SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM  10-Q

 

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

 

For the quarterly period ended March 31, 2005

 

or

 

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

 

Commission File Number 1-9977

 

MERITAGE HOMES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland		86-0611231
(State or Other Jurisdiction)		(I.R.S. Employer
of Incorporation or Organization)		Identification No.)
8501 East Princess Drive, Suite 290 Scottsdale, Arizona		85255
(Address of Principal Executive Offices)		(Zip Code)
(480) 609-3330
(Registrant’s Telephone Number, Including Area Code)

 

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

 

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

 

Common shares outstanding as of May 2, 2005: 27,031,638

 

 

MERITAGE HOMES CORPORATION

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2005

 

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Unaudited Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
	Unaudited Condensed Consolidated Statements of Earnings for the Three Months ended March 31, 2005 and 2004
	Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2005 and 2004
	Notes to Unaudited Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Not Applicable
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Items 3-5.	Not Applicable
Item 6.	Exhibits
SIGNATURES
Index of Exhibits

 

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PART I - - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

 

		March 31,			December 31,
		2005			2004
		(in thousands, except share data)
Assets
Cash and cash equivalents		$	44,828		$	47,876
Real estate		1,002,078			867,218
Real estate not owned		8,185			18,344
Deposits on real estate under option or contract		140,425			129,072
Receivables		12,512			15,974
Goodwill		114,313			91,475
Intangibles, net		2,569			—
Property and equipment, net		31,086			27,742
Prepaid expenses and other assets		14,654			16,749
Investments in unconsolidated entities		52,285			50,944
Total assets		$	1,422,935		$	1,265,394
Liabilities
Accounts payable		$	92,280		$	77,799
Accrued liabilities		120,060			135,590
Home sale deposits		52,863			41,537
Liabilities related to real estate not owned		7,096			14,780
Deferred tax liability, net		1,517			1,518
Loans payable and other borrowings		46,870			54,419
Senior notes		481,654			416,996
Total liabilities		802,340			742,639
Minority Interests		—			200
Stockholders’ Equity
Common stock, par value $0.01. 50,000,000 shares authorized; 32,714,480 and 31,460,050 shares issued at March 31, 2005 and December 31, 2004, respectively *		327			315
Additional paid-in capital		283,461			209,630
Retained earnings		405,778			381,583
Treasury stock at cost, 5,704,452 shares at March 31, 2005 and December 31, 2004 *		(68,971		)	(68,973		)
Total stockholders’ equity		620,595			522,555
Total liabilities and stockholders’ equity		$	1,422,935		$	1,265,394

 

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

 

See accompanying notes to consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

 

		Three Months Ended March 31,
		2005			2004
		(in thousands, except per share data)
Home closing revenue		$	550,947		$	423,502
Land closing revenue		221			—
		551,168			423,502
Cost of home closings		(431,622		)	(340,339		)
Cost of land closings		(212		)	—
		(431,834		)	(340,339		)
Home closing gross profit		119,325			83,163
Land closing gross profit		9			—
		119,334			83,163
Commissions and other sales costs		(31,471		)	(25,833		)
General and administrative expenses		(21,997		)	(16,056		)
Loss on extinguishment of debt		(31,280		)	—
Other income, net		4,135			2,189
Earnings before provision for income taxes		38,721			43,463
Provision for income taxes		(14,525		)	(16,544		)
Net earnings		$	24,196		$	26,919
Net earnings per common share:
Basic *		$	0.92		$	1.02
Diluted *		$	0.86		$	0.96

 

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

 

