UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2005

 

or

 

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

 

Commission File Number 1-9977

 

MERITAGE HOMES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

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  o

 

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

 

Common shares outstanding as of August 1, 2005: 27,299,334.

 

 

 

MERITAGE HOMES CORPORATION

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2005

 

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004
	Unaudited Condensed Consolidated Statements of Earnings for the Three and Six Months ended June 30, 2005 and 2004
	Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2005 and 2004
	Notes to Unaudited Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Unregistered Sales of Equity and Use of Proceeds
Item 3.	Not Applicable
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Not Applicable
Item 6.	Exhibits
SIGNATURES
INDEX OF EXHIBITS

 

 

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PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

		June 30,			December 31,
		2005			2004
Assets
Cash and equivalents		$	34,104		$	47,876
Real estate		1,184,793			867,218
Real estate not owned		6,272			18,344
Deposits on real estate under option or contract		145,020			129,072
Receivables		18,186			15,974
Goodwill		113,907			91,475
Intangibles, net		2,278			—
Property and equipment, net		32,605			27,742
Prepaid expenses and other assets		15,976			16,749
Investments in unconsolidated entities		50,056			50,944
Total assets		$	1,603,197		$	1,265,394
Liabilities
Accounts payable		$	146,018		$	77,799
Accrued liabilities		138,073			135,590
Home sale deposits		61,998			41,537
Liabilities related to real estate not owned		5,429			14,780
Deferred tax liability, net		1,518			1,518
Loans payable and other borrowings		81,857			54,419
Senior notes		479,645			416,996
Total liabilities		914,538			742,639
Minority Interests		—			200
Stockholders’ Equity
Common stock, par value $0.01. 50,000,000 shares authorized; 32,976,786 and 31,460,050 shares issued at June 30, 2005 and December 31, 2004, respectively *		330			315
Additional paid-in capital		292,283			209,630
Retained earnings		465,017			381,583
Treasury stock at cost, 5,704,452 shares *		(68,971		)	(68,973		)
Total stockholders’ equity		688,659			522,555
Total liabilities and stockholders’ equity		$	1,603,197		$	1,265,394

* All share amounts reflect a 2-for-1 stock split in the form of a stock dividend that occurred in January 2005.
See accompanying notes to condensed consolidated financial statements

 

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except per share amounts)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
Home closing revenue		$	651,783		$	431,275		$	1,202,730		$	854,777
Land closing revenue		1,788			2,660			2,009			2,660
		653,571			433,935			1,204,739			857,437
Cost of home closings		(499,080		)	(352,568		)	(930,702		)	(692,907		)
Cost of land closings		(1,326		)	(1,731		)	(1,538		)	(1,731		)
		(500,406		)	(354,299		)	(932,240		)	(694,638		)
Home closing gross profit		152,703			78,707			272,028			161,870
Land closing gross profit		462			929			471			929
		153,165			79,636			272,499			162,799
Commissions and other sales costs		(35,869		)	(25,996		)	(67,340		)	(51,829		)
General and administrative expenses		(26,672		)	(16,794		)	(50,635		)	(32,850		)
Loss on extinguishment of debt		(197		)	—			(31,477		)	—
Other income, net		4,369			2,980			10,470			5,169
Earnings before provision for income taxes		94,796			39,826			133,517			83,289
Provision for income taxes		(35,557		)	(15,189		)	(50,082		)	(31,733		)
Net earnings		$	59,239		$	24,637		$	83,435		$	51,556
Earnings per common share:
Basic *		$	2.19		$	0.94		$	3.13		$	1.95
Diluted *		$	2.05		$	0.89		$	2.92		$	1.84

* Amounts reflect a 2-for-1 stock split in the form of a stock dividend that occurred in January 2005.
See accompanying notes to condensed consolidated financial statements

 

