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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended June 30, 2003

or

Commission File Number 1-9977

MERITAGE CORPORATION

(480) 609-3330
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  x   No  o

As of July 15, 2003, 13,026,634 shares of Meritage Corporation common stock were outstanding.

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MERITAGE CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2003

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PART I FINANCIAL INFORMATION

Item 1. Financial Statements

MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements

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MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)

See accompanying notes to consolidated financial statements

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MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to consolidated financial statements

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

     Business. We are a leading designer and builder of single-family homes in the rapidly growing Sunbelt states of Texas, Arizona, California and Nevada. We focus on providing a broad range of first-time, move-up and luxury homes to our targeted customer base. We and our predecessors have operated in Arizona since 1985, in Texas since 1987 and in Northern California since 1989. We expanded our presence in Texas with the July 2002 acquisition of Hammonds Homes (Hammonds), a builder that focuses on the move-up market in the Houston, Dallas/Ft. Worth and Austin areas. We entered the Las Vegas, Nevada market in October 2002 with our acquisition of Perma-Bilt Homes (Perma-Bilt), another move-up builder.

     We operate in Texas as Legacy Homes, Monterey Homes and Hammonds Homes, in Arizona as Monterey Homes, Meritage Homes and Hancock Communities, in Northern California as Meritage Homes and in Nevada as Perma-Bilt Homes. At June 30, 2003, we were actively selling homes in 137 communities, with base prices ranging from $92,000 to $910,000. We have four primary business segments: Texas, Arizona, California and Nevada. See Note 8 to our consolidated financial statements included in this report for information regarding our segments.

     Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and include the accounts of Meritage Corporation, those of our consolidated subsidiaries and unconsolidated variable interest entities. Intercompany balances and transactions have been eliminated in consolidation and certain prior year amounts have been reclassified to be consistent with current period financial statement presentation. In our opinion, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly 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 or for any future periods. These financial statements should be read in conjunction with our consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended December 31, 2002.

     Equity Offering. In June 2002, we sold 2,012,500 shares of our common stock at a price of $42.00 per share. The net proceeds from the offering of $79.7 million were used primarily for our July 2002 purchase of Hammonds Homes, with the balance being used for general corporate purposes and our purchase of Perma-Bilt Homes in October 2002.

     Stock-Based Compensation. At June 30, 2003, we had one stock-based employee compensation plan. We apply the intrinsic value-based method of accounting prescribed in Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees”, as allowed by SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148. Under this method, compensation expense is recorded on the date of the grant only if the market price of the underlying stock on the date of the grant was greater than the exercise price. SFAS No. 123 established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, we have elected to continue to apply the intrinsic value-based method of accounting described above, and have adopted the disclosure requirements of SFAS No. 123. We have not issued options with exercise prices below the market value on the date of the grant, therefore we have not recognized compensation expense for our stock-based plan. Had compensation cost for these plans been determined pursuant to SFAS No. 123, our net earnings and earnings per share would have been reduced to the following amounts.

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

*Deduct: Total stock-based employee compensation expense determined under fair value based method for awards, net of related tax effects.

     The fair value for options granted in the first half of 2003 and 2002 was established at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions.

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

     See discussion of SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” under this note, “Recent Accounting Pronouncements”.

     Common Stock Repurchase. In August 2002, we announced that our Board of Directors authorized the expenditure of up to $32 million to repurchase shares of our common stock. No date for completing the program has been determined, but we will purchase shares subject to applicable securities laws, and at times and in amounts as management deems appropriate. By June 30, 2003, we had repurchased 664,300 shares of our common stock under the August 2002 program at an average price of $33.61 per share. We did not repurchase any shares in the second quarter of 2003.

     Warranty Reserves. We have certain obligations related to post-construction warranties and defects related to homes sold. Historically these amounts have not been material and we do not anticipate future obligations to be material. At June 30, 2003, we had approximately $7.7 million in reserve for various warranty claims which is recorded in accrued liabilities on the accompanying consolidated balance sheets. Summaries of our warranty reserve follow (in thousands):

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

     Recent Accounting Pronouncements. In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities. FIN 46 addresses consolidation by business enterprises of variable interest entities (selected entities with related contractual, ownership, voting or other monetary interests, including certain special purpose entities), and requires certain additional disclosure with respect to these entities. We adopted FIN 46 in the second quarter of 2003 and its impact on our financial position is discussed in Note 3 to our consolidated financial statements included in this report.