See accompanying notes to consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Three Months Ended March 31,
		2005			2004
		(in thousands)
Cash flows from operating activities:
Net earnings		$	24,196		$	26,919
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization		3,754			2,747
Write-off of senior note issuance costs		4,942			—
Increase in deferred tax asset		—			(239		)
Tax benefit from stock option exercises		2,643			900
Equity in earnings of unconsolidated entities		(4,461		)	(434		)
Net increase in liabilities over assets not owned		—			96
Changes in assets and liabilities, net of effect of acquisitions:
Increase in real estate		(83,725		)	(6,597		)
Increase in deposits on real estate under option or contract		(7,735		)	(2,254		)
Decrease (increase) in receivables and prepaid expenses and other assets		5,441			(3,527		)
Decrease in accounts payable and accrued liabilities		(5,217		)	(12,218		)
Increase in home sale deposits		6,103			3,269
Net cash provided by (used in) operating activities		(54,059		)	8,662
Cash flows from investing activities:
Investments in unconsolidated entities		(3,103		)	(4,945		)
Distributions from unconsolidated entities		1,932			916
Purchases of property and equipment		(5,974		)	(4,286		)
Cash paid for acquisitions		(65,956		)	(24,091		)
Cash paid for earn-out agreements		—			(1,015		)
Proceeds from sales of property and equipment		57			—
Net cash used in investing activities		(73,044		)	(33,421		)
Cash flows from financing activities:
Proceeds from loans payable and other borrowings		587,600			466,800
Repayments of loans payable and other borrowings		(595,149		)	(436,300		)
Proceeds from issuance of senior notes		348,250			—
Senior note issuance costs		(4,414		)	—
Payments for repurchase of senior notes		(283,424		)	—
Proceeds from sale of common stock, net		69,694			—
Proceeds from stock option exercises		1,498			1,150
Net cash provided by financing activities		124,055			31,650
Net (decrease) increase in cash and cash equivalents		(3,048		)	6,891
Cash and cash equivalents, beginning of period		47,876			4,799
Cash and cash equivalents, end of period		$	44,828		$	11,690

 

See supplemented disclosure of cash flow information at Note 10.

 

See accompanying notes to consolidated financial statements

 

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2005 AND 2004

 

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

 

Organization.  We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and active adult homes to our targeted customer base.  We and our predecessors have operated in Arizona since 1985, in Texas since 1987 and in Northern California since 1989.  We entered the move-up market in the Las Vegas, Nevada area in 2002 and the Inland Empire region of the greater Los Angeles area in January 2004 with our acquisition of Citation Homes of Southern California (Citation).  We began start-up operations in the Denver, Colorado and Orlando, Florida markets in 2004, and in February 2005, we acquired Colonial Homes, a homebuilder that serves the Fort Myers/Naples, Florida market.  In March 2005, we entered the Reno, Nevada market through a greenfield start-up operation.

 

We operate in Texas as Legacy Homes, Monterey Homes and Hammonds Homes; in Arizona as Meritage Homes and Monterey Homes; in Florida as Meritage Homes and Colonial Homes and in Northern California, Nevada and Colorado as Meritage Homes.  At March 31, 2005, we were actively selling homes in 147 communities, with base prices ranging from $96,000 to $927,000.

 

Basis of Presentation.  The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of Meritage Homes Corporation and those of our consolidated subsidiaries, partnerships and other entities in which we have a controlling financial interest, and variable interest entities (see Note 3) in which we are deemed the primary beneficiary (the “Company”). Intercompany balances and transactions have been eliminated in consolidation and certain prior year amounts have been reclassified to be consistent with current financial statement presentation.  In our opinion, these unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial position, results of operations and cash flows for the periods presented.  The results of operations for any interim period are not necessarily indicative of results to be expected for a full fiscal year or for any future periods.  These financial statements should be read in conjunction with our consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended December 31, 2004.

 

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

 

Stock-Based Compensation.  At March 31, 2005, we had a stock-based employee compensation plan under which officers, key employees, non-employee directors and consultants may be granted options to purchase shares of our common stock.  We currently apply the intrinsic value-based method of accounting prescribed in Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees”, as allowed by SFAS No. 123 “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”  Under this method, compensation expense is recorded on the date of the grant only if the market price of the underlying stock on the date of the grant is greater than the exercise price.  SFAS No. 123 established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans.  We have adopted the disclosure requirements of SFAS No. 123.  We have not issued options with exercise prices below the market value on the date of the grant; therefore, we have not recognized compensation expense for our stock-based plan.  Had compensation cost for this plan been determined pursuant to SFAS No. 123, our net earnings and earnings per common share would have been reduced to the following pro forma amounts.  For the purpose of this disclosure, the value of the options is estimated by applying a Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.