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Six Months Ended June 30,
		2005			2004
Cash flows from operating activities:
Net earnings		$	83,435		$	51,556
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization		8,024			5,764
Write-off of senior note issuance cost		4,977
Increase in deferred tax asset		—			(239		)
Tax benefit from stock option exercises		8,168			1,701
Equity in earnings from unconsolidated entities		(6,514		)	(1,491		)
Distributions of income from unconsolidated entities		6,934			1,975
Changes in assets and liabilities, net of effect of acquisition:
Increase in real estate		(250,249		)	(65,584		)
Increase in deposits on real estate under option or contract		(16,451		)	(15,857		)
Increase in receivables and prepaid expenses and other assets		(2,562		)	(339		)
Increase (decrease) in accounts payable and accrued liabilities		70,822			(11,193		)
Increase in home sale deposits		15,238			13,013
Net cash used in operating activities		(78,178		)	(20,694		)
Cash flows from investing activities:
Investments in unconsolidated entities		(19,101		)	(10,929		)
Cash paid for acquisitions		(66,220		)	(24,165		)
Cash paid for earnout agreements		—			(1,805		)
Purchases of property and equipment		(11,009		)	(8,648		)
Proceeds from sales of property and equipment		446			—
Net cash used in investing activities		(95,884		)	(45,547		)
Cash flows from financing activities:
Proceeds from loans payable and other borrowings		1,350,600			776,000
Repayments of loans payable and other borrowings		(1,323,162		)	(815,100		)
Proceeds from issuance of senior notes, net		343,836			130,000
Purchase of treasury stock		—			(19,853		)
Payments for repurchase of senior notes		(285,472		)	—
Proceeds from sale of common stock, net		69,699			—
Proceeds from stock option exercises		4,789			2,130
Net cash provided by financing activities		160,290			73,177
Net (decrease) increase in cash and equivalents		(13,772		)	6,936
Cash and equivalents at beginning of period		47,876			4,799
Cash and equivalents at end of period		$	34,104		$	11,735
See supplemental disclosures of cash flow information at Note 10.
See accompanying notes to condensed consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004

 

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

 

        Organization.  We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and active adult 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 entered the move-up market in the Las Vegas, Nevada area in 2002 with our acquisition of PermaBilt Homes and the Inland Empire region of the greater Los Angeles area in January 2004 with our acquisition of Citation Homes of Southern California (Citation).  We began greenfield start-up operations in the Denver, Colorado and Orlando, Florida markets in 2004, and in February 2005, we acquired Colonial Homes, a homebuilder that serves the Fort Myers/Naples, Florida market.  In March 2005, we entered the Reno, Nevada market through a greenfield start-up operation.

 

        We operate in Texas as Legacy Homes, Monterey Homes and Hammonds Homes; in Arizona as Meritage Homes and Monterey Homes; in Florida as Meritage Homes and Colonial Homes and in Northern California, Nevada and Colorado as Meritage Homes.  At June 30, 2005, we were actively selling homes in 163 communities, with base prices ranging from $99,000 to $940,000.

 

        Basis of Presentation.  The accompanying unaudited condensed 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 Homes Corporation and those of our consolidated subsidiaries, partnerships and other entities in which we have a controlling financial interest, and variable interest entities (see Note 3) in which we are deemed the primary beneficiary (the “Company”). Intercompany balances and transactions have been eliminated in consolidation and certain amounts have been reclassified to be consistent with current financial statement presentation.  In our consolidated statement of cash flows for the six months ended June 30, 2005, we changed the classification of distributions of income from unconsolidated entities to present such changes as an operating activity.  We previously presented such changes as investing activity.  In the accompanying consolidated statements of cash flows for the six months ended June 30, 2004, we reclassified changes in balances of distributions of income from unconsolidated entities to be consistent with our 2005 presentation which resulted in a $2.0 million increase to operating cash flows and a corresponding decrease to investing cash flows from the amounts previously reported.  In our opinion, these unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly our financial position, results of operations and cash flows 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 audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2004.

 

        The Company designs, constructs and sells a wide range of homes designed to meet the specific needs of each of its markets.  Because each of our geographic homebuilding regions has similar economic characteristics, housing products and class of prospective buyers, the geographic homebuilding regions have been aggregated into a single homebuilding segment.

 

        Stock-Based Compensation.  At June 30, 2005, we had a stock-based employee compensation plan under which officers, key employees, non-employee directors and consultants may be granted options to purchase shares of our common stock.  We currently 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, “Accounting for Stock-Based Compensation — Transition and Disclosure.”  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 is 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, which we have adopted.  We have not issued options with exercise prices below the market value on the date of the grant; therefore, no compensation expense for our stock-based plan has been recognized.  Had compensation cost for this plan been determined pursuant to SFAS No. 123, our net earnings and earnings per common share would have been reduced to the following pro forma amounts.  For the purpose of this disclosure, the value of the options is

 

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estimated by applying a Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.