NOTE 2 – REAL ESTATE AND CAPITALIZED INTEREST

     Real estate consists of the following (in thousands):

     We capitalize certain interest costs incurred during the development and construction period of real estate. Capitalized interest is allocated and capitalized to real estate when incurred and charged to cost of sales when the related property is closed. Summaries of interest incurred, interest capitalized and interest expensed follow (in thousands):

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

NOTE 3 – CONSOLIDATED REAL ESTATE NOT OWNED

     Pursuant to FASB Interpretation No. 46, a variable interest entity (“VIE”) is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE pursuant to FIN 46, the enterprise that absorbs a majority of the expected losses or residual returns of the VIE is considered the primary beneficiary and must consolidate the VIE. FIN 46 is effective immediately for VIE’s created after January 31, 2003. For VIE’s created before January 31, 2003, FIN 46 must be applied at the beginning of the first interim or annual reporting period beginning after June 15, 2003.

     Based on the provisions of FIN 46, we have concluded that typically when we enter into a purchase contract or option agreement to acquire land or lots (“options”) from an entity and pay a non-refundable deposit, a VIE is created because we are deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity’s expected theoretical losses if they occur. For each VIE created we compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If we are deemed to be the primary beneficiary of the VIE we will consolidate it in our consolidated financial statements. As prescribed by FIN 46, the fair value of the VIE’s assets will be reported as “Consolidated Assets Not Owned”. To the extent we have been able to determine that the value of the land or lots under option to Meritage represents less than half of the value of all of the property owned by the VIE, then FIN 46 does not require consolidation of the VIE.

The table below presents a summary of our lots under option at June 30, 2002 (dollars in thousands):

Note: Except for our specific performance options, none of our option agreements require us to purchase lots. Our option to purchase lots remains effective so long as we purchase a pre-established minimum number of lots each month or quarter, as determined by the agreement. The pre-established number typically is structured to approximate our expected rate of home orders.

*	Fair value of specific performance options approximates the purchase price due to the short-lived nature of the options.
**	Deposits are non-refundable except if certain contractual conditions are not performed by the selling party.
***	Deposits are refundable at our sole discretion.

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

     At June 30, 2003, the amount of VIE assets included on our balance sheet is approximately $31.1 million, which represents the estimated fair value of the specific performance options and the other VIE assets, and is recorded as consolidated real estate not owned. The corresponding credit relating to these assets is to liabilities and minority interest, net of the related cash option deposits we have already paid. At June 30, 2003, the liabilities and minority interest total approximately $29.4 million and $265,000 respectively, which is net of option deposits of approximately $1.4 million.

     The options recorded on our balance sheet represent all specific performance options and only those non-specific performance options which we entered into since February 1, 2003 and which are required to be consolidated by FIN 46. Meritage does not have any ownership interest in the VIE’s that hold the lots and accordingly do not have legal or other access to the VIE’s books or records. Therefore, it is not possible for Meritage to accurately determine the underlying capital structure of the VIE’s. Creditors of these VIE’s have no recourse against Meritage.

     The determination of fair value involves the establishment of a probability-weighted discounted cash flow model. Accordingly, the fair value of the lots under option typically will not equal the actual purchase price. The actual contractual purchase price of these lots has also been provided in the table for additional disclosure. Since Meritage does not have access to the VIE’s records, we have used the per lot fair value established at the inception of the option transaction as the carrying value.

     Not all of our option agreements will be determined to be VIE’s. The maximum exposure to loss in these options (as with all of our options) is limited to our option deposit. In some cases, our option deposits are refundable if certain contractual conditions are not performed by the party selling the lots.

     We are still in the process of evaluating non-specific option agreements entered into before February 1, 2003 to determine if we are the primary beneficiary and plan to complete the analysis by the end of September 2003. Based on preliminary results, we believe that between $10 million and $12 million of additional options will be recorded at September 30, 2003. We are also in the process of evaluating the impact of the consolidation of options relating to VIE’s under the indenture for our senior notes and the agreement for our senior unsecured credit facility, including the calculation of our financial covenant ratios and the determination of whether obligations relating to consolidated VIE’s fall within the definition of indebtedness under those agreements. We do not believe that the consolidation of certain VIE’s pursuant to FIN 46 will have a material adverse affect under our indenture or credit facility agreement.

NOTE 4 – LOANS PAYABLE AND SENIOR NOTES

Loans payable consist of the following (in thousands):

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

     At June 30, 2003, our outstanding 9.75% senior notes due 2011 totaled $206.6 million, which includes $155.0 million in principal amount issued in May 2001 and an add-on of $51.6 million, including premium, issued in February 2003. The February 2003 add-on offering of $50 million in aggregate principal amount of our 9.75% senior notes was issued at a price of 103.25% of their face amount to yield 9.054%, and together with the May 2001 offering, constitute a single series of notes.

