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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________to__________
Commission File Number 1-9977
MERITAGE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Maryland 86-0611231
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
6613 North Scottsdale Road, Suite 200 85250
Scottsdale, Arizona (Zip Code)
(Address of Principal Executive Offices)
(480) 998-8700
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
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 [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of common stock held by non-affiliates of the
registrant (3,968,028 shares) as of March 15, 2002, was $259,945,514, based on
the closing sales price per share as reported by the New York Stock Exchange on
such date. For purposes of this computation, all executive officers and
directors of the Registrant have been deemed to be affiliates.
The number of shares outstanding of the Registrant's common stock on March 15,
2002 was 5,660,473.
DOCUMENTS INCORPORATED BY REFERENCE
Portions from the Registrant's Proxy Statement relating to the Annual Meeting of
Stockholders to be held on May 8, 2002 have been incorporated by reference into
Part III, Items 10, 11, 12 and 13.
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MERITAGE CORPORATION
FORM 10-K
TABLE OF CONTENTS
PAGE
NUMBER
PART I
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 10
Item 3. Legal Proceedings............................................. 10
Item 4. Submission of Matters to a Vote of Security Holders........... 10
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters........................................... 11
Item 6. Selected Financial Data....................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk... 23
Item 8. Financial Statements and Supplementary Data................... 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 41
PART III
Item 10. Directors and Executive Officers of the Registrant........... 41
Item 11. Executive Compensation....................................... 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................... 41
Item 13. Certain Relationships and Related Transactions............... 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K..................................................... 42
SIGNATURES ................................................................ S-1
2
PART I
ITEM 1. BUSINESS
We are a leading designer and builder of single-family homes in the rapidly
growing Sunbelt states of Texas, Arizona and California. 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. To expand our presence in
Arizona, we acquired Hancock Communities, another well-established homebuilder
that serves the first-time and move-up markets in the Phoenix area, in 2001.
We operate in Texas under the Legacy Homes name, in Arizona as Monterey
Homes, Meritage Homes and Hancock Communities, and in Northern California as
Meritage Homes. At December 31, 2001, we were actively selling homes in 74
communities, with base prices ranging from $90,000 to $820,000. Information
about our active communities is provided through our Internet web site at
www.meritagehomes.com. The information on our website is not considered part of
this report.
COMPETITIVE STRENGTHS
We believe we possess the following competitive strengths:
CONSERVATIVE INVENTORY MANAGEMENT. We seek to minimize land and inventory
risk in order to optimize our use of capital and maintain low leverage ratios.
We accomplish this by:
* generally purchasing land subject to complete entitlements, including
zoning and utility services;
* developing smaller parcels, generally projects that can be completed
within a three-year period;
* controlling approximately 70% of our land inventory through rolling
options with relatively minimal deposit commitments;
* managing housing inventory by pre-selling and obtaining substantial
customer deposits on our homes prior to starting construction;
* limiting speculative home construction; and
* minimizing home construction cycles.
DISCIPLINED FINANCIAL MANAGEMENT. We believe that our disciplined financial
management policies enable us to achieve above-average returns on assets
compared to our competitors in the homebuilding industry and maintain reasonable
leverage ratios. Our rigorous investment requirements for the acquisition of
land enable us to deploy capital efficiently and to preserve our cash flow for
debt service.
SUPERIOR MARGINS. Our focus on achieving high margins results in greater
profitability during strong economic periods and also enables us to realize
lower break-even points and higher pricing flexibility during slower economic
periods. In addition to maintaining low overhead costs, we actively manage
construction costs and pricing and marketing strategies in order to maximize
margins. We seek to optimize our mix of available housing upgrades and
customization features to offer the highest value to customers at the lowest
cost. Within our pricing structure we provide our sales and marketing
professionals with the autonomy and flexibility to respond rapidly to
competitive offerings in our markets by customizing sales programs and
incentives.
EXPERIENCED MANAGEMENT TEAM WITH SIGNIFICANT EQUITY OWNERSHIP. Members of
our senior management team have extensive experience in the homebuilding
industry as well as in each of the local markets that we serve. Our co-chief
executive officers and senior executives average over 15 years of homebuilding
experience and each has a successful track record of delivering superior results
in varying homebuilding cycles. In addition, our co-chief executive officers
together beneficially own approximately 27% of our outstanding common stock.
3
PRODUCT BREADTH. We believe that our product breadth and geographic
diversity enhance our growth potential and help to reduce exposure to economic
cycles. In Arizona, we serve the first-time and first and second-time move-up
markets, and beginning in 2002, we plan to begin delivering homes in our
active-adult communities. We also build for the Arizona luxury market,
characterized by unique communities and distinctive luxury homes. In Texas, we
target the first-time and first and second move-up markets, and in Northern
California, we focus on first and second move-up homes.
BUSINESS STRATEGY
We seek to distinguish ourselves from other production homebuilders and to
respond rapidly to changing market conditions through a business strategy that
incorporates the following:
FOCUS ON HIGH GROWTH MARKETS. Our housing markets are located in three
rapidly growing Sunbelt states. We operate in the Dallas/Ft. Worth, Austin and
Houston, Texas, markets as Legacy Homes, in the Phoenix/Scottsdale and Tucson,
Arizona, markets as Monterey Homes, Meritage Homes and Hancock Communities and
in the East San Francisco Bay and Sacramento, California, markets as Meritage
Homes. These areas are characterized by high job growth and in-migration trends,
creating strong demand for new housing and we believe they represent attractive
homebuilding markets with opportunities for long-term growth. We also believe
that our operations in certain markets are well established and that we have
developed a reputation for building distinctive quality homes within our
markets.
MAINTAIN LOW COST STRUCTURE. Throughout our history, we have focused on
minimizing construction costs and overhead, and we believe this attention is a
key factor in maintaining high cash flow margins and profitability. We reduce
costs by:
* using subcontractors for home construction and site improvement on a
fixed-price basis;
* obtaining favorable pricing from subcontractors through long-term
relationships and high volume;
* reducing interest carry by minimizing our inventory of unsold or
speculative homes and shortening the home construction cycle;
* generally beginning construction on a home once it is under contract,
we have received a satisfactory earnest money deposit and the buyer
has obtained approval for a mortgage loan;
* minimizing overhead by centralizing certain administrative activities;
and
* monitoring homebuilding production, scheduling and budgeting through
management information systems.
SUPERIOR DESIGN, QUALITY AND CUSTOMER SERVICE. We believe we maximize
customer satisfaction by offering homes that are built with quality materials
and craftsmanship, exhibit distinctive design features and are situated in
premium locations. We believe that we generally offer higher caliber homes in
their defined price range or category compared to those built by our
competitors. In addition, we are committed to achieving the highest level of
customer satisfaction as an integral part of our competitive strategy. As part
of the sales process, our experienced sales personnel keep customers informed of
their home's construction progress. After delivery, our customer care
departments respond to homebuyers' questions and warranty matters.
EXPANSION IN NEW AND EXISTING MARKETS. Depending on market conditions, we
may explore expansion opportunities in new or existing geographic areas where we
see an ability to exploit a competitive advantage. Expansion may occur through
strategic acquisitions of existing homebuilders, through start-up operations or
through internal growth. In pursuing expansion, we explore markets with
demographic and other growth characteristics similar to our current markets and
will pursue the acquisition of entities with operating policies and cash flow-
and earnings-focused philosophies similar to ours.
4
PRODUCTS
Our homes range from first-time purchases to semi-custom luxury, with base
prices ranging from $90,000 to $820,000. A summary of activity by state and
product type as of and for the year ended December 31, 2001, follows (dollars in
thousands):
Number Average Number of
of Homes Closing Homes in Dollar Value Home Sites Active
Closed Price Backlog of Backlog Remaining(1) Communities
------ ----- ------- ---------- ------------ -----------
Texas - First-time 532 $149 250 $ 37,073 1,273 11
Texas - Move-up 986 183 441 77,774 3,790 19
Texas - Luxury -- -- 2 804 82 1
Arizona - First-time 483 124 271 33,977 1,412 3
Arizona - Move-up 638 242 376 103,760 6,016 18
Arizona - Luxury 222 503 129 68,248 423 12
California - Move-up 409 384 133 53,315 1,838 10
------ ------ -------- ------- ----
Total 3,270 $227 1,602 $374,951 14,834 74
====== ====== ======== ======= ====
(1) "Home Sites Remaining" - the estimated number of homes that could be built
both on the remaining lots available for sale and land to be developed into
lots.
LAND ACQUISITION AND DEVELOPMENT
We typically option or purchase land only after necessary entitlements have
been obtained so that development or construction may begin as market conditions
dictate. The term "entitlements" refers to development agreements, tentative
maps or recorded plats, depending on the jurisdiction within which the land is
located. Entitlements generally give the developer the right to obtain building
permits upon compliance with conditions that are ordinarily within the
developer's control. Even though entitlements are usually obtained before land
is purchased, we are still required to secure a variety of other governmental
approvals and permits during development. The process of obtaining such
approvals and permits can substantially delay the development process. For this
reason, we may consider, on a limited basis, purchasing unentitled property in
the future when we can do so in a manner consistent with our business strategy.
We select land for development based upon a variety of factors, including:
* internal and external demographic and marketing studies;
* project suitability, which generally means developments with fewer
than 300 lots;
* suitability for development generally within a one to four-year time
period from the beginning of the development process to the delivery
of the last home;
* financial review as to the feasibility of the proposed project,
including projected profit margins, returns on capital employed, and
the capital payback period;
* the ability to secure governmental approvals and entitlements;
* results of environmental and legal due diligence;
* proximity to local traffic corridors and amenities; and
* management's judgment as to the real estate market and economic
trends, and our experience in particular markets.
We occasionally purchase larger properties consisting of 300 to 500 lots or
more if the situation presents an attractive profit potential and acceptable
risk limitations.
We acquire land through purchases and rolling option contracts. Purchases
are financed through traditional bank financing or working capital. We acquire a
majority of our land through rolling option contracts, which allow us to control
lots and land through third parties who own or buy properties on which we plan
to build homes. We enter into option contracts to purchase finished lots from
these third parties as home construction begins. These contracts are generally
non-recourse and we generally require non-refundable deposits of 2% to 15% of
the sales price. At December 31, 2001, we had approximately $45.3 million in
deposits on real estate under option or contract.
5
Once we acquire land, we generally initiate development through contractual
agreements with subcontractors. These activities include site planning and
engineering, as well as constructing road, sewer, water, utilities, drainage,
recreation facilities and other refinements. We often build homes in
master-planned communities with home sites that are along or near a major
amenity, such as a golf course.
We develop a design and marketing concept for each project, which includes
determination of size, style and price range of homes. For these projects, we
also determine street layout, individual lot size and layout, and overall
community design. The product line offered in each project depends upon many
factors, including the housing generally available in the area, the needs of a
particular market, and our lot costs for the project; though we are sometimes
able to use standardized design plans for a product line.
To a very limited extent, we may use partnerships or joint ventures to
purchase and develop land where such arrangements are necessary to acquire the
property or appear to be otherwise economically advantageous. At December 31,
2001, we were not involved in any significant partnerships or joint ventures.
The following table presents information regarding land owned or land under
contract or option by market as of December 31, 2001:
LAND OWNED (1) LAND UNDER CONTRACT OR OPTION (1)
--------------------------------------- ----------------------------------------
LOTS HELD
LOTS UNDER FOR LOTS UNDER LOTS HELD FOR
FINISHED DEVELOPMENT DEVELOPMENT FINISHED DEVELOPMENT DEVELOPMENT
LOTS (ESTIMATED) (ESTIMATED) LOTS (ESTIMATED) (ESTIMATED) TOTAL
---- ----------- ----------- ---- ----------- ----------- -----
TEXAS:
Dallas/Ft. Worth 515 2,020 -- 203 730 -- 3,468
Austin 47 110 -- 143 416 -- 716
Houston 205 260 -- 32 607 -- 1,104
------ ------ ------ ------ ------ ------ ------
Total Texas 767 2,390 -- 378 1,753 -- 5,288
------ ------ ------ ------ ------ ------ ------
ARIZONA:
Phoenix/Scottsdale 632 251 -- 612 1,540 2,569 5,604
Tucson 144 -- -- 552 397 1,259 2,352
------ ------ ------ ------ ------ ------ ------
Total Arizona 776 251 -- 1,164 1,937 3,828 7,956
------ ------ ------ ------ ------ ------ ------
CALIFORNIA:
Sacramento 53 -- -- 270 267 -- 590
East San Francisco
Bay 72 -- 77 208 696 110 1,163
------ ------ ------ ------ ------ ------ ------
Total California 125 -- 77 478 963 110 1,753
------ ------ ------ ------ ------ ------ ------
TOTAL 1,668 2,641 77 2,020 4,653 3,938 14,997
====== ====== ====== ====== ====== ====== ======
(1) Excludes lots with finished homes or homes under construction.
