76,309

 
(730
)
 
4,666

 
88,343

Net earnings/(loss)
 
$
124,464

 
$
105,163

 
$
(21,106
)
 
$
7,150

 
$
(66,456
)
Earnings/(loss) per common share:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
3.45

 
$
3.09

 
$
(0.65
)
 
$
0.22

 
$
(2.12
)
Diluted (2)
 
$
3.25

 
$
3.00

 
$
(0.65
)
 
$
0.22

 
$
(2.12
)
Balance Sheet Data (December 31):
 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents, investments and securities and restricted cash
 
$
363,823

 
$
295,469

 
$
333,187

 
$
412,642

 
$
391,378

Real estate
 
$
1,405,299

 
$
1,113,187

 
$
815,425

 
$
738,928

 
$
675,037

Total assets
 
$
2,003,361

 
$
1,575,562

 
$
1,221,378

 
$
1,224,938

 
$
1,242,667

Senior, senior subordinated and convertible notes, loans payable and other borrowings
 
$
905,055

 
$
722,797

 
$
606,409

 
$
605,780

 
$
605,009

Total liabilities
 
$
1,161,969

 
$
881,352

 
$
732,466

 
$
724,943

 
$
757,242

Stockholders’ equity
 
$
841,392

 
$
694,210

 
$
488,912

 
$
499,995

 
$
485,425

Cash Flow Data:
 
 
 
 
 
 
 
 
 
 
Cash (used in)/provided by:
 
 
 
 
 
 
 
 
 
 
Operating activities
 
$
(86,276
)
 
$
(220,487
)
 
$
(74,136
)
 
$
32,551

 
$
184,074

Investing activities
 
$
1,031

 
$
23,844

 
$
141,182

 
$
(174,515
)
 
$
(145,419
)
Financing activities
 
188,924

 
$
193,488

 
$
2,613

 
$
(3,414
)
 
$
4,753

 
(1)
Loss from unconsolidated entities in 2013, 2012, 2011, 2010 and 2009 includes $0, $0, $0, $0.3 million and $2.8 million, respectively, of joint venture investment impairments. See Note 4 of our consolidated financial statements for additional information.
(2)
Diluted earnings per common share for the years ended December 31, 2013 and 2012 includes adjustments to net earnings to account for the interest attributable to our convertible debt, net of income taxes. See Note 7 of our consolidated financial statements for additional information.

26



Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview and Outlook
Industry Conditions

During 2013, the overall housing market's results continued to improve from the recovery that began to accelerate in 2012. The existing pent-up demand and increased consumer confidence, coupled with excellent housing affordability based on historical metrics and decreasing inventory home levels in many markets resulted in strong financial and operational performance for the entire homebuilding sector. While individual markets continue to experience varying results as local economic and employment situations strongly influence demand, all of our markets benefited from the homebuilding recovery, particularly those markets most affected by the downturn, including California, Arizona and Florida.

We continue to focus on successfully differentiating ourselves from our competition by offering exciting and desirable new plans that successfully demonstrate the benefits of our industry-leading energy efficient homes situated in well-located communities. We also offer our buyers the ability to personalize their homes and provide a home warranty, successfully setting us apart from the competition we face with resale homes. Our positive results throughout 2013 have strengthened our financial position, with strong improvements in all of our key operating metrics.
Summary Company Results
Total home closing revenue was $1.8 billion for the year ended December 31, 2013, increasing 50.6% from $1.2 billion for 2012 and 107.2% from $860.9 million in 2011. We earned net income of $124.5 million compared to $105.2 million in 2012 and a net loss of $21.1 million in 2011. Our 2013 results include $1.0 million of impairments, $3.8 million of early debt extinguishment costs and $53.2 million of taxes as our deferred tax asset valuation allowance was almost fully reversed in 2012. Our 2012 results include $2.0 million of real estate-related impairments, a $5.8 million of loss from early extinguishment of debt, an $8.7 million charge for litigation accruals related to a joint venture, and reflect a $76.3 million benefit from income taxes due to the reversal of most of our deferred tax asset valuation allowance. In 2011, results included $15.3 million of real estate-related impairments, $9.2 million of which is related to our Las Vegas operations and a $0.7 million income tax provision. See Note 2 in the accompanying consolidated financial statements for additional discussion regarding our remaining Nevada assets.
At December 31, 2013, our backlog of $686.7 million was up 43.3% from $479.3 million at December 31, 2012. Our December 31, 2011 backlog was $248.9 million. Increased community count and higher average sales prices in 2013 are largely responsible for the increase in ending backlog over 2012. Our average sales price for homes in backlog increased to $370,600, up 13.8% from $325,600 at December 31, 2012, and up 36.3% from $272,000 at December 31, 2011 primarily due to our pricing power in many communities and mix of homes shifting to higher-priced markets and states. Our cancellation rate on sales orders as a percentage of gross sales decreased in 2013 to 12.8% down from 13.2% and 17.0%, respectively, for the years ended December 31, 2012 and 2011, reflecting a high quality backlog and greater confidence among buyers, supported by increasing prices and expectations of further home value appreciation. We believe these positive trends will result in continued positive operating results in 2014.
Company Actions and Positioning