 

				Three Months Ended June 30,				Six Months Ended June 30,
				2005		2004 *		2005		2004 *
				(in thousands, except per share amounts)
Net earnings		As reported		$59,239		$24,637		$83,435		$51,556
		Deduct**		(1,989	)	(1,179	)	(3,355	)	(2,037	)
		Pro forma		$57,250		$23,458		$80,080		$49,519
Basic earnings per share		As reported		$2.19		$0.94		$3.13		$1.95
		Pro forma		$2.11		$0.89		$3.00		$1.88
Diluted earnings per share		As reported		$2.05		$0.89		$2.92		$1.84
		Pro forma		$1.98		$0.85		$2.81		$1.77

 

*                     Per share amounts reflect a 2-for-1 stock split in the form of a stock dividend that occurred in January 2005.

 

**              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 2005 and 2004 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.

 

        Common Stock Repurchase.  In August 2004, the Board of Directors approved a stock buyback program authorizing the expenditure of up to $50 million to repurchase shares of our common stock.  As of June 30, 2005, we had not purchased any shares under this program.  No date for completing the program has been determined, but we will purchase shares subject to applicable securities law, and at times and in amounts as management deems appropriate.

 

        Off-Balance Sheet Arrangements.  We often acquire finished homesites at market prices from various development entities under fixed price purchase agreements.  We consider this lot acquisition strategy, which reduces the financial requirements and risks associated with direct land ownership and land development, an important aspect of our business model.  We are subject to customary obligations associated with these purchase agreements, which typically require us to make deposits in the form of cash or letters of credit that may be forfeited if we fail to perform under the agreement.  Often, we contract to complete a project at a fixed cost on behalf of the development entity and are at risk for items over budget related to land development on property we have under contract.  As of June 30, 2005, we had entered into purchase agreements with an aggregate purchase price of approximately $2.2 billion, by making deposits of

 

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approximately $145.0 million in the form of cash, most of which is non-refundable, and approximately $52.2 million in letters of credit.

 

        Occasionally, we enter into land development joint ventures.  We and/or our joint venture partners occasionally provide limited repayment guarantees on debt of certain unconsolidated entities on a pro rata share basis.  As of June 30, 2005, we had limited repayment guarantees of approximately $15.6 million.

 

        We and our joint venture partners are also typically obligated to the project lenders to complete land development improvements if the joint venture does not perform the required development.  Provided we and the other joint venture partners are in compliance with these completion obligations, the project lenders are generally obligated to fund these improvements through any financing commitments available under the applicable joint venture development and construction loans.  In addition, we and our joint venture partners have from time to time provided unsecured environmental indemnities to joint venture project lenders.  In some instances, these indemnities are subject to caps.  These indemnities obligate us to reimburse the project lenders only for claims related to environmental matters for which such lenders are held responsible.  As part of our project acquisition due diligence process to determine potential environmental risks, we generally obtain an independent environmental review from outside consultants.

 

        Additionally, we and our joint venture partners have agreed to indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures.  If a joint venture does not perform its obligations, the surety bond could be called.  If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners would be obligated to indemnify the surety.  These surety indemnity arrangements are generally joint and several obligations with our other joint venture partners.  As of June 30, 2005, we had approximately $20.6 million of surety bonds outstanding subject to these indemnity arrangements.  None of these bonds have been called to date and we believe it is unlikely that any of these bonds will be called.

 

        We also obtain letters of credit and performance, maintenance and other bonds in support of our related obligations with respect to the development of our projects.  The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities.  In the event the letters of credit or bonds are drawn upon, we would be obligated to reimburse the issuer of the letter of credit or bond.  At June 30, 2005, we had approximately $9.1 million in outstanding letters of credit and $189.2 million in performance bonds for such purposes.  We believe it is unlikely that any of these letters of credit or bonds will be drawn upon.

