================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-9977 MERITAGE CORPORATION (Exact Name of Registrant as Specified in Its Charter) Maryland 86-0611231 (State or Other Jurisdiction) (I.R.S. Employer of Incorporation or Organization) Identification No.) 6613 North Scottsdale Road, Suite 200 Scottsdale, Arizona 85250 (Address of Principal Executive Offices) (Zip Code) (480) 998-8700 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ]. As of November 7, 1999; 5,464,906 shares of Meritage Corporation common stock were outstanding. ================================================================================ MERITAGE CORPORATION AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999 TABLE OF CONTENTS PAGE NO. PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998............................................. 3 Consolidated Statements of Earnings for the Three and Nine Months ended September 30, 1999 and 1998...................... 4 Consolidated Statements of Cash Flows for the Nine Months ended September 30, 1999 and 1998...................... 5 Notes to Consolidated Financial Statements.................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk................................................... 15 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K.............................. 15 SIGNATURES ................................................................ S-1 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MERITAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------ ------------ ASSETS Cash and cash equivalents $ 3,835,754 $ 12,386,806 Real estate under development 180,151,276 104,758,530 Deposits on real estate under option or contract 13,665,743 7,338,406 Other receivables 2,004,365 2,460,966 Deferred tax asset 571,436 6,935,000 Goodwill 19,008,403 14,640,712 Property and equipment, net 4,032,473 2,566,163 Other assets 1,581,314 1,163,737 ------------ ------------ Total Assets $224,850,764 $152,250,320 ============ ============ LIABILITIES Accounts payable and accrued liabilities $ 33,832,074 $ 34,068,178 Home sale deposits 11,098,691 8,587,245 Notes payable 95,733,724 37,204,845 Minority interest in consolidated joint ventures 186,937 110,922 ------------ ------------ Total Liabilities 140,851,426 79,971,190 ------------ ------------ STOCKHOLDERS' EQUITY Common stock, par value $.01 per share; 50,000,000 Shares authorized; issued and outstanding - 5,474,906 Shares at September 30, 1999, and 5,334,942 shares at December 31, 1998 54,749 53,349 Additional paid-in capital 100,258,418 99,319,669 Accumulated deficit (16,200,867) (27,093,888) Less cost of shares held in treasury (10,000 shares) (112,962) -- ------------ ------------ Total Stockholders' Equity 83,999,338 72,279,130 ------------ ------------ Total Liabilities and Stockholders' Equity $224,850,764 $152,250,320 ============ ============ See accompanying notes to consolidated financial statements 3 MERITAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1999 1998 1999 1998 ------------ ------------ ------------- ------------- Home sales revenues $ 76,786,202 $ 68,416,768 $ 204,739,270 $ 160,538,271 Cost of home sales (62,231,991) (54,447,139) (164,364,352) (129,771,511) ------------ ------------ ------------- ------------- Gross profit 14,554,211 13,969,629 40,374,918 30,766,760 Commissions and other sales costs (4,572,040) (3,661,365) (12,479,899) (8,555,753) General and administrative expense (3,531,611) (3,062,087) (10,355,955) (7,242,025) Interest expense (1,725) (119,030) (4,404) (314,624) Other income, net 361,938 434,298 1,395,659 720,705 Residual interest and real estate loan interest income -- -- -- 5,230,549 Minority interest in net income of consolidated joint ventures -- (1,395,443) -- (1,395,443) ------------ ------------ ------------- ------------- Earnings before income taxes 6,810,773 6,166,002 18,930,319 19,210,169 Income taxes 2,783,597 1,898,000 8,037,298 2,794,000 ------------ ------------ ------------- ------------- Net earnings $ 4,027,176 $ 4,268,002 $ 10,893,021 $ 16,416,169 ============ ============ ============= ============= Basic earnings per share $ .74 $ .80 $ 2.00 $ 3.09 Diluted earnings per share $ .67 $ .70 $ 1.80 $ 2.68