CONSTRUCTION OPERATIONS
We are the general contractor for our projects and typically hire
subcontractors on a project-by-project or reasonable geographic-proximity basis
to complete construction at a fixed price. We usually enter into agreements with
subcontractors and materials suppliers after receiving competitive bids on an
individual basis. We obtain information from prospective subcontractors and
suppliers with respect to their financial condition and ability to perform their
agreements before formal bidding begins. Occasionally, we enter into longer-term
contracts with subcontractors and suppliers if we can obtain more favorable
terms. Our project managers and field superintendents, who coordinate and
supervise the activities of subcontractors and suppliers, subject the
development and construction work to quality and cost controls, and assure
compliance with zoning and building codes. At December 31, 2001, we employed 251
construction operations personnel.
6
We specify that quality, durable materials be used in construction of our
homes and we do not maintain significant inventories of construction materials,
except for work in process materials for homes under construction. When
possible, management negotiates price and volume discounts with manufacturers
and suppliers on behalf of its subcontractors to take advantage of production
volume. Historically, access to our principal subcontracting trades, materials
and supplies has been readily available in each of our markets. Prices for these
goods and services may fluctuate due to various factors, including supply and
demand shortages that may be beyond the control of our vendors. We believe that
we have strong relationships with our suppliers and subcontractors.
We generally build and sell homes in clusters or phases within our larger
projects, which we believe creates efficiencies in land development and
construction, and improves customer satisfaction by reducing the number of
vacant lots surrounding a completed home. Our homes are typically completed
within four to twelve months from the start of construction, depending upon home
size and complexity. Construction schedules may vary depending on the
availability of labor, materials and supplies, product type, location and
weather. Our homes are usually designed to promote efficient use of space and
materials, and to minimize construction costs and time. We do not enter into any
weather or materials commodity futures derivative contracts.
MARKETING AND SALES
We believe that we have an established reputation for developing high
quality homes, which helps generate interest in each new project. We also use
advertising and other promotional activities, including our website
(meritagehomes.com), magazine and newspaper advertisements, brochures, direct
mailings, and the placement of strategically located signs in the immediate
areas of our developments.
We use furnished model homes as tools in demonstrating the competitive
advantages of our home designs and various features to prospective homebuyers.
We generally employ or contract with interior and landscape designers who are
responsible for creating an attractive model home for each product line within a
project. We generally build between one and four model homes for each active
community, depending upon the number of homes to be built in the project and the
products to be offered. At times, we sell our model homes and lease them back
from buyers who purchased the homes for investment purposes or who do not intend
to move in immediately. A summary of model homes owned or leased at December 31,
2001, follows:
MODEL HOMES MODEL HOMES MONTHLY LEASE MODELS UNDER
OWNED LEASED BACK AMOUNT CONSTRUCTION
----- ----------- ------ ------------
Texas 41 -- -- 5
Arizona 33 74 $160,700 12
California -- 36 56,000 --
---- ---- -------- ----
Total 74 110 $216,700 17
==== ==== ======== ====
Our homes generally are sold by full-time, commissioned employees who
typically work from a sales office located in the model homes for each project.
At December 31, 2001, we had 127 sales and marketing employees. Our goal is to
ensure that the sales force has extensive knowledge of our operating policies
and housing products. To achieve this goal, we train our sales personnel and
conduct periodic meetings to update them on sales techniques, competitive
products in the area, financing availability, construction schedules, marketing
and advertising plans, and the available product lines, pricing, options, and
warranties offered. Sales personnel are licensed real estate agents where
required by law. Independent brokers also sell our homes, and are usually paid a
sales commission based on the price of the home. Our sales personnel assist our
customers in selecting upgrades or in adding available customization features to
their homes. We attempt to present our available upgrade and customization
options to appeal to local consumer demands while at the same time minimizing
our costs. Occasionally we offer various sales incentives, such as landscaping
and certain interior home improvements, to attract buyers. The use and type of
incentives depends largely on economic and competitive market conditions.
7
BACKLOG
Most of our home sales are made under standard sales contracts signed
before construction of the home begins. The contracts require substantial cash
deposits and are usually subject to certain contingencies such as the buyer's
ability to qualify for financing. Homes covered by such sales contracts but not
yet closed are considered "backlog." Sales contingent upon the sale of a
customer's existing home are not included as new sales contracts until the
contingency is removed. We do not recognize revenue upon the sale of a home
until it is delivered to the homebuyer and other criteria for sale and profit
recognition are met. We sometimes build homes before obtaining a sales contract,
however, these homes are excluded from backlog until a sales contract is signed.
At December 31, 2001, 17.5% of our homes under construction were speculative
homes, and there were 24 completed speculative homes in inventory at December
31, 2001. We believe we will deliver almost all homes in backlog at December 31,
2001 to customers during 2002.
Our backlog increased to 1,602 units with a value of $375.0 million at
December 31, 2001 from 1,246 units with a value of $309.9 million at December
31, 2000. These increases are primarily due to additional communities that
opened for sale in 2001, along with a strong demand for homes.
CUSTOMER FINANCING
We attempt to help qualified homebuyers who require financing to obtain
loans from mortgage lenders that offer a variety of financing options. We
provide mortgage-broker services in some of our markets through a wholly owned
subsidiary, which originates loans on behalf of third party lenders, and through
joint ventures with independent mortgage banking companies. In other markets we
use unaffiliated preferred mortgage lenders. We may pay a portion of the closing
costs and discount mortgage points to assist homebuyers with financing. We do
not service or fund the mortgages we originate, and therefore do not assume the
risks associated with a mortgage servicing business. Since many customers use
long-term mortgage financing to purchase homes, adverse economic conditions,
increases in unemployment and rising mortgage interest rates may deter or reduce
the number of potential homebuyers.
CUSTOMER RELATIONS, QUALITY CONTROL AND WARRANTY PROGRAMS
We believe that positive customer relations and an adherence to stringent
quality control standards are fundamental to continued success, and that our
commitment to buyer satisfaction and quality control has significantly
contributed to our reputation as a high quality builder.
A Meritage project manager or project superintendent and a customer
relations representative generally oversee compliance with quality control
standards for each development. These representatives perform the following
tasks:
* oversee home construction;
* oversee subcontractor and supplier performance;
* review the progress of each home and conduct formal inspections as
specific stages of construction are completed; and
* regularly update buyers on the progress of their homes.
We generally provide a one-year limited warranty on workmanship and
building materials with each home. As subcontractors usually provide an
indemnity and a certificate of insurance before beginning work, claims relating
to workmanship and materials are generally the subcontractors' primary
responsibility. Reserves for future warranty costs are established based on
historical experience within each division or region, and are recorded when the
homes are delivered. Reserves range from 0.3% to 0.5% of a home's sale price.
Historically, these reserves have been sufficient to cover warranty repairs.
8
COMPETITION AND MARKET FACTORS
The development and sale of residential property is a highly competitive
industry. We compete for sales in each of our markets with national, regional,
and local developers and homebuilders, existing home resales, and to a lesser
extent, condominiums and rental housing. Some competitor homebuilders have
significantly greater financial resources, lower costs and/or more favorable
land positions than we do. Competition among both small and large residential
homebuilders is based on a number of interrelated factors, including location,
reputation, amenities, design, quality and price. We believe that we compare
favorably to other homebuilders in the markets in which we operate due to our:
* experience within our geographic markets which allows us to develop
and offer new products;
* ability to recognize and adapt to changing market conditions,
including from a capital and human resource perspective;
* ability to capitalize on opportunities to acquire land on favorable
terms; and
* reputation for outstanding service and quality products.
The homebuilding industry is cyclical and is affected by consumer
confidence levels, job availability, general economic conditions, and interest
rates. Other factors affecting the homebuilding industry and demand for new
homes are changes in costs associated with home ownership such as increases in
property taxes and energy costs, changes in consumer preferences, demographic
trends, availability of and changes in mortgage financing programs, and the
availability and cost of land and building materials. Any slowing in new home
sales would increase competition among homebuilders in our market areas. There
is no assurance that we will be able to compete successfully against other
homebuilders in our current markets in a more competitive business environment
or that such increased competition will not have a material adverse affect on
our business and operating results.
GOVERNMENT REGULATION AND ENVIRONMENTAL MATTERS
We option or purchase most of our land after entitlements have been
obtained, which provide for zoning and utility services to project sites and
give us the right to obtain building permits. Construction may begin almost
immediately on such entitled land upon compliance with and receipt of specified
permits, approvals and other conditions, which generally are within our control.
The time needed to obtain such approvals and permits affects the carrying costs
of unimproved property acquired for development and construction. The continued
effectiveness of permits already granted is subject to factors such as changes
in government policies, rules and regulations, and their interpretation and
application. To date, the government approval processes discussed above have not
had a material adverse effect on our development activities, although there is
no assurance that these and other restrictions will not adversely affect future
operations.
Local and state governments have broad discretion regarding the imposition
of development fees for projects under their jurisdictions. These fees are
normally established when we receive recorded maps and building permits. In
addition, communities occasionally impose construction moratoriums. Because most
of our land is entitled, construction moratoriums generally would affect us if
they arose from health, safety or welfare issues, such as insufficient water,
electric or sewage facilities. We could become subject to delays or may be
precluded entirely from developing communities due to building moratoriums, "no
growth" or "slow growth" initiatives or building permit allocation ordinances,
which could be implemented in the future.
We are also subject to a variety of local, state, and federal statutes,
ordinances, rules and regulations concerning the protection of health and the
environment. In some markets, we are subject to environmentally sensitive land
ordinances that mandate open space areas with public elements in housing
developments, and prevent development on hillsides, wetlands and other protected
areas. We must also comply with flood plain restrictions, desert wash area
restrictions, native plant regulations, endangered species acts and view
restrictions. These and similar laws may result in delays, cause substantial
compliance and other costs, and prohibit or severely restrict development in
certain environmentally sensitive regions or areas. To date, compliance with
such ordinances has not materially affected our operations, although it may do
so in the future.
9
We usually will condition our obligation to option or purchase property on,
among other things, an environmental review of the land. To date, we have not
incurred any unanticipated liabilities relating to the removal of unknown toxic
wastes or other environmental matters. However, there is no assurance that we
will not incur material liabilities in the future relating to toxic waste
removal or other environmental matters affecting land currently or previously
owned.
BONDS AND OTHER OBLIGATIONS
We 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 in
accordance with pending development activities. In the event the bonds or
letters are drawn upon, we would be obligated to reimburse the issuer of the
bond or letter of credit. At December 31, 2001, there were approximately $12.2
million in outstanding letters of credit and $46.1 million in performance bonds
for such purposes. We do not believe that any of these bonds or letters of
credit are likely to be drawn upon.
EMPLOYEES AND SUBCONTRACTORS
At December 31, 2001, we had 570 employees, including 192 in management and
administration, 127 in sales and marketing, and 251 in construction operations.
Our employees are not unionized, and we believe that we have strong employee
relationships. We act solely as a general contractor and all construction
operations are conducted through project managers and field superintendents who
manage third party subcontractors. We use independent contractors for
construction, architectural and advertising services, and we believe that we
have strong relationships with our subcontractors and independent contractors.
ITEM 2. PROPERTIES
We lease approximately 14,000 square feet of office space in Scottsdale,
Arizona and a 13,000 square foot office in Plano, Texas, which serve as our
corporate offices. The Scottsdale lease expires in August 2004. The Plano lease
expires in May 2002 and the building is leased from a company owned beneficially
by one of our co-chairmen. We believe that the Plano lease rate is competitive
with rates for comparable space in the area and terms of the lease are similar
to those we could obtain in an arm's length transaction. In addition, we lease
approximately 35,200 square feet of office space for our operating divisions
under leases expiring between April 2002, and March 2007.
As of December 31, 2001, we also had leases for 110 model homes at a total
monthly lease amount of approximately $216,700. The leases have terms ranging
from three months to 27 months, with various renewal options.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various routine legal proceedings incidental to our
business, some of which are covered by insurance. We believe that none of these
matters will have a material adverse impact upon our financial condition or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of stockholders during the fourth
quarter of 2001.
10
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
GENERAL
Our common stock is traded on the New York Stock Exchange ("NYSE") under
the symbol "MTH". The high and low sales prices of the common stock for the
periods indicated, as reported by the NYSE, follow:
2001 2000
--------------- ---------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter $48.00 $27.40 $11.50 $ 8.88
Second Quarter $53.75 $26.10 $12.00 $ 9.75
Third Quarter $59.96 $27.50 $18.25 $10.69
Fourth Quarter $52.98 $34.00 $41.25 $18.25
On March 15, 2002, the closing sales price of the common stock as reported
by the NYSE was $61.50 per share. At that date, there were approximately 205
owners of record. There are approximately 2,600 beneficial owners of common
stock.
The transfer agent for our common stock is Mellon Investor Services LLC, 85
Challenger Road, Ridgefield Park, NJ 07660. (www.melloninvestor.com)
We did not declare cash dividends in 2001, 2000 or 1999, nor do we intend
to declare cash dividends in the foreseeable future. Earnings will be retained
to finance the continuing development of the business. Future cash dividends, if
any, will depend upon our financial condition, results of operations, capital
requirements, compliance with debt covenants, as well as other factors
considered relevant by our Board of Directors.
FACTORS THAT MAY AFFECT FUTURE STOCK PERFORMANCE
The performance of our common stock depends upon several factors, including
those listed below and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Factors That May Affect Our Future Results
and Financial Condition."