 

        Warranty Reserves.  We have certain obligations related to post-construction warranties and defects related to homes closed.  We have estimated these reserves based on historical data and trends with respect to similar product types and geographic areas.  Warranty reserves are included in accrued liabilities on the accompanying consolidated balance sheets.  Additions to warranty reserves are included in cost of sales within the accompanying statement of earnings. We periodically review the adequacy of our warranty reserves, and believe they are sufficient to cover potential costs for materials and labor related to post-construction warranties and defects.  A summary of changes in our warranty reserve follow (in thousands):

 

 

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        Recently Issued Accounting Pronouncements.  In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), effective for the first fiscal year beginning after June 15, 2005.  SFAS 123R requires that all stock-based compensation be treated as a cost that is reflected in the financial statements.  The Company is required to adopt the new standard for its fiscal year beginning January 1, 2006.  The Company is currently reviewing the effect of this statement on the Company’s consolidated financial statements.

 

NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST

 

Real estate consists of the following (in thousands):

 

 

        We capitalize all development period interest costs incurred in connection with the development and construction of real estate. Capitalized interest is allocated to real estate when incurred and charged to cost of home closings when the related property is delivered.  Certain information regarding interest follows (in thousands):

 

 

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

 

        FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”) requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity.  Prior to the issuance of FIN 46R, entities were generally consolidated by an enterprise when it had a controlling financial interest through ownership of a majority voting interest in the entity.  FIN 46R applied immediately to variable interests created after January 31, 2003, and with respect to variable interests created before February 1, 2003, FIN 46R application was deferred and not required to be applied until the end of the first reporting period ending after March 15, 2004.  Accordingly, we fully implemented FIN 46R by March 31, 2004.

 

        Under FIN 46R, a variable interest entity, or 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

 

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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.

 

        Based on the provisions of FIN 46R, we have concluded that when we enter into option or purchase agreements to acquire land or lots 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 losses if they occur.  For each VIE created where the fair value of the land or lots under contract by us are not more than half of the total fair value of the entity’s assets, we are not deemed to be the primary beneficiary of the VIE and therefore do not consolidate the assets on our consolidated financial statements. For each VIE created where the fair value of the land or lots under contract by us are more than half of the total fair value of the entity’s assets, then we compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46R.  If we are deemed to be the primary beneficiary of the VIE, because we are obligated to absorb the majority of the expected losses, receive the majority of the residual returns, or both, we will consolidate the VIE in our consolidated financial statements.  Not all of our purchase or option agreements are determined to be VIEs.

 

        We have applied FIN 46R by developing a methodology to determine whether or not we are the primary beneficiary of the VIE.  Part of this methodology requires the use of estimates in assigning probabilities to various future cash flow possibilities relative to changes in the fair value and changes in the development costs associated with the property.  Although we believe that our accounting policy properly identifies our primary beneficiary status with these VIEs, changes in the probability estimates could produce different conclusions regarding our primary beneficiary status.

 

        We generally do not have any ownership interest in the VIEs that hold the lots and land under option or contract, and accordingly, we generally do not have legal or other access to the VIE’s books or records.  Therefore, it is not possible for us to compel the VIEs to provide financial or other data to us in performing our primary beneficiary evaluation.  Accordingly, this lack of information from the VIEs may result in our evaluation being conducted primarily based on management judgments and estimates.

 

        Creditors, if any, of the entities with which we have option agreements have no recourse against us.  In most cases, the maximum exposure to loss in our option agreements is limited to our option deposit.  Often, we are at risk for items over budget related to land development on property we have under option.  In these cases, we have contracted to complete development at a fixed cost on behalf of the land owner.  Some of our option deposits may be refundable if certain contractual conditions are not performed by the party selling the lots.

 

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        The table below presents a summary of our lots under option at June 30, 2005 (dollars in thousands):

 

										Option/Earnest Money Deposits
		# of Lots		Fair Value			Purchase Price			Cash			Letters of Credit
Specific performance options (1)		103		$	4,846		$	4,846		$	532		$	—
Options recorded on balance sheet(2)		19		1,426			1,466			311			—
Total options recorded on balance sheet as real estate not owned (3)		122		6,272			6,312			843			—
Option contracts not recorded on balance sheet — non-refundable deposits (3)		27,159		$	—		$	1,586,611		$	120,138		$	52,185
Purchase contracts not recorded on balance sheet — non-refundable deposits (3)		13,661		—			441,559			21,875			—
Purchase contracts not recorded on balance sheet — refundable deposits (4)		4,422		—			218,033			3,007			—
Total options not recorded on balance sheet		45,242		—			2,246,203			145,020			52,185
Total lots under option or contract		45,364		$	6,272		$	2,252,515		$	145,863		$	52,185

(1)          Fair value of specific performance options approximates purchase price due to the short-lived nature of the options.