As the homebuilding market stabilizes and recovers, we remain focused on our main goals of growing our orders
and revenue, generating profit and maintaining a strong balance sheet. To help meet these goals we continued to execute on the following initiatives in 2013:

Strengthening our balance sheet - completed two new senior note issuances, and extending our earliest debt maturities until 2018;
Generating additional working capital and improving liquidity - increased the capacity of our revolving credit facility and completed an equity offering in January 2014;
Eliminated our cash secured letter of credit facilities and transferred all outstanding letters of credit to be supported by our increased unsecured revolving credit facility;
Increased the percentage of controlled lots through optioned contracts in order to minimize initial cash outlays for land purchases;
Continuing to actively acquire and develop lots in markets we deem key to our success in order to maintain and grow our lot supply and active community count; increasing controlled lots by 23.3%;

27



Utilizing our enhanced market research to capitalize on the knowledge of our buyers' demands in each community, tailoring our pricing, product and amenities offered;
Continuing to innovate and promote the Meritage Green energy efficiency program, where every new home we construct, at a minimum, meets ENERGY STAR® standards, certified by the U.S. Environmental Protection Agency, for indoor air quality, water conservation and overall energy efficiency;
Adapting sales and marketing efforts to generate additional traffic and compete with resale homes;
Focusing our purchasing efforts to manage cost increases as homebuilding recovers and demand rises;
Growing our inventory balance while ensuring sufficient liquidity through exercising tight control over cash flows;
Striving for excellence in construction; and monitoring our customers' satisfaction as measured by survey scores and working toward improving them based on the results of the surveys.

We previously consolidated overhead functions in all of our divisions and at our corporate offices to hold down
general and administrative cost burden and we continue to carefully manage such expenditures.

Additionally, we are continually evaluating opportunities for expansion into new markets that indicate positive long-term growth trends. We are looking to redeploy our capital into projects both within our geographic footprint and through entry into new markets. In connection with these efforts, in 2011 we announced our entry into the Raleigh-Durham, North Carolina and Tampa, Florida markets and our wind down of operations in the Las Vegas, Nevada market. In 2012, we announced our entry into the Charlotte, North Carolina market. In the last half of 2013, we entered the Nashville, Tennessee, market through the acquisition of a local homebuilder (See Note 1 of the accompanying consolidated financial statements for additional information).

We believe that the investments in our new communities, markets and product offerings create a differentiated strategy that has lessened the impact of the economic conditions over the past several years and has improved our operating leverage. Throughout 2013, we opened 101 new communities while closing out 71 communities, ending the year with 188 active communities. The improved community count is to a large extent the result of our land acquisition efforts to support growth in existing and new markets.

In the first and fourth quarters of 2013, we also took steps to strengthen our balance sheet and extend debt maturities through three capital transactions. In March 2013, we concurrently issued $175.0 million of 4.50% senior notes due 2018 and redeemed all of our $99.8 million senior subordinated notes due 2017, extending our earliest debt maturities to 2018. During the fourth quarter of 2013, we completed a $100 million add-on debt issuance to our existing 7.15% senior notes due 2020. In addition, we increased the capacity of our unsecured revolving credit facility to $200 million during the fourth quarter to provide additional liquidity. Finally, in the first quarter of 2014 we further strengthened our balance sheet by raising $110.5 million, net of offering costs, in a public equity offering. (See Note 5 to the accompanying consolidated financial statements for further discussion regarding our debt transactions).