See accompanying notes to consolidated financial statements. 4 MERITAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, 1999 1998 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 10,893,021 $ 16,416,169 Adjustments to reconcile net earnings to net cash used in operating activities: Depreciation and amortization 1,607,658 963,540 Minority interest in net income of consolidated joint ventures -- 1,395,443 Deferred tax expense 6,363,564 1,534,000 Stock option compensation expense 444,987 1,040,342 Gain on sales of residual interests -- (5,180,046) Increase in real estate under development (75,392,746) (32,675,132) Increase in deposits on real estate under option or contract (6,327,337) (2,580,682) (Increase) decrease in other receivables and other assets 39,024 (579,583) Increase (decrease) in accounts payable and accrued liabilities 1,638,776 (3,718,429) Increase in home sale deposits 2,511,446 6,030,740 ------------- ------------- Net cash used in operating activities (58,221,607) (17,353,638) ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash acquired in merger/acquisition -- 785,403 Cash paid for merger/acquisition (6,966,890) (9,744,607) Purchases of property and equipment (2,273,634) (986,598) Proceeds from sales of residual interest -- 6,600,000 ------------- ------------- Net cash used in investing activities (9,240,524) (3,345,802) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings 213,469,099 120,341,231 Repayment of borrowings (154,940,220) (102,456,502) Purchase of treasury shares (112,962) -- Stock options exercised 495,162 304,796 ------------- ------------- Net cash provided by financing activities 58,911,079 18,189,525 ------------- ------------- Net decrease in cash and cash equivalents (8,551,052) (2,509,915) Cash and cash equivalents at beginning of period 12,386,806 8,245,392 ------------- ------------- Cash and cash equivalents at end of period $ 3,835,754 $ 5,735,477 ============= ============= See accompanying notes to consolidated financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION We develop, construct and sell new high-quality, single family homes in the semi-custom luxury, move-up and entry-level markets. Our operations in the Phoenix and Tucson, Arizona metropolitan markets are under the Monterey Homes and Meritage Homes of Arizona brand names, in the Dallas/Fort Worth, Austin and Houston, Texas markets we use the Legacy Homes name and in the San Francisco Bay and Sacramento, California markets we are known as Meritage Homes of Northern California. We have recently undergone significant growth and are pursuing a strategy of expanding our operations. BASIS OF PRESENTATION. The consolidated financial statements include the accounts of Meritage Corporation and its subsidiaries. Intercompany balances and transactions have been eliminated in consolidation and certain prior period amounts have been reclassified to be consistent with current financial statement presentation. Results for the first six months of 1998 do not include the operations of Meritage Homes of Northern California, which we acquired on July 1, 1998. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present our financial position and results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of results to be expected for a full fiscal year. NOTE 2 - REAL ESTATE UNDER DEVELOPMENT AND CAPITALIZED INTEREST The components of real estate under development follow (in thousands): SEPTEMBER 30, 1999 DECEMBER 31, 1998 ------------------ ----------------- Homes under contract, in production $ 88,900 $ 44,186 Finished lots and lots under development 63,932 46,558 Model homes and homes held for resale 27,319 14,015 -------- -------- $180,151 $104,759 ======== ======== We capitalize certain interest costs incurred during development and construction. Capitalized interest is allocated to real estate under development and charged to cost of home sales when the units are delivered. Summaries of interest capitalized and interest expensed follow (in thousands):
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 1999 1998 1999 1998 ------- ------- ------- ------- Beginning unamortized capitalized interest $ 2,653 $ 2,130 $ 1,982 $ 1,890 Interest capitalized 1,942 1,608 4,541 3,092 Interest amortized in cost of home sales (1,118) (1,199) (3,046) (2,443) ------- ------- ------- ------- Ending unamortized capitalized interest $ 3,477 $ 2,539 $ 3,477 $ 2,539 ======= ======= ======= ======= Interest incurred $ 1,944 $ 1,727 $ 4,545 $ 3,407 Interest capitalized (1,942) (1,608) (4,541) (3,092) ------- ------- ------- ------- Interest expensed $ 2 $ 119 $ 4 $ 315 ======= ======= ======= =======