(2)          The purpose and nature of these consolidated lot option contracts (VIE’s) is to provide the Company the option to purchase lots in anticipation of building homes on the lots in the future.

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

(4)          Deposits are refundable at our sole discretion.

 

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 of lots typically is structured to approximate our expected rate of home orders.

 

NOTE 4 — INVESTMENTS IN UNCONSOLIDATED ENTITIES

 

        We participate in homebuilding and land development joint ventures from time to time as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base.  We had equity investments of 50% or less and did not have controlling financial interests in these unconsolidated entities at June 30, 2005.  Our joint venture partners generally are unrelated homebuilders, land sellers or other real estate investor entities.  We also enter into mortgage and title business joint ventures from time to time.  These unconsolidated entities follow accounting principles generally accepted in the United States of America and we share in their profits and losses generally in accordance with our ownership interests.

 

        We and/or our joint venture partners usually obtain certain options or enter into other arrangements under which we can purchase portions of the land held by the unconsolidated joint ventures.  Option prices are generally negotiated prices that approximate market value when we enter into the option contract.  Our share of the joint venture earnings is deferred until homes are delivered by us and title passes to a homebuyer. At such time, we allocate our joint venture earnings to the land acquired by us as a reduction in

 

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the basis of the property. Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method was as follows (in thousands):

 

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
Revenues		$	52,868		$	3,533		$	83,535		$	7,209
Costs and expenses		38,546			1,918			59,376			3,805
Net earnings of unconsolidated entities		$	14,322		$	1,615		$	24,159		$	3,404
Meritage’s share of pre-tax earnings		$	3,137		$	1,058		$	7,598		$	1,491

 

        Our share of net earnings, including any applicable management fees, but excluding earnings related to properties acquired by us, is recorded in “Other income, net” on our consolidated statements of earnings.

 

        At June 30, 2005 and December 31, 2004, our investments in unconsolidated entities includes $1.1 million and $2.9 million, respectively, related to the difference between the amounts at which our investments are carried and the amount of underlying equity in net assets.  These amounts are amortized to equity of earnings of unconsolidated entities over the lives of the respective joint ventures.  Amortization was $1.1 million for the three and six months ended June 30, 2005.  There was no amortization recorded in 2004.

 

        In addition to joint ventures accounted for under the equity method summarized in the above table, at June 30, 2005, and December 31, 2004, our investments in unconsolidated entities included joint ventures recorded under the cost method.  These joint ventures have obtained large parcels of land and were formed to perform off-site development work and to sell lots to the joint venture members.  As of June 30, 2005, and December 31, 2004, our investments in unconsolidated entities recorded under the cost method were $11.6 and $7.3 million, respectively. As of June 30, 2005, we have not recorded any income or distributions from these joint ventures.

 

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NOTE 5 — LOANS PAYABLE AND OTHER BORROWINGS

 

Loans payable consist of the following (in thousands):

 

		June 30, 2005			December 31, 2004
$400 million unsecured revolving credit facility maturing May 2009 with extension provisions, and interest payable monthly approximating LIBOR plus 2.0% or prime. The rates ranged from 5.34% to 6.25% at June 30, 2005.		$	38,200		$	—
Model home lease program, with interest in the form of lease payments payable monthly approximating LIBOR (approximately 3.512% at June 30, 2005) plus 2.5%		43,657			53,819
Acquisition and development seller carry back financing, paid in full in 2005		—			600
Total loans payable and other borrowings		$	81,857		$	54,419

 

        During January 2005 we determined that the construction costs and related debt associated with model homes which are owned and leased to us by others and that we use to market our communities are required to be included on our balance sheets.  We do not legally own the model homes, but we are reimbursed by the owner for our construction costs and we have the right, but not the obligation, to purchase these homes.  Although we have no legal obligation to repay any amounts received from the third-party owner, such amounts are recorded as debt and are typically deemed repaid when we simultaneously exercise our option to purchase the model home and sell such model home to a third-party home buyer.  Should we elect not to exercise our rights to purchase these model homes, the model home costs and related debt under the model lease program will be eliminated upon the termination of the lease, which is generally between one and three years from the origination of the lease.