Critical Accounting Policies
We have established various accounting policies that govern the application of United States generally accepted accounting principles (“GAAP”) in the preparation and presentation of our consolidated financial statements. Our significant accounting policies are described in Note 1 of the consolidated financial statements included in this Form 10-K. Certain of these policies involve significant judgments, assumptions and estimates by management that may have a material impact on the carrying value of certain assets and liabilities, and revenue and costs. We are subject to uncertainties such as the impact of future events, economic, environmental and political factors and changes in our business environment; therefore, actual results could differ from these estimates. Accordingly, the accounting estimates used in the preparation of our financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. Changes in estimates are revised when circumstances warrant. Such changes in estimates and refinements in methodologies are reflected in our reported results of operations and, if material, the effects of changes in estimates are disclosed in the notes to our consolidated financial statements. The judgments, assumptions and estimates we use and believe to be critical to our business are based on historical experience, knowledge of the accounts, industry practices, and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we have made, actual results may differ from these judgments and estimates and could have a material impact on the carrying values of assets and liabilities and the results of our operations.


28



The accounting policies that we deem most critical to us and involve the most difficult, subjective or complex judgments are as follows:

Revenue Recognition
We recognize revenue from a home sale when title passes to the homeowner, the homeowner’s initial and continuing investment is adequate to demonstrate a commitment to pay for the home, the receivable, if any, from the homeowner is not subject to future subordination and we do not have a substantial continuing involvement with the sold home. These conditions are typically achieved when a home closes.
Revenue from land sales is recognized when a significant down payment is received, the earnings process is relatively complete, title passes and collectability of the receivable is reasonably assured. Although there is limited subjectivity in this accounting policy, we have designated revenue recognition as a critical accounting policy due to the significance of this balance in our statements of operations.
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 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10, Property, Plant and Equipment. Inventory includes the costs of land acquisition, land development and home construction, capitalized interest, real estate taxes, direct overhead costs incurred during development and home construction that benefit the entire community, less impairments, if any. Land and development costs are typically allocated and transferred to homes under construction when home 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 allocated land acquisition, land development and other common costs (both incurred and estimated to be incurred) 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, an entitled community’s life cycle ranges from three to five years, commencing with the acquisition of the land, 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 absorption rates and whether the land purchased was raw land 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 at least quarterly, or more frequently if impairment indicators are present, as our inventory is considered “long-lived” in accordance with GAAP. 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 and actual results may also differ from our assumptions. Our analysis is completed at a community level with each community or land parcel evaluated individually. We pay particular attention to communities experiencing a larger-than-anticipated reduction in their absorption rates or sales prices or where gross margins are trending lower than anticipated. For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the assets’ carrying balance exceeds their fair value. The impairment of a community is allocated to each lot on a straight-line basis.
Existing and continuing communities. When projections for the remaining income expected to be earned from an existing community are no longer positive, the underlying real estate assets are not deemed 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 to be sold and the impairments are charged to cost of home closings 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 sales activity in the local market, adjusted for known variances as determined by our knowledge of the region and general real estate expertise. If a discounted cash flow approach is used, we compute fair value based on a proprietary model. 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, or to be implemented, to stimulate the sales pace and expected cancellation rates, (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% and varies based on our perceived risk inherent in the community’s other cash flow assumptions. These assumptions

29



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 areas;
Desirability of the particular community, including unique amenities or other favorable or unfavorable attributes; and
Existing home inventory supplies, including foreclosures and short sales.
These local circumstances may significantly impact our assumptions and the resulting computation of fair value, and are, therefore, closely evaluated by our division personnel in their creation of the discounted cash flow models. 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. 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 community.

Mothball communities. In certain cases, we may elect to stop development (mothball) of an existing community if we believe the economic performance of the community would be maximized by deferring development for a period of time to allow market conditions to improve. When a community is initially placed into mothball status, it is management's belief that the community is affected by local market conditions that are expected to improve within the next 1-5 years. Therefore, a temporary postponement of construction and development work is expected to yield better overall future returns. The decision may be based on financial and/or operational metrics. If we decide to mothball a community, we will impair it to its fair value as discussed above and then cease future development activity until such a time when management believes that market conditions have improved and economic performance will be maximized. No interest or other costs are capitalized to communities that are designated as mothballed.