6 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 3 - NOTES PAYABLE Notes payable consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ------------ $60 million bank construction line of credit, interest payable monthly approximating prime (8.25% at September 30, 1999) or LIBOR (30 day LIBOR 5.4% at September 30, 1999), plus 2.25% payable at the earlier of close of escrow, maturity date of individual homes within the line or June 9, 2000, secured by first deeds of trust on homes $27,362 $4,641 $80 million bank construction line of credit, interest payable monthly approximating prime or LIBOR plus 2.25%, payable at the earlier of close of escrow, maturity date of individual homes within the line or July 31, 2000, secured by first deeds of trust on homes 34,982 10,925 $20million bank acquisition and development credit facility, interest payable monthly approximating prime or LIBOR plus 2.25%, payable at the earlier of funding of construction financing, the maturity date of individual projects within the line or June 19, 2000, secured by first deeds of trust on land 5,100 3,314 $15 million unsecured revolving line of credit, interest payable monthly approximating prime, maturing on December 17, 1999 11,116 -- Other acquisition and development credit facilities with commitments totaling $4.5 million, interest payable monthly, ranging from prime to prime plus .25%; payable at the earlier of funding of construction financing or the maturity date of the individual projects, secured by first deeds of trust on land 2,144 2,407 Senior unsecured notes, maturing September 15, 2005, annual interest of 9.10% payable quarterly, principal payable in three equal installments on September 15, 2003, 2004 and 2005 15,000 15,000 Other 30 918 ------- ------- Total $95,734 $37,205 ======= =======
7 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 4 - EARNINGS PER SHARE A summary of the reconciliation from basic earnings per share to diluted earnings per share for the three and nine months ended September 30, 1999 and 1998 follows (in thousands, except per share amounts): QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------- ------------------ 1999 1998 1999 1998 ------ ------ ------- ------- Net earnings $4,027 $4,268 $10,893 $16,416 Weighted average shares outstanding - basic 5,463 5,317 5,448 5,313 ------ ------ ------- ------- Basic earnings per share $ .74 $ .80 $ 2.00 $ 3.09 ====== ====== ======= ======= Basic EPS - Weighted average shares outstanding 5,463 5,317 5,448 5,313 Effect of dilutive securities: Contingent shares 70 129 83 150 Stock options 491 622 527 660 ------ ------ ------- ------- Weighted average shares outstanding - dilutive 6,024 6,068 6,058 6,123 ------ ------ ------- ------- Diluted earnings per share $ .67 $ .70 $ 1.80 $ 2.68 ====== ====== ======= ======= NOTE 5 - TREASURY STOCK In June 1999, we began acquiring shares of our common stock in connection with a stock repurchase program announced in April 1999. The program authorizes us to purchase up to $6 million of common stock from time to time on the open market or in privately negotiated transactions at price levels we consider attractive. As of September 30, 1999, we have purchased 10,000 shares of common stock at an aggregate cost of $112,962. The purpose of the stock repurchase program is to help us achieve our long-term goal of enhancing stockholder value. NOTE 6 - ACQUISITIONS On June 15, 1998, we signed a definitive agreement with Sterling Communities, S.H. Capital, Inc., Sterling Financial Investments, Inc., Steven W. Hafener and W. Leon Pyle (together, the Sterling Entities), to acquire substantially all of the assets of Sterling Communities. The transaction was effective as of July 1, 1998. Assets acquired principally consist of real property and other residential homebuilding assets located in the San Francisco Bay and Sacramento areas of California. Operations of the Sterling Entities continue under the name Meritage Homes of Northern California. Consideration paid for the assets and stock acquired, and various liabilities assumed, consisted of $6.9 million in cash and additional consideration to be paid for up to four years after the transaction date. We used the purchase method of accounting and the purchase price was allocated among our net assets based on their estimated fair market value at the transaction date. Goodwill of approximately $2.2 million was recorded, which is being amortized over 20 years. The additional consideration will be equal to 20% of the pre-tax income of Meritage's California division and will be expensed as earned. In connection with the 1997 acquisition of Legacy Homes, additional consideration of $5.2 million was recorded as a non-cash addition to goodwill and accrued liabilities for the nine month period ended September 30, 1999. The purchase agreement provided that additional consideration was not to exceed $15 million and was based on the Company's earnings. The additional consideration reached the $15 million limit during the first quarter of 1999. The $5.2 million final payment will be made in January 2000, and will represent additional cash paid for the acquisition of Legacy Homes. 