     The bank credit facility and senior unsecured notes contain covenants which require maintenance of certain levels of tangible net worth, compliance with certain minimum financial ratios and place limitations on the payment of dividends and redemptions of equity, and limit the incurrence of additional indebtedness, asset dispositions, mergers, certain investments and creations of liens, among other items. As of June 30, 2003 we were in compliance with these covenants. The senior unsecured notes restrict our ability to pay dividends.

     Obligations to pay principal and interest on the bank credit facility and senior unsecured notes are guaranteed by all of our subsidiaries, each of which is directly or indirectly 100% owned by Meritage Corporation (Guarantor Subsidiaries), other than certain minor subsidiaries (collectively, Non-Guarantor Subsidiaries). Such guarantees are full and unconditional, and joint and several. Separate financial statements of the Guarantor subsidiaries are not provided because Meritage Corporation (the parent company) has no independent assets or operations and the Non-Guarantor Subsidiaries are, individually and in the aggregate, minor. There are no significant restrictions on the ability of the parent company or any guarantor to obtain funds from its subsidiaries by dividend or loan.

NOTE 5 – ACQUISITIONS

     Perma-Bilt Acquisition. Effective October 1, 2002, we purchased the homebuilding assets of Perma-Bilt Homes (“Perma-Bilt Homes” or “Perma-Bilt”), a builder of single-family homes in the Las Vegas, Nevada metropolitan area. The purchase price was approximately $46.6 million in cash including the repayment of existing debt in the amount of $16.7 million. We also assumed accounts payable, accrued liabilities and home sale deposits totaling $5.8 million. In addition, we agreed to an earn-out of 10% of the pre-tax profits of Perma-Bilt, payable in cash over three years. Perma-Bilt Homes builds a wide range of homes with a focus on serving the move-up housing markets in Nevada.

     Hammonds Acquisition. On July 1, 2002, we acquired substantially all of the homebuilding and related assets of Hammonds Homes, Ltd., and Crystal City Land & Cattle, Ltd., (collectively, “Hammonds Homes” or “Hammonds”). The purchase price was approximately $83.4 million in cash plus the assumption of accounts payable, accrued liabilities, and home sale deposits totaling $11.0 million and a note payable totaling $1.1 million. Established in 1987, Hammonds Homes builds a wide range of homes in communities throughout the Houston, Dallas/Ft. Worth and Austin, Texas areas with a focus on serving the move-up housing market.

     The following unaudited pro forma financial data for the three and six months ended June 30, 2003 and 2002 has been prepared as if the acquisitions of the assets and liabilities of Hammonds on July 1, 2002 and Perma-Bilt on October 1, 2002 had occurred on January 1, 2002. Unaudited pro forma financial data is presented for informational purposes only and is based on historical information. This information may not be indicative of our actual results had the transactions occurred on the dates listed above, nor does it purport to represent future periods (in thousands except per share amounts):

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

     Goodwill. Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the assets acquired. The acquisitions of Hammonds and Perma-Bilt were recorded using the purchase method of accounting with the results of operations of these entities included in our consolidated financial statements as of the date of the acquisition. The purchase prices were allocated based on estimated fair value of the assets and liabilities at the date of the acquisition. Intangible assets equal to the excess purchase price over the fair value of the net assets of $21.3 million and $17.2 million for Hammonds and Perma-Bilt, respectively, were recorded as goodwill, which is presented on our consolidated balance sheets. The earnout of our Nevada division resulted in an increase in the carrying amount of goodwill of approximately $469,000 and $723,000 for the three and six months ended June 30, 2003, respectively. The earnout was negotiated at the time we acquired the Nevada operations and the calculation is based on a percentage of Perma-Bilt’s earnings for the period.

     Under the guidelines contained in SFAS No. 142, “Goodwill and Other Intangible Assets,” management selected January 1, 2003 as the date of our annual goodwill impairment test. During the first quarter of 2003 we completed our analysis concerning potential impairment of the goodwill carried on our balance sheet and it was determined that no impairment existed.

NOTE 6 – EARNINGS PER SHARE

     A summary of the reconciliation from basic earnings per share to diluted earnings per share for the three and six months ended June 30, 2003 and 2002 follows:

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MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003 and 2002
(Unaudited)

NOTE 7 – INCOME TAXES

     Components of income tax expense attributable to earnings before income taxes for the three and six months ended June 30, 2003 and 2002 are (in thousands):