In addition to our quarterly impairment analysis, which is conducted to determine if any current impairments exist, we also conduct a thorough quarterly review of our mothballed communities to determine if they are at risk of future impairment. The financial and operational status and expectations of these communities are analyzed as well as any unique attributes that could be viewed as indicators for future impairments. Adjustments are made accordingly and incremental impairments, if any, are recorded at each re-evaluation. Based on the facts and circumstances available as of December 31, 2013, we do not believe that any of our underperforming or mothballed communities will incur material impairments in the future. Changes in market and/or economic conditions could materially impact the conclusions of this analysis, and there can be no assurances that future impairments will not occur.

Inventory assessments on inactive assets. For our mothballed communities as well as our land held for future development, our inventory assessments typically include highly subjective estimates for future performance, including the timing of development, the product to be offered, sales rates and selling prices of the product when the community is anticipated to open for sales, and the projected costs to develop and construct the community. We evaluate various factors to develop our forecasts, including the availability of and demand for homes and finished lots within the marketplace, historical, current and future sales trends, and third-party data, if available. Based on these factors, we reach conclusions for future performance based on our judgment.
Option deposits and pre-acquisition costs: We 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 income to be generated by our future communities is 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 the 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. In certain circumstances, we may also elect to continue with a project because it is expected to generate positive future cash flows, even though it may not be generating an accounting profit, or because of 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.
Due to the complexity and subjectivity of these fair value computations, as well as the significance of associated impairments to our financial statements in recent years, we have concluded that the valuation of our real-estate and associated assets is a critical accounting policy.

30



During 2013, we recorded $1.0 million of such impairment charges related to our home and land inventories and corresponding deposits. Refer to Notes 2 and 6 of these consolidated financial statements in this Annual Report on Form 10-K for further discussion regarding these impairments and the associated remaining fair values of impaired communities.
The impairment charges we record are based on our fair value calculations, which are affected by current market conditions, assumptions and expectations, all of which are highly subjective and may differ significantly from actual results if market conditions change. Due to the volume of possible outcomes that can be generated from changes in the various model inputs for each community, we do not believe it is possible to create a sensitivity analysis that would provide meaningful information for the users of our financial statements.
Warranty Reserves
We use subcontractors for nearly all aspects of home construction. Although our subcontractors are generally required to repair and replace any product or labor defects, we are, during applicable warranty periods, ultimately responsible to the homeowner for making such repairs. As such, warranty reserves are recorded to cover our exposure to absorb the costs for materials and labor not expected to be covered by our subcontractors to the extent they relate to warranty-type claims subsequent to the delivery of a home to the homeowner. Reserves are reviewed on a regular basis and, with the assistance of an actuary for the structural warranty, we determine their sufficiency based on our and industry-wide historical data and trends. These reserves are subject to variability due to uncertainties regarding structural defect claims for the products we build, the markets in which we build, claim settlement history, insurance and legal interpretations and expected recoveries, among other factors.
At December 31, 2013, our warranty reserve was $22.0 million, reflecting an accrual of 0.2% to 0.6% of a home’s sale price depending on our loss history in the geographic area in which the home was built. A 10% increase in our warranty reserve rate would have increased our accrual and corresponding cost of sales by approximately $1.1 million in 2013. We recorded $1.3 million unfavorable and $2.6 million favorable adjustments to our reserve in 2013 and 2011, respectively, based on historical trends of actual claims paid and our success in recovery of expended amounts. We recorded no such adjustments in 2012. While we believe that the warranty reserve is sufficient to cover our projected costs, there can be no assurances that historical data and trends will accurately predict our actual warranty costs. Furthermore, there can be no assurances that future economic or financial developments might not lead to a significant change in the reserve.
Off-Balance Sheet Arrangements
We enter into option or purchase agreements to acquire land or lots, for which we generally pay non-refundable deposits. We also analyze these agreements under ASC 810-10, Consolidation (“ASC 810-10”) to determine whether we are the primary beneficiary of the variable interest entity ("VIE"). In cases where we are the primary beneficiary, even though we do not have title to such land, we would be required to consolidate these purchase/option agreements and reflect such assets and liabilities as “Real estate not owned” in our consolidated balance sheets. The liabilities related to consolidated VIEs are generally excluded from our debt covenant calculations. See Note 3 in the accompanying financial statements for additional information related to our off-balance-sheet arrangements.
Valuation of Deferred Tax Assets
We account for income taxes using the asset and liability method, which requires that deferred tax assets and liabilities be recognized based on future tax consequences of both temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted.