 

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			Three Months Ended March 31,
			2005			2004
			(in thousands, except per share amounts)
Net earnings	As reported		$	24,196		$	26,919
	Deduct*		(1,402		)	(902		)
	Pro forma		$	22,794		$	26,017
Basic earnings per share	As reported		$	0.92		$	1.02
	Pro forma		$	0.87		$	0.98
Diluted earnings per share	As reported		$	0.86		$	0.96
	Pro forma		$	0.81		$	0.93

 

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

 

The fair value for options granted in the first quarter of 2005 and 2004 was established at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions.

 

		Three Months Ended March 31,
		2005		2004
Expected dividend yield		0	%	0	%
Risk-free interest rate		4.44	%	3.83	%
Expected volatility		52	%	53	%
Expected life (in years)		7		7

 

The weighted average fair value of the options for the three months ended March 31, 2005 and 2004 are $34.26 and $18.35, respectively.

 

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

 

Common Stock Repurchase.  In August 2004, the Board of Directors approved a stock buyback program authorizing the expenditure of up to $50 million to repurchase shares of our common stock.  As of March 31, 2005, we had not purchased any shares under this program.  No date for completing the program has been determined, but we will purchase shares subject to applicable securities law, and at times and in amounts as management deems appropriate.

 

Off-Balance Sheet Arrangements.  We often acquire finished homesites at market prices from various development entities under fixed price purchase agreements.  This lot acquisition strategy reduces the financial requirements and risks associated with the direct ownership of undeveloped land.  We are subject to customary obligations associated with these purchase agreements, which typically require us to make deposits in the form of cash or letters of credit.  These deposits may be forfeited if we fail to perform under the agreement.  As of March 31, 2005, we had entered into purchase agreements with an aggregate purchase price of approximately $2.1 billion, by making deposits of approximately $141.5 million in the form of cash and approximately $50.9 million in letters of credit.

 

Occasionally, we enter into land development joint ventures.  We and/or our joint venture partners occasionally provide limited repayment guarantees.  As of March 31, 2005, we had limited repayment guarantees of approximately $15.5 million.

 

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

 

Additionally, we and our joint venture partners have agreed to indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures.  If a joint venture does not perform its obligations, the surety bond could be called.  If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners would be obligated to indemnify the surety.  These surety indemnity arrangements are generally joint and several obligations with our other joint venture partners.  As of March 31, 2005, there were approximately $13.4 million of surety bonds outstanding subject to these indemnity arrangements.  None of these bonds have been called to date and we believe it is unlikely that any of these bonds will be called.

 

We also obtain letters of credit and surety bonds in support of our related obligations with respect to the development of our projects.  The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities.  In the event the letters of credit or bonds are drawn upon, we would be obligated to reimburse the issuer of the letter of credit or bond.  At March 31, 2005, we had approximately $50.9 million in outstanding letters of credit and $166.2 million in performance bonds for such purposes.  We believe it is unlikely that any of these letters of credit or bonds will be drawn upon.

 

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

 

		Three Months Ended March 31,
		2005			2004
Warranty reserve, beginning of period		$	14,967		$	9,253
Additions to reserve		3,546			2,271
Warranty claims and expenses		(2,213		)	(1,537		)
Warranty reserve at end of period		$	16,300		$	9,987

 

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

 

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NOTE 2 – REAL ESTATE AND CAPITALIZED INTEREST

 

Real estate consists of the following (in thousands):

 

		March 31, 2005			December 31, 2004
Homes under contract under construction		$	577,802		$	492,378
Finished home sites		198,648			179,306
Home sites under development		106,564			83,735
Unsold homes completed and under construction		57,585			53,098
Model homes		11,154			1,294
Model home lease program		46,870			53,819
Land held for development		3,455			3,588
		$	1,002,078		$	867,218

 

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

 

		Three Months Ended March 31,
		2005			2004
Capitalized interest, beginning of period		$	19,701		$	13,074
Interest incurred and capitalized		10,129			8,191
Amortization to cost of home closings		(7,928		)	(6,682		)
Capitalized interest, end of period		$	21,902		$	14,583

 

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

 

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

 

Under FIN 46R, a variable interest entity, or VIE, is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur.