8 MERITAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) NOTE 7 - INCOME TAXES Components of income tax expense are as follows (in thousands): QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 1999 1998 1999 1998 ------ ------ ------ ------ Current taxes: Federal $ 724 $ 99 $ 964 $ 325 State 250 265 709 935 ------ ------ ------ ------ 974 364 1,673 1,260 ------ ------ ------ ------ Deferred taxes: Federal 1,769 1,534 6,236 1,534 State 40 -- 128 -- ------ ------ ------ ------ 1,809 1,534 6,364 1,534 ------ ------ ------ ------ Total $2,783 $1,898 $8,037 $2,794 ====== ====== ====== ====== CARRYFORWARDS At September 30, 1999, our federal net operating loss carryforward had been fully utilized. NOTE 8 - SEGMENT INFORMATION We classify our operations into three primary geographic segments: Arizona, Texas and California. These segments generate revenues through the sale of homes to external customers. We are not dependent on any one major customer. Operational information relating to the different business segments follows. Information for the first six months of 1998 has not been included for the California operations that were acquired July 1, 1998. Certain information has not been included by segment due to the immateriality of the amount to the segment or in total. We evaluate segment performance based on several factors, of which the primary financial measure is earnings before interest and taxes (EBIT). The accounting policies of the business segments are the same as those described in Notes 1 and 2 for the Company. There are no significant transactions between segments. 9
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ----------------------- 1999 1998 1999 1998 -------- -------- --------- -------- (in thousands) HOME SALES REVENUE: Texas $ 43,604 $ 34,767 $ 116,399 $ 93,613 Arizona 26,056 19,911 75,740 53,186 California 7,126 13,739 12,600 13,739 -------- -------- --------- -------- Total $ 76,786 $ 68,417 $ 204,739 $160,538 ======== ======== ========= ======== EBIT: Texas $ 5,790 $ 5,040 $ 15,344 $ 13,069 Arizona 2,565 1,822 8,270 4,594 California 515 1,731 1,288 1,731 Corporate and other (937) (1,109) (2,921) 2,574 -------- -------- --------- -------- Total $ 7,933 $ 7,484 $ 21,981 $ 21,968 ======== ======== ========= ======== AMORTIZATION OF CAPITALIZED INTEREST: Texas $ 445 $ 316 $ 1,112 $ 818 Arizona 559 433 1,750 1,175 California 114 450 184 450 -------- -------- --------- -------- Total $ 1,118 $ 1,199 $ 3,046 $ 2,443 ======== ======== ========= ======== AT SEPTEMBER 30, AT DECEMBER 31, 1999 1998 ---------------- --------------- ASSETS: Texas $103,646 $ 64,448 Arizona 77,355 58,758 California 42,109 12,321 Corporate 1,741 16,723 -------- -------- Total $224,851 $152,250 ======== ========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward-looking statements. The words "believe," "expect," "anticipate," and "project" and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of revenues, income or loss, capital expenditures, plans for future operations, financing needs or plans, the impact of inflation, the impact of changes in interest rates, plans relating to our products or services, potential real property acquisitions, and new or planned development projects, as well as assumptions relating to the foregoing. Statements in Exhibit 99 to this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 1998, including the Notes to the Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations," describe factors that could contribute to or cause such differences. Additional factors that could cause actual results to differ materially from those expressed in such forward-looking statements are set forth in "Business" and "Market for the Registrant's Common Stock and Related Stockholder Matters" in our December 31, 1998 Annual Report on Form 10-K. RESULTS OF OPERATIONS The following discussion and analysis provides information regarding the results of operations of Meritage and its subsidiaries for the three and nine months ended September 30, 1999 and September 30, 1998. All material balances and transactions between Meritage and its subsidiaries have been eliminated. This discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 1998. In management's opinion, the data reflects all adjustments, consisting of only normal recurring adjustments, necessary to fairly present our financial position and results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of results expected for a full fiscal year. Comparative information for the first six months of 1998 has not been included for the California operations, which we acquired in July 1998. 10 HOME SALES REVENUE Home sales revenue is the product of the number of units closed during the period and the average sales price per unit. Comparative 1999 and 1998 housing revenues follow (dollars in thousands):