In accordance with ASC 740-10, Income Taxes, we evaluate our deferred tax assets by tax jurisdiction, including the benefit from NOLs by tax jurisdiction, to determine if a valuation allowance is required. Companies must assess, using significant judgments, 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, experience with operating losses and experience of utilizing tax credit carryforwards and tax planning alternatives. Based upon a review of all available evidence, we recorded a full non-cash valuation allowance against our deferred tax assets during 2008 due to economic conditions and the weight of negative evidence at the time. During 2012 and 2013, we reversed all of the valuation allowance against our net deferred tax assets as we had determined that the weight of the positive evidence exceeds that of the negative evidence and it is more likely than not that we will be able to utilize all of our deferred tax assets and NOL carryovers.

31



At December 31, 2013 and 2012, we had a valuation allowance of $0 and $8.7 million (all state related), 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. Federal net operating loss carryforwards may be used to offset future taxable income for 20 years and expire in 2030. State net operating loss carryforwards may be used to offset future taxable income for a period of time ranging from 5 to 20 years, depending on the state, some of which expired in 2012 and 2013.
Share-Based Payments
We have stock options and restricted common stock units (“nonvested shares”) outstanding under our stock compensation plan. Per the terms of the plan, the exercise price of our stock options may not be less than the closing market value of our common stock on the date of grant. Such option exercises are permitted in pre-determined installments based upon a vesting schedule established at the time of grant. Each stock option expires on a date determined at the time of the grant, but not to exceed seven years from the date of the grant. Our last stock option grant was in 2009. Our restricted stock generally vests on a pro-rata basis over either three or five years.
The calculation of employee compensation expense involves estimates that require management judgments. These estimates include determining the value of each of our stock options on the date of grant using a Black-Scholes option-pricing model. The fair value of our stock options, which typically vest ratably over a five-year period, is determined at the time of grant and is expensed on a straight-line basis over the vesting life of the options. Expected volatility is based on a composite of historical volatility of our stock and implied volatility from our traded options. The risk-free rate for periods within the contractual life of the stock option award is based on the rate of a zero-coupon Treasury bond on the date the stock option is granted with a maturity equal to the expected term of the stock option. We use historical data to estimate stock option exercises and forfeitures within our valuation model. The expected life of our stock option awards is derived from historical experience under our share-based payment plans and represents the period of time that we expect our stock options to be outstanding. A 10% decrease in our forfeiture rate would have increased our stock compensation by approximately $31,000 in 2013.


32




Home Closing Revenue, Home Orders and Order Backlog - Segment Analysis

The composition of our closings, home orders and backlog is constantly changing and is based on a dissimilar mix of communities between periods as new projects open and existing projects wind down. Further, individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality and location of lots (e.g. cul-de-sac, view lots, greenbelt lots). These variations result in a lack of meaningful comparability between our home orders, closings and backlog due to the changing mix between periods. The tables on the following pages present operating and financial data that we consider most critical to managing our operations (dollars in thousands):

33



 
 
 
 
 
 
 
 
 
 
 
Years Ended December 31,
 
Year Over Year
 
 
2013
 
2012
 
Chg $
 
Chg %
Home Closing Revenue
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
Dollars
 
$
1,783,389

 
$
1,184,360

 
$
599,029

 
50.6
 %
Homes closed
 
5,259

 
4,238

 
1,021

 
24.1
 %
Average sales price
 
$
339.1

 
$
279.5

 
$
59.6

 
21.3
 %
West Region
 
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
 
Dollars
 
$
329,855

 
$
221,100

 
$
108,755

 
49.2
 %
Homes closed
 
1,041

 
825

 
216

 
26.2
 %
Average sales price
 
$
316.9

 
$
268.0

 
$
48.9

 
18.2
 %
California
 
 
 
 
 
 
 
