Meritage Homes - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2005

or

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

Commission File Number 1-9977

MERITAGE HOMES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

(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

Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o       No ý

Common shares outstanding as of November 1, 2005:  27,353,506.

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

See supplemental disclosures of cash flow information at Note 10.

See accompanying notes to condensed consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005 AND 2004

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

                Organization.  We are a leading designer and builder of single-family homes in the rapidly growing Western and Southern states of Texas, Arizona, California, Nevada, Colorado and Florida.  We focus on providing a broad range of first-time, move-up, luxury and active adult homes to our targeted customer base.

                We operate in Texas as Legacy Homes, Monterey Homes, Meritage Homes and Hammonds Homes; in Arizona as Meritage Homes and Monterey Homes; in Florida as Meritage Homes, Colonial Homes and Greater Homes and in Northern California, Nevada and Colorado as Meritage Homes.  At September 30, 2005, we were actively selling homes in 174 communities, with base prices ranging from $102,000 to $1,000,000.

                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 (collectively, the “Company”). Intercompany balances and transactions have been eliminated in consolidation and certain previously reported amounts have been reclassified to be consistent with current financial statement presentation.  In our consolidated statement of cash flows for the nine months ended September 30, 2005, we changed the classification of distributions of income from unconsolidated entities to present such changes as an operating activity.  We previously presented such changes as an investing activity.  In the accompanying consolidated statements of cash flows for the nine months ended September 30, 2004, this reclassification resulted in a $7.6 million increase to operating cash flows and a corresponding decrease to investing cash flows from the amounts previously reported.  In our opinion, these unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly our financial position, results of operations and cash flows for the periods presented.  The results of operations for any interim period are not necessarily indicative of results to be expected for a full fiscal year or for any future periods.  These financial statements should be read in conjunction with our audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2004.

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

                Stock-Based Compensation.  At September 30, 2005, we had a stock-based employee compensation plan under which officers, key employees, non-employee directors and consultants may be granted options to purchase shares of our common stock.  We currently apply the intrinsic value-based method of accounting prescribed in Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees,” as allowed by SFAS No. 123 “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.”  Under this method, compensation expense is recorded on the date of the grant only if the market price of the underlying stock on the date of the grant is greater than the exercise price.  SFAS No. 123 established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans, which we have adopted.  We have not issued options with exercise prices below the market value on the date of the grant; therefore, no compensation expense for our stock-based plan has been recognized.  Had compensation cost for this plan been determined pursuant to SFAS No. 123, our net earnings and earnings per common share would have been reduced to the following pro forma amounts.  For the purpose of this disclosure, the value of the options is estimated by applying a Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.

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

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

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

                We have generally granted options only to employees and non-employee directors.  To date, the amount of compensation expense recorded in connection 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 September 30, 2005, we had not purchased any shares under this program.  No date for completing the program has been determined, but we may purchase shares subject to applicable securities law, and at times and in amounts as management deems appropriate.  In November 2005, we repurchased 85,000 shares at an average price of $61.87.

                Off-Balance Sheet Arrangements.  We often acquire finished homesites at market prices from various development entities under fixed price purchase agreements.  We consider this lot acquisition strategy, which reduces the financial requirements and risks associated with direct land ownership and land development, an important aspect of our business model.  We are subject to customary obligations associated with these purchase agreements, which typically require us to make deposits in the form of cash or letters of credit that may be forfeited if we fail to perform under the agreement.  Often, we contract to complete a project at a fixed cost on behalf of the development entity and are at risk for items over budget related to land development on property we have under contract.  As of September 30, 2005, we had entered into purchase agreements with purchase prices aggregating approximately $2.6 billion, by making deposits of approximately $174.8 million in the form of cash, most of which is non-refundable, and approximately $67.1 million in letters of credit.

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                Occasionally, we enter into land development joint ventures.  We and/or our joint venture partners occasionally provide limited repayment guarantees on debt of certain unconsolidated entities on a pro rata share basis.  As of September 30, 2005, we had limited repayment guarantees of approximately $31.2 million.