 

Based on the provisions of FIN 46R, we have concluded that when we enter into option or purchase agreements to acquire land or lots from an entity and pay a non-refundable deposit, a VIE is created because we are deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity’s expected losses if they occur.  For each VIE created where the fair value of

 

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

 

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

 

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

 

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

 

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The table below presents a summary of our lots under option at March 31, 2005 (dollars in thousands):

 

										Option/Earnest Money Deposits
		# of Lots		Fair Value			Purchase Price			Cash			Letters of Credit
Specific performance options (1)		148		$	6,759		$	6,759		$	778		—
Options recorded on balance sheet(2)		19		1,426			1,466			311			—
Total options recorded on balance sheet as real estate not owned (3)		167		8,185			8,225			1,089			—
Option contracts not recorded on balance sheet – non-refundable deposits (3)		25,921		—			1,441,004			115,987			$	50,903
Purchase contracts not recorded on balance sheet – non-refundable deposits (3)		11,866		—			400,247			20,877			—
Purchase contracts not recorded on balance sheet – refundable deposits (4)		7,383		—			222,517			3,561			—
Total options not recorded on balance sheet		45,170		—			2,063,768			140,425			50,903
Total lots under option or contract		45,337		$	8,185		$	2,071,993		$	141,514		$	50,903

 

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

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

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

(4)  Deposits are refundable at our sole discretion.

 

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

 

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NOTE 4 – INVESTMENTS IN UNCONSOLIDATED ENTITIES

 

We enter into homebuilding and land development joint ventures from time to time as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base.  At March 31, 2005, we had equity investments of 50% or less and did not have controlling financial interests in these unconsolidated entities.  Our partners generally are unrelated homebuilders, land sellers or other real estate entities.  We also enter into mortgage and title business joint ventures from time to time.  These unconsolidated entities follow accounting principles generally accepted in the United States of America and we share in their profits and losses generally in accordance with our ownership interests.

 

We and/or our joint venture partners sometimes obtain certain options or enter into other arrangements under which we can purchase portions of the land held by the unconsolidated joint ventures.  Option prices are generally negotiated prices that approximate fair value when we enter into the option contract.  Our share of the joint venture earnings is deferred until homes are delivered by us and title passes to a homebuyer. At such time, we allocate our joint venture earnings to the land acquired by us as a reduction in the basis of the property. Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method was as follows:

 

		March 31,			December 31,
		2005			2004
		(in thousands)
Assets:
Cash		$	12,778		$	8,689
Inventories		215,652			227,104
Other assets		24,819			13,026
Total assets		$	253,249		$	248,819
Liabilities and equity:
Accounts payable and other liabilities		$	18,010		$	13,284
Notes and mortgages payable		126,972			145,209
Equity of:
Meritage		38,962			40,785
Other		69,305			49,541
Total liabilities and equity		$	253,249		$	248,819

 

		Three Months Ended March 31,
		2005			2004
		(in thousands)
Revenues		$	30,668		$	3,676
Costs and expenses		(20,830		)	(1,887		)
Net earnings of unconsolidated entities		$	9,838		$	1,789
Meritage’s share of pre-tax earnings		$	4,461		$	433

 

 

Our share of net earnings, including any applicable management fees, is recorded in “Other income, net” on our consolidated statements of earnings.

 

At March 31, 2005 and December 31, 2004, our investment in unconsolidated entities includes $1.8 million and $2.9 million, respectively, related to the difference between the amounts at which our investments

 

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are carried and the amount of underlying equity in net assets.  This amount will be amortized to equity of earnings of unconsolidated entities over the lives of the respective joint ventures.