The market price of our common stock could be subject to significant
fluctuations in response to certain factors, such as variations in anticipated
or actual results of our operations or that of other homebuilding companies,
changes in conditions affecting the general economy, widespread industry trends
and analysts' reports, changes in interest rates, as well as other factors
unrelated to our operating results.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical consolidated financial and
operating data of Meritage Corporation and subsidiaries as of and for each of
the last five years ended December 31, 2001. The financial data has been derived
from our consolidated financial statements and related notes audited by KPMG
LLP, independent auditors. For additional information, see the consolidated
financial statements included elsewhere in this Annual Report on Form 10-K. The
following table should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and the Results of Operations. These historical
results may not be indicative of future results.
The data below includes the operations of Legacy Homes, Sterling
Communities and Hancock Communities since their respective dates of combination
11
or acquisition. Those dates are as follows: Legacy Homes, combined in July 1997;
Sterling Communities, acquired July 1998; and Hancock Communities, acquired May
2001.
HISTORICAL CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
-------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
STATEMENT OF EARNINGS DATA:
Total sales revenue $ 744,174 $ 520,467 $ 341,786 $ 257,113 $ 149,630
Total cost of sales (586,914) (415,649) (277,287) (205,188) (124,594)
--------- --------- --------- --------- ---------
Gross profit 157,260 104,818 64,499 51,925 25,036
Earnings from mortgage assets and other
income, net(1) 2,884 1,847 2,064 3,961 5,435
Commissions and other sales costs (41,085) (28,680) (19,243) (14,292) (8,295)
General and administrative expenses (35,723) (21,215) (15,100) (10,632) (6,812)
Interest expense -- (8) (6) (462) (165)
--------- --------- --------- --------- ---------
Earnings before income taxes and
extraordinary items 83,336 56,762 32,214 30,500 15,199
Income taxes(2) (32,444) (21,000) (13,269) (6,497) (962)
Extraordinary items, net of tax effect(3) (233) -- -- -- --
--------- --------- --------- --------- ---------
Net earnings $ 50,659 $ 35,762 $ 18,945 $ 24,003 $ 14,237
========= ========= ========= ========= =========
Net earnings per common share(4)
Basic $ 9.55 $ 6.92 $ 3.49 $ 4.51 $ 2.93
Diluted $ 8.60 $ 6.26 $ 3.14 $ 3.92 $ 2.68
BALANCE SHEET DATA (END OF YEAR):
Real estate $ 330,238 $ 211,307 $ 171,012 $ 104,759 $ 63,955
Total assets 436,715 267,075 226,559 152,250 96,633
Notes payable 177,561 86,152 85,937 37,205 22,892
Total liabilities 260,128 145,976 136,148 79,971 50,268
Stockholders' equity 176,587 121,099 90,411 72,279 46,365
SUPPLEMENTAL FINANCIAL DATA:
Cash provided by (used in):
Operating activities $ (19,847) $ 6,252 $ (36,387) $ (2,366) $ 6,676
Investing activities (73,029) (8,175) (9,902) (3,928) 11,073
Financing activities 91,862 (7,102) 47,324 10,436 (25,072)
(1) Earnings from mortgage assets that were obtained from our predecessor and
disposed of in 1998 and 1997 are not applicable for 2001, 2000 and 1999.
(2) Due to the use of our net operating loss carryforward (NOL) obtained from
our predecessor, we paid limited income taxes during 1998 and 1997, until
the NOL was fully utilized.
(3) The 2001 amount reflects the net effect of extraordinary items from early
extinguishments of long-term debt.
(4) 2001 earnings per share are shown after a $0.04 loss from the extraordinary
items. Basic and diluted earnings per share before the extraordinary items
were $9.59 and $8.64, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make a number of estimates and assumptions that affect
the reported amounts and disclosures in the consolidated financial statements.
On an ongoing basis, we evaluate our estimates and assumptions based upon
historical experience and various other factors and circumstances. We believe
that our estimates and assumptions are reasonable in the circumstances; however,
12
actual results may differ from these estimates and assumptions under different
future conditions.
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 developments, the ultimate recoverability (or
impairment) of these costs, the likelihood of closing lots held under option or
contract 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 individual home sales
may be uncertain. Furthermore, non-refundable deposits paid for land options or
contracts may have no economic value to us if the land is not ultimately
purchased. Finally, our inability to accurately estimate expenses or accruals
could result in charges or income in the future results of operations related to
activities or transactions in a preceding period.
We acquired Hancock Communities, a homebuilder in the Phoenix, Arizona
metropolitan area, on May 31, 2001. The results discussed below include the
operations of Hancock Communities since its date of acquisition.
The results presented below are not necessarily indicative of those to be
expected in the future.
HOME SALES REVENUE, SALES CONTRACTS AND NET SALES BACKLOG
The tables provided below show operating and financial data regarding our
homebuilding activities.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
HOME SALES REVENUE ($ IN THOUSANDS)
Total
Dollars $742,576 $515,428 $334,007
Homes closed 3,270 2,227 1,643
Average sales price $ 227.1 $ 231.4 $ 203.3
Texas
Dollars $259,725 $214,472 $174,850
Homes closed 1,518 1,239 1,135
Average sales price $ 171.1 $ 173.1 $ 154.1
Arizona
Dollars $325,918 $175,674 $120,909
Homes closed 1,343 623 400
Average sales price $ 242.7 $ 282.0 $ 302.3
California
Dollars $156,933 $125,282 $ 38,248
Homes closed 409 365 108
Average sales price $ 383.7 $ 343.2 $ 354.1
SALES CONTRACTS
Total
Dollars $700,104 $604,444 $388,158
Homes ordered 3,016 2,480 1,840
Average sales price $ 232.1 $ 243.7 $ 211.0
Texas
Dollars $255,811 $240,054 $191,655
Homes ordered 1,516 1,368 1,198
Average sales price $ 168.7 $ 175.5 $ 160.0
13
Arizona
Dollars $309,170 $196,567 $127,408
Homes ordered 1,165 643 436
Average sales price $ 265.4 $ 305.7 $ 292.2
California
Dollars $135,123 $167,823 $ 69,095
Homes ordered 335 469 206
Average sales price $ 403.4 $ 357.8 $ 335.4
DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
NET SALES BACKLOG ($ IN THOUSANDS)
Total
Dollars $374,951 $309,901 $199,445
Homes in backlog 1,602 1,246 885
Average sales price $ 234.1 $ 248.7 $ 225.4
Texas
Dollars $115,651 $119,564 $ 93,983
Homes in backlog 693 695 566
Average sales price $ 166.9 $ 172.0 $ 166.0
Arizona
Dollars $205,985 $115,211 $ 72,878
Homes in backlog 776 344 216
Average sales price $ 265.4 $ 334.9 $ 337.4
California
Dollars $ 53,315 $ 75,126 $ 32,584
Homes in backlog 133 207 103
Average sales price $ 400.9 $ 362.9 $ 316.3
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
HOME SALES REVENUE. The increases in total home sales revenue and number of
homes closed in 2001 compared to 2000 resulted mainly from the strong market
activity at the time the orders for these closings were taken in some of our
divisions, continued growth in our mid-priced communities in Arizona and the May
2001 addition of Hancock Communities to our Phoenix operations. These increases
were somewhat offset by decreases in closings in our Monterey Phoenix and Austin
divisions in 2001, due to weaker demand in the luxury price segment and a weaker
local economy, respectively. Hancock contributed 673 closings with a sales value
of approximately $122.5 million to our 2001 results. The decreases in average
home sales prices in Arizona for the year 2001 reflect a change in our product
mix, as we are now selling more first-time and first and second time move-up
homes than in 2000, due in large part to the Hancock acquisition.
SALES CONTRACTS. Sales contracts for any period represent the aggregate
sales price of all homes ordered by customers, net of cancellations. We do not
include sales contingent upon the sale of a customer's existing home as a sales
contract until the contingency is removed. Contributing to the increase in sales
contracts for the year 2001 from the previous year were 484 new contracts from
Hancock Communities acquisition along with strong markets early in the year. As
a whole, we benefited from low mortgage interest rates, generally low
unemployment figures and improved home affordability early in 2001. We saw
declines in new orders in our Monterey Phoenix, Northern California and Austin
divisions in 2001, and believe this is due to a slowing in demand for luxury
homes and weaker local economies in the Northern California and Austin markets.
Historically, we have experienced a cancellation rate approximating 25% of gross
sales, which we believe is consistent with industry norms.
14
NET SALES BACKLOG. Backlog represents net sales contracts that have not
closed. Total dollar backlog at December 31, 2001 increased 21% over the 2000
amount due to a 29% increase in the number of homes in backlog from increased
homes sales over last year and increased sales prices in some of our markets.
The increase in the number of homes resulted mainly from our Hancock
acquisition, which contributed 421 homes with a sales value of approximately
$84.9 million to our December 31, 2001, backlog. Backlog in our Monterey
Phoenix, Northern California and Austin divisions decreased in 2001 due to a
slowing in demand for higher-priced homes and weaker local economies in the
Northern California and Austin markets.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
HOME SALES REVENUE. The increase in total home sales revenue and number of
homes closed in 2000 compared to 1999 resulted mainly from strong market
performance in all of our divisions, as well as the expansion of our operations
in Northern California and in our mid-priced Meritage Phoenix division in
Arizona. The decreases in average home sales prices in Arizona and Northern
California for the year 2000 reflect a change in our product mix, as we are sold
more mid-priced homes in 2000 than in 1999.
SALES CONTRACTS. Total sales contracts increased in 2000 compared to 1999
due mainly to the expansion of our operations in Northern California and our
mid-priced Meritage Phoenix division in Arizona, along with continued economic
strength of our operating markets during 2000.
NET SALES BACKLOG. Total dollar backlog at December 31, 2000, increased 55%
over the 1999 amount due to an increase in the number of homes in backlog and
increased sales prices in most of our markets. Homes in backlog at December 31,
2000, increased 41% over the same period in the prior year. These increases
resulted from expansion of our operations in Northern California, and in our
mid-priced Meritage Phoenix division in Arizona, along with the continued
strength of our other markets during 2000.
OTHER OPERATING INFORMATION
YEARS ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
-------- -------- -------
HOME SALES GROSS PROFIT ($ IN THOUSANDS)
Dollars $157,136 $104,225 $63,810
Percent of home sales revenue 21.2% 20.2% 19.1%
COMMISSIONS AND OTHER SALES COSTS
Dollars $ 41,085 $ 28,680 $19,243
Percent of home sales revenue 5.5% 5.6% 5.8%
GENERAL AND ADMINISTRATIVE EXPENSES
Dollars $ 35,723 $ 21,215 $15,100
Percent of total revenue 4.8% 4.1% 4.4%
INCOME TAXES
Dollars $ 32,444 $ 21,000 $13,269
Percent of earnings before income taxes
and extraordinary items 38.9% 37.0% 41.2%
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
HOME SALES GROSS PROFIT. Home sales gross profit represents home sales
revenue, net of cost of home sales, which include developed lot costs, home
construction costs, an allocation of common community costs (such as model
complex costs and architectural, legal and zoning costs), interest, sales tax,
warranty, construction overhead and closing costs. The dollar increase in gross
profit for the year ended December 31, 2001, is attributable to the 47% increase
in the number of 2001 home closings over 2000 closings and to the strong housing
demand in our markets at the time these homes were sold. We were also able to
benefit from a reasonably favorable market for home construction materials,
15
which resulted in lower construction cost increases than incurred in prior
years.
COMMISSIONS AND OTHER SALES COSTS. Commissions and other sales costs, such
as advertising and sales office expenses, were approximately $41.1 million, or
5.5% of home sales revenue in 2001, as compared to approximately $28.7 million,
or 5.6% of home sales revenue in 2000. The slight decrease in these expenses as
a percentage of home sales revenue reflects greater efficiencies in controlling
costs.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were approximately $35.7 million, or 4.8% of total revenue in 2001, as compared
to approximately $21.2 million, or 4.1% of total revenue in 2000. The higher
expense as a percentage of total revenue in 2001 in comparison to 2000 resulted
from an increase in insurance costs and increased overhead related to our
Hancock acquisition. In addition, the increase in the number of closings in our
Northern California region in 2001 resulted in a greater earn-out payment per
the terms of the purchase contract when we acquired the division. The earn-out,
which terminates in June 2002, is calculated based on 20 percent of the pre-tax
earnings of the Northern California region after reduction for a capital charge.
INCOME TAXES. The increase in income taxes to $32.4 million for the year
ended December 31, 2001, from $21.0 million in the prior year resulted from an
increase in pre-tax income. The tax benefit associated with the exercise of
employee stock options reduced taxes currently payable by approximately $2.5
million for the year ended December 31, 2001, which resulted in a more favorable
tax rate. The tax benefit was credited to additional paid-in capital.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
HOME SALES GROSS PROFIT. The dollar increase in gross profit for the year
ended December 31, 2000, is attributable to the increase in number of homes
closed and continued growth in all of our markets in 2000. The gross profit
percentage increase in 2000 resulted from home-pricing increases in many of our
communities due to a continued strong homebuilding market and due to decreases
in some of our costs of materials resulting from purchasing efficiencies.