 
Dollars
 
$
427,886

 
$
264,388

 
$
163,498

 
61.8
 %
Homes closed
 
989

 
732

 
257

 
35.1
 %
Average sales price
 
$
432.6

 
$
361.2

 
$
71.4

 
19.8
 %
Colorado
 
 
 
 
 
 
 
 
Dollars
 
$
158,793

 
$
96,807

 
$
61,986

 
64.0
 %
Homes closed
 
405

 
292

 
113

 
38.7
 %
Average sales price
 
$
392.1

 
$
331.5

 
$
60.6

 
18.3
 %
Nevada
 
 
 
 
 
 
 
 
Dollars
 
$
8,900

 
$
11,444

 
$
(2,544
)
 
(22.2
)%
Homes closed
 
38

 
61

 
(23
)
 
(37.7
)%
Average sales price
 
$
234.2

 
$
187.6

 
$
46.6

 
24.8
 %
West Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
925,434

 
$
593,739

 
$
331,695

 
55.9
 %
Homes closed
 
2,473

 
1,910

 
563

 
29.5
 %
Average sales price
 
$
374.2

 
$
310.9

 
$
63.3

 
20.4
 %
Central Region - Texas
 
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
492,777

 
$
390,642

 
$
102,135

 
26.1
 %
Homes closed
 
1,834

 
1,655

 
179

 
10.8
 %
Average sales price
 
$
268.7

 
$
236.0

 
$
32.7

 
13.9
 %
East Region
 
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
 
Dollars
 
$
93,210

 
$
41,888

 
$
51,322

 
122.5
 %
Homes closed
 
239

 
117

 
122

 
104.3
 %
Average sales price
 
$
390.0

 
$
358.0

 
$
32.0

 
8.9
 %
Florida
 
 
 
 
 
 
 
 
Dollars
 
$
264,066

 
$
158,091

 
$
105,975

 
67.0
 %
Homes closed
 
691

 
556

 
135

 
24.3
 %
Average sales price
 
$
382.2

 
$
284.3

 
$
97.9

 
34.4
 %
Tennessee
 
 
 
 
 
 
 
 
Dollars
 
$
7,902

 
N/A

 
$
7,902

 
N/M

Homes closed
 
22

 
N/A

 
22

 
N/M

Average sales price
 
$
359.2

 
N/A

 
$
359.2

 
N/M

East Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
365,178

 
$
199,979

 
$
165,199

 
82.6
 %
Homes closed
 
952

 
673

 
279

 
41.5
 %
Average sales price
 
$
383.6

 
$
297.1

 
$
86.5

 
29.1
 %

34



 
 
Years Ended December 31,
 
Year Over Year
 
 
2012
 
2011
 
Chg $
 
Chg %
Home Closing Revenue
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
Dollars
 
$
1,184,360

 
$
860,884

 
$
323,476

 
37.6
 %
Homes closed
 
4,238

 
3,268

 
970

 
29.7
 %
Average sales price
 
$
279.5

 
$
263.4

 
$
16.1

 
6.1
 %
West Region
 
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
 
Dollars
 
$
221,100

 
$
150,258

 
$
70,842

 
47.1
 %
Homes closed
 
825

 
594

 
231

 
38.9
 %
Average sales price
 
$
268.0

 
$
253.0

 
$
15.0

 
5.9
 %
California
 
 
 
 
 
 
 
 
Dollars
 
$
264,388

 
$
120,319

 
$
144,069

 
119.7
 %
Homes closed
 
732

 
355

 
377

 
106.2
 %
Average sales price
 
$
361.2

 
$
338.9

 
$
22.3

 
6.6
 %
Colorado
 
 
 
 
 
 
 
 
Dollars
 
$
96,807

 
$
83,095

 
$
13,712

 
16.5
 %
Homes closed
 
292

 
258

 
34

 
13.2
 %
Average sales price
 
$
331.5

 
$
322.1

 
$
9.4

 
2.9
 %
Nevada
 
 
 
 
 
 
 
 
Dollars
 
$
11,444

 
$
12,593

 
$
(1,149
)
 
(9.1
)%
Homes closed
 
61

 
59

 
2

 
3.4
 %
Average sales price
 
$
187.6

 
$
213.4

 
$
(25.8
)
 