 

In addition to joint ventures accounted for under the equity method summarized in the above table, at March 31, 2005, and December 31, 2004, our investment in unconsolidated entities included joint ventures recorded under the cost method.  These joint ventures have obtained large parcels of land and are designed to perform off-site development work and to sell lots to the joint venture members.  As of March 31, 2005, and December 31, 2004, our investment in unconsolidated entities recorded under the cost method was $11.5 and $7.2 million, respectively. As of March 31, 2005, we have not recorded any income or distributions from these joint ventures.

 

NOTE 5 – LOANS PAYABLE AND OTHER BORROWINGS

 

Loans payable consist of the following (in thousands):

 

		March 31,			December 31,
		2005			2004
$400 million unsecured revolving credit facility maturing May 2009 with extension provisions, and interest payable monthly approximating LIBOR (approximately 3.115% at March 31, 2005) plus 2.0% or prime (5.75% at March 31, 2005)		$	—		$	—
Model home lease program, with interest in the form of lease payments payable monthly approximating LIBOR (approximately 3.115% at March 31, 2005) plus 4.25%		46,870			53,819
Acquisition and development seller carry back financing, interest payable at a fixed rate of 7% per annum, paid in full in 2005		—			600
Total loans payable and other borrowings		$	46,870		$	54,419

 

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

 

NOTE 6 – SENIOR NOTES

 

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

 

In March 2005, we completed the private placement of $350 million in aggregate principal amount of 6.25% senior notes due 2015 which resulted in net proceeds to the Company, after commissions, discounts and fees, of approximately $343.8 million.  The indenture which governs the new 6.25% senior notes contains

 

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covenants that are substantially similar to the covenants in the indentures which govern our existing 7% senior notes.

 

We used the proceeds from the issuance of the 6.25% senior notes to repurchase pursuant to a tender offer and consent solicitation approximately $276.8 million of our outstanding 9.75% senior notes due 2011 and to pay down our bank credit facility.  In connection with this tender offer and repurchase, we recorded an after-tax one-time charge of approximately $19.5 million for premiums, commissions and expenses associated with the tender offer and the write-off of existing offering costs associated with the 9.75% senior notes, net of the accretion of existing note premiums on the 9.75% senior notes and taxes.  Approximately $3.2 million in principal amount of the 9.75% senior notes remained outstanding at March 31, 2005.

 

At March 31, 2005 our outstanding 6.25% senior notes due 2015 totaled approximately $348.3 million, which includes unamortized discounts of approximately $1.7 million.

 

Our bank credit facility and senior notes contain covenants which require maintenance of certain levels of tangible net worth and compliance with certain minimum financial ratios, place limitations on the payment of dividends and redemptions of equity, and limit the incurrence of additional indebtedness, asset dispositions, mergers, certain investments and creations of liens, among other items.  As of and for the quarter ended March 31, 2005, we were in compliance with these covenants.  After considering our most restrictive bank covenants, our borrowing availability under the bank credit facility was approximately $254.2 million at March 31, 2005 as determined by borrowing base limitations defined by our agreement with the lending banks.  The revolving credit facility and senior notes restrict our ability to pay dividends, and at March 31, 2005, our maximum permitted amount available to pay dividends was approximately $68.1 million.

 

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

 

NOTE 7 – ACQUISITIONS, GOODWILL AND INTANGIBLES

 

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

 

Goodwill and Intangibles.  Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the assets acquired.  The acquisition of Colonial was recorded using the purchase method of accounting.  The purchase price was allocated based on estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition, and is subject to change when the Company finalizes its analysis.  The excess purchase price over the fair value of the net assets acquired of $22.5 million for Colonial was recorded as goodwill.