 

        Our revolving credit facility contains covenants which require maintenance of certain levels of tangible net worth and compliance with certain minimum financial ratios, place limitations on the payment of dividends and redemptions of equity, and limit the incurrence of additional indebtedness, asset dispositions, mergers, certain investments and creations of liens, among other items.  As of and for the quarter ended June 30, 2005, we were in compliance with these covenants.  After considering our most restrictive bank covenants, our borrowing availability under the revolving credit facility was approximately $300.5 million at June 30, 2005 as determined by borrowing base limitations defined by our agreement with the lending banks.  The revolving credit facility restricts our ability to pay dividends, and at June 30, 2005, our maximum permitted amount available to pay dividends was approximately $85.4 million.

 

NOTE 6 — SENIOR NOTES

 

        In April 2004 we issued $130 million in aggregate principal amount of our 7% senior notes due 2014.  The notes were priced to us at a slight premium implying an interest rate to us of 6.99%.  At June 30, 2005 and December 31, 2004, these notes totaled approximately $130.1 million, including unamortized premium of approximately $0.1 million.

 

        In March 2005, we completed the private placement of $350 million in aggregate principal amount of 6.25% senior notes due 2015 which resulted in net proceeds to the Company, after commissions, discounts and fees, of approximately $343.8 million.  At June 30, 2005, our outstanding 6.25% senior notes due 2015 totaled approximately $348.3 million, which includes unamortized discounts of approximately $1.7 million.

 

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        During the first quarter of 2005, we used the proceeds from the issuance of the 6.25% senior notes to repurchase pursuant to a tender offer and consent solicitation approximately $276.8 million of our outstanding 9.75% senior notes due 2011 and to pay down our bank credit facility.  The balance of these notes outstanding at December 31, 2004 was $286.9 million, including $6.9 million of unamortized premium.  In connection with this tender offer and repurchase, we recorded an after-tax one-time charge of approximately $19.5 million for premiums, commissions and expenses associated with the tender offer and the write-off of existing offering costs associated with the 9.75% senior notes, net of the accretion of existing note premiums on the 9.75% senior notes and taxes.  During the second quarter of 2005, we subsequently repurchased $2.0 million of our outstanding 9.75% senior notes and incurred an after-tax charge of $0.1 million for premiums, commissions and expenses.  Approximately $1.2 million in aggregate principal amount of the 9.75% senior notes remained outstanding at June 30, 2005.

 

        Our senior notes contain covenants which require maintenance of certain levels of tangible net worth and compliance with certain minimum financial ratios, place limitations on the payment of dividends and redemptions of equity, and limit the incurrence of additional indebtedness, asset dispositions, mergers, certain investments and creations of liens, among other items.  As of and for the quarter ended June 30, 2005, we were in compliance with these covenants.

 

        Obligations to pay principal and interest on the bank credit facility and senior notes are guaranteed by all of our subsidiaries (collectively, the Guarantor Subsidiaries), each of which is directly or indirectly 100% owned by Meritage Homes Corporation, 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 (the parent company) has no independent assets or operations, the guarantees are full and unconditional and joint and several, 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 7 — ACQUISITIONS, GOODWILL AND INTANGIBLES

 

         Colonial Homes of Florida Acquisition.  In February 2005, we purchased the homebuilding and related assets of Colonial Homes of Florida (“Colonial”), which primarily operates in the Fort Myers/Naples area.  The purchase price was approximately $66.0 million in cash.   The results of Colonial’s operations have been included in our consolidated financial statements as of the effective date of acquisition, February 1, 2005.

 

        Goodwill and Intangibles.  Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the assets acquired.  The acquisition of Colonial was recorded using the purchase method of accounting.  The purchase price was allocated based on estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition.  The excess purchase price over the fair value of the net assets acquired of $22.1 million for Colonial was recorded as goodwill.