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

                Additionally, we and our joint venture partners sometimes agree 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 September 30, 2005, we had approximately $26.4 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 in the future.

                We also obtain letters of credit and performance, maintenance and other bonds in support of our related obligations with respect to the development of our projects.  The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities.  In the event the letters of credit or bonds are drawn upon, we would be obligated to reimburse the issuer of the letter of credit or bond.  At September 30, 2005, we had approximately $14.0 million in outstanding letters of credit and $201.2 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.  As is customary in the homebuilding industry, we have obligations related to post-construction warranties and defect claims for homes closed.  We have established reserves for these obligations 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):

                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

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

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

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

(3)          Deposits are refundable at our sole discretion.

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

NOTE 4 — INVESTMENTS IN UNCONSOLIDATED ENTITIES

                We participate in homebuilding and land development joint ventures from time to time as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base.  We had equity investments of 50% or less and did not have controlling financial interests in these unconsolidated entities at September 30, 2005.  Our joint venture partners generally are other homebuilders, land sellers or other real estate investors.  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.

                For homebuilding and land development joint ventures, we, and in some cases our joint venture partners, usually receive an option or other similar arrangement to purchase portions of the land held by the unconsolidated joint ventures.  Option prices are generally negotiated prices that approximate market value when we enter into the option contract.  Our share of the joint venture earnings is deferred until homes are ultimately 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 (in thousands):

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*            Our share of net earnings includes any applicable management fees but excludes earnings related to properties acquired by us.

              At September 30, 2005 and December 31, 2004, our investments in unconsolidated entities includes $1.2 million and $2.9 million, respectively, related to the difference between the amounts at which our investments are carried and the amount of underlying equity in net assets.  These amounts are amortized to equity of earnings of unconsolidated entities over the lives of the respective joint ventures, which offsets their related earnings.  During the three months ended September 30, 2005, no amortization was recorded as no earnings activities related to these joint ventures took place during the period. Amortization was $1.1 million for the nine months ended September 30, 2005.  There was no amortization recorded in 2004.

              In addition to joint ventures accounted for under the equity method summarized in the above table, at September 30, 2005, and December 31, 2004, our investments in unconsolidated entities included joint ventures recorded under the cost method.  These joint ventures were formed to obtain large parcels of land, to perform off-site development work and to sell lots to the joint venture members.  As of September 30, 2005, and December 31, 2004, our investments in unconsolidated entities recorded under the cost method were $14.6 and $7.2 million, respectively. As of September 30, 2005, we have not recorded any income or distributions from these joint ventures.

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                During the first quarter of 2005, we used the proceeds from the issuance of the 6.25% senior notes to repurchase pursuant to a tender offer and consent solicitation approximately $276.8 million of our outstanding 9.75% senior notes due 2011 and to pay down our bank credit facility.  The balance of these notes outstanding at December 31, 2004 was $286.9 million, including $6.9 million of unamortized premium.  In connection with this tender offer and repurchase, we recorded a one-time pre-tax charge of approximately $31.3 million for premiums, commissions and expenses associated with the tender offer and the write-off of existing offering costs associated with the 9.75% senior notes, net of the accretion of existing note premiums on the 9.75% senior notes and taxes.  During the second quarter of 2005, we subsequently repurchased $2.0 million of our outstanding 9.75% senior notes and incurred a pre-tax charge of $0.2 million for premiums, commissions and expenses.  Approximately $1.2 million in aggregate principal amount of the 9.75% senior notes remained outstanding at September 30, 2005.