QUARTER ENDED DOLLAR/UNIT PERCENTAGE NINE MONTHS ENDED DOLLAR/UNIT PERCENTAGE SEPTEMBER 30, INCREASE INCREASE SEPTEMBER 30, INCREASE INCREASE 1999 1998 (DECREASE) (DECREASE) 1999 1998 (DECREASE) (DECREASE) ---- ---- ---------- ---------- ---- ---- ---------- ---------- Total Dollars $76,786 $68,417 $ 8,369 12% $204,739 $160,538 $ 44,201 28% Units closed 399 346 53 15% 1,030 874 156 18% Average sales price $ 192.5 $ 197.7 $ (5.2) (3)% $ 198.8 $ 183.7 $ 15.1 8% Texas Dollars $43,604 $34,767 $ 8,837 25% $116,399 $ 93,613 $ 22,786 24% Units closed 283 255 28 11% 758 681 77 11% Average sales price $ 154.1 $ 136.3 $ 17.8 13% $ 153.6 $ 137.5 $ 16.1 12% Arizona Dollars $26,056 $19,911 $ 6,145 31% $ 75,740 $ 53,186 $ 22,554 42% Units closed 97 59 38 64% 238 161 77 48% Average sales price $ 268.6 $ 337.5 $ (68.9) (20)% $ 318.2 $ 330.3 $ (12.1) (4)% California Dollars $ 7,126 $13,739 $(6,613) (48)% $ 12,600 $ 13,739 $ (1,139) (8)% Units closed 19 32 (13) (41)% 34 32 2 6% Average sales price $ 375.1 $ 429.3 $ (54.2) (13)% $ 370.6 $ 429.3 $ (58.7) (14)%
The increase in revenues and number of units closed in 1999 compared to 1998 resulted mainly from our strong 1999 market performance in Arizona and Texas. The 1999 third quarter decrease in California revenue resulted from a 1998 third quarter which included revenue from close-out communities acquired in the Sterling acquisition, which were replaced by new communities that are just beginning to produce closing revenue. The average sales price in Arizona is decreasing as more homes are sold in our newer, lower priced communities increases. GROSS PROFIT Gross profit is home sales revenue, net of housing cost of sales. Housing cost of sales includes developed lot costs, unit construction costs, amortization of common community costs (such as the cost of model complexes and architectural, legal and zoning costs), interest, sales tax, warranty, construction overhead and closing costs. Comparative 1999 and 1998 housing gross profit follows (dollars in thousands): 11 QUARTER ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, --------------------------- ------------------------------- INCREASE/ 1999 1998 (DECREASE) 1999 1998 INCREASE ---- ---- ---------- ---- ---- -------- Dollars $14,554 $13,970 $ 584 $40,375 $30,767 $9,608 Percentage of housing revenues 19.0% 20.4% (1.4)% 19.7% 19.2% .5% The dollar increase in gross profit for the three and nine months ended September 30, 1999 over the prior year's periods is attributable to the increase in number of units closed. In the September quarter there is an increase in the number of lower priced homes closed, especially in Arizona, and a corresponding decrease in margins. COMMISSIONS AND OTHER SALES COSTS The increase in commissions and other sales costs in the third quarter and first nine months of 1999 compared with the same periods of 1998 are directly related to costs incurred to support growth in closing revenue. The growth in these costs has slightly exceeded revenue growth, primarily due to the need to incur model home operating and advertising costs associated with new communities, particularly in our more newly established Northern California region, several months prior to those communities producing closing revenue. Comparative 1999 and 1998 commissions and other sales costs follows (dollars in thousands): QUARTER ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, --------------------------- ------------------------------- 1999 1998 INCREASE 1999 1998 INCREASE ---- ---- -------- ---- ---- -------- Total Dollars $4,572 $3,661 $911 $12,480 $8,556 $3,924 Percentage of housing revenues 6.0% 5.4% .6% 6.1% 5.3% .8% GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses were approximately $3.5 million (4.6% of revenue) in the third quarter of 1999 as compared with approximately $3.1 million (4.5% of revenue) in the third quarter of 1998. The increase for the nine months ended September 30, 1999 over the 1998 period includes approximately $600,000 related to an employment agreement buyout of a former managing director. Operating costs in the first nine months of 1999 have also increased due to overhead incurred related to our expansion into California and the start-up of our new Meritage Division in Phoenix, Arizona. OTHER INCOME Other income decreased for the three months ended September 30, 1999 compared with the same quarter last year due to fewer miscellaneous fees being collected. The increase in other income for the nine month period ended September 30, 1999, primarily is due to management fees earned by the California division, which is included for the full nine months, and an increase in revenue from the mortgage operations in Texas. RESIDUAL INTEREST AND REAL ESTATE LOAN INTEREST INCOME The remainder of our mortgage security portfolio was sold for a gain of approximately $2.0 million in the second quarter of 1998, and as a result, there is no residual interest or real estate loan interest income in 1999. INCOME TAXES The increase in income taxes to $2.8 million for the quarter ended September 30, 1999 from $1.9 million in the prior year's period resulted from a higher effective tax rate in the current year due to the use of the net operating loss ("NOL") carryforward for accounting purposes in 1998. In future periods we expect to have an effective tax rate approximating the statutory federal and state tax rates as our NOL carryforward is now fully utilized. SALES CONTRACTS Sales contracts for any period represent the number of homes ordered by customers (net of cancellations) multiplied by the average sales price per unit ordered. Comparative 1999 and 1998 sales contracts follow (dollars in thousands): 12