 

        The changes in the carrying amount of goodwill for the six months ended June 30, 2005, follow (in thousands):

 

Balance at December 31, 2004		$	91,475
Goodwill acquired — Colonial acquisition		22,111
Increase due to earn-out agreements		668
Purchase accounting adjustments		(347		)
Balance at June 30, 2005		$	113,907

 

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        Under the guidelines contained in SFAS No. 142, “Goodwill and Other Intangible Assets,” in the first quarter of 2005 management performed its annual assessment of goodwill and determined that no impairment exists.

 

        Intangible assets consist primarily of a non-compete agreement, a tradename and floor plan designs acquired in connection with our February 1, 2005 acquisition of Colonial.  These intangible assets were valued at the acquisition date utilizing accepted valuation procedures.  The non-compete agreement is being amortized over five years while the tradename and floor plan designs are being amortized over one year.  The acquired cost and accumulated amortization of the Company’s intangible assets was $2.8 million and $0.5 million, respectively, at June 30, 2005.  Amortization expense for the quarter ending June 30, 2005 was $0.3 million, and is expected to be approximately $0.6 million in the second half of 2005, $0.5 million in 2006 and $0.4 million per year in 2007, 2008 and 2009.

 

 

NOTE 8 — EARNINGS PER SHARE

 

Basic and diluted earnings per share for the three and six months ended June 30, 2005 and 2004 were calculated as follows (in thousands, except per share amounts):

 

 

NOTE 9 — INCOME TAXES

 

        Components of the provision for income taxes for the three and six months ended June 30, 2005 and 2004 are (in thousands):

 

 

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NOTE 10 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

        The February 2005 acquisition of Colonial Homes and the January 2004 acquisition of Citation Homes resulted in the following changes in assets and liabilities during the first six months of 2005 and 2004 (in thousands):

 

		2005			2004
Increase in real estate		$	(47,592	)	$	(12,036	)
Increase in deposits on real estate under option or contract		(1,343		)	(1,870		)
Increase in receivables and other assets		(1,065		)	(747		)
Increase in goodwill		(22,111		)	(11,214		)
Increase in intangibles		(2,763		)	—
Increase in property and equipment		(327		)	(89		)
Increase in accounts payable and accrued liabilities		3,758			1,704
Increase in home sale deposits		5,223			87
Net cash paid for acquisition		$	(66,220	)	$	(24,165	)
		Six Months Ended June 30,
		2005			2004
Cash paid during the period for:
Interest		$	14,510		$	15,677
Income taxes		$	35,448		$	36,948
Non-cash distributions from unconsolidated entities		$	19,863		$	832

 

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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,” “forecast”, “plan” and “project” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made.  All statements other than forward-looking statements are within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements may include, but are not limited to, projections of revenue, income or loss, capital expenditures and backlog; plans for future operations; financing needs or plans and liquidity; the impact of changes in interest rates; plans relating to our products or services, acquisitions, and new or planned development projects; the demand for and pricing of our homes; the expected outcome of legal proceedings against us; the growth potential of the markets we operate in; the sufficiency of our capital resources to support our growth strategy; the impact of new accounting standards; the likelihood that performance or surety bonds will be called; the sufficiency of our warranty reserves and our ability to continue positive operative results in light of current economic and political conditions, as well as assumptions related to the foregoing.

 

        Actual events and results may differ materially from those expressed in forward-looking statements due to a number of factors.  Risks identified in Exhibit 99.1 to this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2004, including those under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Our Future Results and Financial Condition” describe factors, among others, that could contribute to or cause such differences.  These factors may also affect our business generally and as a result, our stock and note prices may fluctuate dramatically.

 

Overview

 

        We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and active adult 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 entered the move-up market in the Las Vegas, Nevada area in 2002 with our acquisition of PermaBilt Homes and the Inland Empire region of the greater Los Angeles area in January 2004 with our acquisition of Citation Homes of Southern California (Citation).  We began greenfield start-up operations in the Denver, Colorado and Orlando, Florida markets in 2004, and in February 2005, we acquired Colonial Homes, a homebuilder that serves the Fort Myers/Naples, Florida market.  In March 2005, we entered the Reno, Nevada market through a greenfield start-up operation.  With the addition of Reno, we now have a presence in 14 dynamic housing markets in the western and southern regions of the country.  We operate in these states, predominantly in one industry, homebuilding, and thus have only one single reportable segment.