COMMISSIONS AND OTHER SALES COSTS. Commissions and other sales costs were
approximately $28.7 million, or 5.6% of home sales revenue in 2000, as compared
to approximately $19.2 million, or 5.8% of home sales revenue in 1999. The
decrease in these expenses as a percentage of home sales revenue reflects
greater efficiency related to economies of scale resulting from revenue growth.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were approximately $21.2 million, or 4.1% of total revenue in 2000, as compared
to approximately $15.1 million, or 4.4% of total revenue in 1999. The higher
expense as a percentage of revenue in 1999 includes approximately $600,000
related to the buyout of an employment agreement of a former managing director.
Operating costs in 1999 were also higher as a percentage of revenue due to
overhead increases incurred related to our California expansion and the start-up
of our new Meritage division in Phoenix, Arizona.
INCOME TAXES. The increase in income taxes to $21.0 million for the year
ended December 31, 2000, from $13.3 million in the prior year resulted from an
increase in pre-tax income, partially offset by a slightly lower effective tax
rate. The tax benefit associated with the exercise of employee stock options
reduced taxes currently payable by approximately $1.9 million for the year ended
December 31, 2000. This amount was credited to additional paid in capital.
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 short-term working capital requirements and we issue equity
or debt in order to meet long-term capital requirements.
Cash flow for each of our communities depends on the status of the
development cycle, and can differ substantially from reported earnings. Early
stages of development or expansion require significant cash outlays for land
16
acquisitions, plat and other approvals, and construction of model homes, roads,
certain utilities, general landscaping and other amenities. Because these costs
are capitalized, income reported for financial statement purposes during those
early stages may significantly exceed cash flow. Later, cash flow can
significantly exceed earnings reported for financial statement purposes, as cost
of sales includes charges for substantial amounts of previously expended costs.
At December 31, 2001, we had short-term secured revolving construction
loans and acquisition and development facilities totaling $175.0 million, of
which approximately $16.2 million was outstanding. An additional $128.4 million
of unborrowed funds supported by approved collateral were available under our
credit facilities at that date, subject to compliance with the financial and
other covenants in our loan agreements. This additional borrowing was limited to
approximately $93 million under such loan covenants at December 31, 2001.
On May 30, 2001, we issued $165 million in principal amount of 9.75% senior
notes due June 1, 2011. Approximately $66 million of this offering was used to
complete the acquisition of the assets and liabilities of Hancock Communities,
approximately $78 million was used to pay down existing bank debt, approximately
$5.1 million was used to pay costs related to the bond offering and
approximately $15.9 million was used to repay existing senior notes. This early
repayment of debt resulted in prepayment fees of approximately $731,000, which,
net of the related income tax benefit, resulted in an extraordinary loss of
approximately $445,000 in the second quarter of 2001.
In September 2001, we purchased and retired $10 million in principal amount
of our outstanding 9.75% senior notes. The purchases were made at 93.25% of par
at a gain of approximately $348,000, which net of related income tax effect of
$136,000, resulted in an extraordinary gain of $212,000.
Our senior notes require us to comply with a number of covenants that
restrict certain transactions, including:
* limitations on additional indebtedness;
* limitations on the payment of dividends, redemption of equity
interests and certain investments;
* maintenance of a minimum level of consolidated tangible net worth;
* limitations on liens securing certain obligations; and
* limitations on the sale of assets, mergers and consolidations and
transactions with affiliates.
We believe that our current borrowing capacity, cash on hand at December
31, 2001, and anticipated cash flows from operations are sufficient to meet
liquidity needs for the foreseeable future. There is no assurance, however, that
future cash flows 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 notes and by the terms of our other credit
agreements.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at December 31, 2001,
and the effect such obligations are expected to have on our liquidity and cash
flow in future periods (in thousands):
PAYMENTS DUE BY PERIOD
LESS THAN AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
----------------------- ----- ------ --------- --------- -------
Senior notes $155,000 -- -- -- $155,000
Revolving construction facilities 16,207 $15,590 $ 617 -- --
A & D facilities 6,204 3,103 3,101 -- --
Other borrowing obligations 150 150 -- -- --
Operating lease obligations 6,853 3,049 3,555 $ 249 --
Recourse option obligations 20,378 15,829 4,549 -- --
-------- ------- ------- ----- --------
Total $204,792 $37,721 $11,822 $ 249 $155,000
======== ======= ======= ===== ========
17
We do not engage in commodity trading or other similar activities. We have
no derivative financial instruments as of December 31, 2001 and 2000.
As a component of our model home construction activities, we enter into
lease transactions with third parties. The total cost, including land costs, of
model homes leased by us and constructed under these lease agreements is $19.0
million, all of which is excluded from our balance sheet as of December 31,
2001.
In May 1999, we announced a stock repurchase program in which our Board of
Directors approved the buyback of up to $6 million of our outstanding common
stock. The amount was increased to $20 million in July 2000. In 2001 we
repurchased 7,000 shares of our common stock at an average price of $29.63 per
share. As of December 31, 2001, 818,963 shares had been repurchased for an
aggregate price of approximately $11.2 million.
CONSOLIDATED CASH FLOW
In 2001 we used $92.9 million in cash from our operating and investing
activities, and available cash decreased by $1.0 million. This decrease in cash
was caused primarily by our acquisition of Hancock, repayments on our lines of
credit and increased purchases of real estate, offset by the issuance of our
9.75% senior notes.
Operating activities used cash of $19.8 million in 2001, compared with cash
generated of $6.3 million in 2000 and cash used of $36.4 million in 1999. The
decrease in 2001 resulted from increases in our real estate, option deposits and
homebuilding assets in conjunction with our increased homebuilding operations
and an increase in other assets from the deferred bond costs recorded in
connection with the issuance of our senior notes. Cash used in 1999 was more
than in 2000 due to higher real estate purchases in 1999 along with higher
payments on accounts payable and accrued liabilities. Also, there was no tax
benefit from stock option exercises in 1999.
Investing activities used cash of $73.0 million in 2001, compared with cash
of $8.2 million and $9.9 million used in 2000 and 1999, respectively. The
increase in cash used in 2001 primarily was due to the Hancock acquisition,
which used cash of approximately $65.8 million.
Financing activities generated cash of $91.9 million in 2001, compared with
cash used of $7.1 million in 2000 and cash generated of $47.3 million in 1999.
The increase in cash generated in 2001 mainly was due to the issuance of our
9.75% senior notes, compared to 2000. The cash used of $7.1 million in 2000
compared to cash provided by financing activities in 1999 primarily was due to
stock repurchases in the amount of $9.1 million, partially offset by the
proceeds from the exercises of stock options and the borrowings in excess of
repayments of debt.
SEASONALITY
We historically have closed more homes in the second half of the fiscal
year than in the first half, due in part to the slightly seasonal nature of the
market for our move-up and semi-custom luxury products. We expect this seasonal
trend to continue, although it may vary as operations continue to expand.
NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE
ASSETS. SFAS No. 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. Use of the
pooling-of-interests method is no longer permitted. SFAS No. 141 also includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets acquired in business combinations completed after June 30,
2001. We adopted SFAS No. 141 upon issuance.
SFAS No. 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead be tested for impairment at
least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142
will also require that intangible assets with definite useful lives be amortized
18
over their respective estimated useful lives to their estimated residual values,
and reviewed for impairment in accordance with SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF.
As of December 31, 2001, we had unamortized goodwill in the amount of
approximately $30.4 million, which will be subject to the transition provisions
of SFAS No. 142. Amortization expense related to goodwill was approximately $1.4
million and $1.1 million for the years ended December 31, 2001 and 2000,
respectively, and under the provisions of SFAS No. 142 will no longer be
recorded in the future. We adopted SFAS No. 142 on January 1, 2002. We have not
determined the impact of the adoption of SFAS No. 142 on our financial position
or results of operations.
In October 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. We
believe the adoption of SFAS No. 144 will not have a material impact on our
financial position or results of operations.
FACTORS THAT MAY AFFECT OUR FUTURE RESULTS AND FINANCIAL CONDITION
Future operating results and financial condition depend on our ability to
successfully design, develop, construct and sell homes that satisfy dynamic
customer demand patterns. Inherent in this process are factors that we must
successfully manage to achieve favorable future operating results and financial
condition. These operating and financial factors, along with many other factors,
could affect the price of our common stock and notes. Potential risks and
uncertainties that could affect future operating results and financial condition
could include the factors discussed below.
HOMEBUILDING INDUSTRY FACTORS. The homebuilding industry is cyclical and is
significantly affected by changes in economic and other conditions, such as
employment levels, availability of financing, interest rates, and consumer
confidence. These factors can negatively affect the demand for and pricing of
our homes. Homebuilders are also subject to various risks, many of which are
outside their control, including delays in construction schedules, cost
overruns, changes in governmental regulations, increases in real estate taxes
and other local government fees, and availability and cost of land, materials,
and labor. Although the principal raw materials used in the homebuilding
industry generally are available from a variety of sources, the materials are
subject to periodic price fluctuations.
The homebuilding industry is also subject to the potential for significant
variability and fluctuations in real estate availability and values. Write-downs
of our land inventories could occur if market conditions deteriorate and these
write-downs could be material in amount. Write-downs may also occur if we
purchase land at higher prices during stronger economic cycles and the value of
that land subsequently declines during slower economic cycles.
FLUCTUATIONS IN OPERATING RESULTS. We historically have experienced, and
expect to continue to experience, variability in home sales and net earnings on
a quarterly basis. As a result of such variability, our historical performance
may not be a meaningful indicator of future results. Factors that contribute to
this variability include:
* timing of home deliveries and land sales;
* our ability to acquire additional land or options for additional land
on acceptable terms;
* conditions of the real estate market in areas where we operate and of
the general economy;
* the cyclical nature of the homebuilding industry, changes in
prevailing interest rates and the availability of mortgage financing;
* costs and availability of materials and labor; and
* delays in construction schedules due to strikes, adverse weather, acts
of God, reduced subcontractor availability and governmental
restrictions.
19
INTEREST RATES AND MORTGAGE FINANCING. In general, housing demand is
adversely affected by increases in interest rates and the unavailability of
mortgage financing. Most of our buyers finance their home purchases through
third-party lenders providing mortgage financing. If mortgage interest rates
increase and, consequently, the ability of prospective buyers to finance home
purchases is adversely affected, home sales, gross margins and cash flow may
also be adversely impacted and the impact may be material. Our homebuilding
activities depend upon the availability and costs of mortgage financing for
buyers of homes owned by potential customers, as those customers (move-up
buyers) often need to sell their residences before they purchase our homes. Any
reduction of financing availability could adversely affect home sales.
Changes in federal income tax laws may also affect demand for new homes.
Various proposals have been publicly discussed to limit mortgage interest
deductions and to limit the exclusion of gain from the sale of a principal
residence. Enactment of such proposals may have an adverse effect on the
homebuilding industry in general, and on demand for our products in particular.
No meaningful prediction can be made whether any such proposals will be enacted
and, if enacted, the particular form such laws would take.
COMPETITION. The homebuilding industry is highly competitive. We compete
for sales in each of our markets with national, regional and local developers
and homebuilders, existing home resales and, to a lesser extent, condominiums
and rental housing. If we are unable to successfully compete, our financial
results and growth could suffer. Some of our competitors have significantly
greater financial resources or lower costs than we do. Competition among both
small and large residential homebuilders is based on a number of interrelated
factors, including location, reputation, amenities, design, quality and price.
Competition is expected to continue and become more intense, and there may be
new entrants in the markets in which we currently operate and in markets we may
enter in the future.
LACK OF GEOGRAPHIC DIVERSIFICATION. We have operations in Texas, Arizona
and Northern California. Failure to be more geographically diversified could
adversely impact us if the homebuilding business in our current markets should
decline, since there may not be a balancing opportunity in a stronger market in
other geographic regions.
ADDITIONAL FINANCING; LIMITATIONS. The homebuilding industry is capital
intensive and requires significant up-front expenditures to acquire land and
begin development. Accordingly, we incur substantial indebtedness to finance our
homebuilding activities. At December 31, 2001, our debt totaled approximately
$177.6 million. We may be required to seek additional capital in the form of
equity or debt financing from a variety of potential sources, including bank
financing and securities offerings. Also, lenders are increasingly requiring
developers to invest significant amounts of equity in a project both in
connection with origination of new loans as well as the extension of existing
loans. The high level of our indebtedness could have important consequences to
our stockholders, including the following:
* our ability to obtain additional financing for working capital,
capital expenditures, acquisitions or general corporate purposes may
be impaired;
* we must use a substantial portion of our cash flow from operations to
pay interest and principal on our indebtedness, which will reduce the
funds available to use for other purposes such as capital
expenditures;
* we have a higher level of indebtedness than some of our competitors,
which may put us at a competitive disadvantage and reduce our
flexibility in planning for, or responding to, changing conditions in
our industry, including increased competition; and
* we are more vulnerable to economic downturns and adverse developments
in our business.
We expect to obtain the money to pay our expenses and to pay the principal
and interest on our indebtedness from cash flow from operations. Our ability to
meet our expenses thus depends on our future performance, which will be affected
by financial, business, economic and other factors. We will not be able to
control many of these factors, such as economic conditions in the markets where
we operate and pressure from competitors. We cannot be certain that our cash
flow will be sufficient to allow us to pay principal and interest on our debt
and meet our other obligations. If we do not have enough money, we may be
20
required to refinance all or part of our existing debt, sell assets or borrow
more money. We cannot guarantee that we will be able to do so on terms
acceptable to us, if at all. In addition, the terms of existing or future debt
agreements may restrict us from pursuing any of these alternatives.