QUARTER ENDED DOLLAR/UNIT PERCENTAGE NINE MONTHS ENDED DOLLAR/UNIT PERCENTAGE SEPTEMBER 30, INCREASE INCREASE SEPTEMBER 30, INCREASE INCREASE 1999 1998 (DECREASE) (DECREASE) 1999 1998 (DECREASE) (DECREASE) ---- ---- ---------- ---------- ---- ---- ---------- ---------- Total Dollars $93,955 $65,327 $ 28,628 44% $295,969 $225,455 $ 70,514 31% Units ordered 405 309 96 31% 1,455 1,196 259 22% Average sales price $ 232.0 $ 211.4 $ 20.6 10% $ 203.4 $ 188.5 $ 14.9 8% Texas Dollars $36,562 $36,007 $ 555 2% $156,178 $134,440 $ 21,738 16% Units ordered 219 234 (15) (6)% 996 934 62 7% Average sales price $ 167.0 $ 153.9 $ 13.1 9% $ 156.8 $ 143.9 $ 12.9 9% Arizona Dollars $39,027 $28,687 $ 10,340 36% $100,265 $ 90,382 $ 9,883 11% Units ordered 132 74 58 78% 344 261 83 32% Average sales price $ 295.7 $ 387.6 $ (91.9) (24)% $ 291.5 $ 346.3 $ (54.8) (16)% California Dollars $18,366 $ 633 $ 17,733 2,801% $ 39,526 $ 633 $ 38,893 6,144% Units Ordered 54 1 53 5,300% 115 1 114 11,400% Average sales price $ 340.1 $ 633 $ (292.9) (46)% $ 343.7 $ 633 $ (289.3) (46)%
We do not include sales contingent upon the sale of a customer's existing home as a sales contract until the contingency is removed. Historically, we have experienced a cancellation rate of less than 20% of gross sales. Total sales contracts increased in 1999 compared to 1998 due mainly to the expansion into California and the increased sales of our lower priced homes in Arizona. NET SALES BACKLOG Backlog represents net sales contracts that have not closed. Comparative 1999 and 1998 net sales backlog follows (dollars in thousands): DOLLAR/UNIT PERCENTAGE AT SEPTEMBER 30, INCREASE INCREASE 1999 1998 (DECREASE) (DECREASE) ---- ---- ---------- ---------- Total Dollars $236,524 $182,461 $ 54,063 30% Units in backlog 1,113 835 278 33% Average sales price $ 212.5 $ 218.5 $ (6) (3)% Texas Dollars $116,957 $ 82,857 $ 34,100 41% Units in backlog 741 557 184 33% Average sales price $ 157.8 $ 148.8 $ 9.0 6% Arizona Dollars $ 90,904 $ 94,142 $ (3,238) (4)% Units in backlog 286 268 18 7% Average sales price $ 317.8 $ 351.3 $ (33.5) (1)% California Dollars $ 28,663 $ 5,462 $ 23,201 425% Units in backlog 86 105 76 760% Average sales price $ 333.3 $ 546.2 (212.9) (39)% Total dollar backlog at September 30, 1999 increased 30% over the 1998 period due to a corresponding increase in new sales contracts entered into in 1999. Units in backlog at September 30, 1999 increased 33% over the same period in 1998 due to the increase in net orders caused in part by expansion into California, and to some extent, a lengthening of the construction cycle for our homes. The average sales price of homes in backlog in Arizona is decreasing as the percentage of lower priced homes sold in that region increases. 13 LIQUIDITY AND CAPITAL RESOURCES Our principal uses of working capital are land purchases, lot development and home construction. We use a combination of borrowings and funds generated by operations to meet our working capital requirements. At September 30, 1999 we had short-term secured revolving construction loan facilities totaling $140 million and had $24.5 million in acquisition and development facilities, of which approximately $62.3 and $7.2 million were outstanding, respectively. An additional $18.8 million of unborrowed funds supported by approved collateral were available under these credit facilities at that date. We also have $15 million outstanding in unsecured, senior subordinated notes due September 15, 2005, which were issued in October 1998, and $15 million in an unsecured credit facility of which $11.1 million is outstanding. Management believes that the current borrowing capacity, cash on hand at September 30, 1999 and anticipated cash flows from operations are sufficient to meet our liquidity needs for the foreseeable future. There is no assurance, however, that future amounts available from our sources of liquidity will be sufficient to meet future capital needs. The amount and types of indebtedness that we incur may be limited by the terms of the indenture governing our