 

Intangible assets consist primarily of a non-compete agreement, a tradename and floor plan designs acquired in connection with our February 1, 2005 acquisition of Colonial.  These intangible assets were valued at the acquisition date utilizing accepted valuation procedures.  The non-compete agreement is being amortized over five years while our tradename and floor plan designs are being amortized over one year.  The acquired cost and accumulated amortization of the Company’s intangible assets was $2.8 million and $0.2 million at

 

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March 31, 2005.  Amortization expense for the quarter ending March 31, 2005 was $0.2 million and is expected to be approximately $1.1 million in 2005, $0.5 million in 2006 and $0.4 million in 2007, 2008 and 2009, respectively.

 

The changes in the carrying amount of goodwill for the three months ended March 31, 2005, follow (in thousands):

 

Balance at December 31, 2003		$	91,475
Goodwill acquired – Colonial acquisition		22,528
Increase due to earn-out agreements		453
Purchase accounting adjustments		(143		)
Balance at March 31, 2005		$	114,313

 

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

 

NOTE 8 – EARNINGS PER SHARE

 

A summary of the reconciliation from basic earnings per share to diluted earnings per share for the three months ended March 31, 2005 and 2004 follows:

 

		Three Months Ended March 31,
		2005 *			2004 *
		(in thousands, except per share amounts)
Basic average number of shares outstanding		26,218			26,468
Effect of dilutive securities:
Options to acquire common stock		1,966			1,636
Diluted average shares outstanding		28,184			28,104
Net earnings		$	24,196		$	26,919
Basic earnings per share		$	.92		$	1.02
Diluted earnings per share		$	.86		$	.96
Antidilutive stock options not included in the calculation of diluted earnings per share		—			—

 

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

 

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NOTE 9 – INCOME TAXES

 

Components of income tax expense are (in thousands):

 

 

NOTE 10 – SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

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

 

		2005			2004
Increase in real estate		$	(47,010	)	$	(12,036	)
Increase in deposits on real estate under option or contract		(1,343		)	(1,870		)
Increase in receivables and other assets		(1,065		)	(747		)
Increase in goodwill		(22,421		)	(11,214		)
Increase in intangibles		(2,763		)	—
Increase in property and equipment		(327		)	(89		)
Increase in accounts payable and accrued liabilities		3,750			1,704
Increase in home sale deposits		5,223			87
Net cash paid for acquisition		$	(65,956	)	$	(24,165	)

 

Supplemental cash flow information is as follows:

 

		Three Months Ended March 31,
		2005			2004
Cash paid during the period for:
Interest		$	8,529		$	977
Income taxes		$	17,000		$	6,373

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Quarterly Report on Form 10-Q contains forward-looking statements.  The words “believe,” “expect,” “anticipate,” “forecast”, “plan” and “project” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made.  All statements other than forward-looking statements are within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements may include, but are not limited to, projections of revenue, income or loss, capital expenditures and backlog; plans for future operations; financing needs or plans and liquidity; the impact of changes in interest rates; plans relating to our products or services, acquisitions, and new or planned development projects; the demand for and pricing of our homes; the expected outcome of legal proceedings against us; the growth potential of the markets we operate in; the sufficiency of our capital resources to support our growth strategy; the sufficiency of our warranty reserves; and our ability to continue positive operating results in light of current economic and political conditions, as well as assumptions relating to the foregoing.

 

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

 

Overview

 

We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and Active Adult homes to our targeted customer base.  We and our predecessors have operated in Arizona since 1985, in Texas since 1987 and in Northern California since 1989.  We entered the move-up market in the Las Vegas, Nevada area in 2002.  We entered the Inland Empire region of the greater Los Angeles area in January 2004 with our acquisition of Citation Homes of Southern California (Citation), and we began start-up operations in the Denver, Colorado and Orlando, Florida markets.  In February 2005, we acquired Colonial Homes, a homebuilder that serves the Fort Myers/Naples, Florida market.  In March 2005, we entered the Reno, Nevada market through a greenfield start-up operation.  With the addition of Reno, we now have a presence in 14 dynamic housing markets in the southern and western regions of the country.  We operate in these states, predominantly in one industry, homebuilding, and thus have only one single reportable segment.