OPERATING AND FINANCIAL LIMITATIONS. The indenture for our senior notes and
credit facilities impose significant operating and financial restrictions on us.
These restrictions will limit our ability, among other things, to:
* incur additional indebtedness;
* pay dividends or make other distributions;
* repurchase our stock;
* make investments;
* sell assets;
* enter into agreements restricting our subsidiaries' ability to pay
dividends;
* enter into transactions with affiliates; and
* consolidate, merge or sell all or substantially all of our assets.
In addition, the indenture for our senior notes requires us to maintain a
minimum consolidated tangible net worth and our credit facilities require us to
maintain other specified financial ratios. We cannot assure that these covenants
will not adversely affect our ability to finance our future operations or
capital needs or to pursue available business opportunities. A breach of these
covenants or our inability to maintain the required financial ratios could
result in a default in respect of the related indebtedness. If a default occurs,
the relevant lenders could declare the indebtedness, together with accrued
interest and other fees, to be immediately due and payable and proceed against
any collateral securing that indebtedness.
GOVERNMENT REGULATIONS; ENVIRONMENTAL CONDITIONS. Regulatory requirements
could cause us to incur significant liabilities and costs and could restrict our
business activities. We are subject to local, state, and federal statutes and
rules regulating certain developmental matters, as well as building and site
design. We are subject to various fees and charges of governmental authorities
designed to defray the cost of providing certain governmental services and
improvements. We may be subject to additional costs and delays or may be
precluded entirely from building projects because of "no growth" or "slow
growth" initiatives, building permit ordinances, building moratoriums, or
similar government regulations that could be imposed in the future due to
health, safety, welfare, or environmental concerns. We must also obtain
licenses, permits and approvals from government agencies to engage in certain
activities, the granting or receipt of which are beyond our control.
We are also subject to a variety of local, state and federal statutes,
ordinances, rules and regulations concerning the protection of health and the
environment. Environmental laws or permit restrictions may result in project
delays, may cause substantial compliance and other costs and may prohibit or
severely restrict development in certain environmentally sensitive regions or
geographic areas. Environmental regulations can also have an adverse impact on
the availability and price of certain raw materials such as lumber.
RECENT ACQUISITION. During 2001 we acquired Hancock Communities and we
cannot assure you that:
* the Hancock business will be integrated with our existing business;
* the market and financial synergies we anticipate will be achieved in
our expected time frame, or at all;
* the acquisition will be accretive to earnings due to unexpected
expenses, contingencies or liabilities, or due to the financial
performance of the Hancock business;
* the combined companies will not lose key employees, management,
suppliers or subcontractors; and
* we can successfully manage new housing lines that were previously
managed by Hancock or new lines planned for the future.
FUTURE EXPANSION. We may continue to consider growth or expansion of our
operations in our current markets or in other areas of the country. There can be
no assurance that we will be able to expand into new or existing markets without
21
a material adverse effect on our cash flows or profitability. The magnitude,
timing and nature of any future expansion will depend on a number of factors,
including suitable acquisition candidates, the negotiation of acceptable terms,
our financial capabilities, and general economic and business conditions. New
acquisitions may result in the incurrence of additional debt. Acquisitions also
involve numerous risks, including difficulties in the assimilation of the
acquired company's operations, the incurrence of unanticipated liabilities or
expenses, the diversion of management's attention from other business concerns,
risks of entering markets in which we have limited or no direct experience and
the potential loss of key employees of the acquired company.
DEPENDENCE ON KEY PERSONNEL. Our success largely depends on the continuing
services of certain key employees, including John Landon and Steve Hilton, and
our continued favorable development depends on our ability to attract new
personnel. We do not have employment agreements with certain key officers, and
the loss of their services could harm our business.
DEPENDENCE ON SUBCONTRACTORS. We conduct our construction operations only
as a general contractor. Virtually all architectural and construction work is
performed by unaffiliated third-party subcontractors. As a consequence, we are
dependent upon the continued availability of and satisfactory performance by
these subcontractors for the design and construction of our homes. There is no
assurance that there will be sufficient availability of and satisfactory
performance by these unaffiliated third-party subcontractors. In addition,
inadequate subcontractor resources could have a material adverse affect on our
business.
INFLATION. We, like other homebuilders, may be adversely affected during
periods of high inflation, mainly because of higher land and construction costs.
Also, higher mortgage interest rates may significantly affect the affordability
of mortgage financing to prospective buyers. Inflation also increases our cost
of financing, materials and labor, and could cause our financial results or
growth to decline. We attempt to pass cost increases on to our customers through
higher sales prices. To date, inflation has not had a material adverse effect on
our results of operations; however, inflation could impact our future operating
results.
NATURAL DISASTERS. We have significant homebuilding operations in Texas and
Northern California. Some of our markets in Texas occasionally experience severe
weather conditions such as tornadoes or hurricanes. Northern California has been
heavily impacted at times by earthquakes, flooding, landslides and other natural
disasters. We do not insure against some of these risks. These conditions could
cause us to incur damage to or losses of our homes under construction or our
building lots that exceed our insurance and could cause significant
constructions delays or substantial fluctuations in the pricing or availability
of building materials. Any of these events could cause a decrease in our
revenues, cash flow and earnings.
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS
In passing the Private Securities Litigation Reform Act of 1995 (the
"PSLRA"), Congress encouraged public companies to make "forward-looking
statements" by creating a safe-harbor to protect companies from securities law
liability in connection with forward-looking statements. We intend to qualify
both our written and oral forward-looking statements for protection under the
PSLRA.
The words "believe," "expect," "anticipate," "forecast," "plan," 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 1993, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Forward-looking statements in this Form 10-K include statements
concerning the demand for and the pricing of our homes, our ability to deliver
existing backlog, the expected outcome of legal proceedings against us, the
sufficiency of our capital resources, the impact of new accounting standards,
the future realizability of deferred tax assets, the expectation of continued
positive operating results in 2002 and beyond, the expected benefits of the
Hancock acquisition, including future home closings and Hancock's future
contribution to our revenues and earnings, and our ability to continue positive
operating results in light of current economic conditions. Such statements are
subject to significant risks and uncertainties.
22
Important factors currently known to management that could cause actual
results to differ materially from those in forward-looking statements, and that
could negatively affect our business, and stock and note prices are discussed in
this report under the heading "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Factors That May Affect Our Future Results
and Financial Condition."
Forward-looking statements express expectations of future events. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they are subject to
numerous known and unknown risks and uncertainties that could cause actual
events or results to differ materially from those projected. Due to these
inherent uncertainties, the investment community is urged not to place undue
reliance on forward-looking statements. In addition, we undertake no obligations
to update or revise forward-looking statements to reflect changed assumptions,
the occurrence of anticipated events or changes to projections over time. As a
result of these and other factors, our stock and note prices may fluctuate
dramatically.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not enter into derivative financial instruments for trading purposes,
although we do have other financial instruments in the form of notes payable and
senior debt. 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.
The interest rate on our senior debt is at a fixed rate. We do not have an
obligation to prepay our fixed-rate debt prior to maturity and, as a result,
interest rate risk and changes in fair value should not have a significant
impact in the fixed rate debt until we would be required to refinance such debt.
For example, based on an average bank borrowings of $81.1 million during
2001, if the interest rate indices on which our bank borrowing rates are based
were to increase 100 basis points in 2002, interest incurred would increase and
cash flows would decrease in 2002 by $811,000. A portion of the increased
interest would be expensed as a period cost in 2002, while the balance would be
capitalized to real estate under development and be expensed as a cost of home
sales in 2002 and future years.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements as of December 31, 2001 and 2000 and
for each of the years in the three-year period ended December 31, 2001, together
with related notes and the report of KPMG LLP, independent auditors, are on the
following pages. Other required financial information is more fully described in
Item 14.
23
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Meritage Corporation:
We have audited the accompanying consolidated balance sheets of Meritage
Corporation and subsidiaries (the Company) as of December 31, 2001 and 2000, and
the related consolidated statements of earnings, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2001.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Meritage
Corporation and subsidiaries as of December 31, 2001 and 2000, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Phoenix, Arizona
February 6, 2002
24
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------
2001 2000
--------- ---------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash and cash equivalents $ 3,383 $ 4,397
Real estate 330,238 211,307
Deposits on real estate under option or contract 45,252 24,251
Receivables 5,508 2,179
Deferred tax asset 2,612 543
Goodwill 30,369 17,675
Property and equipment, net 9,667 4,717
Prepaid expenses and other assets 9,686 2,006
--------- ---------
Total assets $ 436,715 $ 267,075
========= =========
LIABILITIES
Accounts payable and accrued liabilities $ 69,029 $ 48,907
Home sale deposits 13,538 10,917
Notes payable 177,561 86,152
--------- ---------
Total liabilities 260,128 145,976
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, par value $0.01. Authorized 50,000,000
shares; issued and outstanding 6,306,969 and 5,922,822
shares at December 31, 2001 and 2000, respectively 63 59
Additional paid-in capital 109,475 104,443
Retained earnings 78,272 27,613
Treasury stock at cost, 818,963 and 811,963 shares at
December 31, 2001 and 2000, respectively (11,223) (11,016)
--------- ---------
Total stockholders' equity 176,587 121,099
--------- ---------
Total liabilities and stockholders' equity $ 436,715 $ 267,075
========= =========
See accompanying notes to consolidated financial statements
25
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Home sales revenue $ 742,576 $ 515,428 $ 334,007
Land sales revenue 1,598 5,039 7,779
--------- --------- ---------
744,174 520,467 341,786
--------- --------- ---------
Cost of home sales (585,440) (411,203) (270,197)
Cost of land sales (1,474) (4,446) (7,090)
--------- --------- ---------
(586,914) (415,649) (277,287)
--------- --------- ---------
Home sales gross profit 157,136 104,225 63,810
Land sales gross profit 124 593 689
--------- --------- ---------
157,260 104,818 64,499
Commissions and other sales costs (41,085) (28,680) (19,243)
General and administrative expenses (35,723) (21,215) (15,100)
Interest expense -- (8) (6)
Other income, net 2,884 1,847 2,064
--------- --------- ---------
Earnings before income taxes and extraordinary items 83,336 56,762 32,214
Income taxes (32,444) (21,000) (13,269)
--------- --------- ---------
Earnings before extraordinary items 50,892 35,762 18,945
Extraordinary items, net of tax effects (233) -- --
--------- --------- ---------
Net earnings $ 50,659 $ 35,762 $ 18,945
========= ========= =========
Earnings per share:
Basic:
Earnings before extraordinary items $ 9.59 $ 6.92 $ 3.49
Extraordinary items, net of tax effects (0.04) -- --
--------- --------- ---------
Net earnings per share $ 9.55 $ 6.92 $ 3.49
========= ========= =========
Diluted:
Earnings before extraordinary items $ 8.64 $ 6.26 $ 3.14
Extraordinary items, net of tax effects (0.04) -- --
--------- --------- ---------
Net earnings per share $ 8.60 $ 6.26 $ 3.14
========= ========= =========
See accompanying notes to consolidated financial statements
26
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(IN THOUSANDS)
RETAINED
ADDITIONAL EARNINGS
NUMBER OF COMMON PAID-IN (ACCUMULATED TREASURY
SHARES STOCK CAPITAL DEFICIT) STOCK TOTAL
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1998 5,335 $ 53 $ 99,320 $ (27,094) $ -- $ 72,279
Net earnings -- -- -- 18,945 -- 18,945
Exercise of stock options 51 1 495 -- -- 496
Contingent shares issued 89 1 (1) -- -- --
Stock option and contingent stock
compensation expenses -- -- 593 -- -- 593
Purchase of treasury stock -- -- -- -- (1,902) (1,902)
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1999 5,475 55 100,407 (8,149) (1,902) 90,411
Net earnings -- -- -- 35,762 -- 35,762
Tax benefit from stock option
exercises -- -- 1,917 -- -- 1,917
Exercise of stock options 359 3 2,047 -- -- 2,050
Contingent shares issued 89 1 (1) -- -- --
Stock option and contingent stock
compensation expenses -- -- 73 -- -- 73
Purchase of treasury stock -- -- -- -- (9,114) (9,114)
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2000 5,923 59 104,443 27,613 (11,016) 121,099
Net earnings -- -- -- 50,659 -- 50,659
Tax benefit from stock option
exercises -- -- 2,486 -- -- 2,486
Exercise of stock options 384 4 2,546 -- -- 2,550
Purchase of treasury stock -- -- -- -- (207) (207)
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2001 6,307 $ 63 $ 109,475 $ 78,272 $ (11,223) $ 176,587
========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements
27
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 50,659 $ 35,762 $ 18,945
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities:
Depreciation and amortization 5,741 3,407 2,528
(Increase) decrease in deferred tax asset before
extraordinary items (2,069) 156 6,236
Stock option and contingent stock compensation expenses -- 73 593
Tax benefit from stock option exercises 2,486 1,917 --
Changes in assets and liabilities, net of effect of
acquisition in 2001:
Increase in real estate (64,386) (40,295) (66,254)
Increase in deposits on real estate under option or
contract contract (12,102) (8,551) (8,361)
(Increase) decrease in receivables and prepaid expenses
and other assets (13,526) (1,241) 680
Increase in accounts payable and accrued liabilities 13,232 12,368 9,572
Increase (decrease) in home sale deposits 118 2,656 (326)
--------- --------- ---------
Net cash provided by (used in) operating
activities (19,847) 6,252 (36,387)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for merger/acquisition (65,759) (5,158) (6,967)
Purchases of property and equipment (7,270) (3,017) (2,935)
--------- --------- ---------
Net cash used in investing activities (73,029) (8,175) (9,902)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings 527,910 447,269 273,824
Repayments of debt (578,391) (447,054) (225,093)
Proceeds from issuance of senior debt 165,000 -- --
Repayments of senior debt (25,000) -- --
Purchase of treasury stock (207) (9,114) (1,902)
Proceeds from exercises of stock options 2,550 1,797 495
--------- --------- ---------
Net cash provided by (used in) financing activities 91,862 (7,102) 47,324
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents (1,014) (9,025) 1,035
Cash and cash equivalents, beginning of year 4,397 13,422 12,387
--------- --------- ---------
Cash and cash equivalents, end of year $ 3,383 $ 4,397 $ 13,422
========= ========= =========
See Supplemental Disclosure of Cash Flow Information at Note 9.