(12.1
)%
West Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
593,739

 
$
366,265

 
$
227,474

 
62.1
 %
Homes closed
 
1,910

 
1,266

 
644

 
50.9
 %
Average sales price
 
$
310.9

 
$
289.3

 
$
21.6

 
7.5
 %
Central Region - Texas
 
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
390,642

 
$
395,278

 
$
(4,636
)
 
(1.2
)%
Homes closed
 
1,655

 
1,660

 
(5
)
 
(0.3
)%
Average sales price
 
$
236.0

 
$
238.1

 
$
(2.1
)
 
(0.9
)%
East Region
 
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
 
Dollars
 
$
41,888

 
N/A

 
$
41,888

 
N/M

Homes closed
 
117

 
N/A

 
117

 
N/M

Average sales price
 
$
358.0

 
N/A

 
$
358.0

 
N/M

Florida
 
 
 
 
 
 
 
 
Dollars
 
$
158,091

 
$
99,341

 
$
58,750

 
59.1
 %
Homes closed
 
556

 
342

 
214

 
62.6
 %
Average sales price
 
$
284.3

 
$
290.5

 
$
(6.2
)
 
(2.1
)%
East Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
199,979

 
$
99,341

 
$
100,638

 
101.3
 %
Homes closed
 
673

 
342

 
331

 
96.8
 %
Average sales price
 
$
297.1

 
$
290.5

 
$
6.6

 
2.3
 %

35



 
 
 
 
 
 
 
 
 
 
 
Years Ended December 31,
 
Year Over Year
 
 
2013
 
2012
 
Chg $
 
Chg %
Home Orders (1)
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
Dollars
 
$
1,982,303

 
$
1,414,772

 
$
567,531

 
40.1
 %
Homes ordered
 
5,615

 
4,795

 
820

 
17.1
 %
Average sales price
 
$
353.0

 
$
295.1

 
$
57.9

 
19.6
 %
West Region
 
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
 
Dollars
 
$
346,278

 
$
256,684

 
$
89,594

 
34.9
 %
Homes ordered
 
1,070

 
916

 
154

 
16.8
 %
Average sales price
 
$
323.6

 
$
280.2

 
$
43.4

 
15.5
 %
California
 
 
 
 
 
 
 
 
Dollars
 
$
410,761

 
$
361,328

 
$
49,433

 
13.7
 %
Homes ordered
 
899

 
965

 
(66
)
 
(6.8
)%
Average sales price
 
$
456.9

 
$
374.4

 
$
82.5

 
22.0
 %
Colorado
 
 
 
 
 
 
 
 
Dollars
 
$
201,088

 
$
123,403

 
$
77,685

 
63.0
 %
Homes ordered
 
465

 
364

 
101

 
27.7
 %
Average sales price
 
$
432.4

 
$
339.0

 
$
93.4

 
27.6
 %
Nevada
 
 
 
 
 
 
 
 
Dollars
 
$
5,795

 
$
13,473

 
$
(7,678
)
 
(57.0
)%
Homes ordered
 
24

 
70

 
(46
)
 
(65.7
)%
Average sales price
 
$
241.5

 
$
192.5

 
$
49.0

 
25.5
 %
West Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
963,922

 
$
754,888

 
$
209,034

 
27.7
 %
Homes ordered
 
2,458

 
2,315

 
143

 
6.2
 %
Average sales price
 
$
392.2

 
$
326.1

 
$
66.1

 
20.3
 %
Central Region - Texas
 
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
 
Dollars
 
$
606,115

 
$
429,465

 
$
176,650

 
41.1
 %
Homes ordered
 
2,126

 
1,759

 
367

 
20.9
 %
Average sales price
 
$
285.1

 
$
244.2

 
$
40.9

 
16.7
 %
East Region
 
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
 
Dollars
 
$
119,087

 
$
50,613

 
$
68,474

 
135.3
 %
Homes ordered
 
298

 
142

 
156

 
109.9
 %
Average sales price
 
$
399.6

 
$
356.4

 
$
43.2

 
12.1
 %
Florida
 
 
 
 
 
 
 
 
Dollars
 
$
282,328

 
$
179,806

 
$
102,522

 
57.0
 %
Homes ordered
 
696

 
579

 
117

 
20.2
 %
Average sales price
 
$
405.6

 
$
310.5

 
$
95.1