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

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

NOTE 7 — ACQUISITIONS, GOODWILL AND INTANGIBLES

                Greater Homes Acquisition.  In September 2005 we purchased all of the outstanding stock of Greater Homes, Inc. (“Greater Homes”), a builder of single-family and vacation homes in Orlando, Florida.  The purchase price was approximately $86.2 million in cash, including the repayment of existing debt of approximately $27.7 million.  The results of Greater Homes’ operations have been included in our financial statements since September 1, 2005, the effective date of the acquisition.  We also assumed accounts payable, accrued liabilities and home sale deposits of approximately $15.9 million.  In addition, we agreed to a bonus pay-out for certain key Greater Homes employees, which is contingent upon their fulfillment of certain employment obligations.  The bonus pay-out is equal to 20% of the pre-tax profits of Greater Homes, less a capital charge, payable in cash over three years, with the total payments restricted to a maximum of $16.0 million.  Assets and liabilities were recorded at their estimated fair market value at the date of acquisition, and are subject to change when the Company finalizes its analysis.

                 Colonial Homes Acquisition.  In February 2005, we purchased the homebuilding and related assets of Colonial Homes of Florida (“Colonial Homes”), which operates primarily in the Ft. Myers/Naples area.  The purchase price was approximately $66.2 million in cash.   The results of Colonial Homes’ 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 acquisitions of Colonial Homes and Greater Homes were recorded using the purchase method of accounting.  The purchase price for each was allocated based on estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition.  The excess purchase price over the

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

NOTE 10 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

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

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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 of historical fact are within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements may include, but are not limited to, statements concerning 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 operations and growth strategy; the impact of new accounting standards; the likelihood that performance or surety bonds will be called; the sufficiency of our warranty reserves and our ability to continue positive operative results in light of current economic and political conditions, as well as assumptions related to the foregoing.

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

Overview

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

              Total home closing revenue was $753.5 million for the three months ended September 30, 2005, increasing $290.8 million, or 63% from $462.7 million for the same period last year.  Net earnings for the third quarter of 2005 increased $34.7 million, or 97%, to $70.3 million from $35.6 million in the same quarter of 2004.

              These results reflect our very strong first nine months of 2005. Through September 30, 2005, we benefited in most of our markets from strong order demand and strong pricing power, which resulted in record orders, closings and backlog. Our ability to obtain price increases, which have exceeded increases in land and construction costs, resulted in our gross margin for the first nine months of fiscal 2005, increasing to 23.01% from 19.49% in the comparable period a year ago.

              At September 30, 2005, we had a record backlog of 7,536 homes with a value of approximately $2.5 billion. This backlog gives us good visibility into our anticipated results over the next few quarters. The homebuilding industry as a whole has generally benefited over the last few years from strong demand and strong pricing power. Because of the extended time period required to construct homes, i.e., from the contracting of raw land through the entitlement process to the construction of homes, strong pricing power has a favorable impact on homebuilders’ gross margins because the underlying land (a significant component of the cost of a home) was contracted for several years earlier in a lower price environment. Thus, we believe, based on our significant backlog, that in the near term we will be able to continue to achieve strong gross margins, unless we experience an unusually high number of order cancellations or construction costs increase significantly. In the mid- to longer-term, however, a slowing or decline in home sales prices could have an adverse effect on our gross margins because the land relating to homes sold in the longer term future will generally have been contracted for in a comparatively higher price environment. In addition, our gross margins could be adversely impacted if home price increases do not keep pace with construction cost increases.

              We increased the dollar value of home orders in the third quarter by 51% to $971 million, and for the first nine months of fiscal 2005 we increased the dollar value of home orders by 48% to $2.9 billion. We are aware of investor concerns about demand trends. Overall, our sales orders in 2005 have been strong and we believe that most of our markets continue to be strong. We have noticed a slowdown in October 2005 in our Northern California market with respect to orders and sales prices and an increase in the number of cancellations and it is our expectation that price appreciation in some of our other more robust markets will moderate. Nevertheless, we remain optimistic about the future and we continue to believe that we are offering the right product at the right price and in the right locations.

Critical Accounting Policies

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

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*         The number and dollar amount of homes closed include the effect of the Colonial Homes and Greater Homes acquisitions in February and September 2005, respectively.

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