 

        Total home closing revenue was $651.8 million for the three months ended June 30, 2005, increasing $220.5 million, or 51% from $431.3 million for the same period last year.  Net earnings for the second quarter of 2005 increased $34.6 million, or 140%, to $59.2 million from $24.6 million in the same quarter of 2004.

 

Critical Accounting Policies

 

        We have established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation and presentation of our consolidated financial statements.  Our significant policies are described in Note 1 of the consolidated financial statements in our Annual Report on Form 10-K for December 31, 2004.  Certain of these policies involve significant judgments, assumptions and estimates by management that have a material impact on revenues and costs and on the carrying value of certain assets and liabilities.  The judgments, assumptions and estimates we use and believe to be critical to our business are based on historical experience, knowledge of the accounts and other factors which we believe to be reasonable under the circumstances.  We evaluate our judgments and assumptions on an on-going basis. Because of the nature of the judgments and assumptions we have made,

 

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actual results may differ from these judgments and estimates, which could have a material impact on our results of operations and on the carrying values of assets and liabilities.

 

        The accounting policies that we deem most critical to us, and involve the most difficult, subjective or complex judgments, include our estimates of costs to complete our individual projects, the ultimate recoverability (or impairment) of these costs, goodwill impairment, the likelihood of closing lots held under option or contract, the ability to determine the fair value of consolidated real estate not owned and liabilities related to such, certain estimates and assumptions related to complying with FIN 46R, and the ability to estimate expenses and accruals, including legal and warranty reserves.  Should we under or over estimate costs to complete individual projects, gross margins in a particular period could be misstated and the ultimate recoverability of costs related to a project from home sales may be uncertain.  Furthermore, non-refundable deposits paid for land options or contracts may have no economic value to us if we do not ultimately purchase the land.  Our inability to accurately estimate expenses, accruals, or an impairment of real estate or goodwill could result in charges, or income, in future periods, which relate to activities or transactions in a preceding period.  The estimates and assumptions we make relating to our implementation of FIN 46R, if not accurate, could result in us incorrectly including, or excluding, certain contractual land acquisition arrangements as variable interest entities in, or from, respectively, our consolidated financial statements.

 

Results of Operations

 

        The following discussion and analysis of financial condition and results of operations is based on our consolidated unaudited financial statements for the three and six months ended June 30, 2005 and 2004.  All material balances and transactions between us and our subsidiaries have been eliminated.  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.

 

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Home Closing Revenue, Home Orders and Order Backlog

 

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

 

		Three Months Ended June 30,						%		Six Months Ended June 30,						%
Home Closing Revenue		2005			2004			Change		2005			2004			Change
Total
Dollars		$	651,783		$	431,275		51	%	$	1,202,730		$	854,777		41	%
Homes closed		2,095			1,620			29	%	3,882			3,189			22	%
Average sales price		$	311.1		$	266.2		17	%	$	309.8		$	268.0		16	%
Texas
Dollars		$	184,229		$	160,377		15	%	$	340,184		$	317,649		7	%
Homes closed		856			741			16	%	1,573			1,471			7	%
Average sales price		$	215.2		$	216.4		(1	)%	$	216.3		$	215.9		**
Arizona
Dollars		$	194,108		$	115,535		68	%	$	348,063		$	213,467		63	%
Homes closed		745			473			58	%	1,344			854			57	%
Average sales price		$	260.5		$	244.3		7	%	$	259.0		$	250.0		4	%
California
Dollars		$	228,412		$	123,840		84	%	$	422,899		$	254,710		66	%
Homes closed		379			294			29	%	724			601			20	%
Average sales price		$	602.7		$	421.2		43	%	$	584.1		$	423.8		38	%
Nevada
Dollars		$	25,493		$	31,523		(19	)%	$	56,682		$	68,951		(18	)%
Homes closed		66			112			(41	)%	154			263			(41	)%
Average sales price		$	386.3		$	281.5		37	%	$	368.1		$	262.2		40	%
Florida *
Dollars		$	19,541		n/a			n/a		$	34,902		n/a			n/a
Homes closed		49			n/a			n/a		87			n/a			n/a
Average sales price		$	398.8		n/a			n/a		$	401.2		n/a			n/a

*         The number and dollar amount of homes closed include the effect of the Colonial Homes of Florida acquisition in February 2005.

 

**    Less than 1%

 

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