See accompanying notes to consolidated financial statements
28
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS. We are a leading designer and builder of single-family homes in
the rapidly growing Sunbelt states of Texas, Arizona and California. 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. To expand our presence
in Arizona, we acquired Hancock Communities (Hancock), another well-established
homebuilder that serves the first-time and move-up markets in the Phoenix area,
in 2001.
BASIS OF PRESENTATION. The accompanying consolidated financial statements
include the accounts of Meritage Corporation and our wholly owned subsidiaries.
Intercompany balances and transactions have been eliminated in consolidation and
certain amounts have been reclassified to be consistent with current financial
statement presentation. Financial results include the operations of Hancock from
May 31, 2001, the date of acquisition (See Note 4).
CRITICAL ACCOUNTING POLICIES AND ESTIMATES. The preparation of our
consolidated financial statements required us to make a number of estimates and
assumptions that affect the reported amounts and disclosures in the consolidated
financial statements. On an ongoing basis, we evaluate these estimates and
assumptions based upon historical experience and various other factors and
circumstances. We believe that our estimates and assumptions are reasonable in
the circumstances; however, actual results may differ from these estimates and
assumptions under different future conditions.
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 developments, the ultimate recoverability (or
impairment) of these costs, the likelihood of closing lots held under option or
contract 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 individual home sales
may be uncertain. Furthermore, non-refundable deposits paid for land options or
contracts may have no economic value to us if the land is not ultimately
purchased. Finally, our inability to accurately estimate expenses or accruals
could result in charges or income in the future results of operations related to
activities or transactions in a preceding period.
CASH AND CASH EQUIVALENTS. We consider all highly liquid investments with
an initial maturity of three months or less to be cash equivalents. Amounts in
transit from title companies for home closings of approximately $317,000 and
$5.5 million are included in cash and cash equivalents at December 31, 2001 and
2000, respectively.
REAL ESTATE. Real estate consists of raw land, lots under development,
homes under construction, completed homes and land held for development. This
real estate is carried at cost unless such costs would not be recovered from the
cash flows generated by future disposition. In such case, amounts are carried at
estimated fair value less disposal costs. Costs capitalized include direct
construction costs for homes, development period interest and certain common
costs that benefit the entire community. Common costs are incurred on a
community-by-community basis and allocated to residential lots based on the
number of lots to be built in the project, which approximates the relative sales
value method.
Deposits paid related to land options and contracts to purchase land are
capitalized when incurred and classified as deposits on real estate under option
or contract until the related land is purchased. The deposits are then
transferred to real estate at the time the lots are acquired. The deposits are
charged to expense if the land acquisition is no longer considered probable.
29
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
COST OF HOME SALES. Cost of home sales includes land acquisition and
development costs, direct home construction costs, development period interest,
closing costs and an allocation of common costs.
REVENUE RECOGNITION AND CLASSIFICATION OF COSTS. Revenues from sales of
residential real estate and related activities are recognized when closings have
occurred, the buyer has made the required minimum down payment and other
criteria for sale and profit recognition are satisfied.
Estimated future warranty costs are charged to cost of sales in the period
when the revenues from the related home closings are recognized. These estimated
warranty costs generally range from 0.3% to 0.5% of the home's sales price.
PROPERTY AND EQUIPMENT. Property and equipment, generally consisting of
computer and office equipment and model home furnishings, is stated at cost less
accumulated depreciation. Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets, which range from three to
seven years. Accumulated depreciation was approximately $7.1 million and $5.4
million at December 31, 2001 and 2000, respectively. Maintenance and repair
costs are expensed as incurred.
GOODWILL. Goodwill represents the excess of purchase price over fair value
of net tangible assets and identifiable intangible assets acquired, and is being
amortized on a straight-line basis over a 20-year period. Accumulated
amortization was approximately $4.3 million and $2.8 million at December 31,
2001 and 2000, respectively. Management periodically evaluates the business to
which the goodwill relates to determine if the carrying value of goodwill has
been impaired. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting our average cost of funds. No goodwill impairment was recorded in the
accompanying statements of earnings. In accordance with Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002, goodwill will no longer be amortized but reviewed for
impairment at least annually.
DEFERRED BOND COSTS. We incurred costs of approximately $5.2 million in
relation to the 2001 issuance of our 9.75% senior notes, due June 2011. We have
deferred these bond costs and are amortizing them using the effective interest
method over the life of the bonds. At December 31, 2001, approximately $4.9
million of deferred bond costs, net of amortization, was included on our balance
sheet as prepaid expenses and other assets.
INCOME TAXES. We account for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under the asset and liability method of SFAS No.
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using the enacted tax
rates expected to apply to taxable income in future years and are subsequently
adjusted for changes in the rates. The effect on deferred tax assets and
liabilities of a change in tax rates is a charge or credit to deferred tax
expense in the period of enactment.
EARNINGS PER SHARE. We compute basic earnings per share by dividing
earnings available to common stockholders by the weighted-average number of
common shares outstanding during the year. Diluted earnings per share reflects
the potential dilution that could occur if dilutive securities or contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in our earnings.
STOCK OPTION PLANS. We have elected to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion (APB) No. 25, as allowed by SFAS No. 123 "Accounting for Stock-Based
30
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Compensation." As such, compensation expense would be recorded on the date of
the grant only if the market price of the stock underlying the grant was greater
than the exercise price. To date, we have only granted options to employees and
non-employee directors. The pro forma disclosures that are required by SFAS No.
123 are presented in Note 6.
FAIR VALUE OF FINANCIAL INSTRUMENTS. Due to the short-term nature of these
investments, we consider the carrying amounts of our short-term financial
instruments to be at fair value. Our lines of credit and acquisition and
development loans carry interest rates that are variable and/or comparable to
current market rates based on the nature of the loans, their terms and remaining
maturity, and therefore are stated at approximate fair value. Considerable
judgment is required in interpreting market data to develop estimates of fair
value. Accordingly, these fair value estimates are subjective and not
necessarily indicative of the amounts we would pay or receive in actual market
transactions. (See Note 8.)
NOTE 2 - REAL ESTATE AND CAPITALIZED INTEREST
The components of real estate at December 31 are as follows (in thousands):
2001 2000
-------- --------
Homes under contract, in production $135,005 $ 92,881
Finished home sites 81,151 60,630
Home sites under development 57,291 27,636
Homes held for resale 33,278 15,337
Model homes 18,289 11,600
Land held for development 5,224 3,223
-------- --------
$330,238 $211,307
======== ========
We capitalize certain interest costs incurred during development and
construction. Capitalized interest is allocated to real estate and charged to
cost of sales when the property is closed. Summaries of interest capitalized and
interest expensed follow (in thousands):
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
-------- --------
Interest capitalized, beginning of year $ 5,426 $ 3,971
Interest capitalized 16,623 10,626
Amortization to cost of home and land sales (13,303) (9,171)
-------- --------
Interest capitalized, end of year $ 8,746 $ 5,426
======== ========
Interest incurred $ 16,623 $ 10,634
Interest capitalized (16,623) (10,626)
-------- --------
Interest expensed $ -- $ 8
======== ========
The purchase of real estate under option contracts with specific
performance is dependent upon the completion of certain requirements by the
sellers and us. At December 31, 2001, we had approximately 702 lots with an
aggregate purchase price of approximately $20.4 million under option contracts
with specific performance. Real estate under option or contact and related
deposits are summarized below (dollars in thousands):
DEPOSITS ON
REAL ESTATE
UNDER OPTION
# LOTS OR CONTRACT
------- ------------
Real estate under option or contract
with specific performance 702 $ 1,730
Real estate under option or contract
with non-specific performance 9,909 43,522
------- -------
10,611 $45,252
======= =======
31
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 3 - NOTES PAYABLE
Notes payable at December 31 consist of the following:
2001 2000
-------- --------
(IN THOUSANDS)
$100 million bank revolving construction line of credit, interest payable
monthly approximating prime (4.75% at December 31,2001) or LIBOR (rates
varying from 1.87% to 1.88% at December 31, 2001) plus 2.0%, payable at the
earlier of close of escrow, maturity date of individual homes and lots within
the collateral pool or over a 24-month period beginning on June 1, 2003,
secured by first deeds of trust on real estate $ 617 $ 50,354
$75 million bank revolving construction line of credit, interest payable monthly
approximating prime or LIBOR plus 2.0%, payable at the earlier of close of
escrow, maturity date of individual homes and lots within the collateral pool
or May 31, 2002, secured by first deeds of trust on real estate 15,590 17,269
Acquisition and development seller carry back financing, interest payable
monthly at fixed rates of 9% to 10% per annum; payable at the maturity date
of the individual projects, secured by first deeds of trust on land 6,204 3,516
Senior unsecured notes, maturing June 1, 2011, interest only payments at 9.75% per
annum, payable semi-annually 155,000 --
Senior unsecured notes, paid in full May 30, 2001 -- 15,000
Other 150 13
-------- --------
Total $177,561 $ 86,152
======== ========
In May 2001, we issued $165 million in principal amount of 9.75% senior
notes due June 1, 2011. Approximately $15.9 million of this amount was used to
repay our existing senior notes. The early repayment of debt resulted in
prepayment fees of approximately $731,000, which, net of the related income tax
benefit of approximately $286,000, resulted in an extraordinary loss of
$445,000.
In September 2001, we purchased and retired $10 million in principal amount
of our outstanding 9.75% senior notes for 93.25% of par. The purchases resulted
in an extraordinary gain of $212,000 (net of approximately $136,000 in income
taxes).
Scheduled maturities of notes payable as of December 31, 2001 follow (in
thousands):
YEARS ENDING
DECEMBER 31,
------------
2002 $ 18,843
2003 3,718
2004 --
2005 --
2006 --
Thereafter 155,000
--------
$177,561
========
32
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Obligations to pay principal and interest on our senior unsecured notes are
guaranteed by all of our wholly-owned subsidiaries (Guarantor Subsidiaries),
other than certain inconsequential 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.
The bank credit facilities 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 limit incurrence of indebtedness, asset dispositions and creations
of liens, among other items. As of December 31, 2001 and 2000 and for the years
ended December 31, 2001, 2000 and 1999, we were in compliance with these
covenants. The senior unsecured notes restrict our ability to pay dividends.
NOTE 4 - ACQUISITION
On May 30, 2001, we acquired substantially all of the homebuilding and
related assets of HC Builders, Inc. and Hancock Communities, L.L.C. The purchase
price was $65.8 million in cash, plus the assumption of accounts payable,
accrued liabilities and home sales deposits totaling $9.4 million and a note
payable totaling $1.9 million. In addition, we granted to Greg Hancock, the
founder of the company, an earn-out, payable in cash over three years, equal to
20% of Hancock's pre-tax net income after a 10.5% charge on capital.
This acquisition was accounted for using the purchase method of accounting.
Accordingly, we recorded goodwill of approximately $11.4 million, which
represents the excess of the purchase price over the fair value of the net
tangible and identifiable intangible assets acquired and liabilities assumed.
Prior to January 1, 2002, the goodwill was being amortized over a period of 20
years (see Note 1).
The following unaudited pro forma financial data for the years ended
December 31, 2001 and 2000 has been prepared as if the acquisition of the assets
and liabilities of Hancock on May 30, 2001 had occurred on January 1, 2000.