senior subordinated notes and by the covenants and other terms of our credit agreements. YEAR 2000 COMPLIANCE The year 2000 presents potential concerns for business computing due to calculation problems from the use of a two-digit format as the year changes from 1999 to 2000. The problem affects certain computer software, hardware, and other systems containing processors and embedded chips. Consequently, information technology ("IT") systems and non-IT systems (collectively, "business systems") may not be able to accurately process certain transactions before, during, or after January 1, 2000. As a result, business and governmental agencies are at risk for potential disruption from business systems malfunctions or failures. This is commonly referred to as the Year 2000 ("Y2K") issue. We could be impacted by failures of our own business systems as well as those of our suppliers and business partners. We have implemented our Y2K compliance program that consisted of business systems identification, testing and remediation, assessments of critical suppliers, and contingency planning. The compliance program's first component was the identification of our business systems for purposes of evaluating which systems are Y2K compliant and which will be replaced or remediated. This phase is complete. The second part of the program is the evaluation and replacement or remediation of our business systems that are not Y2K compliant. We have converted to new versions of substantially all of our homebuilding database systems and our replacement or remediation program is substantially complete. We have identified critical suppliers and business partners ("key business partners") and have taken steps to determine their Y2K readiness. These steps include various types of inquiries. Because of the number of business systems used by key business partners and the varying levels of Y2K readiness, it is difficult to assess the likelihood and impact of a malfunction due to this issue. We are not currently aware of any business relationships with key business partners that we believe will likely result in a significant disruption of our business. However, a Y2K failure could occur and have an adverse impact on us. Management currently believes that our greatest risk is with suppliers, banking and financial institutions, and suppliers of telecommunications services, all of which are operating within the United States. Potential consequences of Meritage or its key business partners having business systems that are not Y2K compliant include delays in receiving homebuilding components and supplies. Concurrent with the remediation and evaluation of our business systems and those of our key business partners, we have developed contingency plans to decrease the risks that could occur in the event of a Y2K related business disruption. Contingency plans include increasing the level of homebuilding components, securing additional financing or other actions management deems advisable. Estimated costs associated with developing and implementing contingency measures are expected to be minimal. 14 The remediation and testing of our business systems has cost approximately $160,000. These costs have been expensed in the period incurred and funded through cash flows from operations. The future financial impact is not expected to be material to our financial position or results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not trade in derivative financial instruments and at September 30, 1999 had no significant derivative financial instruments. We do have other financial instruments in the form of notes payable and senior debt, which are at fixed interest rates. Our lines of credit and credit facilities are at variable interest rates and are subject to market risk in the form of interest rate fluctuations. PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Page or Number Description Method of Filing ------ ----------- ---------------- 10.23 $15 Million Credit Agreement by and among Meritage Corporation and California Bank and Trust, Dated as of September 17, 1999 Filed herewith 27 Financial Data Schedule Filed herewith 99 Private Securities Reform Act of 1995 Safe Harbor Compliance Statement for Forward-Looking Statements Filed herewith (b) Reports on Form 8-K No reports on form 8-K were filed during the quarter ended September 30, 1999. 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly cause this report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, this 15th day of November 1999. MERITAGE CORPORATION, a Maryland Corporation By /s/ Larry W. Seay --------------------------------------------------------- Larry W. Seay Chief Financial Officer and Vice President-Finance (Principal Financial Officer and Duly Authorized Officer) S-1