 

Total home closing revenue was $550.9 million for the three months ended March 31, 2005, increasing $127.4 million, or 30% from $423.5 million for the same period last year.  Net earnings for the first quarter of 2005 decreased $2.7 million, or 10%, to $24.2 million from $26.9 million in the same quarter of 2004. This decrease was primarily due to a one-time bond refinancing charge related to a series of refinancing transactions.  We believe these transactions will enhance our liquidity and, in the long term, result in significant cash interest savings.  On March 2, 2005, we completed the sale of 1,035,000 shares of our common stock in a registered public offering resulting in net proceeds to the Company of approximately $69.7 million.  On March 10, 2005, we completed the private placement of $350 million in aggregate principal amount of 6.25% senior notes due 2015 which resulted in net proceeds to the Company, after commission, discounts and fees of approximately $343.8 million.  We used the proceeds from these transactions to repurchase pursuant to a tender offer and consent solicitation approximately $276.8 million of our outstanding 9.75% senior notes due 2011.  In connection with this tender offer and repurchase, we incurred a one-time charge of $31.3 million, which reduced net earnings after-tax by $19.5 million and diluted earnings per share by $0.69.  Excluding this one-time charge, we would have reported net earnings of $43.7 million, an increase of 62% compared to the same period a year earlier.

 

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Critical Accounting Policies

 

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

 

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

 

Results Of Operations

 

The following discussion and analysis of financial condition and results of operations is based on our consolidated unaudited financial statements for the three months ended March 31, 2005 and 2004.  All material balances and transactions between us and our subsidiaries have been eliminated.  In management’s opinion, the data reflects all adjustments, consisting of only normal recurring adjustments, necessary to fairly present our financial position and results of operations for the periods presented.  The results of operations for any interim period are not necessarily indicative of results expected for a full fiscal year.

 

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Home Closing Revenue, Sales Contracts and Net Sales Backlog

 

                                                The data provided below presents operating and financial data regarding our homebuilding activities.

 

 

		Quarter Ended March 31,
		($ in thousands)
Home Closing Revenue		2005			2004			% Change
Total
Dollars		$	550,947		$	423,502		30	%
Homes closed		1,787			1,569			14	%
Average sales price		$	308.3		$	269.9		14	%
Texas
Dollars		$	155,955		$	157,272		(1	)%
Homes closed		717			730			(2	)%
Average sales price		$	217.5		$	215.4		1	%
Arizona
Dollars		$	153,955		$	97,932		57	%
Homes closed		599			381			57	%
Average sales price		$	257.0		$	257.0		—
California
Dollars		$	194,487		$	130,870		49	%
Homes closed		345			307			12	%
Average sales price		$	563.7		$	426.3		32	%
Nevada
Dollars		$	31,189		$	37,428		(17	)%
Homes closed		88			151			(42	)%
Average sales price		$	354.4		$	247.9		43	%
Florida
Dollars		$	15,361		$	n/a		n/a
Homes closed		38			n/a			n/a
Average sales price		$	404.2		$	n/a		n/a

 

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		Quarter Ended March 31,
		($ in thousands)
Home Orders		2005			2004			% Change
Total
Dollars		$	881,346		$	591,999		49	%
Homes ordered		2,639			2,193			20	%
Average sales price		$	334.0		$	269.9		24	%
Texas
Dollars		$	212,601		$	199,857		6	%
Homes ordered		973			947			3	%
Average sales price		$	218.5		$	211.0		4	%
Arizona
Dollars		$	272,849		$	208,388		31	%
Homes ordered		925			807			15	%
Average sales price		$	295.0		$	258.2		14	%
California
Dollars		$	288,206		$	159,831		80	%
Homes ordered		474			365			30	%
Average sales price		$	608.0		$	437.9		39	%
Nevada
Dollars		$	46,856		$	23,923		96	%
Homes ordered		129			74			74	%
Average sales price		$	363.2		$	323.3		12	%
Florida
Dollars		$	60,834		$	n/a		n/a
Homes ordered		138			n/a			n/a
Average sales price		$	440.8		$	n/a		n/a

 

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