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 amounts had the transaction occurred on the date listed above, nor
does it purport to represent future periods (in thousands except per share
amounts):
YEARS ENDED
DECEMBER 31,
-----------------------
2001 2000
-------- --------
Revenue $796,884 $704,118
Earnings before extraordinary items 56,617 43,422
Net earnings 56,829 42,976
Diluted EPS before extraordinary items 9.62 7.60
Diluted EPS after extraordinary items 9.65 7.52
33
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 5 - EARNINGS PER SHARE
A summary of the reconciliation from basic earnings per share to diluted
earnings per share for the years ended December 31, follows (in thousands,
except per share amounts):
2001 2000 1999
-------- -------- --------
BASIC:
Earnings before extraordinary items $ 50,892 $ 35,762 $ 18,945
Extraordinary items, net of tax effects (233) -- --
-------- -------- --------
Net earnings $ 50,659 $ 35,762 $ 18,945
======== ======== ========
Weighted average number of shares outstanding 5,305 5,171 5,431
-------- -------- --------
Basic earnings per share before extraordinary items $ 9.59 $ 6.92 $ 3.49
Extraordinary items (0.04) -- --
-------- -------- --------
Basic earnings per share $ 9.55 $ 6.92 $ 3.49
======== ======== ========
DILUTED:
Earnings before extraordinary items* $ 50,892 $ 35,762 $ 18,945
Extraordinary items, net of tax effects (233) -- --
-------- -------- --------
Net earnings $ 50,659 $ 35,762 $ 18,945
======== ======== ========
Weighted average number of shares outstanding 5,305 5,171 5,431
Effect of dilutive securities:
Contingent shares and warrants -- 19 89
Options to acquire common stock 583 524 512
-------- -------- --------
Diluted weighted common shares outstanding 5,888 5,714 6,032
-------- -------- --------
Diluted earnings per share before extraordinary items $ 8.64 $ 6.26 $ 3.14
Extraordinary items (0.04) -- --
-------- -------- --------
Diluted earnings per share $ 8.60 $ 6.26 $ 3.14
======== ======== ========
Antidilutive stock options not included in diluted EPS -- 38 279
======== ======== ========
* There were no reconciling items between earnings before extraordinary items
on a basic and diluted basis.
NOTE 6 - STOCK OPTIONS
Our Board of Directors administers our stock option plan. The plan provides
for stock option grants to key personnel and directors, and provides a means of
performance-based compensation in order to attract and retain qualified
employees.
We apply APB Opinion No. 25 and related interpretations in accounting for
our plan. Under APB No. 25, if the exercise price of our stock options is equal
to the market price of the underlying stock on the date of the grant, no
compensation expense is recognized.
34
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 pro forma amounts (in thousands, except per share amounts):
2001 2000 1999
-------- -------- --------
Net earnings As reported $ 50,659 $ 35,762 $ 18,945
Pro forma 49,195 35,464 18,472
Basic earnings per share As reported 9.55 6.92 3.49
Pro forma 9.27 6.86 3.40
Diluted earnings per share As reported 8.60 6.26 3.14
Pro forma 8.36 6.21 3.06
The per share weighted average fair values of stock options granted during
2001, 2000 and 1999 were $16.64, $5.67 and $7.81, respectively, on the dates of
grant calculated using the Black-Scholes pricing model based on the following
weighted average assumptions:
2001 2000 1999
-------- -------- --------
Expected dividend yield 0% 0% 0%
Risk-free interest rate 4.79% 6.71% 4.76%
Expected volatility 55% 47% 52%
Expected life (in years) 6 6 6
THE MERITAGE PLAN
Meritage stockholders approved our current stock option plan at the 1997
Annual Stockholders Meeting. The plan authorizes grants of incentive stock
options and non-qualified stock options to our executives, directors, employees
and consultants. At December 31, 2001, a total of 662,720 shares of Meritage
common stock are reserved for issuance upon exercise of stock options granted
under this plan. The options vest over periods from two to five years from the
date such options were granted, are based on continued employment and expire
five to ten years after the date of grant.
OTHER OPTIONS
The 1988 Homeplex Mortgage Investments Corporation Stock Option Plan was in
effect at the time of the merger. No new grants were issued under this plan
since the merger, and all remaining options were exercised during 2000.
In connection with the merger and Legacy combination, Mssrs. Hilton, Landon
and Cleverly each received 166,667 non-qualified stock options with three year
vesting periods. The exercise price of these options is $5.25 per share, which
was negotiated at the time of the transactions. Mr. Hilton's and Mr. Cleverly's
options expire in December 2002. Mr. Landon exercised his options in 2001. There
are 165,834 shares of Meritage common stock reserved for issuance upon exercise
of such stock options at December 31, 2001.
35
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
SUMMARY OF STOCK OPTION ACTIVITY:
2001 2000 1999
--------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- ------- --------- ------- --------- -------
Options outstanding at beginning of year 894,000 $ 8.73 1,173,226 $ 7.65 1,028,302 $ 6.25
Granted 321,950 30.34 89,800 10.43 264,500 14.74
Exercised (384,147) 6.64 (359,026) 5.00 (51,076) 7.08
Canceled (21,440) 15.75 (10,000) 12.17 (68,500) 14.39
--------- ------- --------- ------- --------- -------
Options outstanding at end of year 810,363 $ 18.12 894,000 $ 8.73 1,173,226 $ 7.65
========= ======= ========= ======= ========= =======
Options exercisable at end of year 294,294 587,700 801,669
Price range of options exercised $5.25 - $17.63 $4.37 - $14.25 $5.62 - $11.25
Price range of options outstanding $5.25 - $41.77 $5.25 - $18.00 $4.50 - $17.63
Total shares reserved at end of year 828,554 1,226,571 1,386,583
STOCK OPTIONS OUTSTANDING AT DECEMBER 31, 2001, WERE:
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
----------------------------------------------- -------------------------
WEIGHTED WEIGHTED
WEIGHTED AVERAGE AVERAGE AVERAGE
NUMBER REMAINING EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- ------------------------ ----------- ---------------- ----- ----------- -----
$ 5.25 - $12.50 289,633 2.6 years $ 6.96 216,014 $ 6.00
$14.25 - $18.00 204,500 3.9 14.99 77,800 14.84
$28.86 - $41.77 316,230 6.5 30.37 480 28.86
-------- ---- ------- -------- ------
810,363 4.5 years $ 18.12 294,294 $ 8.37
======== ==== ======= ======== ======
NOTE 7 - INCOME TAXES
Total income tax expense was allocated as follows (in thousands):
2001 2000 1999
-------- -------- --------
Income from continuing operations $ 32,444 $ 21,000 $ 13,269
Extraordinary items (benefit) (149) -- --
-------- -------- --------
$ 32,295 $ 21,000 $ 13,269
======== ======== ========
36
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Components of income tax expense attributable to income from continuing
operations are (in thousands):
2001 2000 1999
-------- -------- --------
Current taxes:
Federal $ 29,295 $ 18,255 $ 5,748
State 5,218 2,589 1,285
-------- -------- --------
34,513 20,844 7,033
-------- -------- --------
Deferred taxes:
Federal (1,742) 140 6,121
State (327) 16 115
-------- -------- --------
(2,069) 156 6,236
-------- -------- --------
Total $ 32,444 $ 21,000 $ 13,269
======== ======== ========
Deferred tax assets and liabilities have been recognized in the consolidated
balance sheets due to the following temporary differences at December 31, 2001
and 2000 (in thousands):
2001 2000
-------- --------
Warranty reserve $ 931 $ 675
Real estate and fixed asset basis differences 247 324
Wages payable 1,719 --
Other 603 221
-------- --------
3,500 1,220
Deductible merger/acquisition costs (888) (677)
-------- --------
Net deferred tax asset $ 2,612 $ 543
======== ========
We believe it is more likely than not that future operating results will
generate sufficient taxable income to realize the net deferred tax asset.
RECONCILIATION OF EFFECTIVE INCOME TAX EXPENSE:
Income taxes differ for the years ended December 31, 2001, 2000 and 1999,
from the amounts computed using the federal statutory income tax rate as a
result of the following (in thousands):
2001 2000 1999
-------- -------- --------
Expected taxes at current federal
statutory income tax rate $ 29,355 $ 19,299 $ 10,953
State income taxes 3,097 1,719 890
Non-deductible merger/acquisition costs
and other (8) (18) 1,426
-------- -------- --------
Income tax expense $ 32,444 $ 21,000 $ 13,269
======== ======== ========
NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of our 9.75% senior notes at December 31, 2001, is
$160.4 million, based on independent dealer quotes. The recorded amount of the
senior notes at December 31, 2001 is $155 million.
37
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 9 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Additional information related to our Consolidated Statements of Cash Flows
follows (in thousands):
The 2001 acquisition of Hancock resulted in the following changes in assets and
liabilities:
Increase in real estate $(54,545)
Increase in deposits on real estate under option
or contract (8,899)
Increase in receivables and other assets (543)
Increase in goodwill (11,423)
Increase in property and equipment (1,632)
Increase in accounts payable and accrued liabilities 6,890
Increase in home sale deposits 2,503
Increase in notes payable 1,890
--------
Net cash paid for acquisition $(65,759)
========
2001 2000 1999
------- ------- -------
Cash paid during the year for:
Interest $14,722 $ 8,403 $ 5,873
Income taxes $31,160 $18,786 $ 5,423
NOTE 10 - RELATED PARTY TRANSACTIONS
We have transacted business with related or affiliated companies and with
certain officers and directors of the Company.
Since 1997, we have leased office space in Plano, Texas from Home Financial
Services, a Texas partnership owned by a co-chief executive officer and his
wife. The lease expires May 15, 2002. Rents paid to the partnership were
$193,771, $185,613 and $176,773, in 2001, 2000 and 1999, respectively, and were
recorded as general and administrative expenses.
We paid legal fees of approximately $420,000, $311,000 and $334,000 to
Tiffany & Bosco, P.A., a law firm of which one of our directors is a partner, in
2001, 2000 and 1999, respectively. These fees were recorded as general and
administrative expenses.
In 2001, we purchased 77 lots for development in Arizona at a cost of
approximately $3.5 million from a business controlled by one of our directors.
We purchased 42 lots at a cost of approximately $2.4 million from this same
business in 2000, and no lots in 1999. The land purchased from this business was
recorded as real estate on our balance sheet.
In connection with our acquisition of Hancock, we assumed the following
existing transactions with affiliates of Greg Hancock, the founder of Hancock
and now its division president at Meritage.
Mr. Hancock is the majority owner of a venture that is developing a master
planned community in Casa Grande, Arizona. We have entered into an option
contract to purchase approximately 410 acres of residential land in this
community. At December 31, 2001, we had not purchased any land, but had paid
deposits to the venture for our option, totaling approximately $750,000, which
is included in deposits on real estate under option or contract on our
accompanying balance sheet. In addition, we received from the venture, at no
cost, 185 acres of land on which to build a golf course. We have assumed
responsibility for the construction of the golf course which, as an amenity, is
expected to benefit the land under option. We also perform certain
38
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
planning and construction supervision functions for the venture for which we are
paid a management fee of 3% of the development costs. For the year ended
December 31, 2001, we earned approximately $173,000 pursuant to this
arrangement, which we recorded as other income in our statement of earnings.
At December 31, 2001, we owed approximately $1.9 million to a venture
controlled by Mr. Hancock that had sold land to Hancock. The note payable was
repaid in full in January 2002.
At December 31, 2001, Mr. Hancock owed us approximately $340,000, related
to the resolution of various post-closing matters pertaining to the Hancock
acquisition. This obligation was recorded as a receivable on our balance sheet
and was paid in full in January 2002.
NOTE 11 - SEGMENT INFORMATION
We classify our operations into two primary management segments: first-time
and volume priced homes and mid to luxury priced homes. These segments generate
revenue through the home sales to external customers. We are not dependent on
any one major customer.
Operational information relating to the different business segments
follows. 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, taxes and extraordinary items (EBIT). The accounting
policies of the business segments are the same as those described in Note 1.
There are no significant transactions between segments.
YEARS ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(IN THOUSANDS)
HOME SALES REVENUE:
First-time and volume priced $ 433,861 $ 246,953 $ 185,783
Mid to luxury priced 308,715 268,475 148,224
--------- --------- ---------
Total $ 742,576 $ 515,428 $ 334,007
========= ========= =========
EBIT:
First-time and volume priced $ 62,145 $ 35,934 $ 23,961
Mid to luxury priced 40,310 33,633 17,391
Corporate and other (5,815) (3,626) (4,094)
--------- --------- ---------
Total $ 96,640 $ 65,941 $ 37,258
========= ========= =========
DECEMBER 31,
----------------------
2001 2000
--------- ---------
(IN THOUSANDS)
ASSETS AT YEAR END:
First-time and volume priced $ 261,825 $ 140,348
Mid to luxury priced 164,156 124,359
Corporate and other 10,734 2,368
--------- ---------
Total $ 436,715 $ 267,075
========= =========
39
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 12 - COMMITMENTS AND CONTINGENCIES
We are involved in legal proceedings and claims that have arisen in the
normal course of business. Also, at December 31, 2001, we had approximately $5.2
million in reserve for various warranty claims. We believe the ultimate
liabilities, if any, with respect to these matters will not have a material
adverse effect on our financial position or results of operations.
In the normal course of business, we provide standby letters of credit and
performance bonds issued to third parties to secure performance under various
contracts. At December 31, 2001, outstanding letters of credit were $12.2
million and performance bonds were $46.1 million. We do not believe that any
such letters of credit or bonds are likely to be drawn upon.
As a component of our model home construction activities, we enter into
lease transactions with third parties. The total cost, including land costs, of
model homes leased by us and constructed under these lease agreements is $19.0
million, all of which is excluded from our balance sheet as of December 31,
2001.
We lease office facilities, model homes and equipment under various
operating lease agreements. Approximate minimum lease payments for
non-cancelable operating leases as of December 31, 2001, are as follows (in
thousands):
DECEMBER 31,
2002.................................. $ 3,049
2003.................................. 1,637
2004.................................. 1,128
2005.................................. 790
2006.................................. 227
Thereafter............................ 22
-------
$ 6,853
=======
Rent expense approximated $2.5 million, $1.6 million and $1.1 million in
2001, 2000 and 1999, respectively. Included in these amounts are $151,000,
$185,600 and $415,000 in 2001, 2000 and 1999, respectively, related to office
facilities leased from companies owned beneficially either by one of our
co-chairmen or by a co-chairman and a director.
We have certain obligations related to post-construction warranties and
defects related to homes constructed and sold. Historically, these amounts have
not been material and we do not anticipate future obligations to be material.
NOTE 13 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
HOME SALES BASIC EARNINGS DILUTED EARNINGS
REVENUE NET EARNINGS PER SHARE PER SHARE
------- ------------ --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2001 - THREE MONTHS ENDED:
March 31 $ 116,113 $ 7,389 $ 1.44 $ 1.28
June 30 174,403 12,493 2.36 2.12
September 30 207,177 14,887 2.77 2.50
December 31 244,883 15,890 2.93 2.69
2000 - THREE MONTHS ENDED:
March 31 $ 91,653 $ 4,771 $ 0.90 $ 0.82
June 30 120,802 8,573 1.62 1.50
September 30 134,464 10,509 2.06 1.85
December 31 168,509 11,909 2.38 2.12
40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is included under the captions "Election
of Directors," "Director and Officer Information," and "Section 16(a) Beneficial
Ownership Reporting Compliance" in our Notice and Proxy Statement relating to
our 2002 Annual Meeting of Stockholders and is incorporated by reference into
this Form 10-K Report. With the exception of the foregoing information and other
information specifically incorporated by reference into this Form 10-K Report,
our 2002 Proxy Statement is not being filed as a part of this report.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the captions "Executive
Compensation," "Director Compensation," and "Employment Agreements" in our 2002
Proxy Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is included under the caption "Stock
Owned by Principal Stockholders and Management" in our 2002 Proxy Statement and
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the caption "Certain
Transactions and Relationships" in our 2002 Proxy Statement and is incorporated
herein by reference.
41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
PAGE OR
METHOD OF FILING
----------------
(a) FINANCIAL STATEMENTS AND SCHEDULES
(i) Financial Statements:
(1) Report of KPMG LLP Page 24
(2) Consolidated Financial Statements and Notes to Consolidated Page 25
Financial Statements of the Company, including Consolidated
Balance Sheets as of December 31, 2001 and 2000 and related
Consolidated Statements of Earnings, Stockholders' Equity and
Cash Flows for each of the years in the three-year period ended
December 31, 2001
(ii) Financial Statement Schedules:
Schedules have been omitted because of the absence of conditions under
which they are required or because the required material information
is included in the Consolidated Financial Statements or Notes to the
Consolidated Financial Statements included herein.
(b) REPORTS ON FORM 8-K
We filed no reports on Form 8-K in the fourth quarter of 2001.
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION PAGE OR METHOD OF FILING
------ ----------- ------------------------
2.1 Agreement and Plan of Reorganization, dated as of Incorporated by reference to Exhibit 2 of Form S-4
September 13, 1996, by and among Homeplex, the Registration Statement No. 333-15937.
Monterey Merging Companies and the Monterey
Stockholders
2.2 Agreement of Purchase and Sale of Assets, dated as Incorporated by reference to Exhibit 2 of Form
of May 20, 1997, by and among Monterey, Legacy 8-K/A dated June 18, 1997.
Homes, Ltd., Legacy Enterprises, Inc., and John
and Eleanor Landon
2.3 Agreement of Purchase and Sale of Assets, dated as Incorporated by reference to Exhibit 2.2 of Form
of June 15, 1998, by and among the Company, 10-Q for the quarterly period ended June 30, 1998.
Sterling Communities, S.H. Capital, Inc., Sterling
Financial Investments, Inc., Steve Hafener and W.
Leon Pyle
2.4 Master Transaction Agreement (with exhibits), Incorporated by reference to Exhibit 2.1 of Form
dated May 7, 2001 by and among the Company, 8-K dated May 10, 2001.
Hancock-MTH Builders, Inc., Hancock-MTH
Communities, Inc., HC Builders, Inc. and Hancock
Communities, L.L.C.
42
2.4.1 Amendment No. 1 to Master Transaction Agreement Incorporated by reference to Exhibit 2.1 of Form
and Agreement of Purchase and Sale of Assets, 8-K dated June 6, 2001.
dated May 30, 2001 by and between Meritage
Corporation, Meritage-MTH Communities, Inc., HC
Builders, Inc., Hancock Communities, L.L.C. and
American Homes West, Incorporated
3.1 Amendment to Articles of Incorporation Incorporated by reference to Exhibit 3.1 of Form
10-Q for the quarterly period ended September 30,
1998.
3.2 Restated Articles of Incorporation Incorporated by reference to Exhibit 3.2 of Form
10-Q for the quarterly period ended September 30,
1998.
3.3 Amended and Restated Bylaws Incorporated by reference to Exhibit 3.3 of Form
S-3 #333-58793.
4.1 Specimen of Common Stock Certificate Incorporated by reference to Exhibit 4 of Form
10-K for the year ended December 31, 1996.
4.2 Indenture dated as of May 31, 2001, by and among Incorporated by reference to Exhibit 4.1 of Form
Meritage Corporation, the Guarantors named therein 8-K dated June 6, 2001.
and Wells Fargo Bank, N.A.
10.1 $70 Million Borrowing Base Loan Agreement by and Incorporated by reference to Exhibit 10.4 of Form
among the Company, Norwest Bank, Arizona, N.A. and 10-K for the year ended December 31, 1999.
California Bank and Trust, dated as of September
15, 1999
10.1.1 Modification to Loan Agreement with Wells Fargo Incorporated by reference to Exhibit 10.1 of Form
Bank, Arizona, N.A. and California Bank and Trust, 10-Q for the quarterly period ended June 30, 2000.
dated as of May 16, 2000
10.1.2 Second Modification to Loan Agreement with Wells Incorporated by reference to Exhibit 10.1.2 of
Fargo Bank, Arizona, N.A. and California Bank and Form S-4 dated July 3, 2001.
Trust, dated June 1, 2001
10.2 Modification to Guaranty Federal Bank Loan, dated Incorporated by reference to Exhibit 10.1 of Form
as of May 19, 1998 10-Q for the quarterly period ended June 30, 1998.
10.2.1 Modification to Guaranty Federal Bank Loan, dated Incorporated by reference to Exhibit 10.4 of Form
as of July 31, 1999 10-K for the year ended December 31, 1999.
10.2.2 Modification to Guaranty Federal Bank Loan, dated Incorporated by reference to Exhibit 10.1 of Form
as of March 29, 2000 10-Q for the quarterly period ended March 31,
2000.
10.2.3 Extension of Guaranty Federal Bank Loan, dated as Incorporated by reference to Exhibit 10.2 of Form
of July 31, 2000 10-Q for the quarterly period ended June 30, 2000.
10.2.4 Modification to Guaranty Federal Bank Loan, dated Incorporated by reference to Exhibit 10.1 of Form
as of July 31, 2000 10-Q for the quarterly period ended September 30,
2000.
10.2.5 Seventh Modification Agreement to Guaranty Federal Incorporated by reference to Exhibit 10.2.4 of
Bank Loan, dated as of May 29, 2001 Form S-4 dated July 3, 2001.
10.2.6 Modification Letter to the Guaranty Federal Bank Incorporated by reference to Exhibit 10.1 of Form
Loan, dated as of May 29, 2001 10-Q for the quarterly period ended June 30, 2001.
43
10.3 $3.3 Million Construction Loan Agreement by and Incorporated by reference to Exhibit 10.2 of Form
between the Company and Compass Bank, Dated as of 10-Q for the quarterly period ended March 31,
February 10, 2000 2000.
10.4 Amended 1997 Stock Option Plan * Incorporated by reference to Exhibit 4.1 of
Registration Statement No. 333-39036 filed on June
12, 2000.
10.5 2001 Annual Incentive Plan* Incorporated by reference to Exhibit B of the
Proxy Statement for the 2001 Annual Meeting of
Stockholders.
10.6 Employment Agreement, dated as of May 30, 2001, by Incorporated by reference to Exhibit 10.2 of Form
and among Meritage Corporation, Hancock MTH 8-K dated June 6, 2001.
Builders, Inc., Hancock Communities, Inc. and Greg
Hancock*
10.7 Employment Agreement between the Company and Incorporated by reference to Exhibit 10.10 to the
William W. Cleverly* Form 10-K for the year ended December 31, 1996.
10.8 Separation and Consulting Agreement between the Incorporated by reference to Exhibit C of the Form
Company and William W. Cleverly* 8-K filed on March 23, 1999.
10.9 Employment Agreement between the Company and Incorporated by reference to Exhibit 10.11 to the
Steven J. Hilton* Form 10-K for the year ended December 31, 1996.
10.10 Employment Agreement between the Company and John Incorporated by reference to Exhibit C of the Form
R. Landon* 8-K filed on June 18, 1997.
10.11 Stock Option Agreement between the Company and Incorporated by reference to Exhibit 10.12 of the
William W. Cleverly* Form 10-K for the year ended December 31, 1996.
10.12 Stock Option Agreement between the Company and Incorporated by reference to Exhibit 10.13 to the
Steven J. Hilton* Form 10-K for the year ended December 31, 1996.
10.13 Stock Option Agreement between the Company and Incorporated by reference to Exhibit C of the Form
John R. Landon* 8-K filed on June 18, 1997.
10.14 Registration Rights Agreement between the Company Incorporated by reference to Exhibit 10.14 to the
and William W. Cleverly* Form 10-K for the year ended December 31, 1996.
10.15 Registration Rights Agreement between the Company Incorporated by reference to Exhibit 10.15 to the
and Steven J. Hilton* Form 10-K for the year ended December 31, 1996.
10.16 Registration Rights Agreement between the Company Incorporated by reference to Exhibit C of the Form
and John R. Landon* 8-K filed on June 18, 1997.
10.17 Employment Agreement between the Company and Incorporated by reference to Exhibit 10.1 of Form
Larry W. Seay* 10-Q for the quarterly period ended September 30,
2001.
10.18 Change of Control Agreement between the Company Incorporated by reference to Exhibit 10.3 of Form
and Steven J. Hilton* 10-Q for the quarterly period ended March 30,
2000.
10.19 Change of Control Agreement between the Company Incorporated by reference to Exhibit 10.4 of Form
and John R. Landon* 10-Q for the quarterly period ended March 30,
2000.
10.20 Change of Control Agreement between the Company Incorporated by reference to Exhibit 10.5 of Form
and Larry W. Seay* 10-Q for the quarterly period ended March 30,
2000.
44
10.21 Change of Control Agreement between the Company Incorporated by reference to Exhibit 10.6 of Form
and Richard T. Morgan* 10-Q for the quarterly period ended March 30,
2000.
21 List of Subsidiaries Filed herewith.
23 Consent of KPMG LLP Filed herewith.
24 Powers of Attorney See signature page.
- -------
* Indicates a management contract or compensation plan.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, this 27th
day of March 2002.
MERITAGE CORPORATION,
a Maryland Corporation
By /s/ JOHN R. LANDON
---------------------------------------
John R. Landon
CO-CHAIRMAN AND CHIEF EXECUTIVE OFFICER
By /s/ STEVEN J. HILTON
---------------------------------------
Steven J. Hilton
CO-CHAIRMAN AND CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints John R. Landon, Steven J. Hilton and Larry W.
Seay, and each of them, his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all amendments to this
Form 10-K Annual Report, and to file the same, with all exhibits thereto and
other documents in connection therewith the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act of things requisite and
necessary to be done in and about the premises, as fully and to all intents and
purposes as he might or could do in person hereby ratifying and confirming all
that said attorneys-in-fact and agents, or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to these requirements of the Securities Exchange Act of 1934, the
following persons on behalf of the registrant and in the capacities and on the
dates indicated have signed this report on Form 10-K below:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JOHN R. LANDON Co-Chairman and March 27, 2002
- -------------------------- Chief Executive Officer
John R. Landon
/s/ STEVEN J. HILTON Co-Chairman and March 27, 2002
- -------------------------- Chief Executive Officer
Steven J. Hilton
/s/ LARRY W. SEAY Chief Financial Officer, Vice March 27, 2002
- -------------------------- President-Finance, Secretary and
Larry W. Seay Treasurer (Principal Financial and
Accounting Officer)
/s/ WILLIAM W. CLEVERLY Director March 27, 2002
- --------------------------
William W. Cleverly
/s/ RAYMOND OPPEL Director March 27, 2002
- --------------------------
Raymond Oppel
/s/ ROBERT G. SARVER Director March 27, 2002
- --------------------------
Robert G. Sarver
/s/ C. TIMOTHY WHITE Director March 27, 2002
- --------------------------
C. Timothy White
/s/ PETER L. AX Director March 27, 2002
- --------------------------
Peter L. Ax
S-1